Taxes -> Direct -> Income tax

                             -> Profit tax

           -> Indirect -> Expenditure taxes (VAT) 

                                -> Import taxes

a. Direct taxes
i. Income Tax
• A tax used by most governments
• It is a tax on people’s incomes.
• Usually, the higher a person’s income, the greater will be the amount of tax they have to pay to the government.
• It is set at a certain percentage of income.
• It can be progressive, which means that the higher their income, the more they pay.

 

• Individual taxpayers would have a lower disposable income. They would then have less money to spend and save.
• Businesses would be likely to experience a fall in sales.
• Managers may decide to produce fewer goods and services as sales are lower.
• Some workers can lose their jobs.

 

Which businesses are likely to be most affected by this increase in income tax rates?
• Businesses which produce luxury goods which consumers do not have to buy are most likely to be the most affected.
• Businesses producing essential goods and services will be less affected as consumers will still have to buy these products.

 

ii. Profits Tax or Corporate Tax
• It is a tax on the profits made by businesses – usually companies.

 

• Businesses would have lower profits after tax. Managers will therefore have less money or finance to put back into the business.
The business would will find it more difficult to expand. New projects, such as additional factories or shops may have to be cancelled.
• The owners will have less money to take after the taxes as a results of their original investment in the business. Fewer people will want to start their own business if they consider that the government will take a high amount of taxes from their profits.

 

• It is a tax on the price of products that we all buy.
• They make products more expensive for consumers.
• Governments avoid putting these taxes on essential items such as food, because this would conflict with their social objective of allowing all the needs for everyone in the community.

 

Prices of goods in the shops would rise. Consumers may buy fewer items as a result. This will reduce the demand for products made by businesses.
• As prices rise so the workers employed by a firm notice that their wages buy less
in the shops. It is said that their real incomes have declined.
• Businesses might therefore be forced to raise their wages which will lead to the costs of the products going up.

Which businesses are likely to be most affected by this increase in income tax rates?

• Sales of luxurious goods and services (foreign holidays, jewelry) rather than the sales of the essential goods and services (bread, cooking oil) will be affected.

 

We’ve agreed before that countries always want a surplus from its balance of trade, therefore countries try to limit the imports that go into the country by two main methods:

Import Tariffs or duties	Import Quota
It is a special tax on the imports of a country	A physical limit on the quantity of a product that can be brought in
	Usually used selectively on certain industries

How are businesses affected by an increase in imports and quotas?

• Firms will benefit if they are competing with imported goods. These
  will now become more expensive, leading to an increase in sales of
  home-produced goods.
• Businesses will suffer higher costs if they have to import raw
  materials or components for their own factories. These will now be
  more expensive.
• Other countries may now take the same action and introduce
  import tariffs too. This is called retaliation. A business trying to
  export to these countries will probably sell fewer goods than
  before.

Taxes -> Direct -> Income tax

                             -> Profit tax

           -> Indirect -> Expenditure taxes (VAT) 

                                -> Import taxes -> Import Quotas

-> Export Quotas

Policy 2: Monetary Policy – Interest Rates
An interest rate is the cost of borrowing money.
In most countries the level of the interest rates is fixed by the government or the central bank by the monetary policies.
Most of the people and businesses in the country will borrow money and they will have to pay interest on the loan.

How are businesses affected by an increase in the interest rates?

• Firms with existing loans will have to pay more in interest to the banks. This will reduce their profits.
• Lower profits means less is available to distribute to the owners and less is
  retained for expansion.
• Managers thinking about borrowing money to expand their business may delay their decision.
• New investment in business activity will be reduced. People hoping to start a new business may not now be able to afford to borrow the capital needed.
• Consumers who have taken out loans such as mortgages to buy their houses, then the higher payments will reduce their disposable incomes. Demand for all goods and services could fall as consumers have less money to spend.
• Consumers will also be unwilling to borrow money to buy expensive consumer items like cars. These businesses may have to reduce output and make workers redundant.
• When the interest rates of a country are higher than other countries,
  foreign banks and individuals will be encouraged to deposit their
  capital in that country. They will be able to earn higher rates of
  interest on their capital.
• By switching their money into this country’s currency, they are
  increasing the demand for it. This will cause the exchange rate to
  rise, creating an exchange rate appreciation.
• Local firms will notice the demand for their products falling for this
  reason. This is because imports will become cheaper and the local
  products become more expensive.

Investment decisions and spending on capital goods	Exports/Imports (due to changes in the value of the currency)
Changes in the level of consumer spending	Repayment of loans becomes a burden
Opportunity cost of saving	Business Confidence

Effect on exchange rate
EXCHANGE RATE- based on the demand and supply of sterling.
How does a high interest rate cause a shift in the value of the currency?

Effect on exchange rate

	UK rates rise relative to those in other countries
	Foreign investors see higher potential returns on money invested in the UK
Example: The interest rates increased from 10% to 12.5% in the UK
	Demand for sterling increases
	The value of the pound (price of the pound) rises

Effect on imports and exports

	The value of the UK pound rises as a result of high interest rates			The value of the UK pound falls as a result of lower interest rates
Example: The interest rates increased from 10% to 12.5% in the UK	Rise in export prices		Example: The interest rates decreased from 10% to 7.5% in the UK	Fall in export prices
	Fall in import prices			Rise in import prices

Policy 3: Supply Side Policies

• The government aims to increase competitiveness and efficiency of
  industries against those from other countries.
• Called Supply-Side Policies because they are trying to improve the
  efficient supply of goods and services.
• Privatization– Use the profit motive to improve business efficiency
• Improve Training and Education – Governments plan to improve the skills of the country’s workers.
• Increase competition in all industries – Reducing government controls over industries and take actions against monopolies

We now know the policies that are being applied by the governments to have a positive effect on the government and the economy in general. . But there
are still more actions that the government takes to further control business activity directly…
-Production of certain goods and services
-Consumer Protection
-Competition Policies:
-Control of Monopolies
-Protection of employees
-Location of industry

Governments Control of Business Activity
Control 1: Production of certain Goods and Services

• Countries want to avoid the production of dangerous goods and
  services.
• Some countries also prohibit the sale and existence of items such as
  alcohol.

Control 2: Consumer Protection

• Weights and Measures Act
• Trade Descriptions Act (advertising must be truthful)
• Sale of Goods Act

Control 3: Competition Policy: Control of Monopolies

• A monopoly is when one firm controls or dominates the market for a
  good or a service.

	Disadvantages
Fix high profits since there are no competitors	Prevent new firms from setting up to compete with them	The monopoly is not encouraged to elevate the quality of the products

• The government controls monopolies in two main ways:

1. Interferes with decisions taken by monopolists which are thought to be against consumer interests – such as trying to eliminate competitors or refusing to supply retailers which charge lower prices or sell competing products.
2. Proposed mergers or takeovers that will create a monopoly might be stopped.

Control 4: Protecting Employees

The government sets out to protect the employees that are working in
any business…

• The government protects employees in four ways:

1. Protection against unfair discrimination (race, color, gender,
   religion, age, disability)
2. Health and safety at work (protect from dangerous machinery,
   provide safety equipment, maintain reasonable temperatures,
   provide hygienic conditions and washing facilities, durations of
   shifts are reasonable and provide breaks in the daily workload)

• When managers comply with these laws, they are making
  an ethical decision. This is a decision based on the moral
  code; doing what’s ultimately right.

3. Protection against unfair dismissal (No dismissals for joining a trade
   union, for being pregnant, without a warning).

• Industrial Tribunal is a legal meeting which considers workers’
  complaints of unfair dismissal or discrimination at work.

3. Protections against not being paid their wages.

• Contract of Employment: a legal agreement between
  employer and employee listing the rights and responsibilities
  of workers. (how much is paid, how frequently, deductions
  such as the income tax)
• Minimum Wage: The lowest wage an employer can pay his
  employees per hour.

The Minimum Wage has advantages and disadvantages:

Advantages	Disadvantages
It should prevent strong employers from exploiting unskilled workers who could not easily find other work	It increases business costs which will force them to increase prices
Encourage businesses to train their workers to be worthy of the new minimum wage	Some employers will not be able to afford this minimum wage. They may be forced to let the workers go and so unemployment will rise.
Encourages more people to seek work	Other workers will ask for a raise to be able to maintain the differential salary pay between them and the lower-skilled workers
Low-paid workers will be earning more and so improving their standards of living

Control 5: Location of Industry

• The decisions taken by firms about where to locate their business can have a very important effect on the firm’s profitability.
• Managers will want to place their businesses in the best possible area, taking into account factors such as cost of land, proximity of transport links and customers, availability of workers, and so on.

Why do governments try to influence these decisions?

1. To encourage businesses to develop and set up in areas of high unemployment – often called developmental areas.
2. To discourage firms from opening in overcrowded areas or areas that can be ruined due to its natural duty

Governments take two types of measures for this…

1. Planning controls will legally restrict the business activities that can be undertaken in certain areas. Businesses can be refused planning permissions by the government if they government believes that their presence in a certain location will harm them.
2. Many governments provide regional assistance to businesses to encourage them to locate in undeveloped parts of the country.
   For example, low rentals or financial grants. These areas are known as developmental areas, having high unemployment rates and there is a need for new jobs and possibilities.

Governments can Help Businesses too
As well as controlling business activities, governments can positively encourage businesses too by 3 main ways.
– Regional Assistance
– Small Firms Assistance
– Exporting of Goods and Services

Support 1: Regional Assistance
Serious social and economic problems can result from a country having some very rich areas and some very poor areas.

1. It is common for governments to try to make economic development more evenly spread.
2. The government uses financial grants and subsidies to attract new firms to areas of high unemployment or to persuade existing firms to relocate there.

Support 2: Supporting Small Firms
Small businesses have important advantages for an economy

1. They provide jobs to many workers.
2. Many small firms operate in rural areas where unemployment would otherwise be very high.
3. They can sometimes grow into very important businesses.
4. Even though they are small, they provide choice for the consumers and act as competition to larger firms.
5. They are often managed in a very flexible way, with the owners close to the consumers and can quickly adapt their goods and services to meet consumers’ needs

Governments can provide assistance to entrepreneurs running their
own small business or planning to set up by:

1. Low profit taxes
2. Giving grants or cheap loans to people setting up in business.
3. Providing advice and information centers
4. Providing college courses and other training programs.

Support 3: Exporting Goods and Services
Governments are very keen to encourage businesses in their country to
export for the following reasons.

1. To ensure a positive balance of payments and so reducing the chances of foreign debts.
2. Exports earn a country foreign exchange. This can be used to pay for imports or to pay off foreign loans.
3. The more goods and services exported, the more people have to be employed to produce them.
4. Successful exporters will make profits and this will increase the money the government earns from profit taxes

Governments can support exports by doing the following:

1. Encourage banks to lend to exporters at lower interest rates.
2. Offering subsidies or tax reductions to exporters.
3. Try to keep the exchange rate of the country as stable as possible so
   that exporters know how much they can earn from selling goods
   abroad.
4. Organizing trade fairs abroad to encourage foreign businesses to buy a
   country’s exports.
5. Offering credit facilities to exporters so that if a foreign customer
   should refuse to pay for goods the government will guarantee
   payment.