fiscal-policy-types-of-public-expenditure-and-taxation

Sources of Government Revenue

• The main sources of government revenue include taxation, the sale of goods/services by government owned firms, and the sale of government owned assets (privatisation)

1. Taxation

•  Direct taxes are taxes imposed on income and profits

  • They are paid directly to the government by the individual or firm

    • E.g. Income tax, corporation tax, capital gains tax, national insurance contributions, inheritance tax

• Indirect taxes are imposed on spending

  • The supplier is responsible for sending the payment to the government

    • Depending on the PED and PES producers are able to pass on a proportion of the indirect tax to the consumer

    •  The less a consumer spends the less indirect tax they pay

    • E.g Value Added Tax (20% VAT rate in the UK in 2022), taxes on demerit goods, excise duties on fuel etc.

2. Sale of goods and services

• Government owned firms sometimes charge for the goods/services that they provide

  • E.g. Charges on public transport and fees paid to access some medical services

3. The sale of government owned assets

• Privatisation can generate significant government revenue during the year in which the government sells the asset

  • Most assets can only be sold once e.g. national airlines or railways

  • Some assets, such as the right for mobile phone operators to use the airwaves, can be sold every few years (the airway licence is for a defined period of time)

Types of Government Expenditure

• Government expenditure represents a significant portion of the aggregate demand in many economies

• The expenditure can be broken down into three categories:

1. Current expenditures: These include the daily payments required to run the government and public sector. E.g. The wages and salaries of public employees such as teachers, police, members of parliament, military personnel, judges, dentists etc. It also includes payments for goods/services such as medicines for government hospitals

2. Capital expenditures: These are investments in infrastructure and capital equipment. E.g. High speed rail projects; new hospitals and schools; new aircraft carriers

3. Transfer payments: These are payments made by the government for which no goods/services are exchanged. E.g. Unemployment benefits, disability payments, subsidies to producers and consumers etc. This type of government spending does not contribute to aggregate demand, as income is only transferred from one group of people to another

Why Governments Levy Taxes

• Tax revenue is required to fund government expenditure

Diagram: reasons for government tax interventions

• Taxes can be used to discourage consumption 

  • Excise taxes (on alcohol, cigarettes) can be used to reduce the consumption of demerit goods that create negative externalities 

  • Tariffs (taxes on imports) can reduce imported goods 

• Taxes should aid the redistribution of income

  • A good tax system should help the government redistribute income from the rich to the poor

  • Revenue could also be used through the provision of services 

    • Eg. Health care and education promote more opportunities for lower-income earners

Progressive, Proportional and Regressive Taxes

• Tax systems can be classified as progressive, regressive or proportional

• Most countries have a mix of progressive (direct taxation) & regressive (indirect taxation) taxes in place

An Explanation of Tax Systems

System	Explanation	Diagram
Progressive	As income rises, a larger percentage of income is paid in tax In the diagram, when personal income rises from Y1 to Y2, the tax rate rises from TR1 to TR2
Regressive	As income rises, a smaller percentage of income is paid in tax In the diagram, when personal income rises from Y1 to Y2, the tax rate falls from TR1 to TR2 All indirect taxes are regressive In the USA, Federal income tax is progressive but almost all State taxes are regressive (the bottom 20% of income earners pay as much as 6x the % of their income than the top 20%)
Proportional	As income rises, the same percentage of income is paid in tax In the diagram, when personal income rises from Y1 to Y2, the tax rate remains constant at 20% In 2022, Bolivia was using this system with a proportional tax rate of 13%

• Progressive tax systems are built around the idea of marginal tax rates

• The calculation of an individual’s personal income tax requires several calculations

• Using this system, a salary of £60,000 would attract a tax bill of £11,499.80, calculated as follows:

Calculation Using UK Progressive Tax Rates – June 2022