Knowledge Checkpoint: Discuss the reasons why the UK government might change the levels of direct and indirect taxation, and the effect of this alteration on individuals and firms
- One reason the UK government might change the levels of direct and indirect taxation is to promote fairness and reduce income inequality. For instance, by making the income tax system more progressive, the government ensures that higher earners contribute a greater share of their income to public finances than lower earners.
- Another reason is to generate revenue. Indirect taxes, such as VAT, are a significant source of revenue for the government, particularly during periods of strong economic growth. This is because indirect taxes are applied broadly to goods and services, and therefore collect revenue from a wide range of economic activities.
- For individuals, an increase in indirect taxes, like VAT, can lead to a higher cost of living as prices for goods and services increase. A more progressive income tax system could potentially lessen the tax burden on lower-income individuals.
- For firms, an increase in indirect taxes can potentially reduce demand for their products if they pass on the tax to consumers in the form of higher prices. Higher direct taxes such as corporation tax could also reduce firms' after-tax profits.