Types of Taxes Which a Government can impose on the citizens are as follows:
With the theory of taxation covered, we can now move towards the actual menu of the taxes the government can enforce to increase the revenue for itself.
i. Direct taxes, such as income tax, which is imposed on the factor incomes. Income tax for the individuals is known personal income tax, while for firms is known corporate income tax.
ii. Indirect taxes, such as sales tax or the value added taxes, which is imposed on expenditure on goods/commodities and services
iii. Tariffs which and are imposed on the import expenditure
iv. Wealth or property taxes which are imposed on the particular fixed assets.
For the LICs, income tax collection is very much low and the indirect taxes frequently account for more than 2/3rd of the entire revenue as the citizens frequently under-report their incomes in these countries, there is not any voluntary tax payment culture, and income tax collection agencies are weak and corrupt. By contrast, for HICs, income taxes are very much important, accounting for the over 2/3rd of entire tax revenue.
Disposable income is obtained by subtracting the income tax from whole income. At national level, disposable income Yd is computed as Y-T, or Y-tY, where t is net income tax rate. One important question in front of the governments is of determining the optimal tax rate, t, for an average citizen. If t is too low, not enough taxes can be collected to enable the government to run and provide the proper services. If t becomes very high, the incentive for citizens to work will be decreased, meaning national income will go below and tax collection will certainly fall. Also at quite high levels of t, the incentive to cheat and evade taxes rises and the government, thus, might face serious enforcement problems.
The Laffer curve:
The relationship amongst the tax rate and tax revenue collection might be summarized in the Laffer curve diagram drawn. In tax revenue-tax rate space, the Laffer curve plots as an “inverted U”, which is delivering an optimal tax rate t* which is less than the 100%.