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Government Finances and Taxation

Functions of Taxation
1. To raise money for government expenditure (approx. 50 bn per year, without it could not function) 2. To redistribute wealth taxing people with good incomes to provide an income for those who cannot earn it themselves. 3. To achieve desirable social objectives increasing tax on tobacco to discourage smoking and promote healthier living. 4. To provide merit goods goods which society deem should be available to anybody at some minimum quantity, regardless of their income e.g. Education, Food, Medical Services, Shelter 5. To provide public goods goods which benefit everyone e.g. An Garda 6. Acts as an automatic stabiliser when changes in government expenditure and tax revenue happen without any change in government policy as national income changes. As national income increases tax revenue automatically increases. This has the effect of dampening inflation & providing extra funds needed to finance current exp. E.g. If inflation occurs prices increase so pushing up the absolute cost of Gov. exp. However as prices rise Gov. Income from Indirect Tax will also increase giving it the extra income it needs to finance its expenditure & at the same time prices will slow down (Demand Pull Inflation)

Functions of taxation Cont.

7. To achieve some economic objectives such as:
Reduce inflation e.g. by cutting indirect taxes the Gov. can reduce Cost-push inflation, or by increasing Direct Taxes it can reduce Demand Pull Inflation. To encourage investment in certain industries E.g. Oil Exploration companies in Ireland are given generous tax incentives. Balance the balance of trade By increasing Customs Duties the Government can discourage the importation of Goods. Protect particular domestic industries Decreasing Taxes on Profits of SOME firms can protect these from foreign competition

Adam Smiths Canons of Taxation NB

There should be Equity of Taxation it should take into account the ability of people to pay the tax. Certainty of Taxation people should know their tax liability at the start of the year. Convenience of Taxation the method of payment should suit the taxpayer, not the government. Economy of Taxation the revenue from the tax should far exceed the cost of collecting it.

Modern Aspects
Taxation should not act as a disincentive to work if the
marginal rate of tax is very high people may be reluctant to take extra work. This would have a detrimental effect on the supply of Labour.

Taxation should not act as a disincentive to investment

If potential investors feel that too much of the profit which they could earn is to be deducted as tax, they may consider that the risk of investing their money is not properly rewarded. Results in a loss of extra productive capacity and potential employment.

Taxation should not act as a disincentive to save - If rate of taxation on interest earned on saving results in a negative rate of interest then dissaving would take place. Results in a lack of funds available for investment & lack of security later in life.

Progressive, Regressive and Proportional Taxes - NB

A progressive tax takes a higher percentage of income from a person as that persons taxable income increases, e.g. PAYE. A regressive tax takes a higher percentage of income from a low-income earner than from a highincome earner, e.g. VAT. A proportional tax takes a constant rate of tax from income as income rises.

The Impact / Imposition of Taxation

This refers to the individuals or companies on whom the tax is actually levied (imposed). These have to pay the tax directly to the government. For example:

The excise duty on petrol is imposed / levied on the petrol companies.


The (Effective) Incidence of a Tax

This refers to the people who bear the burden of the tax. For example: The tax on petrol is levied / imposed on the petrol companies. They pass this on in the form of increased prices to the motorists.

Tax Avoidance
Is the practice of using the Tax Code (laws) to the best possible advantage in order to reduce your tax liability to the minimum. This is legal. Tax Evasion Is the non-payment of taxes due by either making no tax returns or making false tax returns. This is illegal


Forms of Taxation
Direct taxes These are taxes on all forms of income, for example: PAYE Capital Gains Tax Capital Acquisition Tax DIRT. Indirect taxes These are taxes on transactions, for example: VAT Customs Duties Excise Duties Stamp Duties.


Advantages of Direct Taxation

1. It is a progressive tax equity.

2. It is a convenient form of taxation for most PAYE workers. 3. It is economical employers collect the tax and pass it on to the revenue commissioners. No fee is paid to the employer. 4. There is certainty of liability. Tax rates and tax bands are announced in the budget before the commencement of the tax year. 5. It simplifies government budgeting as national levels of income are well known.


Disadvantages of Direct Taxation

1. High rates of tax may discourage work and /or investment. 2. Direct taxes can be avoided by those working in the black economy. 3. If there is a small tax base (no. of people paying tax) then the burden of tax may be great on those paying the taxes.

Advantages of Indirect Taxation

1. People can reduce the amount of tax they pay by altering their consumption to those goods that carry a low rate of VAT. 2. Evasion of tax is almost impossible as everybody spends money in shops. 3. It is a cheap form of tax to administer as producers / retailers collect it free of charge and pass them onto the Revenue Commissioners. Thus there is economy of taxation.

4. The taxpayer often does not even realise that he / she is paying any tax as it is included in the price of the good. Thus there is convenience of taxation.
5. It is unlikely to act as a disincentive to work. May actually act as an incentive because of indirect taxes increase people need more money to purchase the same amount of goods.

Disadvantages of Indirect Taxation

1. It is a regressive tax system. It does not take into account a persons ability to pay the tax. 2. It lacks certainty. The government can never accurately forecast its revenue from these taxes. 3. Indirect taxes add to inflation. This may make Irish goods less competitive on both the foreign and the domestic markets. 4. These taxes increase the cost of living. They often lead to demands for wage increases which add further to cost push inflation. 5. Indirect taxes add to the administration costs of the business community and takes up much labour time for which there is no return.


Different Taxes
Ad valorem tax takes a given percentage of the price of the good. E.g. VAT A specific tax is levied at a given absolute amount on each unit of a good sold; for example, 10 on a litre of petrol. A proportional tax takes a constant rate of tax from income as income rises. A lump sum tax is a fixed sum of tax levied on a firm irrespective of its level of income / profit. Capital Gains tax is a tax on the profits from the sale of assets. Capital Acquisition tax is a tax on gifts received or on inheritances. Stealth Taxes charges made for the use of services provided by the government or by a local authority, e.g. water charges, household charge, bin charges and outpatients hospital charges. Double Taxation


Revenue Buoyancy
The actual taxation revenue collected for the year was greater than that which had been planned. E.g. Levels of Income tax in the past year had been greater than been planned.


Tax Increases & law of Diminishing returns

Some workers may find themselves better off on the dole Tax Evasion occurs as people are tempted to dodge tax. Increases in direct tax may slow down the economy and leads to less money being collected in other forms e.g. VAT. If increases in Direct Tax slow down the economy to such an extent , unemployment may occur and less money will be collected in Income tax

Reasons for a decrease in Tax Revenue

1. Fall in income tax revenue Increase in unemployment leading to an decrease in income tax revenue. Decreasing number of taxpayers contributing at a higher marginal rate of tax. 2. Lower indirect tax revenue Decrease in economic activity, leading to lower spending. 3. Increased in tax evasion Many citizens are not declaring their full income. Increase in the Black economy. 4. Corporation profits tax revenue has fallen With many businesses downsizing the amount of corporation profits tax revenue has fallen. 5. Emigration: many of the people who would be paying tax in Ireland have emigrated to find work abroad.



Potential Question




Characteristics of a Good Tax System




National Debt
The total outstanding amount of money borrowed by central government and not repaid to date, less liquid assets available for redemption of those liabilities at the same date. Made up of 1. Internal or Domestic Debt (money borrowed from citizens & institutions in the country 2. External Foreign Debt (money borrowed from abroad)


Reasons for National Debt

Productive Investment = money spent on projects which become self-financing over time e.g. Toll Roads (cause no problems in long term) Social Investment = involves financing projects which can never be self financing, but are desired and required by society e.g. Expenditure on Hospitals & Schools ( could benefit economy in long run better educated & healthier workforce) Current Budget Deficit = borrowing to finance current government expenditure e.g. payment of civil service wages. Undesirable form of borrowing as it simply delays taxation to a future date.

Problems associated with National Debt


The National Budget

This is a plan of Government income & expenditure for the year. It outlines how all policy initiatives in order to raise income and spend it.


Organisation of Government Finances

1. 2. 3. 4. Each Gov. Department makes estimate of all it expenditure for the coming year submitted to the DoF for approval. DoF calculates its estimated income for the coming year based on the current rev. structure. October the gov. published pre-budget estimates in the Pre-Budget Outlook sets out Economic & Fiscal Outlook for next 3 Years December all policy initiatives regarding public income & expenditure published in THE BUDGET along with social welfare & Tax changes. Budget must be approved by the Dil by passing The Finance Act (permission to raise revenue) and the Appropriation Act (permission to spend money). Finally Gov. Accounts are examined at year end by Comptroller 7 Auditor general to ensure all money spent & raised was done in accordance with legislation above. 31



Government Current & Capital Expenditure

Current Expenditure is spending by the government on the provision of goods and services which will be totally consumed in that year. E.g. Nurses Salaries It is Highly desirable that the governments current income covers current expenditure in that year. Capital Expenditure is spending by the government on assets which will benefit the country for some time into the future. E.g. A new Hospital. Borrowing for capital expenditure can be justified as the citizens of the future will benefit from this expenditure and so their future taxes can be used toward the repayment of the loans incurred.


Local Taxation
Commercial rates tax levied on properties which are used for business purposes (47% of operating costs to council) Local Gov. Fund comes from Gov. Department of Environment Heritage & Local Gov (out of our taxes) Household Charges Water Charges

Government Finances
Exchequer Balance The difference between total current and capital expenditure and total government income. General Government Balance (GGB) Total income minus expenditure of all arms of government, both local and national(local authorities, non-commercial state bodies). General Government Debt (GG Debt) This includes the National Debt, as described above, as well as Local Government debt and some other minor liabilities of government. Dead-weight debt or borrowings This is borrowed money that is not self-financing

Rolled Over Debt This is the substitution of an old debt for a new one.


NTMA National Treasury Management Agency

Allows government to delegate the borrowing and debt management functions of the Minister for Finance to the NTMA. Functions 1. Managing National Debt on behalf of the Government. 2. Provides financial advice, funding and guarantees for all major public investment projects. 3. Manages the National Pension Reserve Fund and other Government funds such as the Social Insurance Fund, the Dormant Accounts Fund as well as borrowing on behalf of the housing finance agency. 4. Provides a central treasury service by taking deposits and lending to local government bodies and liquidity management for the Central Bank & FSAI 5. Manages all personal injury claims brought against government 35 departments & other state authorities.

General Gov. Debt / GDP Ratio: This reflects our debt as a percentage of what we produce/earn in a year.


Government Finances
Balanced Current Budget planned current income = planned current expenditure
Surplus Current Budget planned current income > planned current expenditure Deficit Current Budget planned current income < planned current expenditure Balanced Budget planned total income = planned total expenditure Surplus Budget planned total income > planned total expenditure Deficit Budget planned total income < planned total expenditure. A Neutral Budget is one that is neither inflationary nor deflationary.



Fiscal Policy
Any action taken by the government which influences the timing, magnitude and structure of current revenue & expenditure.


Exchequer Deficit Total Income < Total Expenditure


Government Deficit what does the government do?

If the government is running a budget deficit, it has to borrow this money through the issue of government debt such as Treasury Bills and long-term government bonds. The issue of debt is done by the central bank and involves selling debt to the bond and bill markets. Most of the government debt is bought up by financial institutions but individuals can buy bonds, premium bonds and buy national savings certificates. Irelands credit rating had gone so bad that it withdrew from the bond market and went to the IMF/EU for a bailout. It is expected that Ireland will return to the bond market this year.

How would you reduce the Government Deficit and Effects?


How would you reduce the Government Deficit and Effects?


Consequences of a Gov. Deficit

Financing a deficit: A budget deficit has to be financed, the issue of new government debt to domestic or overseas investors can do this. But it may be that if the budget deficit rises to a high level, the government may have to offer higher interest rates to attract buyers of government debt. Difficulty Managing our finances as increased deficit means increased borrowing which means increased interest repayments. In the long run, higher government borrowing today may mean that TAXES WILL HAVE TO RISE and this would put a squeeze on spending by private sector businesses and millions of households. E.g. VAT, Income, Excise Reduction in Social Welfare Benefits as income needed to finance current levels is not there e.g. Child Benefit reduced Reduction of spending on State Services: Health, Education Fall in Economic Activity people have to pay higher taxes so have less disposable income to spend and may decide to save more for a rainy day. Job & Pay cuts in the public sector / Recruitment freezes Inability to Finance Productive & Social Investment which would benefit the country in the long run and may provide employment e.g. Dublin Metro

Consequences of Reducing Deficit


Privatisation = sale of state owned company to private owners. e.g. Eircom, Aerlingus (potentially ESB & the National Lottery)
In Favour Revenue from Sale (reduce debt) Shedding loss making company (financial burden removed) More competitive prices Employment Opportunities (increased share) Improved Quality & Choice (improved efficiency) Against Loss of Jobs + Security/ increased Social Welfare cutting back of loss making services Cost of sale = legal fees etc. Increased Prices as main motive to make profit Changes in pay, pension & working conditions


Nationalisation - Government acquires ownership of privately owned businesses (Banks e.g. Anglo Irish)
In Favour Stability to Economy (protect an important resource) Protection of Employment (& consumers) Ensure Availability of Credit to individual & businesses Continued provision of services Against Unnecessary state Interference (discourages investment) Shareholders forced to sell shares at unfair price Increased Tax on citizens to purchase & run nationalised business. Opportunity cost money spent could have been spent on something more productive. Profit Motive Gone Reduced Efficiency Large Financial cost needed to ensure future


Economic Effects of EU/ IMF bailout


Government Surplus Consequences


Government Surplus Consequences


Economic Outlook



Main Things I need to know about Tax

Function of Taxation Smiths Cannons & Modern Aspects (Characteristics of Good tax System) If these arent present poor tax system. Progressive & Regressive Tax Avoidance / Evasion - Definition Forms of Tax Direct & Indirect Adv (2) & Disadv (2) Types of Tax e.g. Stealth & Local Taxation Revenue Buoyance Definition Tax & Law of Diminishing Marginal Returns Broaden the Tax Base PED & Setting Indirect Taxes Reasons Tax revenue is Falling


Main Points on Gov. Finances

Definition of National Budget Current & Capital Budget (Income & Expenditure & examples) Budgetary Position (deficit 25.2 Bn.) National debt definition & problems (4) Debt / GDP ratio (117%) Fiscal Policy Definition NTMA & Functions (3 functions) How to reduce Budget Deficit (Increase Tax, Cut Expenditure & Consequences) Privatisation Definition + 2 arguments in favour & 2 against Nationalisation Definition + 2 arguments in favour & 2 against