Government Spending PDF

Government spending 4.3.2  Reasons for government spending  To provide goods and services  To invest in infrastructure  To support agriculture and other industries  To reduce inequalities  To manage the macroeconomy  Reasons for taxation  To fund public expenditures  T...

Government spending 4.3.2  Reasons for government spending  To provide goods and services  To invest in infrastructure  To support agriculture and other industries  To reduce inequalities  To manage the macroeconomy  Reasons for taxation  To fund public expenditures  To manage the macroeconomy  To reduce inequalities in incomes  To discourage spending on imported goods  To discourage production and consumption of harmful products  To protect the environment  Principles of Taxation In order for the population to accept a tax system and pay into it, the taxes imposed need to be considered to be 'good' There are several principles which should be applied when developing a 'good' tax system 1. Simple: taxpayers should know what, when, where and how to pay the tax 2. Fair (equity): taxes should reflect a taxpayer’s ability to pay - progressive taxation aims to achieve this as the wealthy can afford to pay more than the poor do 3. Convenient: systems to collect payment should be easy and provide choice for taxpayers e.g. monthly payments spread over 12 months or tax collected by the employer each month before the salary is paid 4. Efficient: the management of the tax system by the government should not be overly expensive or wasteful 5. Fit for purpose: there should not be any unintended side effects of the system e.g. disincentivising workers from working 6. Flexible: it should be easy to adjust/change as required by changes in the economy Progressive, regressive and proportional tax systems  Tax systems can be classified as progressive, regressive or proportional  Progressive: The percentage of tax taken from income increases as income increases.  Regressive: The proportion (percentage) of tax falls as income increases. (may look unfair, it isn’t)  Proportional: The same proportion of tax is taken from everyone, whatever the income level.  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%  The Classification of Taxes  The main source of government revenue is 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, inheritance tax  Indirect taxes are imposed on spending  The less a consumer spends the less indirect tax they pay  Examples of indirect tax include Value Added Tax (19% VAT rate in the European Union in 2022)  Advantages of direct tax High revenue yield Reduce inequalities in incomes Based on ability to pay Disadvantages of direct tax  Disposable income  Employment  Labor productivity  Enterprise and investments  Tax evasion  Indirect   1. Service Tax A consumer pays service tax to purchase a service from any entity. The Indian government collects service tax on certain transactions that a service provider taxes  performs to sell a service. 2. Value Added Tax  State governments collect this tax on a good or service at each point of purchase where a value has been added. This tax is applicable from the point of a raw material Indirect Taxes Meaning purchase to the sale of a finished product.  3. Custom Duty As the name suggests, Indirect  The Union government collects this indirect tax on an import of a product in India. Timely, it is applicable on products exported from India. Taxes are levied indirectly to the  4. Excise Duty taxpayer. These taxes are levied  Our government collects excise duty from the manufacturers of goods manufactured on the manufacturers and/or in an Indian company. The manufacturers collect it from their buyers through the sellers of commodities that are price of the goods. passed on to the consumers.  5. Sales Tax Hence, they indirectly pay the  Central government imposes this tax on an Inter-state sale and the State tax*. The best example of government on an Intra-state sale of a good.  indirect tax* is the Goods and 6. Entertainment Tax Services Tax (GST@). The  State government charges this tax on the purchase of any entertainment-related goods and services. This can be purchasing goods like video games or services like government levies this tax* on movies, theatres, sports, amusement parks the sellers of goods. However,  7. Securities-Transaction-Tax they pass it on to the buyers by  Securities-Transaction-Tax or STT is levied during purchase of securities via Stock adding it to the cost of the Exchanges of India. These are inclusive of F&O transactions, mutual funds, shares etc. product.  8. Stamp Duty  This type of indirect tax is levied by the State Governments upon immovable property transfer of respective states. Furthermore, the State Government levies tax on legal documents. The rate of stamp duty varies from one state to another.  Advantages of Indirect Tax  The government levies various types of taxes to generate revenue for the running and management of the country. Of these, indirect taxes are levied on consumers via the sellers of goods or commodities. Here are some benefits of indirect tax:  Tax participation from the entire country – Direct taxes, like Income tax*, are levied on people from certain income brackets only. There is a large part of the population that does not pay income tax*. However, indirect taxes are applicable to anyone who purchases goods or commodities regardless of their income bracket. This makes indirect tax an inclusive taxation model.  Convenient – Usually, indirect taxes are very nominal and levied as a part of the purchase price of a good or commodity. Hence, consumers don’t feel the pinch while paying them. Also, levying indirect tax* is easy since the sellers incorporate it into the selling price.  No tax evasion – Many people avoid paying income tax*. Being a populous country, it is very difficult to track and penalize tax* evaders. However, there is no way to evade an indirect tax*. Every time someone buys a commodity, a tax* is paid.  Spread over a wide range – Some people have to pay as high as 30% income tax. This can feel like a burden. However, indirect taxes are spread across a wide range of products and the tax* rate is very small. Therefore, consumers do not feel the burden of paying them. Disadvantages of Indirect Taxes  Can be perceived as regressive – Indirect taxes are not levied based on the income of the taxpayer. They are standard across the rich and poor. While affluent people might not mind paying indirect taxes, the poor can feel the burden. Hence, many people might perceive indirect taxes as regressive.  Increase the price of commodities – Since the tax* is included in the price of the commodity, indirect tax* can result in an increase in the overall price of goods and commodities. Not all sellers calculate the exact tax* amount and add it to the selling price. Many sellers charge a slightly more amount to ensure complete tax* adherence. This can also have an undue inflationary effect on prices.  Fiscal Policy  Fiscal policy refers to the steps that governments take in order to influence the direction of the economy. But rather than encouraging or restricting spending by businesses and consumers, fiscal policy aims to target the total level of spending, the total composition of spending, or both in an economy. The two most widely used means of affecting fiscal policy are:  Government Spending Policies: Governments can increase the amount of money they spend if they believe there is not enough business activity in an economy. This is often referred to as stimulus spending  Government Tax Policies: By increasing taxes, governments pull money out of the economy and slow business activity. Fiscal policy is typically used when the government seeks to stimulate the economy. It might lower taxes or offer tax rebates in an effort to encourage economic growth. Contractionary vs. Expansionary Fiscal Policy Governments can execute their fiscal policies through contractionary or expansionary measures:  Contractionary Fiscal  Expansionary Fiscal Policy: Governments can turn Policy: This is commonly done to contractionary measures to during recessions to encourage slow down the economy and people to spend. Governments curb inflation. These steps often turn to measures like include raising taxes and stimulus checks issued to reducing government spending. taxpayers. They may also It isn't uncommon that a increase government spending recession follows to bring as a way to boost employment. balance back to the economy. Expansionary fiscal policies are commonly associated with deficit spending. Monetary Policy  Central banks typically use monetary policy to either stimulate an economy or to check its growth. By incentivizing individuals and businesses to borrow and spend, the monetary policy aims to spur economic activity. Conversely, by restricting spending and incentivizing savings, monetary policy can act as a brake on inflation and other issues associated with an overheated economy.