Income Tax Worksheet - Income Tax - Who pays what?
This worksheet looks at a variety of issues to do with income tax including income distribution, the Laffer Curve, and how progressive or regressive the tax system is. Step 1 was also covered in worksheet 1, so obviously you may want to look back to your answers there if you have already done it.
There is also a printable version of this worksheet available for classroom or personal use with spaces to fill in the answers.
Step 1 - How do you rate tax?
For more details on the UK tax system, you may want to look at the explanation of income tax.
Different tax changes will have different effects on the economy. There are two principal ways to cut taxes - cutting tax rates or increasing personal allowances - and they will have very different effects on the level of income distribution.
To show this let's try an experiment on the Virtual Economy. We're going to look at the different effects of changing tax rates and tax allowances. Go to the model
and try the strategies given below:
- First - try cutting tax by increasing the personal allowance by £2,000. Record the results in the table below.
- Second - try an equivalent tax cut, but this time by cutting the basic tax rate by 2 percentage points. Again record the results below.
| Tax rate cut | Tax allowance increase | ||
|---|---|---|---|
| Effect on: | |||
| Macroeconomy | |||
| 2001 | Economic growth | ||
| Unemployment | |||
| Inflation | |||
| 2002 | Economic growth | ||
| Unemployment | |||
| Inflation | |||
| 2003 | Economic growth | ||
| Unemployment | |||
| Inflation | |||
| Microeconomy | |||
| Single-earner couple with two children earning £12,000 | |||
| Single-earner couple with two children earning £17,000 | |||
| Two-earner couple with two children earning £50,000 | |||
In the table below, work out the percentage gain for each family for the above policies. To do this go through the following steps:
- Multiply the weekly gain by 52 weeks to get the annual gain.
- Then calculate how much this is as a percentage of the original income level
- Do this for both policies
| Family | Weekly gain (£) |
Annual gain (£)
weekly gain x 52 |
Percentage gain (%)
annual gain as % of income | |
|---|---|---|---|---|
| Single earner couple with 2 children earning £12,000 | Tax cut | |||
| Tax allowance change | ||||
| Single earner couple with 2 children earning £17,000 | Tax cut | |||
| Tax allowance change | ||||
| Two earner couple with 2 children earning £50,000 | Tax cut | |||
| Tax allowance change |
Which group has gained the most from the tax rate cut?
Which group has gained the least from the tax rate cut?
Which group has gained the most from the tax allowance increase?
Which group has gained the least from the tax allowance increase?
Step 2 - Distributing the tax cuts
As we have seen in Step 1, the same tax cut given in a different way can have very different effects across the income range. If the government wanted to redistribute income from better-off taxpayers to less-well-off ones, which of the policies below would be the most effective? Try ranking them from 1 to 4, with 1 being the best policy and 4 the worst.
| Tax change | Ranking (1-4) |
|---|---|
| Cut the top rate of tax | |
| Increase personal allowances | |
| Increase VAT | |
| Cut the basic rate of tax |
Write a short paragraph outlining your reasons for these rankings.
One way to show how equally distributed the level of income is in a country is to use a Lorenz Curve
. This shows the percentage of national income earned by the different groups in society. A typical Lorenz Curve is shown below. The closer the line is to the 45-degree line, the more equal the distribution of income.
As the distribution of income changes, so the Lorenz Curve will change to reflect this. Draw on the diagrams below the change you would expect in the Lorenz Curve for the tax changes given:
1...A substantial reduction in the top rate of tax
2...A substantial increase in the tax-free personal allowance
3...A significant cut in the lower rate of income tax
N.B. To check what is meant by the 'lower rate of tax', you may want to look at the explanation of income tax.
Step 3 - It takes a 'Gini' to measure income distribution
One problem with the Lorenz Curve is that it is a slightly imprecise method of measuring income distribution. Just looking at a curve may give a false impression. The Gini Coefficient
measures the ratio of the area between the Lorenz Curve and the 45-degree line to the whole area below the 45-degree line.
If the Lorenz Curve was the 45-degree line, the value of the Gini Coefficient would be zero, but as the level of inequality grows so does the Gini Coefficient. In the most extreme possible scenario, the Gini Coefficient would be 1. In the UK, the figure is around 0.35, and during the 1980s it grew as the level of inequality increased.
What will happen to the Gini Coefficient in each of the cases given in Step 2 above?
| Tax policy | Gini Coefficient Increase or decrease? |
|---|---|
| 1...A substantial reduction in the top rate of tax | |
| 2...A substantial increase in the tax-free personal allowance | |
| 3...A significant cut in the lower rate of income tax |
Step 4 - All incomes are equal - but some are more equal than others!
Now see how much difference you can make with your policies. Go to the Virtual Economy model and try out policies to try to make the income distribution in the economy more equal. To test how well your policies have worked, look at how your policies have affected the sample families in the economy.
Fill in the table below with the policies you used, and the effect on the families:
| Policies used: | Families: | Effect on their income? (£ per week) |
|---|---|---|
| 1..... | Unemployed couple (2 children) | |
| 2..... | Single-earner couple £12k (2 children) | |
| 3..... | Two-earner couple £50k (2 children) | |
| 4..... | Pensioner couple £7k |
What problems do you think that your policies might cause for the economy?
What advantages might there be to the economy of a more equal distribution of income?
What disadvantages might there be from this equality?
Step 5 - Progressing or regressing?
Use the glossary to find out the meaning of the terms progressive tax and regressive tax. Note down the meanings.
Are the following taxes progressive or regressive?
| Tax | Progressive or regressive? |
|---|---|
| Income tax | |
| VAT | |
| Tax on cigarettes | |
| Council Tax |
The Conservative government from 1979 to 1997 shifted the burden of taxation from direct tax
to indirect tax
. Does this make the tax system more or less progressive?
More / Less (Delete as appropriate)
What are the arguments for changing the tax system in this way?
Step 6 - Tax - a 'Laff - er' minute?
Use the income tax theories or the glossary to find out what the Laffer Curve is. Draw a possible Laffer Curve on the axes below:
What is the definition of the Laffer Curve?
If the Laffer Curve
does exist in the UK, what implications does this have for the government when it formulates its tax policies?