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Understanding The Government

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Public expenditure can be divided into two categories – operating and


development.

Ways to use Government Expenditure:

1. Resource allocation by diverting resources


2. Reduce inequity
3. Economic growth (income, employment and output)
4. Fiscal tool

Sources of Government Revenue

1. Taxes
2. Income from public assets, services, fines and fees, etc The Laffer Curve illustrates that excessive tax rates will have a dampening
3. Loans effect on national income and tax revenue.
4. Issue of new money
5. Grants and gifts from other countries Strategy in Collecting Taxes

Purpose of Taxation 1. Reducing direct taxes


2. Widening the tax base
1. Source of revenue
2. Economic management tool Evaluation of Direct Taxes
3. Reduce income inequality
4. Correct market failures Merits
5. Attraction for foreign labour
1. Clarity and certainty
Characteristics of a Tax System 2. No shifting of tax burden
3. Progressive in nature, able to improve income equality
1. Income equality
2. Clarity and certainty Demerits
3. Convenience
4. Economical 1. Disincentive effect on production
2. Less savings and investments
Types of Taxes 3. Loopholes for tax dodging

1. Direct taxes Evaluation of Indirect Taxes


2. Indirect taxes
a. Ad Valorem taxes Merits
b. Specific taxes
1. Substantial revenue at relatively low rates
Rates of Taxation 2. Tax burden is hidden
3. No direct effect on savings and investment
1. Marginal Tax Rate (MTR) 4. Few loopholes for tax dodging
5. Can be used to discourage demerit goods
a. Change in tax rateChange in total
incomeX 100 Demerits
2. Average Tax Rate (ATR)
1. Producers shift burden of tax to consumer
a. Total taxTotal incomeX 100 2. Prices higher, lower real income
3. Negative effect on exports and tourism
Impact of Taxation 4. Discourage investment due to higher production costs
5. Regressive in nature, worsening inequity
1. Proportional tax (ATR constant)
2. Progressive tax (ATR rises) Impact – who pays the tax first
3. Regressive tax (ATR falls)
Incidence – who eventually pays the tax
Effects of Taxation
Budget Types
Positive
1. Surplus - Contractionary fiscal policy
1. Income equality 2. Deficit – Expansionary fiscal policy
2. Discourage demerit goods 3. Balanced – Overall still expansionary, used to stabilise and maintain
3. Fiscal policy to affect AD
Factors Determining a Country’s Budget Policy
Negative
1. Achieving monetary stability (full employment with price stability)
1. Lower desire to work 2. Rate of economic development intended
2. Less savings and investment 3. State of economy
3. Higher prices, may lead to inflation
4. Distort demand and supply interaction Evaluating Balanced Budget

The Laffer Curve Positive

1. Government is well-disciplined in its fiscal policy


2. Monetary stability
3. Government does not spend more than what it collects

Negative

1. Aggravates inflation and deflation


2. Unfeasible on the long term economic planning of a country

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Financing Budget Deficits

Internal sources

1. General public
2. Central bank or commercial banks
3. Print new notes

External sources

1. Loans from other countries


2. International financial institutions (eg. World Bank, IMF)

Reasons of Budget Deficits

1. Expansionary fiscal policy (stimulate AD)


2. Economic development in a poor country
3. Finance a war

Public Debt

1. Productive purposes, it has no real burden and may confer a benefit


2. Unproductive purposes, it will impose burdens
3. External burden poses higher welfare loss to society as interest
payment flows out

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