effects of changes in taxes on people’s income

What is a Tax?

💰 A tax is a compulsory amount that the government takes from your earnings or purchases. Think of it as a toll on a road: the higher the toll, the less you can spend on other things.

How Taxes Reduce Your Income

When you earn money, the government takes a part of it as tax. The amount you can actually spend is called disposable income:

$I_d = I - T$

• $I$ = Gross (total) income
• $T$ = Total tax paid
• $I_d$ = Disposable income (what you keep)

Example: Single Income Bracket

Suppose you earn £10,000 a year and the tax rate is 20%.

What Happens if the Tax Rate Changes?

1. Increase to 25%:
   • Tax = £2,500
   • Disposable Income = £7,500
2. Decrease to 15%:
   • Tax = £1,500
   • Disposable Income = £8,500

📉 A higher tax rate means you keep less money. 📈 A lower tax rate means you keep more.

Progressive Tax Brackets

In many countries, the tax rate increases as your income rises. Here’s a simple example:

💡 Remember: only the portion of income that falls into a bracket is taxed at that bracket’s rate.

Exam Tip

When calculating disposable income:

1. Identify the correct tax bracket(s).
2. Apply the appropriate rate to each bracket.
3. Sum the tax amounts to get total tax ($T$).
4. Subtract $T$ from gross income ($I$) to find disposable income ($I_d$).

Use the formula $I_d = I - T$ as a quick check.

Key Takeaways

• Taxes reduce the amount of money you can spend.
• Higher tax rates mean lower disposable income.
• Progressive tax systems tax higher earnings at higher rates.
• Always use the correct formula and check your calculations.