Below is an example model answer to a 25 mark question in the style of AQA Economics A-level.
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Question for model answer
Consider the following question. I have written this question in the style of a 25-mark AQA Economics A-level question for section B:
Taking effect from 1st April 2023, the UK Government has committed to increasing the corporation tax rate from 19% to 25% for companies with profits above £250,000 per year. For firms with profits below £50,000, there is no increase in corporation tax rates. But for firms with profits between £50,000 and £250,000 there will be a smaller increase in corporation tax rates.
(Source: here)
Evaluate the effects on the UK economy of increasing corporation tax rates on firms making high profits (25 marks).
This is a key macroeconomics essay on current affairs. A quick essay plan is here:
- Define key terms.
- Laffer curve – higher government revenue.
- Evaluation – position on Laffer curve.
- AD effect – lower investment and negative multiplier effect.
- Evaluation – proportion of AD that comes from investment.
- LRAS effect – reduced incentives and productivity.
- Evaluation – need to compare corporation tax rates to those of other economies.
- Conclusion.
Possible model answer
Corporation tax is a tax on firms’ profits. Aggregate demand (AD) is the total demand in the economy, AD = C+I+G+X-M.
Increasing corporation tax rates may increase tax revenue for the UK Government. The Laffer curve shows this. An increase in tax rates from T to T1 raises tax revenue from R to R1. This revenue could go towards reducing the budget deficit. The government’s budget deficit is very high at 4.2% of the UK’s GDP in 2023-24. This is because of government spending on Covid support programmes such as the furlough scheme, energy subsidies and other tax cuts. Reducing the budget deficit may lead to government borrowing and hence reduced debt interest payments. With less spending on debt interest the UK Government could choose to spend more money in the future on other priorities such as healthcare spending. Sounder public finances might also make investors more confident in the UK Government’s ability to make bond repayments. This may reduce the interest rates at which investors are willing to buy government bonds and thus reduce future borrowing costs.
Whether the tax increase raises government revenue depends on the position of the UK economy on the Laffer curve. If instead the economy is at point (T1,R1) before raising corporation taxes, then increasing the corporation tax rate to T2 may decrease revenue to R. This is because a corporation tax rise may reduce incentives to start or grow a business, reducing the size of the tax base. The UK Government does predict that tax revenue would rise by over £10bn a year because of the corporation tax rate rise. With corporate tax rates relatively low now, it is likely that there will be higher revenue. But the effect of higher taxes on incentives may reduce the extent to which revenue increases.
Increasing corporation tax rates “from 19% to 25% for companies with profits above £250,000 per year” reduces the post-tax profits of these firms. This leaves reduced funds for investment, so investment may fall. Also as firms know any future profits will be taxed at a higher rate, this will disincentivise investment further. This is because firms will have reduced returns (lower post-tax profits) from any new investment. So investment falls and as investment is a component of aggregate demand (AD=C+I+G+X-M), aggregate demand shifts left from AD to AD1. This may cause a negative multiplier effect. This is where a fall in investment leads to a larger than proportionate fall in A. Lower investment results in lower incomes for firms and cuts in wages, so consumers cut their spending, meaning consumption also falls and so on. So AD shifts further left to AD2. This results in lower real GDP as real GDP falls from Y to Y2. Hence corporation tax may lower real GDP, likely resulting in lower living standards.
However this argument depends on the proportion of AD influenced by the corporation tax rate rise. Only firms making larger profits are facing a corporation tax rise. So firms making lower profits, for example small businesses, are less likely to reduce their investment. Also consumption is the largest component of AD, making up roughly 60% of AD, not investment. So a given percentage fall in investment may have only a smaller effect on AD. Corporation tax is likely to reduce AD leading to lower real GDP. But these impacts are limited by the relative importance of investment to AD and the design of the policy to target high profit firms only.
Decreased investment can also influence the supply side of the economy. Lower investment could mean reduced firm spending on capital goods and human capital. So this could reduce productivity and hence the productive capacity of the economy. This means the LRAS could shift to the left. Higher corporation taxes could mean higher business costs, shifting the short-run aggregate supply curve left too. Lower productivity and higher business costs could lead to a higher price level in the UK economy, reducing the price competitiveness of UK exports which may widen the current account deficit. Productivity for the UK economy is 15% below the average of other G7 economies (as of 2015), so corporate tax rises could further worsen this UK productivity gap with other nations. There may also be fewer businesses choosing to set up in the UK, preferring to set up abroad in locations with lower taxes. This would further reduce the productive potential of the economy, compared to a situation of lower corporation tax rates.
However this depends on the level of corporation tax rates in other economies. The UK has the lowest corporate tax rate among the G7 economies, even after the tax rise. Hence there may be fewer incentives to set up a business abroad, so the effect on competitiveness is reduced. Also many economies have agreed to a global minimum corporation tax of 15%, further reducing the risk to competitiveness from raising corporation taxes. While the corporation tax rate rise may reduce investment, it is less likely to have a significant impact on competitiveness.
Overall raising corporation tax on firms making high profits is likely to be effective in raising revenue. While raising corporation tax will reduce aggregate demand and aggregate supply, by raising taxes only on higher-profit firms, the impact is limited. The impact of the tax rise does depend on how other countries respond – if other countries maintain or reduce their tax rates to attract more businesses, then increasing corporate taxes could significantly reduce the incentive for international businesses to set up in the UK. However, given the increasing degree of tax cooperation globally, as shown by the 15% minimum corporate tax rate agreement, it seems likely that countries will not seek to undercut each other’s corporate tax rates.
Commentary
Application is throughout using examples from the short extract and from own knowledge to support analysis and evaluation.
Analysis is detailed, using chains of reasoning and graphs to support the answer.
Evaluation is also detailed, making use of chains of reasoning and where relevant, data about the economy. The conclusion addresses the question and justifies the answer.
Note for the conclusion you could have picked another side for this policy too depending on the arguments used. You could also use other possible points – there is no right way of doing this. For example with interest rates at historical lows, how does that impact the cost of government borrowing and the necessity of raising taxes? What other factors may matter for investment beside corporate tax rates?
This essay would likely score level 5 according to AQA Economics A-level criteria.
For more guidance on AQA exam technique (25 markers, 15 markers, 9 markers and more), check out the blue button below:
Other Questions
How many words should there be in a 25 marker economics?
Most 25 mark responses, that can be replicated within exam conditions, are within the range of 700 to 1000 words.
However this is arbitrary. Word count does not matter as much, provided you answer the question and write in depth.
Achieving depth in analysis and evaluation, answering the question – see my economics resources here for more information on essay structures and how to evaluate.
How should you structure a 25 marker economics essay?
Introduction
Analysis
Evaluation
Analysis
Evaluation
Depending on depth of your previous points, add another round of analysis and evaluation.
Conclusion.
For more information on AQA Economics essay structure, I recommend the following article linked here.
How should you write a conclusion for 25 markers economics?
A conclusion has these key elements:
- Answer the question.
- Justify your answer in step 1.
- Consider other evaluation points, including real-world context, for further justification or that may go against your answer.
How should you evaluate in economics 25 markers?
I recommend the “depends on” structure for AQA Economics style evaluation. For more information on this, see my AQA Economics style evaluation guide here.
More Resources
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