Taxes and Public Spending (I)

In most economies government revenues come mainly from direct taxes on personal incomes and company profits as well as indirect taxes levied on purchase of goods and services such as value added tax (VAT) and sales tax. Since state provision of retirement pensions is included in government expend­iture, pension contributions to state-run social security funds are included in revenue too. Some small component of government spending is financed through government borrowing.

Government spending comprises spending on goods and services and transfer payments.

Governments mostly pay for public goods. Clean air, national defense, health services are examples of public goods. Governments also provide such services as police fire fighting and the administration of justice.

A transfer is a payment, usually by the government for which no corresponding service is provided in return. Examples are social security, retirement pensions, and unemployment benefits and, in some countries, food stamps. In most countries there are campaigns for cutting government spending. The reason for it is that high levels of government spending are believed to exhaust resources that can used productively in the private sector. Lower incentives to work are also believed to result from social security payments and unemployment benefits.

Taxes and Public Spending (II)

Whereas spending on goods and services directly exhausts resources that can be used elsewhere, transfer payments do not reduce society's resources. They transfer purchasing power from one group of consumers, those paying taxes, to another group of consumers, those receiving transfer payments and subsidies.

Another reason for reducing government spending is to make room for tax cuts. Government intervention manifests itself in tax policy, which is different in different countries. In the United Kingdom the government takes nearly 40

percent of national income taxes. Some governments take a larger share, others a smaller share.

The most widely used progressive tax structure is the one in which the average tax rate rises with a person's income level. As a result of progressive tax and transfer system most is taken from the rich and most is given to the poor.

Rising tax rates initially increase tax revenue but eventually result in such large falls in the equilibrium quantity of the taxed commodity or activity that revenue starts to fall again. High tax rates are said to reduce the incentive to work. If half of all we earn goes to the government, we may prefer to work fewer hours a week and spend more time in the garden or watching television.

Cuts in tax rates will usually reduce the deadweight tax burden and reduce the amount of taxes raised but might increase eventual revenue.

If governments wish to reduce the deadweight tax burden and balance spending and revenue, they are supposed to reduce government spending in order to cut taxes.

Monetary System and Monetary Policies (I)

Today every country has a Central Bank. It acts as a lender to commercial banks and its acts as a banker to the government. It takes responsibility for the funding of the government's budget deficit and the control of the money supply, which includes currency outside the banking system. Thus, money supply is partly a liability of the Central Bank (currency in private circulation) and partly a liability of commercial banks (chequing accounts of the general public).

The Central Bank controls the quantity of currency in private circulation and the one held by the banks through purchases and sales of government securities. In addition, the Central Bank can impose reserve requirements on commercial banks, that is, it can impose the minimum ratio of cash reserves to deposits that banks must hold. The Central Bank also sets discount rate which is the interest rate commercial banks have to pay when they want to borrow money. Having set the discount rate, the Central Bank controls the money market. Thus, the Central Bank is responsible for the government's monetary policy. Monetary policy is the control by the government of a country's currency and its system for lending and borrowing money through money supply in order to control the level of spending in the economy.

The demand for money is a demand for real money, that is, nominal money deflation by the price level to undertake a given quantity of transactions. Hence, when the price level doubles, other things equal, we expect the demand for nominal balances to double, leaving the demand for real money balances unaltered.