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Why Do We Pay Tax? (Full Explanation)

Why do we pay tax
Photo by Karolina Grabowska from Pexels

Unless you plan on setting up a shell company in the Cayman Islands (we don’t advise doing so!), tax is an unavoidable fact of life. As freelancers, we’re responsible for managing and paying our own tax. It’s not easy watching a chunk of our hard-earned money go off to the taxman every year. But a deeper understanding of exactly what our taxes pay for helps take the sting out of tax time. In this article, we answer the question of why do we pay tax and take a look at what different taxes pay for around the world. But first, what are the origins of the tax system in the UK?


History of Tax in the UK

Taxes, in various forms, have existed in the UK since medieval times. Originally, taxes were paid on land ownership and different imports and exports like wool and wine. Income tax in the UK appeared in 1799, mainly to fund England’s contributions to the French Revolutionary War. Over the next several decades, the government abolished income tax but reintroduced it at various times to fund other wartime efforts.

What we now recognise as the modern tax system, including the PAYE (Pay As You Earn) system and purchase tax (the equivalent of VAT), developed following WWII to fund rebuilding efforts. Over the years, income tax rates have changed under different governments depending on the economic situation, as well as the political and economic ideology of the government of the day. So, what kinds of taxes do we pay today?


What Kinds of Taxes Do We Pay?

When we talk about taxes in the UK, the ones that first come to mind are likely personal income tax and National Insurance. But we’re taxed in a variety of other ways too. Let’s look at a few of the main ones.

Income Tax and NI

Anyone earning an income in the UK pays income tax and National Insurance, and these taxes are calculated based on their earnings. Income tax is the largest source of revenue for the government, followed by National Insurance. You can learn more about National Insurance in this article.


VAT (value-added tax) is included in the price of many of the goods or services you buy. In the UK, the standard VAT rate is currently 20%. VAT is only applied to select goods and services. For example, you don’t have to pay any VAT on most supermarket food or newspapers. VAT is the third biggest source of income for the government.

Capital Gains

Capital gains tax is a tax paid on the profit you make when you sell an asset, like property or shares. If you sell something at a loss, you don’t pay capital gains tax. The current capital gains tax rates range between 10%-28%, depending on the type of asset and your personal tax rate.

Inheritance Tax

Inheritance tax is a tax on the estate of someone who has passed away. The rules around when and how inheritance tax applies are complex, but when it does kick in, the standard inheritance tax rate is 40%. Other taxes in the UK include corporation tax, petroleum revenue tax, insurance premium tax, and duties on imported goods. Now that we know the kinds of taxes the government collects, let’s look at exactly what they pay for.


Why Do We Pay Tax in the UK?

Taxes in the UK generate revenue for the government to pay for a range of services such as health care and the social support system, defence, public works, the police, transport, culture, and housing. The government also uses taxes to fund the UK’s overseas aid budget and, up until recently, contributions to the EU budget. On average, the UK raises more than £820 billion each year from taxes. To understand what exactly these taxes pay for, let’s look at some examples from the 2019-2020 financial year. That year, the government spent:

  • £176.5 billion on welfare (not including State Pensions)
  • £164.1 billion on health
  • £98.8 billion on State Pensions
  • £92.4 billion on education
  • £42.2 billion on defence
  • £34.7 billion on transport
  • £12.7 billion on culture e.g. museums and libraries
  • £11.7 billion on environmental protection

This is where our taxes go, but why do we need to pay taxes? Very simply, we don’t have any choice in the matter! By law, we’re required to file and pay our taxes each year and we’re penalised if we don’t. The penalty for filing a late tax return is currently £100, which accrues interest if you don’t pay it on time.

The Moral Argument for Paying Taxes

But beyond the legal requirement to do so, there is also a moral argument for paying taxes. Our taxes fund essential government services like education, healthcare and transport to ensure everyone has equal access to them. As you can see from the figures above, it costs a lot of money to maintain these services. Without the government footing the bill, it would fall on individuals to pay for them privately. This is unsustainable for most people and a recipe for widening inequality.

So, while paying your tax bill is never pleasant, keep in mind that you’re contributing to essential services that you’ll likely use at some point in your lifetime. When you visit the GP, drive to your friend’s house on public roads, or start receiving the State Pension, you’re making use of taxpayer money. These are all examples of how you directly benefit from the way the government uses your taxes. Importantly, your contribution to these services also ensures they’re available equally to everyone in society.

How efficiently the government uses your taxes is another matter, but these are the things your taxes pay for. But what do taxes pay for in other countries?


Taxes Around the World

Tax systems, and how governments spend the taxes they collect, vary around the world. Let’s look at a few examples.

What Do Taxes Pay for in the US?

Federal tax rates in the US range between 12%-37%. Like the UK, US federal taxes fund health services, social security, defence, scientific and medical research, and infrastructure. In 2019, approximately:

  • 25% went to public health services and subsidies
  • 23% went towards social security payments
  • 16% of the federal budget went towards defence

Taxes collected at a state level go towards services including education, health care, transport, assistance to low-income families, state police, and parks and recreation.

Taxes in Sweden

Sweden has one of the highest personal income tax rates in the world, starting at 29% and rising to more than 57% for high-income earners. At 25%, Sweden’s VAT is also one of the highest in the EU. These high tax rates fund what is often described as one of the most comprehensive state welfare systems in the world.

For example, Sweden offers generous paid parental leave, at up to 240 days for each parent; free primary, secondary, and higher education; free school lunches (for almost all children); and a comprehensive public transport system. It’s interesting that, despite (or perhaps because of) its high tax rates, Sweden consistently ranks as one of the happiest countries in the world!

What Are Taxes Used for in The Bahamas?

The Bahamas is one of the few countries in the world that doesn’t collect personal income tax from its residents. There are also no inheritance or capital gains taxes in The Bahamas. Instead, its economy is largely based on tourism and offshore banking. The government also collects other forms of taxes, including property taxes, VAT, and import duties.

This means that the costs of some services in The Bahamas can be very high. While there is a national health insurance program, it’s not extensive, and individuals need to cover the costs for many services or take out private health insurance.

What Do Taxes Pay for in Australia?

Personal income tax rates in Australia start at 19% and go up to 45%. Personal income tax is the largest source of revenue for the Australian government. As in the US and the UK, social security and health are two of the largest government expenditures. In the 2019-2020 financial year, social security and welfare payments accounted for over a third of total government expenditure, while health accounted for 15%.

So, next time you’re doing your taxes, you’ll know where your money is going! If you want to learn more about tax from the perspective of a freelancer, check out our other articles here.

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