Fiscal Policy: Types of Public Expenditure & Taxation (AQA A Level Economics)

• 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)

• Government expenditure represents a significant portion of the aggregate demand in many economies
• The expenditure can be broken down into three categories:

1. 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
   
   
2. Capital expenditures: These are investments in infrastructure and capital equipment. E.g. High speed rail projects; new hospitals and schools; new aircraft carriers
   
   
3. 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
   
   

• 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

• 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

• 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

1. Simple: taxpayers should know what, when, where and how to pay the tax
2. 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
3. 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
4. Efficient: the management of the tax system by the government should not be overly expensive or wasteful
5. Fit for purpose: there should not be any unintended side effects of the system, e.g. disincentivising workers from working
6. Flexible: it should be easy to adjust/change as required by changes in the economy

• 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