Government Activity in Economy

Role of the Public Sector

• The public sector, also referred to as the government, plays a crucial role in the economy through its activities and decisions, influencing economic activity and social welfare.
• Government activities are carried out through various agencies, such as ministries, district councils, and state-owned enterprises, which are grouped into one entity: the public sector.

Market Failure

• Market failure occurs when private markets do not bring about an allocation of resources that best satisfies society's wants.
• Market failure can arise due to several reasons, including:
  • Externalities
  • Information asymmetry
  • Abuse of market power

Externalities

• An externality is a cost to a third party that is external to a transaction.
• Example: income tax in Botswana (for citizens)
  • Taxable Income (P) / Tax Payable:
    • 0 - 48,000.00: 0
    • 48,000.01 - 84,000.00: 5%
    • 84,000.01 - 120,000.00: 12.5%
    • 120,000.01 - 156,000.00: 18.75%
    • 156,000.01 and above: 25%

Taxation

• A tax is a compulsory payment made to the government to provide public goods and services.
• Objectives of taxation:
  • Secure revenue for the government
  • Allocate resources
  • Distribute income and wealth
  • Stabilize the economy

Types of Taxation

• Proportional taxation:
  • A tax is proportional if its average rate remains the same as the tax base increases.
  • The tax payment grows absolutely with income, but remains the same proportionate to income.
  • Example: company income tax in Botswana, with a corporate tax rate of 22%.
• Regressive taxation:
  • A tax is regressive if its average tax rate declines as income increases.

Fiscal Policy

• Fiscal policy is the control of taxes and government spending by the government to influence economic activity.
• Instruments of fiscal policy:
  • Government spending
  • Taxation
• Purpose of fiscal policy:
  • Stimulate economic growth in a period of recession
  • Keep inflation low (target: 3-6%)
  • Achieve full employment

Contractionary Fiscal Policy

• Implemented during demand-pull inflation:
  • Decrease government spending
  • Raise taxes
  • Combination of both
• Aim: reduce aggregate demand and control inflation

Expansionary Fiscal Policy

• Implemented during recessionary conditions:
  • Increase government spending
  • Decrease taxes
  • Combination of both
• Aim: stimulate economic growth

Supply and Demand Theory of Tax Incidence Shifting

• To maximize revenue, tax goods whose demand is inelastic, as consumers are less responsive to price changes.
• Tax incidence shifting:
  • Ed > Es: producer bears most of the tax burden
  • Ed < Es: consumer bears most of the tax burden
  • Ed = Es: equally share the tax burden
• Perfectly inelastic demand:
  • Demand curve is vertical
  • Consumers bear all the tax burden
• Elastic demand:
  • Demand curve is flatter
  • Consumers bear less of the tax burden
• Perfectly elastic demand:
  • All the incidence of the tax falls on producers

Government Expenditure

• Recurrent expenditure:
  • Wages, stationery, etc.
• Development expenditure:
  • Infrastructure development
• Composition of government expenditure in Botswana:
  • 2011/12 to 2020/21: Development expenditure (50-60%) and Recurrent expenditure (40-50%)