Public Finance and Taxation

Objectives:
• Explain how the government uses tax as a means of
public finance.
• Be familiar with the concepts and principles of taxation.
• Acquaint with the current tax proclamation and
regulation with regard to income tax, VAT, Excise,
turnover tax and related issues.
• Properly compute and report the different type of
taxes.
• Realize the effect of taxation on the legal, economic and
political system of any country.
 Chapter 1
Functions of Modern government

Economic activities and government

• Economic System refers to the laws and
institutions in a nation.
• The participation of the government in the
economic activities is essential to accomplish
the goals of any welfare state.
• The governments of advanced countries are
committed to stability and full employment.
 Cont...
• In case of under developed countries the
government aims at accelerated economic
development.
• Government sector can play a decisive role in
shaping and charting the path of any
economy.
• Depending on the level of development of
each country the roles of government sector
differ.
 Private Vs Public Goods

Private Goods
• Private goods refer to all those goods and
services, which are consumed by people to
satisfy their personal and private wants or needs.
• They relate to articles of food, clothing, shelter,
recreation, transportation, communication etc.
• These goods are priced in the market on the
basis of their cost of production on the one side
and the nature of demand on the other.
 Cont...

• Distribution of these goods is based on

effective demand and market price.
• private goods are divisible in the sense that
price mechanism divides people in to two
groups viz., those who want to consume them
and those do not.....
• private goods are subject to the principle of
exclusion.
 Cont...
• Externalities refer to favourable and
unfavourable effects which are associated
with the production of those goods.
• The externalities are also referred to as spill
over effects, neighbourhood effects or third
party effects.
• An atmospheric and water pollution of a
chemical and fertilizer factory in an area is an
example of unfavourable economic effect.
 Cont...
• The setting up of a factory in a backward
region will help the society in terms of many
things.
• The economic gain or economic loss
associated with externalities cannot always be
priced in the market and cannot be
apportioned to particular parties.
 Public Goods

• Goods and services produced to satisfy collective

wants are known as public goods
• Collective wants are those which are demanded by all
members of the community in equal or more or less
equal measures.
• Defence, education, public health, infrastructure
facilities like power, transportation and
communication, etc.
• These goods are produced and supplied by the
country to society to meet its collective wants for
increasing social welfare.
 Cont...

• They can not be divided and their benefits can

not be shared among people on the basis of
their requirement.(shared consumption)
• The principle of exclusion easily associated
with private goods is not applicable in the case
of public goods.(non exclusion principle)
• The price mechanism does not apply and
these goods can not carry a price tag.
 Cont...
• As everyone is a beneficiary -directly or indirectly
of the public goods, everyone is asked by the
public sector authorities to pay towards the cost
of production of the public goods.
• No one can refuse to pay for the supply of public
goods on the ground that they are direct
beneficiaries.
• Again the taste, preferences etc., of consumers
are not relevant and the public authorities do not
attach any importance to the consumers while
producing and supplying public goods.
 Cont...
• The government has the sole responsibility to
decide about how much of these goods should
be produced, the method of production and the
technique of distribution.
• public goods are supplied to all the people
irrespective of their ability and willingness to pay
for them.
• At the same time, the consumers do not have
any system of priority in the case of public goods.
 Adjusting for External costs or benefits
• Some private markets produced too much or too little
goods and services.
• The government can try to correct these market
failures to get the right amount of goods and service
to be produced.
• External costs occur when not all of the costs involved
in the production or consumption of a product are
paid by the producers and consumers of that product.
(some of the costs shift to others) Ex.- drunken driving
- pollution
 Cont…
• When people other than producers and consumers
pay some of the costs of producing or consuming a
product, those external costs have no effect on the
products market price or production level.
• As a result too much of the product is produced
considering the overall social costs.
• To correct this situation the government may tax or
fine the producers or consumers of such products to
force them to cover these external cost.
• If that can be done correctly less of the product will
be produced and consumed.
 Cont…
• External benefits occurs when people other than
producers and consumers enjoy some of the benefits
of the production and consumption of the product.
Ex. – vaccinations against contagious diseases
- Education
• They are not reflected in the market price and
production cost of the product.
• As a result too little products are produced.
• To correct this the government may subsidize
producers or consumers of these products and thus
encourage more production.
 Social and Merit Wants
• Social wants are collective wants require goods,
which are demanded by all members of society
equally whether the people have the capacity to pay
or not.
• Merit wants are essential private wants such as
food, cloth, house etc which are satisfied by the
government at low prices for the poor due to their
low level of income.
• The important difference between the satisfactions
of merit wants and of social wants is that the former
calls for interference with consumer preferences.
 Cont...
• It is for this reason that merit wants must have
substantial element of social wants.
• Others
 FUNCTIONS OF MODERN GOVERNMENT
AND FISCAL OPERATIONS
• Government of a modern state generally
undertakes the following functions:
(a). Allocation Function:
• The government operations basically involve
the efficient provision of government funds in
maximizing the welfare of the community.
• The government taxes the public and uses the
amount in providing certain facilities and
services.
 Cont...
• Fiscal operations of taxation and public
expenditure have the effect of transferring
resources.
• The objective of fiscal operations is to provide
for the proper allocation of resources between
private and public goods so as to maximize
social welfare.
 Cont...
(b). Distribution function:
• In a free enterprise economy, distribution of
income and wealth is unequal.
• Fiscal operations have been used to reduce the
incomes and wealth of the rich (through progressive
taxation) and using the money collected to raise the
income and standard of living of the lower income
group (through public expenditure).
• The use of fiscal policy to reduce inequality of
incomes and wealth has been quite common in
many countries.
 Cont...
(c). Stabilization Function:
• Modern economies are subject to
fluctuations, viz., business boom and inflations
on one side and business recessions and
depressions on the other.
• Such fluctuations are not in the interest of the
country.
• Fiscal operations have been used to moderate
these fluctuations and if possible to eliminate
them altogether.
 Cont...
• For instance, business booms and inflations
are sought to be controlled through heavier
taxation while business recession is sought to
be checked through public expenditure.
• Functions of modern governments are
broadening due to socio-political reasons.
(d). Maintain law and order
 Role of fiscal policy in the economic
development
Fiscal policy
• Fiscal policy is also called as budgetary policy.
• Fiscal policy refers to that segment of national
economic policy, which is primarily concerned
with the receipts, and expenditures of the
government.
• Fiscal policy relate to those activities of the
state that are concerned with raising financial
resources and spending them.
 Cont...

• According to Keynes government revenue and

expenditure should be used deliberately and
consciously to secure economic stabilization.
• Fiscal policy deals with the flow of funds out
of the private spending and saving stream into
the hands of government and the recycle
funds from government into the private
economy.
 Cont...
• Fiscal policy relates to the governments decision
making with respect to the following: 1.Taxation
2.Government spending
3.Government borrowing
4.Management of government debt
5. Others.
• Fiscal policy deals quite directly with matters,
which immediately influence consumption and
investment expenditure.
• It influences the income, output and
employment in the economy.
 Role of Fiscal Policy in the
Economic Development
• The primary task of fiscal policy is to allocate
more resources for investment and to restrain
consumption.
• The fiscal policy should reduce the economic
inequalities of income and wealth.
• Fiscal policy has to be used progressively for
raising the level of investments and savings
rather than keeping the consumption level.
• Fiscal policy has to be used as an instrument
of resource mobilization.
 Cont...
• Fiscal policy should encourage private investment and
attract foreign funds for development projects.
• Fiscal policy should control inflation within tolerable
levels since inflation mostly affects the poor.
• Fiscal policy should aim at reducing both regional and
social imbalances by directing investments to less
developed regions.
• Fiscal policy should assign high priority to the creation
of Investments in social and economic overheads.
• Fiscal policy can be used to mitigate the effects of
trade cycles such as inflation and depression.