Fiscal Policy: Types of Public Expenditure & Taxation (AQA A Level Economics)
Revision Note
Written by: Lorraine
Reviewed by: Steve Vorster
Sources of Government Revenue
The main sources of government revenue include taxation, the sale of goods/services by government owned firms, and the sale of government owned assets (privatisation)
1. 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, corporation tax, capital gains tax, national insurance contributions, inheritance tax
Indirect taxes are imposed on spending
The supplier is responsible for sending the payment to the government
Depending on the PED and PES producers are able to pass on a proportion of the indirect tax to the consumer
The less a consumer spends the less indirect tax they pay
E.g Value Added Tax (20% VAT rate in the UK in 2022), taxes on demerit goods, excise duties on fuel etc.
2. Sale of goods and services
Government owned firms sometimes charge for the goods/services that they provide
E.g. Charges on public transport and fees paid to access some medical services
3. The sale of government owned assets
Privatisation can generate significant government revenue during the year in which the government sells the asset
Most assets can only be sold once e.g. national airlines or railways
Some assets, such as the right for mobile phone operators to use the airwaves, can be sold every few years (the airway licence is for a defined period of time)
Types of Government Expenditure
Government expenditure represents a significant portion of the aggregate demand in many economies
The expenditure can be broken down into three categories:
Current expenditures: These include the daily payments required to run the government and public sector. E.g. The wages and salaries of public employees such as teachers, police, members of parliament, military personnel, judges, dentists etc. It also includes payments for goods/services such as medicines for government hospitals
Capital expenditures: These are investments in infrastructure and capital equipment. E.g. High speed rail projects; new hospitals and schools; new aircraft carriers
Transfer payments: These are payments made by the government for which no goods/services are exchanged. E.g. Unemployment benefits, disability payments, subsidies to producers and consumers etc. This type of government spending does not contribute to aggregate demand, as income is only transferred from one group of people to another
Why Governments Levy Taxes
Tax revenue is required to fund government expenditure
Diagram: reasons for government tax interventions
Taxes can be used to raise revenue, correct market failure, or generate more equity in society
Taxes can be used to discourage consumption
Excise taxes (on alcohol, cigarettes) can be used to reduce the consumption of demerit goods that create negative externalities
Tariffs (taxes on imports) can reduce imported goods
Taxes should aid the redistribution of income
A good tax system should help the government redistribute income from the rich to the poor
Revenue could also be used through the provision of services
Eg. Health care and education promote more opportunities for lower-income earners
Progressive, Proportional and Regressive Taxes
Tax systems can be classified as progressive, regressive or proportional
Most countries have a mix of progressive (direct taxation) & regressive (indirect taxation) taxes in place
An Explanation of Tax Systems
System | Explanation | Diagram |
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Progressive |
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Regressive |
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Proportional |
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Progressive tax systems are built around the idea of marginal tax rates
The calculation of an individual's personal income tax requires several calculations
Using this system, a salary of £60,000 would attract a tax bill of £11,499.80, calculated as follows:
Calculation Using UK Progressive Tax Rates - June 2022
Tax Band | Taxable Income | Tax Rate | Tax Paid on £60,000 |
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Personal Allowance | Up to £12,500 | 0% | 0 |
Basic Rate | £12,501 to £50,000 | 20% | £37, 499 at 20% = £7499.80 |
Higher Rate | £50,001 to £150,000 | 40% | £10,001 at 40% = £4,000 |
Additional Rate | Over £150,000 | 45% | 0 |
Total Tax Paid on £60,000 |
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| £7499.80 + £4,000 = £11,499.80 |
The average tax rate measures the overall burden of the tax on the taxpayer
The marginal tax rate is the tax paid on the last pound of income earned
Worked Example
Calculate the average tax rate for an individual who has an income of £38,000
Taxable income (£) | Income Tax Rate 2014/2015 |
---|---|
from £0 to £5 000 | 0% |
from £5 001 to £20 000 | 20% |
from £20 001 to £40 000 | 40% |
£40 001 and over | 50% |
Step 1: Calculate tax on each bracket
Individual pays tax: (5,000 x 0%) + (15,000 x 20%) + (18,000 x 40%)
Step 2: Sum each bracket
0 + £3,000 + £7,200 = £10,200
Step 3: Substitute values into the formula
The 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
Simple: taxpayers should know what, when, where and how to pay the tax
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
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
Efficient: the management of the tax system by the government should not be overly expensive or wasteful
Fit for purpose: there should not be any unintended side effects of the system, e.g. disincentivising workers from working
Flexible: it should be easy to adjust/change as required by changes in the economy
The Role & Relative Merits of Different UK Taxes
The tax system of a country determines who pays the most
In the UK, corporations pay less than households
In Singapore, households pay less than corporations
Graph: source of UK revenue by taxation type 2017-2022
Households have to pay VAT, Income tax, national insurance contributions (NICs)
Source: www.gov.uk
Role and Merit of Different UK Taxes
Direct taxes | Indirect taxes |
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