Chapter 1: WHY DO WE NEED TO PAY TAXES?
Taxation is levied for a number of reasons. To raise revenue to finance spending on goods and
service by central & local government. The government when managing the level of AD output
and prices uses taxation. When demand is perceived as being too strong the government can
increase direct taxation, to reduce the level of real disposable income and household spending. A
progressive system of taxation can be utilised to achieve great equality in income & wealth
between individuals and households Taxes can correct for externalities and other forms of
market failure (such as monopoly)
Import taxes may control imports and therefore help the country's international balance of
payments and protect industries from overseas competition.
OBJECTIVES FOR THE TAX SYSTEM
•The Labour Government has identified six main objectives for its tax system - these are
•To keep the overall tax burden as low as possible
•To reduce tax rates on income to sharpen incentives to work and create wealth in the economy
•To maintain a broad tax base - having a range of taxes helps to keep each separate tax rate low
•To shift the balance of taxation away from taxes on income towards taxes on spending
•To ensure taxes are applied equally and fairly to everyone
•To use taxes to make markets work better (including the use of environmental taxes to make
both consumers and producers aware of external costs)
PROGRESSIVE REGRESSIVE AND PROPORTIONAL TAXES
Generally, indirect taxes are seen as regressive; the proportion of income paid in tax decreases as
Direct taxes are progressive because the proportion of income paid in tax increases as income
rises. With a progressive tax, the marginal rate of tax exceeds the average rate of tax. As a result,
progressive taxes act to reduce inequalities in the distribution of income. The post-tax
distribution of income will be less dispersed than the pre-tax distribution. With a proportional
tax, the proportion of income paid in tax remains constant as income changes. In this situation,
the marginal rate of tax will be equal to the average rate of tax. Any tax that does not vary with
income is called a lump sum tax. BALANCE OF PAYMENTS
The balance of payments provides us with important information about whether or not a country
is “paying its way” in the international economy.
What is the Balance of Payments?
The balance of payments (BOP) records all of the many financial transactions that are made
between consumers, businesses and the government in India with people across the rest of the
World. The BOP figures tell us about how much is being spent by Indian consumers and firms
on imported goods and services, and how successful Indian firms have been in exporting to other
countries and markets. It is an important measure of the relative performance of India in the
The balance of payments records financial transactions between Indian and the international
economy. The accounts are split into two sections with the current account measuring trade in
goods and services and net investment incomes and transfers whilst the capital account tracks
capital flows in and out of India. This includes portfolio capital flows (e.g. share transactions and
the buying and selling of Government debt) and direct capital flows arising from foreign
Why is the export sector of the economy vital for India?
•Aggregate demand and the multiplier: An increasing share of India’s national output is
exported overseas as the nation becomes ever more integrated into the global economy. Export
earnings are an injection of AD into the circular flow. If Indian companies can successfully sell
more goods and services overseas, the rise in exports boosts national income and should have a
positive multiplier effect on the national income, output and employment.
•Manufacturing industry: Export sales are particularly important for manufacturing industry
where exports are a high % of total production. Thousands of jobs depend directly on the
performance of the export sector and even more are affected in supply industries.
•Regional economic health: The relative success of failure of export industries is important for
certain regions of India. When