Economics (9214) | Government income and expenditure

💰 Government Income and Expenditure: Managing the National Wallet

Hello future Economists! Welcome to a really important chapter: understanding how the government earns money (income) and where it spends it (expenditure). Think of the government as managing a huge national household. Just like your family needs income to pay for food, rent, and school supplies, the government needs income to pay for hospitals, roads, and police forces.

Don't worry if this seems tricky at first. We will break down complex financial concepts into simple, everyday terms. Mastering this topic is key to understanding how a national economy functions and grows!

Part 1: Government Income (Revenue)

Government Revenue is simply all the money the government collects over a period, usually one year. Where does all this money come from?

1.1 Sources of Government Revenue

The vast majority of government income comes from two main sources: Taxation and Non-Tax Revenue.

1. Taxation (The Main Source)

• Taxes are compulsory payments made to the government by individuals and firms.

• It's the mandatory fee we pay to live in a functioning society that provides public services.

2. Non-Tax Revenue (Other Income)

• This includes income earned without directly taxing people.

• Examples: Fees paid for licenses (like driving licenses), fines (like parking tickets), income generated from state-owned enterprises (if the government owns a railway company, for instance), and sales of government assets.

1.2 Understanding Types of Taxes

We categorize taxes based on who pays them directly to the government. This helps us understand who bears the burden.

A. Direct Taxes

• These are taxes paid directly by the individual or firm to the tax authority.

• The burden of the tax cannot easily be shifted to someone else.

• Analogy: The government reaches directly into your pocket/bank account.

• Key Examples: Income Tax (on wages and salaries), Corporation Tax (on company profits), Inheritance Tax (on assets passed down).
  

B. Indirect Taxes

• These are taxes paid when you purchase goods and services. They are paid to the government by the seller (the firm), but the firm raises the price, passing the burden onto the consumer.

• The burden is shifted from the producer/seller to the consumer.

• Analogy: The tax is hidden in the price tag, so you pay it indirectly when you buy something.

• Key Examples: Sales Tax or Value Added Tax (VAT), Excise Duties (taxes on specific goods like fuel, tobacco, or alcohol).

Quick Tip for Remembering: Direct taxes hit David (the individual). Indirect taxes are Included in the price.

1.3 Tax Structures: Who Pays What Proportion?

When we analyze the fairness of a tax, we look at how the tax rate changes as a person’s income changes.

1. Progressive Tax

• The percentage of income paid in tax increases as income rises.

• The rich pay a higher percentage of their income than the poor.

• Example: A person earning \$20,000 pays 10% tax; a person earning \$100,000 pays 30% tax. This is often used for Income Tax.

2. Regressive Tax

• The percentage of income paid in tax falls as income rises.

• Wait, how does that work? This usually applies to indirect taxes (like VAT or excise duties). Because the tax amount is fixed regardless of who buys the product, it takes up a much larger proportion of a low-income person's budget.

• Example: A \$1 tax on a loaf of bread. For a poor person earning \$100, that \$1 is 1% of their income. For a rich person earning \$10,000, that \$1 is only 0.01% of their income. The burden is heavier on the poor.

3. Proportional (or Flat) Tax

• Everyone pays the same fixed percentage rate, regardless of income.

• Example: Everyone pays 15% tax on their income.

Part 2: Government Expenditure (Spending)

Once the government has collected revenue, it needs to spend it. Government Expenditure is the total spending by the government on goods and services, and on making payments to transfer wealth.

2.1 Categories of Expenditure

Government spending is usually split into two main types: Current and Capital.

A. Current Expenditure (Running Costs)

• This is spending on day-to-day items that are consumed immediately or in the short term (usually within a year).

• This spending does not create future assets or wealth.

• Examples: Public sector salaries (e.g., police officers, teachers), heating and lighting for government buildings, paper and office supplies, debt interest payments.

B. Capital Expenditure (Investment Spending)

• This is spending on assets that last a long time (long-term investment).

• This spending improves the country's productive capacity and helps future economic growth.

• Examples: Building new hospitals, constructing new roads, investing in new technology for schools, building a power plant.

Analogy: If you own a house, paying the electricity bill is Current Expenditure. Building a new extension onto the house is Capital Expenditure.

2.2 Why Governments Spend Money (The Functions)

Governments spend money to achieve several key economic and social goals:

1. Provision of Public Goods and Merit Goods: The government provides essential goods that the free market wouldn't supply enough of (like defence or street lighting) or goods beneficial to society (like education and healthcare).

2. Redistribution of Income: Spending helps reduce the gap between the rich and the poor, primarily through transfer payments (see 2.3).

3. Managing the Economy: Spending can be used to stimulate the economy during a recession (for example, by funding large infrastructure projects, boosting employment).

4. Administration and Governance: Funding the police, courts, and government departments to keep the country running smoothly.

2.3 Transfer Payments: Money for Free?

A very important type of government spending is the Transfer Payment.

• These are payments made by the government to individuals or groups without any direct exchange for a good or service.

• They are used purely to redistribute income and provide a safety net for vulnerable citizens.

• Examples: Pensions for the elderly, unemployment benefits, child benefits, and welfare payments.

• Important Note: Transfer payments are not included when calculating Gross Domestic Product (GDP) because they are simply a transfer of money, not payment for production.

Part 3: The Government Budget

The Government Budget is a plan detailing expected income and expected expenditure over the next year. When the government compares its income (revenue) and its spending (expenditure), three outcomes are possible.

3.1 Budget Outcomes

We use the term Budget Position to describe the outcome:

1. Balanced Budget

• Income is exactly equal to Expenditure. (Revenue = Spending).

• This is rare in practice, as predicting economic changes is very difficult.

2. Budget Surplus

• Income is greater than Expenditure. (Revenue > Spending).

• The government has an excess of money. This can be used to pay off national debt or save for the future.

3. Budget Deficit

• Income is less than Expenditure. (Revenue < Spending).

• The government is spending more than it collects in taxes.

• How is the deficit funded? The government must borrow money, usually by issuing bonds (I.O.U.s) to the public and other countries. This borrowing contributes to the National Debt.

Understanding the government's budget position is vital, as it tells us whether the government is managing its finances responsibly or accumulating debt that future generations will have to pay.