Running Head: ALTERNATIVES TO FINANCING GOVERNMENT BY TAXATION

ALTERNATIVES TO FINANCING GOVERNMENT BY TAXATION

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ALTERNATIVES TO FINANCING GOVERNMENT BY TAXATION

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Alternatives to Financing Government by Taxation

For any government that is wishing to increase its expenditures, it has to decide on how

to raise the necessary revenue. In this case, the options are only to increase its debt stock, raise

other alternatives to specific tax rates, or even do both. However, on chapter 18, Hyman (2014)

emphasizes that an immediate problem that always arises is on the way to develop a criterion that

would assess the merits as well as the alternatives forms of financing expenditure. There are

three alternatives modes of financing: lump-sum taxes, tax on labor income, and tax on capital

income. Lump-sum financing is basically introduced in order to serve as a benchmark.

Expectantly, this kind of financing dominates the other two forms of distortionary tax financing

in regard to the overall welfare, even if in the short run, it always leads to losses that are relative

to the other mode of financing. Currently, as Hyman (2014) states in Chapter 10 of Introduction

to Government Finance, the government is capable of maintaining a balanced budget via

continuously adjusting one of the three taxes in order to meet its present expenditures.

Nevertheless, comparisons between the two distortionary taxes are dependent on factors like the

elasticity of labor supply, elasticity of substitution in the production of goods and services, as

well as the extent to which the mode of tax financing aids in correcting the distortion because of

the pre-existing wage taxes (Afolabi, 2004).

By the use of analytical methods, lump-sum financing was found to dominate the other

forms of financing in terms of overall welfare. As well, in regard to the overall welfare, agents

prefer a wage tax to capital tax because wage tax is increasingly more likely to be consistent with

the stability of growth because, in the long-run, capital tax always has an adverse implications on

the level of capital stock, in turn exhibiting growth and consumption in the long-run. As David

(1968) elucidates, only examining steady state utility becomes misleading because, in this way, it
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ignores the welfare along the transition path. For a case in point, the fact that a tax on capital is

perceived to be having more adverse effect on the long-run capital stock than it has on wage tax

implies that during the transition, there is an association of higher rate of decline in the capital

stock that in turns allow a higher short-run consumption rate. All in all, the overall expositions

creates a deeper insight from a welfare perspective on the alternatives to taxation for financing

government expenditures that provide beneficial impacts on a policy that would heighten the

living standards of all citizens in the long-run.

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References

Afolabi, M. (2004). Alternative forms of financing government expenditure: a steady state

analysis (Doctoral dissertation, Arts and Social Sciences: Department of Economics).

David, M. H. (1968). Alternative approaches to capital gains taxation. Brookings institution.

Hyman, D. N. (2014). Public finance: A contemporary application of theory to policy. Cengage

Learning.