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Essay on Taxation and Economics
Finance & Accounting
Pages 8 (2008 words)
“Economics” Module Semester a) i) There are two types of tax systems that work simultaneously in an economy. These two systems are called direct and indirect taxation. Both of these systems have different effects on the economy in terms of an incentive or disincentive.
Direct taxes cannot be avoided. Anything that is earned will have to be given to the national exchequer. Indirect taxation can be avoided by reducing the spending. Indirect taxation leads to substitution effects. Since people know that their effort will earn less than the actual amount they were getting before the tax is levied, they will think that leisure has become cheaper for them now. For example, if a consumer was earning $10 and no tax was being levied on his salary, then any leisure hour was costing him $10. Now after a 10% tax is levied on his salary, each leisure hour is costing him only $9. Hence, leisure has become cheaper for him. This will lead to the substitution effect as people would substitute labor for leisure. Direct taxation can be a disincentive to work and would leads to more people choosing leisure over labor. Similarly, when the tax is reduced, leisure hour becomes expensive and more people try to substitute leisure for work. Hence, tax reduction helps in motivating people to expend more effort to their work. (Brue & McConnell 2006) Indirect taxation leads to income effect. Income effect occurs when people find that they have surplus money and therefore their demand for goods and services increase. In case of no tax levied people after earning certain amount of income will start preferring leisure over work. ...
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