Public Finance and Fiscal Policy
Public Finance and Fiscal Policy
Public Finance and Fiscal Policy
SCHOOL RESUMES “.
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Licenses. These are documents of authorization issued by government to individuals to
engage in specified economic activity such as hunting and fishing, and lumbering.
Licenses must be paid for therefore a source of revenue to government.
Fines collected and assets forfeitured penalty from law breakers. Examples of such fines
include parking and traffic offence fines, and court costs levied on criminal offenders.
Gifts, grants or donations and other contributions forwarded to government from
friendly countries and individual organisations.
Through disinvestment and sale of state assets. This is where government sells off its
shares in government business enterprises and state assets to private investors and
gets revenue in return.
By borrowing money from both internal and external sources.
The market dues collected from market vendors are a major source of revenue for local
governments in developing countries.
Taxation. Taxes are non-quid pro quo compulsory payments by individuals or legal
entity on whom the tax is levied to government authority.
Surplus income realized from national lotteries organized by the government.
Rent. Rent is the regular payment made by tenants of government property for the right
to occupy or use the property for example, ground rent on leased land.
Concessions, and royalties collected by the state when it contracts out the right to profit
from some good or service to a private corporation. Examples are contracts for
extraction of natural resources as minerals, timber, petroleum and natural gas, or
marine resources collected privately under license from state-owned lands.
Tolls. A charge for the use of a service such as roads and bridges.
Rates. A levy by local authorities on property within that locality. It is based on a fixed
ratable value of the property.
TAXATION:
Refers to a process of compulsory transferring of funds from the public to the central government or
local authority as a source of finance irrespective of the exact amount or service in return.
NOTE:
Distinguish between a tax and a fee.
Distinguish between quid pro quo & non quid pro quo payments.
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REASONS FOR TAXATION:
1. To raise public revenue:
The revenue raised out of taxes is used by the government for recurrent and development
expenditure.
2. Decrease income inequality in the country:
Progressive taxation is used to narrow the gab between the rich and the poor.
3. To protect home infant industry and other countries.
Import duties are increased to protect the local infant industries from unfair competition from
foreign industries.
4. To improve the B.O.P position in the country.
This is through increasing import duties to restrict the amount of imports so as to decrease the
excessive expenditure abroad.
5. To restrict production and consumption of undesirable goods.
Such products are taxed highly so as to market them very expensive and discourage their
consumption.
6. To influence resource allocation in the country.
Taxes are decreased on the activities where there is a need to increase resource allocation in the
country and are increased on activities that are considered non-essential in the country.
7. To control inflation:
Inflation is controlled by using direct taxes. An increase in tax helps to reduce people’s disposable
income hence controlling demand full inflation.
8. To control monopoly powers:
The super normal profits of monopolists are taxed either by way of a lump sum or specific tax. This
helps to decrease the powers of over exploiting the consumers.
9. To stimulate economic growth and development:
By restricting volume of imported goods to create market for local goods.
10. To decrease the burden of borrowing:
11. Used as a means of forced savings e.g. NSSF
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6. Direct taxation helps to control demand pull inflation through reducing disposable
income by imposing taxes on individual incomes.
7. Taxes regulate monopoly powers by imposing high taxes on super profits of
monopolists.
8. Taxes influence the level of economic growth by giving tax incentives which encourage
investment and production.
9. Taxes influence resource allocation through differential taxation; resources are
reallocated from highly taxed activities to less taxed activities.
10. Taxes promote hard work among people. Tax payers are forced to work harder in order
to be in position to meet their tax obligation as well as maintain their standard of living
before tax.
Negative effects of taxation;
1. Heavy Taxation discourages savings. This is because individuals are left with little
money to save after tax.
2. High corporation taxes discourage investment since they reduce profits of firms and
lower the enthusiasm to invest.
3. Heavy taxation reduces welfare of the people by reducing the level of consumption
expenditure since high taxation on incomes and goods reduce disposable income and
purchasing power of individuals respectively.
4. Heavy and highly progressive taxation discourages effort and initiative because high
incomes earned from extra effort is all paid in tax, which results into low level of
economic growth.
5. Heavy indirect taxes encourage illegal activities because people attempt to avoid paying
high taxes.
6. High indirect taxes are inflationary. Since they result into hiking of market prices of
goods on which they are imposed.
7. High Taxation leads to misallocation of resources as entrepreneurs divert resources
from highly taxed activities to non-productive activities.
8. Heavy taxation creates resentment among people which erodes political popularity of
government.
9. High taxation reduces benefits from trade due to the fall in the volume of trade.
10. Regressive taxation worsens income inequality in the country.
11. Taxation lowers the standard of living of the people because it reduces the amount of
goods and services they can buy due to reduced spending power.
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10) Consistency: Should be in line with national economic objectives, especially in allocation of
resources.
11) In built stabilizer: It should have stability influence on the economy e.g. B.O.P and price stability.
12) Non double taxation: No income base must be taxed.
FORMS OF TAXES:
These are to forms of taxes i.e. Direct and Indirect tax.
1. Direct taxes:
These are taxes that are levied by the central or local authority directly on income or property of
individuals and the incidence of the tax rests on the tax payer concerned and cannot be shifted to
other individuals.
a) They are simple to understand and implement because a proper assessment is done by paying the
tax.
b) They enable the government to raise revenue for her expenditure:
c) It is used by the government to re-distribute income i.e. through the use of a progressive tax the rich
are taxed more than the poor which helps to decrease the economic gap.
d) They are used to fight inflation in the country. The high taxes charged help to decrease people’s
disposable income hence decreasing aggregate demand and controlling demand through inflation.
e) They are flexible in nature i.e. the government can increase or decrease the amount of the taxes
according to the performance of the economy.
f) The incidence of the tax is very clear i.e. the tax burden falls on the person the tax has been imposed
and can not be shifted to another person.
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g) It is easy to estimate the government tax revenue because the rates are fixed by a given period of
time which facilitates government planning.
h) They are convenient to the tax payer i.e. the taxes are paid when the income is got e.g. employees
pay PAYE at the end of the month after getting their salaries.
i) Direct taxes are equitable in nature i.e. people with low income levels pay taxes that are less than
people with high income levels also people with the same income level pay the same tax.
j) It is easy to determine the people to be exempted from paying a tax unlike the indirect taxes.
Disadvantages of direct taxes:
i. High corporate taxes decrease profits which discourages production, re-investment and hinders the
expansion of the firm.
ii. Direct taxes discourage hard work and productivity especial when they are progressive in nature.
iii. They are always an inconvenience to the tax payer when they are paid in lumpsum.
iv. They decrease the level of savings and consumption since the high taxes decrease people’s
disposable income.
v. They result into political resentment and sabotage leading to the unpopularity of the government.
vi. They are difficult to assess fairly because most of the tax payers are dishonest.
vii. They are expensive to collect, this is mainly because people are scattered all over the country and
others are under subsistence production.
viii. The tax burden falls on very few individuals who have the income and are honest since majority are
poor and unemployed.
ix. They can be inflationary in nature since high taxes may force workers to demand income high wages
causing cost push inflation.
Indirect taxes:
These are taxes that are levied on goods and services in an economy and the incidence of the tax can be
shifted by the tax payer to other people. They are a.k.a. out lays.
ADVANTAGES OF VAT:
1. It helps to check on double taxation since it is levied at every successive stage.
2. It minimizes tax evasion because of the limited loopholes.
3. It encourages book keeping which promotes efficiency among the traders.
4. Reduces corruption since payment is made directly on the account of the tax payment.
5. It is economical because of the less expenses involved.
6. There is a possibility of tax credit this is where a registered trader is allowed to use the VAT revenue
for system before submitting it to the URA.
7. It is not a disincentive to resource allocation because the tax burden can be shifted to the
consumers.
DISADVANTAGES OF VAT:
a) It is complicated to understand hence causing a lot of resistance.
b) It decreases the economic welfare of people by decreasing their purchasing power.
c) It is inflationary in nature. Producers increase prices for the products in response to VAT.
d) High rates of VAT scare way investors leading to limited capital inflow.
e) It involves a lot of costs advertising VAT.
f) It is a disincentive to consumption since it is paid by people who buy goods.
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x. Opposition to the government where the population tends to sabotage government policies
including paying tax.
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v. Developing social, economic infrastructure e.g. construction of roads to make many areas accessible
for taxation.
vi. Fighting corruption and embezzlement so as to increase the subsistence sector and increase the
number of sectors that pay tax.
vii. Encouraging commercialization so as to decrease the subsistence sector and increase the number
sectors that pay tax.
viii. Fighting corruption and embezzlement so as to decrease leakages in the tax collected.
ix. Reducing tax concessions that are given to the private investors especially the foreign investors in
the country.
x. Creating a conducive environment so as to encourage investment in the country which increases
production and the level of employment.
xi. Promoting better services to the public using the tax revenue collected so as to encourage people to
continue paying tax.
TAXABLE CAPACITY.
This is a term used in reference to either an individual or a nation.
Taxable capacity of an individual is the extent to which a tax payer is able to pay a tax assessed on
him/her and yet remains with enough disposable income to enable him live a descent life to which him
and his family are accustomed.
Taxable capacity of a nation refers to the extent to which a government can levy taxes without causing
adverse effect to the tax payer. Or the extent to which the government levies taxes without producing
or causing socially, politically and economically harmful effects.
TAX RATES:
This refers to the percentage of tax on either income or expenditure power of an individual.
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The tax rate can either be progressive, proportional, regressive or digressive tax.
PROGRESSIVE TAX:
This is the one whose rate increases with increase in income level. Or spending power of an individual
i.e. the higher the income the higher the percentage deducted as a tax i.e. PAYE
Progressive tax is the system of taxation where the tax rate increases with increase in taxable income of
an individual.
ADVANTAGES:
i. It increases government revenue.
ii. It helps in decreasing income inequality.
iii. It enables people to pay according to their ability.
DISADVANTAGES:
i. It’s a disincentive to hard work.
ii. It discourages savings because tax rate increases as income increases.
iii. It tends to discourage both local and foreign investors.
iv. It causes resistance and resentment from the rich.
PROPORTIONAL TAX:
This is the tax whose rate remains constant irrespective of change in income of spending power of an
individual.
ADVANTAGES
a. Encourages savings and investment.
b. Encourages hard work.
c. It’s easy for every one to calculate and understand since the percentage is constant.
d. Makes the government unpopular.
DISADVANTAGES:
a. Increases income inequality because the poor and the rich are taxed at the same rate.
b. It is less productive inform of revenue raised by the government.
c. The burden is bigger on the low income groups as to the high income earners.
REGRESSIVE TAX:
This is the tax whose tax rate declines as the taxable income increases i.e. the percentage of the tax is
higher on the low income earners and low on the rich.
EFFECTS:
i. Widens income inequality.
ii. Creates low tax revenue.
iii. Encourages hard work since the rich pay a lower rate.
iv. Doesn’t make the government unpopular among the rich.
DEGRESSIVE TAX:
This is the one whose rate increases with increase in income up to a certain point beyond which the tax
rate remains constant irrespective of the change in income.
EFFECTS:
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i. It increases government revenue especially when still progressive.
ii. It decreases income inequality when still progressive.
iii. It exploits the poor when proportional.
iv. It discourages savings when progressive.
Illustration
Forward shifting of a tax is where the tax payer transfers the tax burden to the consumer through
increasing prices e.g. to retailer who increases prices for commodities after a tax is levied.
Backward shifting of a tax is where the tax that has been levied i.e. the ultimate person to bear the tax
burden after it has been imposed.
INCIDENCE OF A TAX
This refers to the final resting point of the tax has been levied i.e. the ultimate person to bear the
burden after it has been imposed.
Tax burden is what is finally felt by a person who pays the tax at the last stage of distribution.
How the Producer and the consumer share the tax incidence.
Sharing of the tax incidence between the producer and consumer depends on the price elasticity of
demand of the commodity.
1. If its inelastic:
If demand for the commodity is price inelastic, the consumer takes the biggest portion of the tax
and the producer takes a small proportion as illustrated below;-
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2. If demand is elastic:
The producer takes a bigger portion of the tax and the consumer takes a smaller portion as
illustrated.
3. If demand is unitary.
SUBSIDIES:
These are payments by the government to cover part of the costs involved in production or
consumption.
ADVANTAGES:
a. Decreases prices for the final goods leading to improved welfare of the consumer.
b. Decrease the cost of production.
c. They attract increased investment in the sectors that are subsidized.
d. They increase employment opportunities as investment expands.
e. Decrease income inequality especially when put on goods consumed by the poor.
f. They attract public support especially when most of the essential goods are subsidized.
g. They help to protect home infant industries.
h. They enable the poor to purchase goods which would have been expensive for them.
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DISADVANTAGES:
1. They increase government expenditure both in subsidizing the consumers and the producers.
2. They decrease the tax base since the producers are subsidized in the production process.
3. They discourage hard work since consumers expect to be supported by the government.
4. They increase government tax for some sectors to raise revenue to subsidize the poor.
5. Increases the need for foreign aid so as to raise revenue to give subsidize.
FISCAL POLICY
Refers to the deliberate government policy to use taxation, and government expenditure programs to
regulate the level of economic activities.
A national debt refers to the total borrowing by the central government both within and outside the
economy.
Or
A national debt refers to what the central government owes to citizens lenders both within and outside
the economy.
b. External debt:
Refers to the total borrowing from outside the economy by the central government, local
authorities and public corporations.
e. Funded debt:
This is a long term debt for which there is no redemption date but the borrower keeps on paying
interest on the principle.
j. Soft loan:
This is the one on which a low interest rate is charged and a long grace period is given.
k. Hard loan:
This is the one on which a high interest rate is charged and a short period of grace is given.
l. Consul loan:
This is a type of public debt where repayment has been postponed due to agreed terms between
the lender and the government that is borrowing.
Revision questions:
i. Distinguish between the funded debt and an unfunded debt.
ii. Explain the merits and demerits of borrowing.
a. The percentage of the total public debt to the total population of the country.
i.e. Total public debt x 100
Total population
b. The percentage of the total public debt to the total labour force of the country
I.e. Total Public debt x 100
Total labour force
c. The percentage of the total public debt to the total labour force of the country
I.e. Total public debt x 100
Total tax revenue
d. The percentage of the total public debt to the total GNP of the
country I.e. Total public debt x 100
Total GNP
e. The percentage of the total public debt to the total foreign exchange earnings
I.e. Total public debt x 100
Total foreign earnings.
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THE NATIONAL BUDGET
This is a statement showing an estimate of revenue the government intends to raise and how it plans to
use that revenue in a financial year.
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2. It helps to protect domestic infant industries/ firms against competition. This is done through
increasing the import duties and subsidizing the infant firms so that they can grow and compete
favourably.
3. It’s used to increase employment opportunities in the country. The budget identifies various
projects to be invested in so as to increase employment opportunities e.g. agriculture,
infrastructural development, etc.
4. Helps to reduce income inequality in the economy. This is through encouraging income
redistribution policies like progressive taxation, subsidizing the poor.
5. It helps to improve the balance of payment position of the country. This is by decreasing the imports
to save the scarce foreign exchange and encouraging large scale production for the export market.
6. Used to protect the economy from inflation/ helps in attaining and maintaining price stability. This is
by encouraging production of goods and services to avoid scarcity in the economy.
7. Helps to manage public debts.
8. Enables the government to raise tax revenue for her expenditure.
9. It helps to influence balanced regional development in the economy. During the budget, the
government fairly allocates resources to facilitate development of different regions.
10. It’s used as a tool of attracting public support especially when it shows better performance in the
previous years and the government promises to do better.
11. Used to attract inflow of resources coming from out e.g. foreign Aid
12. Helps in reducing economic dependency.
13. Helps in regulation of government expenditure.
14. Helps to discourage consumption of harmful/ demerit/undesirable products.
A surplus budget is one where the estimated government revenue is greater than the estimated
government expenditure.
A deficit budget is one where the estimated government revenue is less than the estimated government
expenditure.
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METHODS OF FINANCING A DEFICIT BUDGET
a. Borrowing internally and externally.
b. Appealing for grants and donations.
c. Disinvestment mainly through privatization of local and foreign enterprises.
d. Printing and issuing money.
e. By special assessment.
f. Use of compulsory savings e.g. NSSF
g. Through national lottery.
STEPS TO DECREASE BUDGET DEFICITS IN UGANDA.
a. Improving the political climate so as to increase investment and production.
b. Putting in place policies to restrict high population growth rate through family planning.
c. By widening the tax base and taxable capacity of the country.
d. Fighting corruption and embezzlement through enforcing strict laws.
e. Developing industries to increase the export value and earn more foreign exchange from exported
products hence earning more from abroad.
f. Encouraging progressive taxation to raise revenue from the rich.
g. Widening non tax sources of revenue.
h. Improving the level of technology to increase efficiency in production.
i. Diversification of the economy to increase production.
j. Widening market through regional economic integration like EAC, COMESA.
k. Improving the level of infrastructure to allow investments.
l. Fighting inflation to attain price stability.
m. Further privatization of public corporations.
n. Encouraging commercialization to increase production.
o. Strengthening the tax administration.
p. Decreasing expenditure on politicians and civil servants.
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