Taxes Levied on Taxpayers by the U.K. Government - Essay Example

Taxation in the UK Introduction Practically every government in the modern world levies some kind of tax on individuals or organizations. Economistsdefine tax as any financial charge or levy that an individual or legal entity pays to the state failure to which they may be punished in accordance with the law (Avi-Yonah, R & Slemrod 2002, p. 1396). In many jurisdictions, the revenues that the state or government collects in the form of tax is used to run government, enforce law and order, create infrastructure, protect property, provide subsidies, pay state debts, and provide social welfare services, just to name a few. The United Kingdom is one country that levies direct and indirect taxes on its subjects. Taxpayers in the U.K. pay taxes to the central and local governments. The U.K. fiscal policy that applies in the U.K. has been subject to change over the years in response to prevailing socio-political and economic conditions of the county. This paper will discuss taxation in the U.K. and will highlight some of the effects that cuts in direct taxes have had on U.K. nationals, businesses and the economy. Taxes Levied on Taxpayers by the U.K. Government In the U.K., the central government earns part of its revenue from taxes. The main taxes in this respect include income tax; value added tax (VAT); national insurance contributions; fuel levy; not to mention corporate tax. Taxes that the local governments of the U.K. levy on nationals and organizations include council tax, business rates, and on-street parking fees. Statistics indicate that income tax is the largest source of revenue for the U.K. government, accounting for about 30 percent of the total revenue (U.K. Government n.d.). Second to income tax in terms of contribution to U.K. government revenue is national insurance contributions according to statistics (U.K. Government n.d.). Many of the taxes that taxpayers have to pay to the U.K. government are commensurate with their income. For example, an individual’s income tax gets higher with the amount of income they get, holding other factors constant. The income that an individual gets is taxed depending on the band in which their income falls. This serves to reduce inequalities between those who earn much and those who earn less. This measure also ensures that those who earn more contribute more toward the social welfare of those who earn less. How the Government Spends Tax Revenues As previously noted, the tax revenues that any government earns is often put into different uses. Generally, one of the reasons government spends money is to reduce the inequalities that exist within the country. The U.K. government is keen on reducing the level of poverty in the country and has taken to providing different social welfare services dedicated to improving personal wellbeing (Pettinger 2013). For example, the government provides unemployment benefits to citizens who have met certain thresholds and yet are yet unemployed. The government also contributes to the social welfare of its citizens by providing those who qualify with income support. In 2013 alone, the U.K. government dedicates roughly £117bn on unemployment benefits, income support and other social welfare services (Pettinger 2013). The Her Majesty’s government also spends on people who have formally retired from work by giving them pension. In total, the government spent in excess of 138 billion Euros on pension. Generally, the U.K. government spends almost 25% of its revenues on social security. In this respect, it spends greatly on such areas as unemployment, child support, housing benefit, and pensions (Pettinger 2013). Closely related to reducing inequality is education. Many studies have shown that the level of poverty in a place has a correlation with the general level of education of the population of the place. Governments throughout the world, therefore, are keen on investing not only in public services like education and health. The U.K. government has been spending substantial amounts of resources on education and health. In 2013 alone, for example, the U.K. government spent about 97.2 billion Euros on education, and about 126 billion Euros on health (Pettinger 2013). Many economists agree that security is an important factor in the growth of an economy. In appreciation of this fact, many a country invests in such areas as national security, police, and fire services which together constitute public goods. According to Pettinger (2013), the U.K. government spent about 32 billion Euros on protection, which accounts for about 5% of government spending. Closely related to national security is national defense. Countries all over the world strive to secure their sovereignty and therefore have to heavily invest in their military. By investing in their military, different nations hope that they will have the capacity to deal with external threats or are able to provide military aid to their allies in case of war or aggression. Like every other nation, the U.K. government money sourced from taxes to purchase military equipment, train military personnel, pay military officers, and pay for other bills that are related to national deference. Statistics indicate that in 2013 alone, the UK government spent about 46.4 billion Euros on defence, which accounts for about 7% of government spending (Pettinger 2013). Governments across the world sometimes rely on loans from different sources to fund their projects. They often borrow internally or externally whenever they are in need of more money to solve certain needs. This money more often than not has to be repaid with an interest. One way through which the government generates money to repay loans and accrued interest is by taxing nationals and legal entities. The U.K. government has in many cases borrowed from different quarters. In 2013, the U.K. government spent more than 45 billion Euros to pay interest on debts and about 1,159 billion to repay net debts (Pettinger 2013). There are several other areas that governments spend tax revenues on. Apart from those discussed above, the government spends on infrastructural development, civil services, and general government and administration, to name but a few. The U.K. government spent 17.9 billion Euros on general government, £18.5 billion Euros on Transport, and 48.6 billion Euros on sports, waste management, leisure, and other local government services (Pettinger 2013). It is not uncommon for governments to use taxes as a way of regulating their economies. By adopting different fiscal policies, governments can regulate aggregate demand and aggregate supply and, therefore, affect the rate of unemployment, regulate inflation, raise money for the repayment of debts, and stimulate economic growth. The government of the United Kingdom commonly applies taxes depending on fiscal policies that change in response to prevailing economic and socio-political situations. Between the 1950s to the 1970s, the U.K. government relied on tax policy heavily to regulate aggregate demand and, therefore, employment (Economics Online 2014). The U.K government tried to balance between inflation and unemployment by tightening or relaxing its tax policy as the situation demanded as noted by Economics Online (2014). When the government sought to lower the unemployment rate in the country, it lowered taxes or softened its fiscal policy. On the other hand, it tightened the fiscal policy and raised taxes to lower inflation. In 2009, the U.K. government opted to rely on taxation policy in addition to monetary policy in an attempt to stimulate the economy. At this time, the economy was experiencing a recession and government borrowing rose sharply as tax revenues dwindled. In a bid to raise aggregate demand (AD) and, therefore, stimulate economic recovery and growth, the government reduced VAT rate to 15% as noted by Pettinger (2014). Figure 1 presents the level of inflation in the UK between 1959 and 1981. Fig. 1: Level of inflation in the UK between 1959 and 1981 Courtesy of Deloitte Touche Tohmatsu Limited Effects of Tax Cuts on Individuals and Organizations Tax cuts involve the lowering of taxes rates. Tax cuts serve to increase the real income of tax payers. Experts have engaged in a lot of debate over whether tax cuts stimulate consumer spending (Avi-Yonah, R & Slemrod 2002, p. 1396). According to the Keynesian school of thought, changing the fiscal policy of a country has powerful effects on employment, output and demand if the economy is performing below its full capacity (Avi-Yonah, R & Slemrod 2002, p. 1396). On the other hand, monetarist economists hold the view that changes in tax rates and government spending only temporarily impact on employment, output, and aggregate demand. Some experts note that tax cuts go a long way in stimulating consumer spending and economic growth (Centre on Budget and Policy Priorities 2008). When tax rates are lower, the real income of tax payers increase which means that they have more money to spend on other things. In other words, tax cuts tend to raise aggregate demand. When the tax rate is raised, individuals tend to work less. Many experts agree that the higher the rate of tax, the more time people spend trying to evade taxes. This also means that the time they spend on productive activity will be reduced. In this respect, the less the tax rate, the higher the value of the products produced. This being the case, many economists are of the view that raising the tax rate does not necessarily translate to higher tax revenues (Centre on Budget and Policy Priorities 2008). This is because high tax rates discourage individuals and organizations from being more productive. When the tax rates are increased, companies tend to be conservative when employing as they have less to spend on more employees. This means that a high tax rate for companies translates to high levels of unemployment as was evident between 1974 and 1975 when the Labour party raised the tax rates significantly (Tomlinson 1990, p. 287). On the contrary, tax cuts stimulate firms toward seeking to produce more and demand more employees. This in effect translates to a lower level of unemployment in the country. Other positive effects associated with tax cuts include higher wages for employees; increased consumption and saving; higher labor productivity; lower prices of goods and services; and stronger research and development incentive. Figure 2 shows the unemployment rates in the UK between 1974 and 2004. Fig. 2: Unemployment rates in the UK between 1974 and 2004. Courtesy of econ.economicshelp.org The government is bound to benefit from tax cuts much as tax payers benefit from it according to some quarters. This is because lower tax rates encourage tax payers to produce more and remit their taxes faithfully (Centre on Budget and Policy Priorities 2008). If the government earns more revenue from taxes as a result of this, its capacity to invest in development projects, social security and payment of debt increases. While tax cuts are generally associated with many positive effects on companies, individuals, and the economy, some studies show that they can lead to greater inequalities as those who are rich tend to benefit more from tax cuts (Blodget 2012). According to Blodget (2012) tax cuts do not spur economic growth based on results of recent studies and could lead to higher inflation rates. Conclusion Governments rely on tax revenues to pay their debts, finance social security, develop the economy, and pay civil servant wages among other uses. The U.K. government has in many instants used fiscal policy to control the economy of the country. By changing tax rates, the U.K. government and indeed other governments have managed to regulate aggregate demand, output, and employment. Tax cuts are generally associated with higher wages for employees; increased consumption and saving; higher labor productivity; lower prices of goods and services. While this is commonly the case, some economists believe that tax cuts do not spur economic growth, and may lead to higher economic inequalities. References Pettinger T. 2013, ‘What does the government spend its money on?’, viewed 4 April, 2014 http://www.economicshelp.org/blog/142/economics/what-does-the-government-spend-its-money-on/ Blodget, H. 2012, ‘Bombshell: New Study Destroys Theory That Tax Cuts Spur Growth’, viewed 4 April, 2014 http://www.businessinsider.com/study-tax-cuts-dont-lead-to-growth-2012-9 Avi-Yonah, R & Slemrod, J. 2002, ‘Why Tax the Rich? Efficiency, Equity, and Progressive Taxation’, The Yale Law Journal 111 (6): 1391–1416. Centre on Budget and Policy Priorities 2008, ‘Tax Cuts: Myths and Realities’, viewed 4 April, 2014 http://www.cbpp.org/cms/?fa=view&id=692 Tomlinson, J. 1990, ‘Public Policy and the Economy since 1900’,p.285, from Leo Pliatzky (1984): Getting and Spending, 2nd ed., Oxford. Economics Online 2014, ‘Fiscal policy’, viewed 4 April, 2014 http://www.economicsonline.co.uk/Managing_the_economy/Fiscal_policy.html Pettinger, T. 2014, ‘UK Fiscal Policy’, viewed 4 April, 2014, viewed 4 April, 2014 http://www.economicshelp.org/macroeconomics/fiscal-policy/uk-fiscal-policy/ U.K. Government n.d., ‘A guide to U.K. Taxation’, viewed 4 April, 2014 https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/183408/A_guide_toUK_taxation.pdf Read More