A1: The UK Tax System and its Administration | The Overall Function and Purpose of Taxation in a Modern Economy (ACCA TX)

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The Overall Function and Purpose of Taxation in a Modern Economy describes the purpose of taxation in a modern economy; explains the difference between direct and indirect taxation and identifies the different types of capital and revenue tax.

The Overall Function and Purpose of Taxation in a Modern Economy

a. Describe the purpose (economic, social etc.) of taxation in a modern economy

Tax policies in a country may be impacted or affected by economic, social and environmental factors. These factors often dictate how the government will plan for the short-term and the long term and how to best use the country’s resources.

Taxes can influence the demand for goods and services such as health, education. By extension, the demand for these goods and services can impact employment and the profitability of certain businesses.

Economic Factors

Although it may not be a popular approach, governments use taxation to either encourage or discourage certain activities. Saving, donations to charities, entrepreneurship and small business development, investment in plant and machinery and marriage and civil partnerships are encouraged. Smoking, the consumption of alcohol and motoring are discouraged.

Social Factors

Taxes can have varied impacts on the social makeup of a country. The tax system is set up to accumulate and redistribute wealth from the rich to the poor. There are different taxes which can have varying social effects:

  • Progressive taxes (Direct taxes) – As you gain more, you pay more taxes. For e.g. income tax.
  • Regressive taxes (Indirect taxes) – Essentially discourage spending and encourage saving. For e.g. Value added tax on consumer goods
  • Proportional taxes – Taxes that remain constant when income rises. For e.g. import taxes, duties
  • Ad Valorem Principle – Taxes are calculated as a percentage of the item. For e.g. value added tax

Environmental Factors

Tax systems may take environmental concerns about climate change, global warming and the advancement of renewable energy into consideration. Some examples of taxes which have been introduced because of environmental reasons are the climate change levy, the landfill tax and incentives for manufacturing or purchasing low CO2 emission vehicles.

 Quick Tip: Taxes can be progressive, regressive, proportional, or based on the ad valorem principle. 

b. Explain the difference between direct and indirect taxation.

Direct taxation includes taxes that the taxpayer pays directly to the Government and are based on income and profit. Examples include income tax, corporation tax, capital gains tax and inheritance tax.

Indirect taxation includes taxes that are paid by the consumer to the supplier who then pays the Government. Examples include Value Added Tax, sales tax, fuel tax and tourism departure taxes.

c. Identify the different types of capital and revenue tax

Capital taxes are charged on capital gains or wealth. Examples are capital gains tax, corporation tax and inheritance tax.

Revenue taxes are charged on income. Examples are income tax, corporation tax and national insurance or social security.

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Accounks is an ACCA student blog that follows my journey to the ACCA qualification.

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