6.1.2 Effects of Government Policy: Changes in Taxes on People’s Income

This section explores how changes in government tax policies directly impact individuals' income. Taxes are a crucial way governments raise revenue to fund public services. Alterations to tax systems can have significant and varied effects on people's disposable income and economic behavior.

Types of Taxes and Their Impact

Governments typically levy several types of taxes. Understanding these different taxes is essential to analyzing their effects on income.

• Income Tax: A tax levied on an individual's earnings.
• Value Added Tax (VAT): A consumption tax added to the price of goods and services.
• Corporation Tax: A tax on the profits of companies. While not directly on individuals, it can indirectly affect income through wages and salaries.
• Capital Gains Tax: A tax on the profit made from the sale of assets like stocks and property.
• Inheritance Tax: A tax on the value of assets passed on after someone's death.

How Tax Changes Affect Income

Changes in tax rates can affect people's income in several ways:

• Increase in Income Tax Rates: This directly reduces the amount of money individuals have available to spend or save. This is because a larger portion of their earnings is directed towards the government.
• Decrease in Income Tax Rates: This increases disposable income, meaning people have more money to spend, save, or invest.
• Changes to Tax Thresholds: Tax thresholds define the income levels at which different tax rates apply. Adjusting these thresholds can affect who pays higher or lower rates of income tax. For example, raising the threshold might mean more people fall into a lower tax bracket.
• Tax Allowances and Credits: These are reductions in the amount of income subject to tax or direct payments. Changes to allowances and credits can alter the overall tax burden.

Impact on Different Income Groups

The effects of tax changes are not uniform across all income groups. Tax policies can have progressive, regressive, or proportional impacts.

• Progressive Tax System: A system where higher earners pay a larger percentage of their income in taxes. Changes to a progressive system typically increase the tax burden on higher earners and decrease it on lower earners.
• Regressive Tax System: A system where lower earners pay a larger percentage of their income in taxes. VAT is often considered regressive because lower-income individuals spend a larger proportion of their income on consumption.
• Proportional Tax System: A system where everyone pays the same percentage of their income in taxes.

Illustrative Examples

Consider the following examples to illustrate the impact of tax changes:

1. Increase in Income Tax: If the government increases the income tax rate from 20% to 25%, a person earning $50,000 per year will have $2,500 less disposable income per year.
2. Reduction in VAT on Essential Goods: If the VAT rate on food is reduced from 20% to 5%, consumers will pay less for groceries, effectively increasing their disposable income.
3. Introduction of a Tax Credit for Low-Income Families: This would directly increase the disposable income of low-income families, helping to alleviate poverty.

Table: Example of Income Impact from Tax Changes

Scenario	Income	Original Income Tax Rate	Original Income Tax Amount	New Income Tax Rate	New Income Tax Amount	Change in Disposable Income
Individual A	$40,000	20%	$8,000	25%	$10,000	-$2,000
Individual B	$80,000	20%	$16,000	25%	$20,000	+$4,000
Family C	$20,000	10%	$2,000	10%	$2,000	$0

This table demonstrates how changes in tax rates can have different impacts depending on the individual's income level. Higher earners are generally more affected by changes in income tax rates.

Conclusion

Government tax policies are a powerful tool for influencing people's income and the overall economy. Understanding the different types of taxes and how changes to tax rates affect individuals is crucial for analyzing economic policy and its consequences. The impact of tax changes varies depending on the type of tax and the individual's income level, highlighting the importance of considering distributional effects.