Is it Correct for Successive Governments to Manipulate the Personal Taxation System for Economic Purposes - Research Paper Example

Is it Correct for Successive Governments to Manipulate the Personal Taxation System for Economic Purposes? Introduction: The main source of revenue for the government is through various taxes. Such as income tax, corporate taxes, VAT, national insurance contribution etc. The Government can manipulate the personal taxation system for the economic growth of the country. “Income tax is a tax levied on the financial income of persons, corporations, or other legal entities. Various income tax systems exist, with varying degrees of tax incidence. Income taxation can be progressive, proportional, or regressive. When the tax is levied on the income of companies, it is often called a corporate tax, corporate income tax, or profit tax. Individual income taxes often tax the total income of the individual (with some deductions permitted), while corporate income taxes often tax net income (the difference between gross receipts, expenses, and additional write-offs)” (Balachandran 2010, p. 146). Taxation in UK may involve payments of two different layers of government, the National Government and the Regional Government. The central government taxes include revenues and Customs. The central Government revenue comes primarily from Income Tax, National Insurance, Contribution of VAT, Corporate Taxes and Fuel Duty. The income tax forms the single largest source of revenue collected by the government. In UK, each person has a taxable income and personal allowance up to a certain amount, free for everyone. . The success of personal taxation system depends upon the principles of taxation procedure. Taxable income is in different ways - depends on income and employment status. “These include PAYE (Pay As You Earn), self assessment, tax deducted at source, and one off payments” (Ways You Pay Income Tax n.d.). Analysis of Personal Taxation System in UK: There are four important canons of taxation. They are economic principles, it includes the cost effectiveness and how should cost less to collect the taxes than the revenues. A system of tax in UK is reflected the communal values and power. To create a taxation system, a nation makes the choice of distribution for the tax that will pay the taxes and how much amount will pay for the tax. And the government can decide how will spent the collected taxes. The government collects taxes in a cost effective manner. The efficient systems of tax should be raise the revenue and the government can be sponsored revenue for those government projects, the tax payer without burden too much, becoming the investment for the work. Another important canons of taxation is to the taxation policy is equitable, that means understandable. The equity of taxation must be vertical or horizontal. The equity is minimizing the cost. The certainty of taxation is governed by the ability to pay the people’s, that is firms or individuals with the income is high will pay more taxes and the lower income groups should pay less the tax amount. The fourth canons of taxation are convenience that is the ease and simplicity of tax payments. The UK Government provides publicity of taxation system. The main source of revenues is comes from the tax collection, the government can simplify the tax payment systems. According to Richard Blundell (Institute for Fiscal Studies). “Around 75% of the VAT reduction will be passed on to consumers and that consumers will react by maintaining their expenditures levels and therefore increasing their demand for consumption goods” (Blundell n.d., p. 2). The paper surveys the tax system in UK. It explains how it functions, and who observes how is implemented now, with reference to the last 30 years. “In Section 2, it is with a brief assessment of the total amount of revenue raised by UK taxation, and the contribution made by each tax to this total. Section 3, describes the structure of each of the main taxes: income tax; National Insurance contributions; value added tax and other indirect taxes; capital taxes such as capital gains tax and inheritance tax; corporation tax; taxes on North Sea production; the bank levy; council tax; and business rates “In Section 4, we set the current system in the context of reforms that have taken place over the last 30 years or so. The section examines the changing structure of income tax and national insurance contributions, and developments in the taxation of savings; indirect taxes, taxes on companies, and local taxation” (Adam & Browne 2011, p. 3). The Systems of Tax: 1. Income Tax: The Tax Base: “The basic state pension is taxable, but some child benefit schemes are not. Gifts to registered charities are a deductible item from income tax, as pension contributes up to an annual and a lifetime limit to employer and employee. “For each 1 per cent reduction in prices that is caused by the policy change, consumption is assumed to increase by half a per cent; and the described mechanism through which this change operates is an income effect whereby the reduction in the price level increases the value of resources today and this extra value can be shared between consumption today and future consumption (saving)” (Crossley et al. 2009, p. 1). Bands, Allowances and Rates: The system of income tax operates through allowances and bands of income. The personal allowance of each individual is deducted from the sum of income before tax, to give income tax. “Taxpayers under 65 receive a personal allowance of £7,475; while older people are entitled to higher personal allowances (see Table 1). In the past, married couples were also entitled to a married couple’s allowance (MCA). This was abolished in April 2000, except for those already aged 65 or over a particular date (i.e. born before April 1935). UK Tax Rates 2008-‘09  Income Tax Rates                            2008 - 09 Basic  tax rate (was £36,000 updated by Chancellor) 20%   0 - 34,800 Higher tax rate (was £36,000 updated by Chancellor) 40%   Over 34,800     Income Tax Allowances  (£) Personal allowance (was £5,435 updated by Chancellor) 6,035 Personal allowance for people aged 65-74 9,030 Personal allowance for people aged 75 and over 9,180 Income limit for age-related allowances 21,800 Married couples allowance - aged 75 or more 6,625 Minimum amount of married couples allowance 2,540 Blind persons allowance 1,800  (UK Tax Rates 2008-9 2004). Payments System: “The Pay-As-You-Earn (PAYE) system of withholding income tax involves the exact cumulative deduction: that is, when calculating tax due each week or month, the employer considers income not simply for the period in question, but for the whole of the tax year to date. Tax due on total cumulative income is calculated, and tax paid thus far is deducted, giving a figure for tax due this week or month. The cumulative system means that, at the end of the tax year, the correct amount of tax should have been deducted – at least for those with relatively simple affairs – whereas under a non-cumulative system (in which only income in the current week or month is considered), an end-of-year adjustment might be necessary. About 90% of income tax revenue is collected through PAYE” (Adam & Browne 2011, p. 8). National Insurance Contributions: The contributions of national insurance act like as earnings on tax, and the payment of national insurance entitles individuals to certain benefits of social security. However, any individual contributor has to bear little relation to each other, for the benefits received and contributions paid, and for the link that has weakened over time. “The NI Fund is notionally used to finance contributory benefits, but in years when the fund was not sufficient to finance benefits, it was topped up from general taxation revenues, and in years when contributions substantially exceed outlays, the fund builds up a surplus, largely investment in gilts: the government is simply lending itself money” (Adam & Browne 2011, p. 13). The government could equally well declare that a quarter of NICs revenue goes towards financing defense expenditure that and no-one would notice the difference. Excise Duties: Excise duties are charged on three important items: liquor, cigarettes and petroleum products.  The units per pint, per packet, per litre etc., the tax are levied at a flat rate; the items of tobacco are subject to an additional payment tax of 16.5% of the retail price including VAT and the flat-rate duty itself. The flat-rate duties are expressed in terms of cash. They must be increased in rate with inflation every year, for the maintained of their original value. Income Taxes (Personal): Income tax and national insurance contributions are the two principal personal income taxes in the UK. Since 1965, the capital gains tax has been separated from income tax, which can also be considered as personal income on tax. The contribution of personal income tax revenue   compared with national insurance and income tax is very little. Income Tax Structure: The income tax structure is based on the income of individuals. “The most dramatic change to income tax has been the reform of the rate structure (see table 3). In 1978–79, there was a starting rate of 25%, a basic rate of 33% and higher rates ranging from 40% to 83%. In addition, an investment income surcharge of 15% was applied to those with very high investment income, resulting in a maximum income tax rate of 98%. In its first budget, in 1979, the Conservative government reduced the basic rate of income tax to 30% and the top rate on earnings to 60%. In 1988, the top rate of tax was cut to 40% and the basic rate to 25%, producing a very simple regime with three effective rates – zero up to the tax allowance, 25% over a range that covered almost 95% of taxpayers and 40% for a small group of those with high incomes” (Adam & Browne 2011, p. 36).  The tax rate structure was introduced at a starting rate of 20% of tax in 1992 in UK pre-election budget. The budget proposed to cut the rate to 10% in 1999 for the promise made by the Labour Party in pre-election time. The UK Budget 2007 announced the tax starting rate from 2008–09 to pay for a cut in the basic rate, the savings of income; the decision though as a simplification to keep the starting rate.  Table 3: Income tax rates on earned income, 1978–79 to 2009-2010 Year Starting Rate                        Basic Rate                          Higher Rate 1978–79 1979–80 1980–81 to 1985–86 1986–87 1987–88 1988–89 to 1991–92 1992–93 to 1995–96 1996–97 1997–98 to 1998–99 1999–2000 2000–01 to 2007–08 2008–09 to 2009–10       25                                        30                                     40-83       25                                        30                                     40-60                                       30                                     40-60                                       29                                     40-60                                       27                                     40-60                                       25                                       40       20                                        25                                       40       20                                        24                                       40       20                                        23                                       40       10                                        23                                       40       10                                        22                                       40                                       20                                        40 (Adam & Browne 2011, p. 37).  The basic tax rate limit was reduced to eliminate the gain from the growing personal allowance, for the high-rate taxpayers. The increased rate of personal allowance is only for those under the age of 65 and the allowances increase for those aged 65 and over. This tax rate was announced in UK Budget 2007. Corporate Tax: The profits made by the companies in UK must pay the Corporate Tax. The companies have profits of from permanent establishments of non- residents in UK companies and the associations that trade in the European Union. “Corporation tax forms the fourth-largest source of government revenue (after income, NIC, and VAT). Prior to the taxs enactment on 1 April 1965, companies and individuals paid the same income tax, with an additional profits tax levied on companies. The Finance Act of 1965  replaced this structure for companies and associations, with a single corporate tax, which borrowed its basic structure and rules from the income tax system. Since 1997, the UKs Tax Law Rewrite Project has been modernizing the UKs tax legislation, starting with income tax, while the legislation imposing corporation tax has itself been amended; the rules governing income tax and corporation tax have thus diverged” (Britain Tax Policy 2011). Capital Gains Tax: “Capital gains are subject to tax at 18 or 28% (for individuals) or at the applicable marginal rate of corporation tax. The basic principle is the same for individuals and companies - the tax applies only on the disposal of a capital asset, and the amount of the gain is calculated as the difference between the disposal proceeds and the "base cost", being the original purchase price plus allowable, related expenditure. Companies apply "indexation relief" to the base cost, increasing it in accordance with the Retail Prices Index so that the gain is calculated on a post-inflation basis. The gain is then subject to tax at the applicable marginal rate of corporation tax” (Britain Tax Policy 2011).  Value Added Tax: “Value-added tax (VAT) is a form of consumption tax. From the perspective of the buyer, it is a tax on the purchase price. From that of the seller, it is a tax only on the "value added" to a product, material or service, from an accounting point of view, by this stage of its manufacture or distribution” (What is VAT (Value Added Tax? 2012). In the view of Richard Blundell, the UK government likely to cut the VAT rate for the consumer demand. Around 75% of the reduction in VAT rate will be passed on the consumers. The VAT rate reduction will maintaining their level of expenditure and increasing the demand for consumption of goods, especially the demand for durable consumer goods. In UK the VAT cut stimulus policy that was announced in 24th November 2008, effects came in December 1st 2008. In the vat cut stimulus policy regarding the 3 important questions. They are, 1. The Pass Through to Consumer Prices: The VAT cut in UK covers those the commodity with full vat rate around 51 percentage of consumer expenditure. The government has reduced the vat rate from 17.5 percentages to 15 percentages for the period of 13 months. The vat rate reduction is very help for the consumers its included food not consumed in restaurants, children’s clothing’s and footwear, and domestic heating. Other remaining goods are subject to cut, are the mix of other goods and services around one third in the category of durable goods. In the economic theory suggest that the vat rate change fully passed to the retail prices. The product market competition producing the different degrees of magnitude, it largely depends on the competition in the various goods market. For the majority of commodities will cover the full rate VAT in UK. The vat rate changes especially would seen the economic recession, the competitive pressure on high street are greater 2. Will Consumers Spend More: The vat rate change is passed through the consumer prices, then how much the consumer will spend. The vat rate is passed through the retail prices, the consumer will react this phenomenon, there are two important potential effects is need to be assessed they are the income of the consumer and the buying capacity. The lower prices make purchases more attractive, and the same direction to increase the consumer demand. In current situation the consumer may look forward, the gain of income will be offset for the future years. The vat rate cut the income effect will be high. The customer may wish to spend all the additional income. It is the reasonable to expect most of the real income gained will lead to increase the demand for the commodities, and the price is fallen. The largest gain from vat cut in UK will be for the middle to higher income households. This will helpful for the consumers for buying the product at constant rates, the consumer will spend more. 3. Will the Depth of the Recession itself Change the Impact of the Stimulus: The vat cut rate is effect the recession, the size of the recession is significant to the size on impact. The impact is mainly affecting the family earnings and income. In the recession there are two candidates first one, growth in uncertainty, the second one in credit problem in families. The period or recession to increase the uncertainty. The growth of income uncertainty will reduce the level of consumption. The reason of uncertainty will play the key role in the impact of stimulus policy, due to the importance of durable commodities. In the absence of uncertainty the durability of consumption of goods being purchased. The large consumer will response the temporary vat cut in full rate, especially durable and semi-durable goods. It means that the consumer effectively locked in the consumption flow one the durable is purchased. The consumer may choose to reduce the debt rather than increase their demand for consumption of goods. The overall impact of VAT cut change, the consumer demand provided the temporary vat cut, it is less in recession than the better economy, the uncertainty is less, and there is less concern about the debt level of consumers. The vat stimulus the two-third expenditures covered by non durables. The expenditure level maintained in the level of fall in prices. The vat rate change passed through the consumers to raise the level of goods purchasing. The consumer demand will rise in proportion to the fall in prices. The vat rat passes on rate around 75 percent. The vat cut has the potential to be very successful for the short run stimulus. VAT Rate Reduction in United Kingdom: For a year, from 2008 December 1 to 2009 December 31, the standard VAT rate in UK is reduced. The change of the rate from 17.5% to 15% again reverts back to the older rate in the year 2010. But this rate reduction has not made any impact on the food stuffs or in children’s clothing (i.e. zero based goods) or in the supplies of power and domestic fuel. Anti-forestalling measures are taken to prevent the companies from taking the gain from VAT rate hike, in the 2009 Finance Bill by way of advance payment. As a result of these changes, the businesses began to face the issues in implementation of new rate, including the issue in dealing with credit notes and goods and services (whose payment has already received) that had to be delivered after 1 December. “Evidence from the National Institutes Global Economic Model suggests that the impact of the recent VAT reduction is likely to build up during the course of 2009. The reduction in VAT from 17½ per cent to 15 per cent is likely to result in consumption being augmented by less than 1 per cent by the fourth quarter of 2009. However, GDP is likely to be raised by less than half a per cent relative to what would have happened without the VAT increase. After the temporary reduction is over, both consumption and GDP are depressed as a result of the policy” (Barrel & Weale 2009). Retailers will re-price their goods, if they can pass on the change in rate, to the consumers. Discounting measures are also adopting by the businesses along with this, in order to stimulate the trade in economic recession. Businesses have to consider the timing of purchases, especially of capital purchases, because the VAT on the cost cannot be recovered fully. The impacts of VAT on ordinary consumers were less significant, because the average income family group can also save average amount of £200/year. Effect of Temporary VAT Reduction on Consumers in UK: There are mainly three effects or impact which is expected to have on consumers due to the reduction in VAT rate. They are: 1. Income effect- in which the consumers will get the advantage of temporary decrease in the cost of living. The consumers will not be much sensitive towards the fluctuations  in  their income for a short term because many of them will add or will draw down the asset’s stock to smoothen their consumption (vice versa in the case of debt too, they will add or repay it) 2) Arbitrage effect- this will arise when the consumers began to buy, but are not consuming non-perishable goods by the announcement of the rate increase in next year. 3) Substitution effect- In which before the increase in the rate, consumer will began to consume the substitute products. The Effect of Temporary VAT Reduction on Consumer Prices: The effect of VAT, even though it is for a temporary period, the impact will depends on how the business will pass the changes to the consumers. If it is not passed properly, the income effect will get delayed and it will reflect in profits rather than real wages. In 2008 December, the RPI (Retail Price Index) had fallen by 0.48% after a small reduction in the percentage in November. The increase in household distribution will not proceed with the gradual increase in the tax rate to finance the reduction in the VAT. Consumer Price Index in UK 2008-2009: Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Annual 2009 108.7 109.6 109.8 110.1 110.7 111 110.9 111.4 111.5 111.7 112 112.6 110.833 2008 105.5 106.3 106.7 107.6 108.3 109 109 109.7 110.3 110 109.9 109.5 108.483   (UK – Consumer Price Index (CPI) 2012). Changes in Consumption in Response to the UK VAT Rate Reduction: The consumer responses aren’t immutable and the effect of cut in VAT relies on the ratio of consumers who are constrained of liquidity. The surveys reveal that there is not much change in the consumption pattern of the consumers during the first half of the Vat cut. But it began to rise during the last quarter of the year 2009. In the situation of financial crisis, more peoples have been facing the credit constraints and their pattern of consumption is also different. But the situation has changed with a hike in the last quarter of 2009. Conclusion: In UK, the local taxes department comprises internal rates on house property and commercial rates on business holdings. In the1990’s, the rates of personal taxes were changed dramatically. when the rate of business property were taken from local to national control, and the residential property rates were replaced by community charge or  poll tax, and individuals levied on  flat-rate. The tax payment was based on the fact that an individual lived at a particular place in a local authority, rather than occupying on the individual’s ability to pay the value of the property In UK, the tax department has centralized the business rates.  After the Budget of 2007 the central government is largely financed by the local services. The centralization of tax rates increased the revenue of government, raised locally to 5% of tax revenue. The main source of revenue depends upon the taxation system; they are income tax revenue, contribution of national insurance, contribution of value added tax, corporate tax and certain indirect taxes, excise duty and capital gain tax. The government has successfully used the tax systems. “Despite clear attempts to reform various aspects of the UK tax system over the last 30 years, with varying degrees of success, there remain many areas still in need of attention. This briefing note has set out the features of the current UK tax system, described the major changes in those features over time and highlighted some of the areas potentially in need of a reformer’s beady eye” (Adam & Browne 2011, p. 57). The successive government can manipulate the personal taxation for economic purposes. The main income for the government is through various types of taxes. There no particular source for the government for increasing the revenue so, it is correct. Reference List Adam, S & Browne, J 2011. A Survey of UK Tax System. The Institute for Fiscal Studies. Available at [Accessed on 07 March 2012]   Balachandran, G 2010. Methodology and Perspectives of Business Studies. Ane’s Books Pvt. Ltd. Print. Barrel, R & Weale, M 2009. The Economics of a Reduction in VAT. Wiley. [Online] Available at [Accessed on 07 March 2012] Blundell, R n.d. Fiscal Studies Symposium on the Economics of VAT Cuts. Institute for Fiscal Studies. Available at [Accessed on 07 March 2012] Britain Tax Policy. 2011. Information Business Brain Base. [Online] Available at [Accessed on 07 March 2012] Crossley et al. 2009. The Economics of a Temporary VAT Cut. Institute for Fiscal Studies. Available at [Accessed on 07 March 2012] Tax and Benefit Tables. n.d. Institute for Fiscal Studies. [Online] Available at [Accessed on 07 March 2012] UK Tax Rates 2008-9. 2004. Scopulus Limited. [Online] Available at [Accessed on 07 March 2012] UK – Consumer Price Index (CPI). 2012. Rate Inflation. [Online] Available at [Accessed on 07 March 2012] Ways You Pay Income Tax. n.d. H M Revenue & Customs. [Online] Available at [Accessed on 07 March 2012] What is VAT (Value Added Tax)? 2012. TaxPur.com. [Online] Available at [Accessed on 07 March 2012]   Read More