Return to original document
Income Tax Worksheet - A taxing business?
This worksheet looks at the impact that tax policy may have on businesses. Different businesses may well be affected in different ways by the same tax policy.
Step 1 - A less taxing policy?
Government policy often aims to cut taxes. This can be for two different reasons. It may be for demand-side
reasons or for supply-side
reasons. Use the Virtual Economy glossary to find what these types of policies are:
Demand-side policies
|
Supply-side policies
|
When they are cutting taxes, the government can do this in various different ways. They could cut the various tax rates or they could increase the tax-free personal allowances. Use the explanation of income tax to find out the current levels of the tax rates and allowances. Fill them in in the table below:
| Income tax allowances 2001/2 | £ | Income tax rates 2001/2 | Tax rate (%) |
|---|---|---|---|
| Personal allowance (under 65) | Lower rate | ||
| Personal allowance (65-74) | Basic rate | ||
| Personal allowance (75 and over) | Higher rate |
Cutting each of these will have different effects. To see the effects try each of the following changes separately on the model
:
- Cut the top rate of tax by 2%
- Cut the basic rate of tax by 2%
- Cut the lower rate of tax by 2%
- Increase the basic tax-free personal allowance by £1,500
Fill in below the effects that each of these policies have had on the families in the table:
| Family |
Effect on income Policy 1 - cut top rate (£ per week) |
Effect on income Policy 2 - cut basic rate (£ per week) |
Effect on income Policy 3 - cut lower rate (£ per week) |
Effect on income Policy 4 - increase personal allowance (£ per week) |
|---|---|---|---|---|
| Employed single parent, 1 child £9,000 | ||||
| Single earner couple, 2 children £12,000 | ||||
| Single earner couple, 2 children £17,000 | ||||
| Two earner couple, 2 children £50,000 | ||||
| Two earner couple, 2 children £100,000 |
Step 2 - Who found this less taxing?
The figures we got in Step 1, however, only give us part of the picture. They show how much money each family has gained each week. The same amount of money represents a very different proportion of their income for each group. For example, £5 per week will mean much more to the single parent than it will to the two earner family on £100,000 per year.
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 each of the 4 policies
Policy 1 - Cut the top tax rate by 2%
| Family |
Weekly gain (£)
from Step 1 |
Annual gain (£)
weekly gain x 52 |
Percentage gain (%)
annual gain as % of income |
|---|---|---|---|
| Employed single parent, 1 child £9,000 | |||
| Single earner couple, 2 children £12,000 | |||
| Single earner couple, 2 children £17,000 | |||
| Two earner couple, 2 children £50,000 | |||
| Two earner couple, 2 children £100,000 |
Policy 2 - Cut the basic tax rate by 2%
| Family |
Weekly gain (£)
from Step 1 |
Annual gain (£)
weekly gain x 52 |
Percentage gain (%)
annual gain as % of income |
|---|---|---|---|
| Employed single parent, 1 child £9,000 | |||
| Single earner couple, 2 children £12,000 | |||
| Single earner couple, 2 children £17,000 | |||
| Two earner couple, 2 children £50,000 | |||
| Two earner couple, 2 children £100,000 |
Policy 3 - Cut the lower tax rate by 2%
| Family |
Weekly gain (£)
from Step 1 |
Annual gain (£)
weekly gain x 52 |
Percentage gain (%)
annual gain as % of income |
|---|---|---|---|
| Employed single parent, 1 child £9,000 | |||
| Single earner couple, 2 children £12,000 | |||
| Single earner couple, 2 children £17,000 | |||
| Two earner couple, 2 children £50,000 | |||
| Two earner couple, 2 children £100,000 |
Policy 4 - Increase personal allowances by £1,500
| Family |
Weekly gain (£)
from Step 1 |
Annual gain (£)
weekly gain x 52 |
Percentage gain (%)
annual gain as % of income |
|---|---|---|---|
| Employed single parent, 1 child £9,000 | |||
| Single earner couple, 2 children £12,000 | |||
| Single earner couple, 2 children £17,000 | |||
| Two earner couple, 2 children £50,000 | |||
| Two earner couple, 2 children £100,000 |
Write a paragraph setting out which group has benefited the most from each type of change, and why this is the case.
|
What effect has each of these policies had on the income distribution in the economy? Has it made income distribution closer or has it widened it?
| Policy | Effect on income distribution Closer or wider? |
|---|---|
| 1... Cut the top rate by 2% | |
| 2... Cut the basic rate by 2% | |
| 3... Cut the lower rate by 2% | |
| 4... Increase personal allowances by £1,500 |
Step 3 - Who buys what?
The relevance of all this to a business is that different income groups spend their money in different ways. If you're running a business you need to analyse the nature of your product and your customers, to be sure of the effect any budget changes will have.
One way to measure the nature of the product is the income elasticity of demand
. This measures how sensitive the product is to changes in the level of income. How income sensitive would you expect the following products to be:
| Product | Income elastic or inelastic? |
|---|---|
| 1.. A box of matches | |
| 2.. A car | |
| 3.. A hi-fi system | |
| 4.. Dairy products - milk, cheese, yoghurts etc. |
As a producer of these products you need to decide how the demand for your product is likely to be affected by any tax changes. Fill in the table below to try to predict how demand will change for each of the policies we have considered, and each of the products above. In each box, fill in more, the same or less to indicate the effect you expect on demand.
| Product | Cut in top tax rate | Cut in basic rate | Cut in lower rate | Increase in personal allowances |
|---|---|---|---|---|
| 1.. A box of matches | ||||
| 2.. A car | ||||
| 3.. A hi-fi system | ||||
| 4.. Dairy products - milk, cheese, yoghurts etc. |
As a business you should therefore be watching carefully what happens in each budget.
Step 4 - Looking ahead - the crystal tax ball?
It is also important for businesses to know that the governments tax policies will mean a healthy level of growth in the economy, but without inflation. Good growth will mean increases in demand, but too much growth and the economy will start to suffer from higher inflation.
To illustrate this go to the model
and try gradually cutting the basic rate and the lower rate of tax by more and more. Record the results below:
| Lower rate | Basic rate | Inflation in 2002? | Growth in 2002? | Unemployment in 2002? |
|---|---|---|---|---|
| 10% | 22% | |||
| 9% | 21% | |||
| 8% | 20% | |||
| 7% | 19% | |||
| 6% | 18% | |||
| 5% | 17% | |||
| 4% | 16% |
| Lower rate | Basic rate | Inflation in 2003? | Growth in 2003? | Unemployment in 2003? |
|---|---|---|---|---|
| 10% | 22% | |||
| 9% | 21% | |||
| 8% | 20% | |||
| 7% | 19% | |||
| 6% | 18% | |||
| 5% | 17% | |||
| 4% | 16% |
| Lower rate | Basic rate | Inflation in 2004? | Growth in 2004? | Unemployment in 2004? |
|---|---|---|---|---|
| 10% | 22% | |||
| 9% | 21% | |||
| 8% | 20% | |||
| 7% | 19% | |||
| 6% | 18% | |||
| 5% | 17% | |||
| 4% | 16% |
| Lower rate | Basic rate | Inflation in 2005? | Growth in 2005? | Unemployment in 2005? |
|---|---|---|---|---|
| 10% | 22% | |||
| 9% | 21% | |||
| 8% | 20% | |||
| 7% | 19% | |||
| 6% | 18% | |||
| 5% | 17% | |||
| 4% | 16% |
What has happened to the economy as you have cut taxes further and further?
|
What problems is this likely to cause for businesses in the UK?
|
What particular problems are businesses likely to face is there is a higher level of inflation?
|
Step 5 - Anything Gordon can do, you can do better?
Now imagine that you are running a medium sized company with a turnover or around £3 million. You have around 50 employees, and you are selling a service. This service is a relatively new one and is targeted at those with above average earnings. It is a fairly income-elastic service and so requires a healthy level of economic growth if it is to continue performing well.
However, to establish the company you have had to borrow quite heavily and so you need there to be a good level of growth, but without high inflation because this may mean increases in interest rates which would raise your loan repayments and dent your profits significantly.
Use the model
to experiment and find what you believe to be the ideal set of income tax policies for your company to ensure it grows well in the future.
What policies have you chosen?
| Level | |
|---|---|
| Lower rate | |
| Basic rate | |
| Top rate | |
| Personal allowances | |
| Other?? |
What effect have these policies had on the economy?
| 2001 | 2002 | 2003 | 2004 | 2005 | 2006 | 2007 | |
|---|---|---|---|---|---|---|---|
| Economic growth | |||||||
| Unemployment | |||||||
| Inflation | |||||||
| PSNCR |
Write a paragraph justifying your policies and saying why you think they are the most appropriate ones for your business.
|