Is a macro-economic discipline which deals with the principles concerning the collection of government revenue and how it is allocated for public expenditures in order to achieve certain objectives and targets in the economy.
It is made up of the following branches:-
- Public revenue: it deals with the methods of raising public revenues through public taxation.
- Public expenditure: it deals with total amount of money that government spends on social services and the effects of such expenditure. The government spends public revenue on services such as:-Defense, Health,, Infrastructure, Education etc.
- The public debts: it deals with the causes and effects of debts which the state, local authorities and public co operations borrow for various reasons. It also examines the methods of public debt management.
- Financial Administration: this deals with preparation and sanctioning of the budget and auditing of all government ministries, government departments and all other organs of the state.
- Fiscal policy: it studies the use of public finance operations especially taxation through budget to supplement the monetary policy so as to bring about economic stability and growth in the economy.
Sources of Government Revenue
- Taxes: Are the most vital sources of Government revenue. It is a compulsory contribution by the population to any public authority.
- License: is the payment made to the government by an individual in order to secure permission or right to operate trade/business or any other gainful activity.
- Fines: are penalties imposed on citizens who break the laws of a country. They form also a substantial source of government revenue.
- Fees: are payments made by individuals for personal services rendered by the government g. money paid for surveying the land of an individual.
- Gifts and Grants: are voluntary contributions made by individuals and societies to the government for meeting the cost of specific projects/schemes in public interest.
- Disinvestment/privatization: it involves the sale of state-owned firms and assets to private individual and the proceeds are used to finance other government obligations.
- Compulsory savings: the government also gets revenue from such savings like insurance payments, social security funds e.t.c.
- Treasury bills/bonds: the government may at times “float” its treasury bills to the public as a means of raising revenue.
- Loans/borrowings: the government can at times borrow internally (from public) or externally (foreign countries) to finance its budget deficits.
- Government investments: the government also gets its revenue in form of profits from its commercial productive activities or the public co-operations.
- Deficit financing: at times there is shortage of money supply in the economy then the government may print more money to finance its obligations. This is usually inflationary in nature.
- Rates: are payments made on urban private properties e.g. lands, houses e.t.c. They are usually calculated on the basis of the value of income received or property value.
Reasons why the Government impose taxes
- Raise revenue-Taxes are the major sources of the government revenue and is the primary purpose of imposing taxes. The revenue collected is used to finance development economic projects and promote economic growth.
- Redistribute income
Through progressive taxes inequalities of income can be reduced by taxing the rich heavily and the poor less or by granting subsidies from tax revenue to industries and projects that benefit the poor.
- To protect home industries
The home industries especially infant industries can be protected by imposing heavy taxes on commodities coming from outside; thus making the imports expensive and encourage the consumption of locally commodity.
- To correct the balance of payment deficit.
When taxes are imposed on imports, taxes can be used to reduce consumption and expenditure on imports because the imports become more expensive and therefore it is an attempt to correct BOP deficit.
- To discourage consumption of dangerous goods
Taxes can be imposed on commodities which are considered dangerous to human health so as to make item expensive and discourage their consumption. Consumption of such products may include polythene, alcohol, cigarettes, and drugs.
- To control inflation
Taxes can be imposed so as to reduce the disposable income and consequently to reduce demand pressure in the economy.
- To discourage dumping
The government may impose tax on dumped commodities so as to raise their prices and reduce their competitive advantage over the locally produced commodities.
- To control monopolies
When imposed a lump sum tax can control monopolies by increasing the cost of production and reducing their profit margins forcing them to increase their output and open up.
- To promote savings-The government can tax and discourage the consumption of luxuries so as to encourage people to save for economic growth and development.
Principles of Taxation (Adam Smith’s Cannon of Taxation)
In his book the ‘wealth of nations’ Adam Smith gave four rules or cannons which should be followed when imposing tax throughout assessment and collection.
- Equity/Equality
A tax should impose equal sacrifice on all tax payers. The burden of the tax should be distributed equally to people’s ability to pay. There are two types of equality namely:-
- Horizontal equality – where different tax payers in similar situation/position are treated equally.
- Vertical equality – this is when tax payer who are in unequal situation are treated different e.g. the rich are taxed heavily than the poor.
- Certainty principle
The nature of the tax payer i.e. its base, the amount to be paid, the time of payment, the manner of payment should all be certain and known and not arbitrary.
- Convenience principle
Taxes should be collected during periods which are convenient to the tax payer in respect to time, season and availability of income. It should be imposed when the tax payer is in position to pay, the mode and places of payment should also be convenient.
- Economy principle (cheapness)
The cost of collecting the tax should be small in relation to the tax revenue i.e. the general cost of collection and administration of tax should be lower than the total revenue realized.
Other principles include:
- Productivity; tax should be able to generate enough revenue to justify its imposition.
- Elasticity; the tax collected should be able to increase or decrease with a rise or a fall in a tax payer’s taxable income or property respectively.
- Simplicity; the nature of the tax and the mode of assessment and collection should be straight forward and simple to understand by both the collector and the payers.
- Flexibility; the tax should be flexible depending on the economic circumstances and according to the requirement of the state.
Public Expenditure
Public expenditure is the amount of money the government spends on social services and the effects of such expenditures. Types of public expenditure:
- Re-current Expenditure
This is the money the government spends on daily consumption of goods and services in order to carry out administrative activities and to maintain law and order throughout the country.
These are expenditures that are continuous and are made in order to facilitate the day to day operations of the government.
- Capital development expenditure-This involves government expenditure on investments in sectors such as agriculture, industries, machinery and equipment, infrastructure, power e.t.c.
- Transfer payment
This is the money spent by the government on emergencies like relief and other types of disasters. It also includes grants, pension, scholar ship, bursary, resettlement packages.
Fiscal policy
Fiscal policy is a set of economic measures that use the public finance operations especially taxation and government spending through the budget to bring about economic stability in the economy.
Aims / Importance of Fiscal policy
- To reduce inflationary pressure in the economy
This is done by reducing money supply in the economy by increasing taxes, reducing government expenditures and internal borrowing in order to deflate the economy.
- To reduce unemployment in the economy
By increasing expenditure on investment projects and decreasing taxes and increasing internal borrowing.
- To achieve more acquitable income distribution in the economy
This is done by levying progressive taxes, subsidizing and setting up projects for the poor.
- To improve the infrastructure so as to raise the productivity of the economy. This involves setting up roads, schools, etc.
- To attain a balanced economic growth: this can be achieved through balancing expenditure between sectors and regions.
- To protect the home industries against aggressive competition from well established domestic firms.
- To improve Balance of Payment: this can be achieved by raising prices of imports through high import duties thereby reducing the import bills to overcome Balance of Payment.
- To provide social services and raise labour productivity: this is through building hospitals, schools e.t.c. and other social services.
Government Budget
A government budget is a fiscal statement of the revenue and expenditure estimate of government for a particular accounting period usually one year. It is usually prepared on annual basis and presented to the parliament by the minister for finance for approval. A budget deals with policy techniques that are aimed at directing the course of the nation for the coming fiscal year while also giving a preview of the precious one.
Types of Budget
The Government budget is basically of two categories namely:-
- The balanced budget
- The unbalanced budget
Balanced Budget
This occurs when the projected fiscal revenue equals the proposed total expenditure in a financial year; that is the planned revenue = the planned expenditure.
Unbalanced Budget
This is a type of budget in which the planned expenditure and revenue are not equal, there are two types namely: the deficit budget and the surplus budget.
Surplus – it is one in which the projected revenue is greater than planned expenditure in a given period usually a year.
Deficit –this is where expenditure is greater than revenue within a fiscal year.
Functions of a budget
- It indicates the estimate of revenue.
- It indicates estimate of recurrent and development expenditure of government.
- It outlines the economic and social policies whose implementation requires government expenditure.
- The Government budget stabilizes the economy through the fiscal policy.
- It regulates government expenditures and programs.
Public Debt
This includes the national debt plus the debt incurred by the local government authorities and public co operations. National Debt is a debt owned by the Central government to the people and institutions within its own borders (internal debts) and to foreign creditors (external debts).
National debts therefore refer to debt which the central government owns both to its nationals and outsider but doesn’t include the debt incurred by the local authorities.
Measures to reduce the debt burdens (debt servicing)
- Increased exports and expansion of foreign market for the exports.
- Improvement of domestic market so as to create a self sustaining economy.
- Reduction of domestic consumption to boost domestic investment; this helps to produce more goods for exports to increase foreign exchange earning.
- Reduction of imports by imposing strict foreign exchange condition.
- Reduction in the volume of debt programs to reduce borrowing from international financial market.
- Adoption of import substitution industries to reduce the need to import expensive commodities and save foreign exchange.
- Reduction of unproductive loans whose payment impose heavy burden on the population and are no self liquidating.
- Regulation of Government expenditure to reduce government budget deficit which are often caused borrowings.
- Encourage borrowing from low interest sources to pay high interest loans.
- Improving terms of trade of the commodities so as to improve BOP and minimize the need for borrowing.
- Debt cancellation; where the creditors are persuaded to cancel the debt.
- Debt relief measures where the affected countries get debt relief from the creditor nation.
Challenges of Public Debt
- An external debts leads to transfer of resources to a foreign country and this imposes a burden to the society as a whole.
- It may widen income disparity when the repayment of locally incurred debt redistributes income from the poor to the rich. This is because it is the rich who can afford to lead the government yet it is the poor who pay taxes to enable the government to repay the rich.
- The availability of loans encourages the government to use tax revenue on unproductive expenditures.
- Borrowing shifts the burden of repayment to the future generations who took no part in the decision to incur the loans.
- Debt servicing leads to forgoing current consumption especially the social service and infrastructure which is stalled.
- It encourage debt depends on other governments and institution that leads.
- External debts put pressure on the BOP position due to debt servicing.
- Debt servicing limits capital accumulation and investment in the economy.
- It may lead to inflation situation in the economy.
