1.

On January 1st 2018, Saudi Arabia and the United Arab Emirates introduced a 5 per
cent value added tax on most goods and services including food, clothes and utilities
as a way to raise npn-oil revenue for the government. Assuming all other taxes have
remained unchanged, which of the following statements is likely to be true about the
new tax system in Saudi Arabia and the UAE?
a. The tax system now takes a larger proportion of tax from those on higher
incomes relative to those on lower incomes.
b. The progressivity of the tax system has remained unchanged because VAT is
a tax on goods and services not income
c. The tax system has become more regressive
d. Income distribution will become more equal
2. Read the above extracts and answer the following.
a. Under the proposed new tax plan, an individual with a monthly income of
10,000 RMB would pay: No tax on the first 5000 RMB, 3% on the next 3000
RMB, and 10% on the last 2000 RMB. Calculate the proportion of income
paid in income tax for individuals in China whose income is 10,000 RMB per
month after the tax reform.
b. Explain what is meant by the term ‘regressive taxation’ Regressive taxation is
where the proportion of income paid in tax falls as the income of the taxpayer
rises. China for example doesn’t have a regressive tax system because those
on lower incomes have received a cut of around 8.1% of tax payments in
contrast to a high income taxpayer who receives a cut of 4.2%
c. With reference to Extract B, analyse the likely effect of high taxes in China, as
indicated by the World Bank’s ‘Doing Business’ rankings, on the future FDI
flows between China and the rest of the world. There would be a decrease in
FDI inflows into China. This is because the percentage of profits taxed in
China is 68%. With higher taxation on profits, the profit incentive decreases,
since the opportunity cost of investing in China would be higher if investing in
countries with lower income tax, therefore there would be a decrease of FDI
inflows into China. However, there would likely be outflows of FDI from
Chinese investors. With the high rate of taxation and the decreased
reputation as a low cost manufacturing economy, Chinese investors will likely
choose to invest in other countries with lower corporation tax rates, therefore
leading to increased outflows of foreign direct investment from China.
d. With reference to the information available, examine the likely impact of the
proposed income tax cuts on income distribution in China. Income tax is a
direct tax levied on the income of individuals, households and firms. In 2018,
China drafted a plan to raise after–tax household income by raising the
minimum level of taxation from 3500 RMB to 5000 RMB. This progressive
taxation system would likely decrease China’s Gini coefficient, meaning
income inequality decreases. China’s Gini coefficient is 0.4 meaning there is
high income inequality. If the income tax rate brackets expand, lower income
households will have more disposable income, therefore their net income
after taxes will increase, hence the distribution of income in China will
improve as an increased number of households have an increased share of
income. This would decrease the Gini coefficient and improve income
distribution. However in contrast, the tax cuts may not improve income
distribution if the higher income tax brackets also experience cuts. The
 proposed cuts would lead to a 4.3% cut in taxes of a person earning more
than US$90,000 therefore the disposable income of higher income individuals
would rise, hence a smaller number of households would have an increasing
share of the income, hence worsening the gini coefficient and income
distribution.
e. With reference to the information available, discuss the likely impact of
China’s planned income tax cuts on real output, employment, and the price
level.

Income tax is a form of direct taxation levied on households, individuals, and firms. The
following diagram shows the level of aggregate demand before and after the implementation
of income tax on individuals and firms. There is an increase in aggregate demand from Q2 to
Q1 and the price level within the economy decreases from P2 to P1.

Original
P2
Income
Tax
P1 Decreased
Income
Tax

AD

Q2 Q1
Outpu
t

Real output in the Chinese economy has expanded due to the tax decreases. With a
decrease in income tax in lower income households, along with a decrease in
regressive taxes such as social security contributions, has led to an increase in
disposable household income which increases aggregate demand in the Chinese
economy. This is shown by the shift from Q2 to Q1 in the aggregate demand curve.
Therefore, the real output level in the Chinese economy increases due to an increase
in household disposable income. However, this would only occur under the pretence
of high confidence in the economy. If consumers are wary of the unstable housing
market or food prices, then perhaps they will decide to save money which would
decrease aggregate demand. Therefore the expansion of real output may be limited
by low confidence in the Chinese economy, however this may be unlikely due to the
high magnitude increase in incomes which would still marginally increase aggregate
demand.

From the perspective of employment, the economy would likely experience an

increase in employment rates. This would occur due to increased aggregate demand
for goods and services and increased incentives to work. Considering the expansion
of the tax bracket leading to increased disposable income for lower income
households in China, there would be increased work incentives. If taxation on income
is too high, many may instead decide to obtain welfare payments instead of working
and having too much income taxed. If taxation on income decreases, then work
incentives for lower income individuals would improve, therefore employment within
the Chinese economy would increase. However, employment levels may remain
constant if the decrease in taxation is still small compared to the welfare benefits.
Assuming the decrease in taxation will lead to a substantial increase in household
income if there was employment, then employment incentives would improve.
However, employment may also be limited due to the high profits tax in China of 68%
which greatly reduces investment and employment incentives for firms, therefore
inhibiting the demand for labour in the Chinese economy which would significantly
limit employment rates.

Furthermore, the price level in the Chinese economy decreases from P2 to P1 after
the decrease in taxation of lower income households. This may occur assuming there
is increased real output in the economy due the increased aggregate demand, which
may generate economies of scale for Chinese firms as output levels outpace
production costs. However, this price decrease may not be significant considering the
regressive indirect taxation policy such as value added taxes. Value added taxes
made up 39% of tax revenue in China in 2017. In contrast, the increase in aggregate
demand may prompt the value added tax to be decreased in order to maintain
revenue constant while still promoting economies of scale for Chinese firms.

Overall, the output level in the Chinese economy would likely increase due to
increased household income, however increases in employment would be limited by
a lack of demand for labour in the Chinese economy that lacks investment and has
high corporation tax, leading to labour being outsourced to lower income countries.
Although there may be a decrease in the price level, the regressive value added tax
on goods and services may limit this change