Advantages and Disadvantages of taxation Advantages (Direct) 1. 2. 3. 4. 5. 6.

Fair and equitable because they are usually progressive/proportional Can be levied according to ability to pay Tend to stabilize economy because of progressive nature They are difficult to pass on They tend to be less inflationary than direct taxes Tax payers know what their liability is

Disadvantages (Direct) 1. 2. 3. 4. 5. 6. Acts as a disincentive to work Can reduce ability to save and invest especially if high Can discourage geographical and occupational mobility of labour May encourage tax avoidance and tax evasion Can discourage foreign investment and encourage investment abroad It reduces the incentive to trade especially if tax is progressive

Advantages (Indirect) 1. 2. 3. 4. 5. Are generally more difficult to evade Does not have a distinctive effect on effort Indirect taxes leave an individual with a choice of not paying tax Hidden in a sense that the taxpayer is usually unaware of the tax he has paid Can be used to encourage or discourage the production and consumption of particular goods and services. 6. It is a flexible instrument of economic policy as they can be changed quickly and easily

Disadvantages (Indirect) 1. Can be inflationary 2. Tend to be more regressive hence make distribution of income more unequal 3. As people are unaware of how much they are paying it goes against the principle of transparency 4. Can reduce the demand for goods and services 5. They are not impartial in their implication

Objective 6: Evaluate the limitations of fiscal policy Lags and potency of fiscal policy

Limitations of fiscal policy Time lags Problems of forecasting the effect of a policy Problems of magnitude the unknown multiplier effect, restrictive effect, crowding out effect, distinctive effect. Political problems- political business cycle Other goals of the govt External shocks

Problems of Time Lags There are 5 lags associated with fiscal policy: 1- Time lags to recognition since the business cycle can be irregular and forecasting unreliable, govt may be unwilling to take action until they are convinced a problem is serious 2- Time lag between recognition and action- most significant changes in govt spending have to be planned well in advance; the govt cant increase spending overnight/change taxes and benefit. They normally have to wait until budget is announced or until it goes to parliament. 3- Lag between action and changes taking place- a change in tax rate may not immediately affect tax payment as some taxes may pay in arrears and new rates may take time to apply 4- Lag between change in govt spending and taxes and resulting change in output, price and employment- the multiplier accelerator take time hence it is difficult to forecast how long before results are seen 5- Consumption lag- consumption may respond slowly to consumption in tax.

There are two stages associated with lags: 1- Inside lag- time period it takes to undertake a policy action this includes recognition lag a) Decision lag b) Action lag

2- Outside lag- timing of the effect of the policy action on the economy

Tax A compulsory payment made by the citizens of a country to the govt through which no direct benefit is derived.

Functions of a Tax To raise revenue for the govt To redistribute wealth To discourage certain activities to protect industries from foreign competition To provide a stabilising effect on national income

Qualities of a good tax 1. Equality- meaning persons should pay based on their ability to pay 2. Certainty- you should know how much is due, when and where 3. Convenience- the payment of tax should be related to how and when people receive and spend their income eg. PAYE and VAT 4. Economy- the cost of collection should be small relative to the yield 5. Others include- flexibility -Difficult to evade -Should not have initiative

Classification of Taxes Progressive tax Takes a higher proportion income in tax (from all levels of income with a proportional tax) on income uses. Income tax generally tends to be progressive since the first part of the individuals income is tax free due to personal allowances. With progressive tax, the marginal rate of tax increases as income increases.

Proportional Tax Takes the same proportion of income in tax from all levels of income but usually only with a ltd range of income. With a proportional tax, the marginal rate of tax is constant.

Regressive Tax Takes a higher proportion of a poor persons salary than of a rich persons. the rate of tax decreases as income rises and the average rate of tax is lower for people with higher income eg. excise duties.

Advantages of progressive Tax Levied according to ability to pay Enables a govt to redistribute wealth from rich to poor Used to balance regressive tax

Disadvantage of progressive Disincentive to work Disincentive to entrepreneur Causes skilled workers to leave a country Causes people to avoid tasks or evade tasks Companies may transfer wealth to other countries

Advantages of proportional Tax Fairness

Disadvantages of proportional Tax Costly to collect Does not contribute to redistribution of wealth

Advantages of regressive Tax Easy to collect Easy to administer

Disadvantages of regressive Tax It is not equitable

Types of taxes Direct tax Paid directly by a person to the revenue authority, it is levied on income, wealth and profit eg. income tax, co-operate tax, capital gain tax, inheritance tax.

Indirect tax Collected by the revenue authority from an intermediary who then passes on the tax to consumers in the price of goods they sell. Indirect taxes are taxes on spending eg. excise duties, VAT, customer duties Indirect tax tends to be regressive and can be avoided.

Objective 7: Distinguish between Discretionary and Non- Discretionary Fiscal Policy a) Expansionary and contractionary b) Automatic stabilisers

Discretionary Fiscal Policy / active fiscal policy These refer to deliberate as in direct and indirect taxation and govt spending in order to influence aggregate demand. If aggregate demand is thought to be low then govt can reduce taxes or increase govt spending or a combination of both. If aggregate demand is thought to be high, then govt increases taxes or govt spending or both. Thus discretionary fiscal policies can be either expansionary/contractionary. Discretionary changes in tax or govt spending in addition to being used to alter aggregate demand, can also be used to alter aggregate supply