Tax
- Distinctions between, and examples of, direct and indirect taxation
- Progressive and regressive taxation
- The balance between direct and indirect taxation
- The effects of taxation on individuals and firms
Direct & Indirect Taxes
Let's break down the two main types of taxes: direct and indirect taxes.
- Income Tax and Corporation Tax are common examples.
- Did you know that Scotland and the UK have Income Tax systems where higher earners contribute a greater proportion of their earnings in taxes than lower earners? This is called progressive taxation.
- One example is Value Added Tax (VAT).
- Individuals do not pay indirect taxes directly to the government. Instead, the tax is included in the price that consumers pay for a good or service. The seller of the good or service deducts the VAT from the transaction and pays the tax to the government.
Do indirect taxes contribute to income inequality?
- This is because indirect taxes tend to be more regressive than direct taxes. This means that the rate of indirect taxes are the same for everyone irrespective of income, which can be a problem because poorer people spend a greater proportion of their income on indirect taxes than richer people.
Knowledge checkpoint: Describe the distinctions between direct and indirect taxation
- Direct tax is a tax paid directly by a person or business to the government from incomes or profits, such as Income Tax and Corporation Tax.
- Indirect tax is a tax applied to a good or service at the point of sale, such as Value Added Tax (VAT). The tax is included in the price that consumers pay for a good or service. The seller of the good or service deducts the VAT from the total price and pays the tax to the government.
Tax Revenues and Economic Shocks
- Decreased sales of goods and services mean that firms earn less.
- This means less VAT receipts sent to the government.
- Decreased profits mean firms send less corporation tax to the government.
- Without government support during lockdown in the form of the Job Retention Scheme, the government would receive less income tax as a result of growing unemployment.
Scotland’s Total Revenues
You can also download the Government Expenditure and Revenue Scotland (GERS) 2021-22 report and database below:
The 2008 financial crisis and the 2020 Covid-19 Pandemic both saw the economy contract sharply. As the economy expands, tax revenues tend to rise. As the economy contracts, tax revenues tend to fall. This is deliberate - automatic fiscal stabilisers mean that when the economy is under pressure, taxes fall and spending increases as the need for unemployment benefits and state welfare increases, pushing up demand.
Knowledge Checkpoint: Explain the distinctions between progressive and regressive taxation
- Progressive taxation is a type of taxation where higher earners are expected to give up a greater proportion of their earnings in taxes than lower earners.
- An example of progressive taxation is the income tax system in Scotland, where higher income brackets are taxed at a higher rate than at the UK wide level. This means that lower earners are better off while higher earners pay even more than they would in the rest of the UK.
- Regressive taxation is a type of taxation where the tax rate is the same for everyone irrespective of income, which can lead to lower-income individuals spending a larger proportion of their income on taxes.
- An example of regressive taxation is the VAT, which is a fixed percentage applied to goods and services, regardless of the buyer's income.
Income Tax: Scotland and the UK
- By 2019, the Scottish Government had moved to a new five-band Income Tax system which was estimated to raise £500m for Scotland’s public finances (compared to if the UK Government policy were applied).
- The additional revenue was raised by subjecting taxpayers in the top half of the income distribution to larger tax rates than they would face in rUK. (FAI)
Income Band | Band name | Tax Rate |
Up to £12,570 | Personal Allowance | 0% |
£12,571 - £14,732 | Starter Rate | 19% |
£14,733 - £25,688 | Scottish Basic Rate | 20% |
£25,689 - £43,662 | Intermediate Rate | 21% |
£43,663 - £125,140 | Higher Rate | 42% |
Over £125,140 | Top Rate | 47% |
(Refers to annual income earned in financial year 2023-2024)
Rest of UK Income Tax Bands
Income Band | Band Name | Tax rate |
Up to £12,570 | Personal Allowance | 0% |
£12,571 to £50,270 | Basic rate | 20% |
£50,271 to £125,140 | Higher rate | 40% |
over £125,140 | Additional rate | 45% |
(Refers to annual income earned in financial year 2023-2024)
United Kingdom | Scotland | |
Taxable Pay | £45,000 | £45,000 |
Income Tax | £6,484.20 | £6,934.70 |
National Insurance | £3,891.60 | £3,891.60 |
Total Tax to Pay | £10,375.80 | £10,826.30 |
Scottish Income Tax in 2023
How many Scots fall into these marginal rates?
Are Scots better or worse off under the Scottish or UK income tax bands?
On the x-axis we have ‘annual taxable income’, which refers to total income before tax. On the y-axis we compare the total income tax liability (rUK minus Scotland), at each of those levels of income, under Scotland’s income tax system and the rUK Income Tax system.
Download the dataset used in this graph below:
- Try it for yourself! Use this calculator to compare tax liability for different income levels in Scotland vs. rUK.
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.