How does the government raise money through taxes, and what does it spend it on?
The types of tax (direct and indirect, progressive and regressive), the main areas of government spending, and the purposes of taxation.
An OCR J205 answer on taxation and government spending: direct versus indirect taxes, progressive versus regressive taxes, the main areas of public spending, and why governments tax.
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What this dot point is asking
OCR wants you to explain the types of tax (direct and indirect, progressive and regressive), the main areas of government spending, and the purposes of taxation. This sits inside the fiscal policy topic and links to fairness and market failure.
Direct and indirect taxes
The key difference is what is taxed. Direct taxes are charged on what you earn or own; indirect taxes are charged on what you spend. Indirect taxes also shift the supply curve left, as covered in the supply topic.
Progressive, proportional and regressive taxes
This matters for fairness: progressive taxes reduce inequality, while regressive taxes can widen it, which is why essentials are often zero-rated for VAT.
What governments spend on
Governments spend tax revenue on a range of areas, the largest usually being:
- Health (the NHS),
- Education (schools, colleges, universities),
- Welfare and pensions (benefits and the state pension),
- Defence and security,
- Infrastructure (roads, railways),
- Debt interest (the cost of past borrowing).
Spending choices reflect priorities and affect the macroeconomic objectives, for example education spending is also a supply-side policy.
The purposes of taxation
Taxes do more than raise money:
- Raise revenue to fund public services and benefits.
- Redistribute income through progressive taxes and the benefits they fund, reducing inequality.
- Discourage harmful consumption by taxing demerit goods such as tobacco, alcohol and sugary drinks.
- Manage demand as part of fiscal policy, raising taxes to cool the economy or cutting them to boost it.
- Correct market failure by taxing goods with negative externalities (such as pollution).
Try this
Q1. Give one example of a direct tax and one example of an indirect tax. [2 marks]
- Cue. Direct: income tax (or corporation tax). Indirect: VAT (or fuel duty).
Q2. Explain why income tax is described as progressive. [3 marks]
- Cue. Higher earners pay a higher percentage of their income in tax because of rising tax bands, so the burden rises with income.
Exam-style practice questions
Practice questions written in the style of OCR exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
OCR J205/02 20204 marksExplain the difference between a direct tax and an indirect tax, giving an example of each.Show worked answer →
A 4 mark Explain question.
A direct tax is paid directly to the government on income or wealth, such as income tax or corporation tax, and is paid by the person or firm on whom it is charged.
An indirect tax is a tax on spending, such as VAT or duty on fuel, collected by sellers and included in the price the consumer pays. Markers reward the income/wealth versus spending contrast and a valid example of each (for example income tax and VAT).
OCR J205/02 20226 marksExplain why an indirect tax such as VAT can be regressive, and discuss one consequence of this.Show worked answer →
A 6 mark question linking tax type to fairness.
VAT is charged at the same rate on goods regardless of the buyer's income. Because lower earners spend a larger share of their income, VAT takes a bigger percentage of a poor person's income than a rich person's, making it regressive.
A consequence is that heavy reliance on VAT can widen inequality, hitting low-income households hardest. The government might offset this by zero-rating essentials (food, children's clothes) or by using progressive income tax and benefits. Markers reward the explanation of why VAT is regressive and a reasoned consequence such as greater inequality.
Related dot points
- What fiscal policy is, how changes in government spending and taxation affect growth, employment and prices, and the costs and benefits of using it.
An OCR J205 answer on fiscal policy: how government spending and taxation are used to pursue economic objectives, their effect on growth, employment and inflation, and the trade-offs involved.
- The difference between income and wealth, the meaning of a fair distribution, the causes of inequality and poverty, and how government can redistribute.
An OCR J205 answer on the distribution of income and wealth: the difference between the two, the causes of inequality and poverty, and how governments redistribute through tax and benefits.
- What market failure is, the main causes (externalities, merit and demerit goods, public goods), and how the government can intervene to correct it.
An OCR J205 answer on market failure: externalities, merit and demerit goods and public goods, why markets misallocate resources, and how government intervention can correct it.
- What supply-side policy is, the main supply-side measures (education, training, infrastructure, incentives), and how they raise productivity and long-run growth.
An OCR J205 answer on supply-side policy: how measures such as education, training, infrastructure and incentives raise productivity and the economy's long-run productive capacity.
- The government's main economic objectives (growth, low unemployment, price stability and a fair distribution of income), and why they can conflict.
An OCR J205 answer on the government's main macroeconomic objectives (economic growth, low unemployment, price stability and a fair distribution of income) and the trade-offs between them.
Sources & how we know this
- OCR GCSE (9-1) Economics J205 specification — OCR (2017)