There are several important economic factors that influence management decisions, such as economic growth, inflation, unemployment, the Balance of Payments, taxation etc.

In the life of a state, government spending has to be financed either by taxation or by borrowing money. Taxation is essential and can’t be avoided. It may be imposed on income, expenditure, capital gains or wealth.

DIRECT taxes are levied on income and wealth (income tax, corporation tax).

INDIRECT taxes are levied on spending money (excise duties, VAT).

There is a tendency to associate direct taxation with progressive taxation and indirect taxation with regressive taxation:

PROGRESSIVE taxes take a higher percentage of a person’s income as income rises. (Combined with welfare payments they can be used to redistribute income in favour of low income groups).

REGRESSIVE taxation means that the growth of taxes per cent is smaller than income rises per cent.

We speak about LINEAR taxation when the growth percentage of taxes is equal with the growth percentage of income.  The main forms of taxation used in the UK are the following:


Charged on all incomes from work and self employment above an amount. This amount is dictated by a personal allowance plus allowances for certain other items such as pension fund premium, etc. Two rates are charged, a standard rate of 25 per cent to a set amount of taxable income and a 40 per cent rate on income above that level. It directly impacts upon sole traders and partners, and in addition has an indirect impact on all businesses (it reduces the disposable income of consumers).


Charged on profits earned by companies. Small firms currently pay a lower rate than larger ones.


Levied on the increase in the value of capital when it is sold.


This is a charge on the value added at each stage of the production process. VAT paid by firms on the cost of inputs is reclaimable. The result is a tax on expenditure by the end user. The current rate is 12-25%, with a zero rate on certain items like food and children’s clothes. Certain other goods are tax exempt which means that though they don’t have to pay VAT on their sales they are not allowed to obtain refunds of taxes paid at previous stages of the production process. The EU directives help to harmonise taxation in the Single Market.


Chargeable on certain products such as tobacco, wines and spirits.


A tax is charged on assets above a given amount which are inherited.

Domestic householders and businesses pay taxation related to capital values (they are subject to a nationally set rate linked to capital values). The business rate raises costs and thereby reduces profits for distribution.

Other taxes worthy of mention:

1. National Insurance Contributions: the employer’s contribution is a payroll tax

2. Vehicle Excise Duty on vehicle ownership,

3. North Sea Taxes (petroleum revenue tax and oil royalties): levied on oil production.


The primary function of taxation is, of course, to raise revenue to finance government expenditure, but taxes can also have other purposes. Indirect excise duties, for example, can be designed to dissuade people from smoking, drinking alcohol, and so on. Governments can also encourage capital investment by permitting various methods of accelerated depreciation accounting that allow companies to deduct more of the cost of investments from their profits, and consequently reduce their tax bills.

There is always a lot of debate as to the fairness of tax systems. Business profits, for example, are generally taxed twice: companies pay tax on their profits (corporation tax in Britain, income tax in the USA), and shareholders pay income tax on dividends. Income taxes in most countries are progressive, and are one of the ways in which governments can redistribute wealth. The problem with progressive taxes is that the marginal rate – the tax people pay on any additional income – is always high, which is generally a disincentive to both working and investing.

The higher the tax rates, the more people are tempted to cheat, but there is a substantial ‘black’ or ‘underground’ economy nearly everywhere. In Italy, for example, self-employed people – whose income is more difficult to control than that of company employees – account for more than half of national income. Lots of people also have undeclared, part-time evening jobs (some people call this ‘moonlighting’) with small and medium-sized family firms, on which no one pays any tax or national insurance. At the end of 1986, the Director of the Italian National Institute of Statistics calculated the size of the underground economy, and added 16.7% to Italy’s gross national product (GNP) figure, and then claimed that Italy had overtaken Britain to become the world’s fifth largest economy.

To reduce income tax liability, some employers give highly-paid employees lots of ‘perks’ (short for perquisites) instead of taxable money, such as company cars, free health insurance, and subsidized lunches. Legal ways of avoiding tax, such as these, are known as loopholes in tax laws. Life insurance policies, pension plans and other investments by which individuals can postpone the payment of tax, are known as tax shelters. Donations to charities that can be subtracted from the income on which tax is calculated are described as tax-deductible.

Companies have a variety of ways of avoiding tax on profits. They can bring forward capital expenditure (on new factories, machines, and so on) so that at the end of the year all the profits have been used up; this is known as making a tax loss. Multinational companies often set up their head offices in countries such as Liechtenstein, Monaco, the Cayman Islands, and the Bahamas, where taxes are low; such countries are known as tax havens. Criminal organizations, meanwhile, tend to pass money through a series of companies in very complicated transactions in order to disguise its origin from tax inspectors – and the police; this is known as laundering money.