Ch2. External Environment Practice question 2.3(i)

[Jun123]

I am trying to understand clearly about the statement written in solution with regard to question 2.3(i) in core reading.
Below is the question.

2.3. The only tax imposed on providers of financial products in a specific country is a premium tax, under which a stated percentage of each premium received by the company is paid to the Government.
(i) Discuss the advantages and disadvantages of this method of taxation from the perspective of the Government

The statement I want to be clearer in the answer is related to disadvantage.
The one of answer is 'A high profile front-end tax on savings may be unpopular with customers and reduce the volume of financial products sold'

The reason of 'unpopular with customers' is, I guess, tax the provider pays will be deducted from premium received which will decrease actual deposit amount to the saving account. Therefore, customers will have lower accumulated value as it gives up investment return from the deducted amount due to tax. Is this fair statement of the reason?
It would also be great if I can have a clear meaning of 'A high profile front-end tax'
I appreciate any comment or answer on my question.

 

[Lindsay Smitherman]

Hi: the clue here is 'high profile', ie it is widely publicised and everyone knows about it. The customer will be able to see clearly exactly how much tax has been taken from them each time it is collected. The word 'front-end' means that the tax is deducted at the start, which is consistent with it being taken straight from the premiums paid.

An alternative approach to taxing financial providers would be to take the tax gradually throughout the term of the policy, perhaps as a % of the investment return earned or as a % of the provider's profits. These taxes would be a lot less transparent for the customer: they would not be able to understand so clearly how much tax was being taken from their policy. Therefore they might be more relaxed about it.

In any case, the customers would have a lower accumulated value due to the deduction of tax. But, on balance, the approach described in this question is more likely to put customers off buying the policy, as they may not like the amount of tax that is clearly being taken. If the tax was more hidden within the arrangement, they might not be so aware of (and therefore concerned about) it and so would happily still keep buying the policies.

Hope that helps with your understanding.

 

[Jun123]

Thanks a lot, Lindsay! Your explanation helped me a lot to understand it.