Income Tax Worksheet - Income Tax - 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.

There is also a printable version of this worksheet available for classroom or personal use with spaces to fill in the answers.

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

The government can cut taxes in different ways. It could cut the various tax rates or it 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 1998/99	£	Income tax rates 1998/99	Tax rate (%)
Personal allowance		Lower rate
Married allowance		Basic rate
		Higher rate

Changing each of these will have different effects. To see the effects, try each of the following changes separately on the model :

1. Cut the top rate of tax by 2 percentage points
2. Cut the basic rate of tax by 2 points
3. Cut the lower rate of tax by 2 points
4. 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, one child, £9,000
Single-earner couple, two children, £12,000
Single-earner couple, two children, £17,000
Two-earner couple, two children, £50,000
Two-earner couple, two 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 four policies

Policy 1 - Cut the top tax rate by 2 points

Family	Weekly gain (£) from Step 1	Annual gain (£) weekly gain x 52	Percentage gain (%) annual gain as % of income
Employed single parent, one child, £9,000
Single-earner couple, two children, £12,000
Single-earner couple, two children, £17,000
Two-earner couple, two children, £50,000
Two-earner couple, two children, £100,000

Policy 2 - Cut the basic tax rate by 2 points

Family	Weekly gain (£) from Step 1	Annual gain (£) weekly gain x 52	Percentage gain (%) annual gain as % of income
Employed single parent, one child, £9,000
Single-earner couple, two children, £12,000
Single-earner couple, two children £17,000
Two-earner couple, two children, £50,000
Two-earner couple, two children, £100,000

Policy 3 - Cut the lower tax rate by 2 points

Family	Weekly gain (£) from Step 1	Annual gain (£) weekly gain x 52	Percentage gain (%) annual gain as % of income
Employed single parent, one child £9,000
Single-earner couple, two children, £12,000
Single-earner couple, two children, £17,000
Two-earner couple, two children, £50,000
Two-earner couple, two children, £100,000

Policy 4 - Increase personal allowance 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, one child £9,000
Single-earner couple, two children, £12,000
Single-earner couple, two children, £17,000
Two-earner couple, two children, £50,000
Two-earner couple, two 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 the income distribution closer or has it widened it?

Policy	Effect on income distribution Closer or wider?
1...Cut the top rate by 2points
2...Cut the basic rate by 2points
3...Cut the lower rate by 2points
4...Increase personal allowance 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 for 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 government's 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 1999?	Growth in 1999?	Unemployment in 1999?
20%	23%
19%	22%
18%	21%
17%	20%
16%	19%
15%	18%
14%	17%

Lower rate	Basic rate	Inflation in 2000?	Growth in 2000?	Unemployment in 2000?
20%	23%
19%	22%
18%	21%
17%	20%
16%	19%
15%	18%
14%	17%

Lower rate	Basic rate	Inflation in 2001?	Growth in 2001?	Unemployment in 2001?
20%	23%
19%	22%
18%	21%
17%	20%
16%	19%
15%	18%
14%	17%

Lower rate	Basic rate	Inflation in 2002?	Growth in 2002?	Unemployment in 2002?
20%	23%
19%	22%
18%	21%
17%	20%
16%	19%
15%	18%
14%	17%

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 if 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 of 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 allowance
Other??

What effect have these policies had on the economy?

	1999	2000	2001	2002	2003	2004	2005
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.