Introduction to macroeconomics: UNIT 4

Lecturer: Rabecca Hatoongo-Masenke

August 2023
OBJECTIVES
 Define public finance.

 Discuss income sources

 Describe government
expenditure

 Discuss types of taxes

 Privatization vs Nationalization.

2
 INTRODUCTION
Public finance is concerned with government expenditure and
government revenue, and the difference between them, which can
either be a budget deficit or surplus and how this can translate into
debt. It also considers the use of fiscal policy to stabilize the economy.
What are the roles of the state
ROLES OF THE STATE (Political)
• To ensure institutionalization and implementation of laws (legislation)
• To enable the enforcement of the law (Judiciary)
• To ensure the protection of rights of the individual and entitles
• To protect and uphold people’s democratic rights (e.g., election or
referendum voters)
• To ensure national security and protect its citizens (military and state
police)
• To provide citizens with legal documents (birth certificates IDs
passport)
ROLES OF THE STATE (Economical)
• The government has to provide infrastructure social amenities for its
citizens (e.g., schools, hospitals, roads, etc.)
• To mitigate environmental effects such as pollution through instituting laws
and regulations.
• Candidate expenditure activities in the country and generate revenue
through taxes, debt, aid, and FDI.
• The state coordinates Public Financial Management (PMF). PMF deals with
the institutionalization, and management of procedures available to the
government effectively and transparency.
• This helps the state in mitigating such as inflation, poverty (income
distribution) unemployment, and stimulating economic growth.
THE GOVERNMENT BUDGET
• A government budget is an annual financial statement presenting the
government's proposed revenues and spending for a financial year
that is often passed by the legislature, approved by the chief
executive or president and presented by the Finance Minister to the
nation.
THE GOVERNMENT BUDGET Cont
• Budget Deficit
• Budget Surplus
• Balanced Budget
 ZAMBIA

• National Planning and Budgeting Policy (2014)-Responsive, Transparent, Accountable and Results-
Oriented Development Planning and Budgeting Processes.
• Designed to guide the process used to plan, implement, monitor and evaluate Development Plans
and Annual Budgets.
• Provide guidance on the attainment of values that enhance transparency, accountability, and citizenry
participation in the planning and budgeting process.
• Facilitate a more inclusive planning and budgeting system and with increased parliamentary oversight
with a view to have greater attainment of results that will have a positive impact on the people.
• Enhance development and service delivery impact of public finance, so that, alongside the goal of
sustaining robust economic growth, Government can attain the wider development objectives of the
nation, following:
• Reducing poverty (especially in the rural areas)
• Economic empowerment through employment creation and entrepreneurship (especially for the
youths)
• Reversing rising levels of inequality in the nation to ensure social justice.
• Incorporate national and regional initiatives and take into account the various progress reports on the
implementation of National Development Plans so that planning and budgeting processes are result-
oriented.
 GOVERNMENT EXPENDITURE

This is made up of capital and current expenditures.

• Government capital expenditure-refers to government spending on
investment goods. This means spending on things that last for a long
period of time such as investment in hospitals, schools, equipment
and roads.
• Government current expenditure-refers to government day to day
spending. This means spending on recurring items such as salaries
and wages, consumables and everyday items that get used up as the
good or service is provided
ZAMBIA GOVERNMENT
EXPENDITURE (% of GDP)

General government final consumption expenditure (formerly general government consumption) includes all government current expenditures for
purchases of goods and services (including compensation of employees). It also includes most expenditures on national defence and security, but
excludes government military expenditures that are part of government capital formation.

Source: World Bank WDI

GOVERNMENT REVENUE
Government revenue is money received by a government. It is an
important tool of the fiscal policy of the government. Sources of
government revenue:
• Tax Revenue
• Non-Tax Revenue
Zambia Government Revenue (% of GDP)

Revenue is cash receipts from taxes, social contributions, and other revenues such as fines, fees,
rent, and income from property or sales. Grants are also considered as revenue but are excluded
here.

Source: World Bank WDI

 NON-TAX REVENUE

• Aid from another level of government (intra-governmental aid)

• Aid from abroad (foreign aid)
• Borrowing domestic and foreign. Foreign borrowing both Bilateral and Multilateral plus from the
international capital markets.
• Revenue from state-owned enterprises (for example, revenue from Zesco, Zamtel etc)
• Revenue (including interest or profit) from investment funds (collective investment schemes),
sovereign wealth funds, or endowments.
• Revenues from sales of state assets.
• Rents, concessions, and royalties collected by the state when it contracts out the right to profit
from some good or service to a private corporation. Fines collected and assets forfeited as a
penalty. Examples include parking fines, court costs levied on criminal offenders.
• Fees for the granting or issuance of permits or licenses. User fees collected in exchange for the
use of many public services and facilities. Toll fees charged for the use of toll roads are an
example.
• Donations and voluntary contributions to the state
 TAX REVENUE

• Tax has three important features:

(i) It is a compulsory contribution, to the state from the citizen. Anyone refusing to
pay tax is punished under law. Nobody can object to taxation on the ground that he
is not getting the benefit of certain state services,
(ii) It is the personal obligation of the individual to pay taxes under all
circumstances,
(iii) There is no direct relationship between benefit and tax payment.
The other reasons for taxation are:
• To check the consumption of demerit goods like beer and cigarettes To reduce
inequality of incomes and wealth through a progressive system of taxation.
• To put into effect the “automatic stabilizers”,
• strategic and declining industries by introducing indirect taxes like import duties.
• To prevent the dumping of goods in the country from other countries.
 PRINCIPLES OF TAXATION

Adam Smith outlined the basic characteristics of a good tax system as the
four canons of taxation, namely:
• Equity, which means that taxes should be fair and therefore should
depend on an individual’s ability to pay. Taxes must be proportional to
one’s income.
• Certainty, with regard to the amount to be paid, how, where and when
it should be paid.
• Convenience of payment and collection by the taxpayer.
• Economy, that is, the cost of collection should not be excessive
especially in relation to yield.
• The additional principles of taxes considered by governments are
summarized as efficiency and flexibility.
 CLASSIFICATION OF TAXES

• Taxes can be classified in several ways depending on:

• Who is levying the tax? This can either be the Central or the Local
government.
• What proportion of a person’s income is taxed? There are three
categories:
A progressive tax - is a tax that takes an increasing proportion of
income as income rises.
A regressive tax - this takes a higher proportion of a poorer person’s
income.
A proportional tax - this is when the tax is the same proportion on all
incomes, whether large or small.
 TYPES OF TAXES

There are two broad type of taxes; direct and indirect tax.
A direct tax is a tax on income, profit or wealth. It is paid directly to the
revenue authorities by the taxpayer. Examples of direct taxes are
• Income Tax
• Corporation Tax
• Capital Tax
• Inheritance tax
 ADVANTAGES OF DIRECT TAXES
• Are equitable, that is they conform to the principle of “ability to pay”, through the
progressive system of taxation.
• Have an elastic and high yield; the rate of taxation can be increased and therefore
increasing government revenue.
• Are certain, both the taxpayer and the government know the amount to be paid,
how, where and when it should be paid.
• Lead to equal distribution of income and wealth, this again is through the progressive
system of taxation.
• Are automatic stabilizers through their progressive nature, taking more money out of
the economy (withdrawals) when the economy is in its “boom” phase, while taking
less money and increasing welfare payments when the economy is faced with a
depression?
• Are not inflationary like indirect taxes.
 DISADVANTAGES OF DIRECT TAXES

• High rates acts as a disincentive to efficiency, effort and enterprise.

Tax reduces the return on the investment and reduces a firm’s ability
to invest and expand as this depends on the retained profits.
• High rate might also encourage migration of skilled manpower to “tax
havens”
• High rates encourage tax avoidance. People find loopholes so as to
avoid paying tax. It also encourages tax evasion, which is illegal non-
payment of tax especially in the informal sector.
 INDIRECT TAX

An indirect tax is a tax on expenditure. Tax is paid indirectly to the revenue

authorities as part of the payment for a commodity or service, whenever particular
purchases are made. Examples of Indirect taxes are:
• Customs or import duties
• Excise duties, this is a tax on some locally produced commodities
• Value added tax.
True cost = selling price/(1 + 0.16)
Selling price = True cost (1 + 0.16)
 THE ADVANTAGES OF INDIRECT
TAXES
• Revenue yield from indirect taxes help to avoid high direct taxes.
• Payment is certain since they are difficult to avoid and to evade.
• Convenient to the taxpayer since they are paid in small amounts and at
intervals instead of one big lump sum of money which is deducted and
paid every month like pay as you earn. In addition, they are convenient
in that they are paid when an individual is in a position to buy the
commodity and therefore can afford to pay the tax.
• Economical in collection as companies and traders collect on behalf of
the government and reduce the administrative burden that should fall
on the revenue authorities.
• It is not harmful to effort and initiative like direct taxes. Instead, it is
less painful since it is hidden in the price of a commodity or service.
 THE DISADVANTAGES OF INDIRECT TAXES

• There are regressive, a flat rate like a poll tax, a specific tax charged as a
fixed sum per unit sold or an ad valorem tax which is charged as a fixed
percentage of the price of the good with no concessions for people in the
low income bracket, take a higher proportion of the income of low income
earners than high income earners.
• They do not depend on a person’s ability to pay both the rich and the poor
pay the same amount as tax as long as they both buy the same product or
service. Therefore they are not equitable.
• Some people who use unauthorized border entry points, the “black
economy”, may evade indirect taxes like customs duties.
• May encourage inflation, whenever value added tax, customs duties or
excise duties increase, the prices of taxed goods and services also increase.
• Possibly harmful to industry especially for goods with elastic demand
 LAFFER CURVE
A Laffer curve shows how tax revenue and tax rate are related. The theory argues that if tax rate is
0%, then government revenue would be zero. If the tax rate is 100%, again there would not be any
government revenue as individuals and firms would not be willing to contribute 100% of their
income to the government. No one would be willing to work.
The Laffer curve also shows the rate at which the government can achieve a maximum revenue Tr,
the tax rate should be Tx. In addition, it also shows that the government can achieve very high tax
revenue at two rates, 25% and 75%.
 PRIVATISATION VS
Privatisation implies
NATIONALISATION
• The transfer of the nationalized industries to private ownership.
• Selling state assets, either completely or partially
• Opening up state monopolies to outside competition
• “Contracting out” to the private sector services paid for out of public funds, such as, refuse
collection, which was previously done by the local government.
• Charging beneficiaries “Economic fees” for publicly provided goods and services like
hospitals and schools.
ARGUMENTS FOR PRIVATISATION
• Reduced burden on the public purse as the government no longer supports loss- making
nationalized companies. Privatisation allows a reduction in the public sector borrowing
requirement and tax cutting, as it provides funds for the treasury when companies are sold.
• There is greater economic freedom from detailed economic control as privatized companies
are not subject to state control.
 ARGUMENTS FOR PRIVATISATION
• Improved efficiency through competition in the market, this encourages
producers to cut their costs in order to be more competitive, and firms have to
be innovative in the search for profits.
• In addition to the above, there is also improved quality since firms have to
compete to survive and have to be responsive to customer complaints.
• If companies are not in state control, there is greater resistance to the power
of trade unions, industries are more fragmented and difficult to organize.
• Privatization leads to a creation of a property-owning class, more people are
able to buy shares, this gives buyers’ market power, they work harder and
strike less, a better understanding of private profit motive and business
problems.
• Costs and inefficiency decrease as bureaucracy from nationalized companies is
reduced.
 ARGUMENTS AGAINST
PRIVATISATION
• Privatisation does not mean that competition is automatically enhanced. Instead,
private monopolies have been created.
• Just as privatization does not mean competition, it also does not guarantee efficiency.
Customers have ended up with fewer services, and at higher prices.
• The quality of service has reduced, with costs being saved by reducing the number of
workers “right sizing”, paying lower wages and reducing the services that were being
provided, as mentioned above, some routes were termed “unprofitable” or the roads
“impassable”.
• Privatisation may allow people in rural areas without Economic power to suffer, since
loss- making services are not provided by the private sector, most of which are
important to the poorest members of the society.
• In theory, it is the loss-making companies that are supposed to be privatized, but in
practice, the privatization exercise is rarely properly done in most countries in the
world, for example asset sales are under-priced to attract buyers and in the process,
create big capital gains for private investors.
 NATIONALIZED INDUSTRIES
The public sector includes some businesses run by the government, such as Zambia
Electricity Company (ZESCO), Zambia Telecommunications Company (ZAMTEL), Lusaka
Water and Sewerage Company etc. Managers of such companies are accountable to the
elected politicians (ministers) in charge of that sector, and government-sponsored boards
such as the Zambia Energy Regulation Board, which regulates ZESCO, regulate them.
ARGUMENTS FOR
• Nationalization can lead to reduced costs through economies of scale, since with
increased competition, each firm produces less output on a small scale, and unit costs
increase.
• There is provision of uneconomic services for consumers. Nationalization, just like the
socialism or planned economic system, social benefits are placed above private profits.
It considers the net gain to society, to the point of keeping industries that are clearly
technologically inefficient, as in the case of Maamba coalmines. Another argument in
favour of providing uneconomic services is that it helps to protect employment.
 NATIONALIZED INDUSTRIES
• It is sometimes in the national interest that some basic industries are brought
under public control, especially, strategic industries which would be dangerous
under private ownership such as atomic or nuclear energy.
• It may also be necessary to carry out government policy, like controlling the
money supply, as in the case of the Bank of Zambia.
• Nationalized industries have sufficient capital available for investment,
because of government support. Where competition is wasteful, it may be
better to create a large state-owned monopoly, to avoid waste and duplication.
• A fairer distribution of wealth, the huge profits do not go to the capitalist
owners, surpluses are used for the benefit of society. A case in point is ZESCO,
the supernormal profits are used for rural electrification. The supernormal
profit also justifies the high salaries enjoyed by ZESCO employees.
 FISCAL POLICY
Fiscal policy is the use of government expenditure and taxation to try to
influence the level of economic activity. There are two types of fiscal
policy:
An expansionary (or reflationary) fiscal policy could mean:
• Cutting levels of direct or indirect tax
• Increasing government expenditure
A contractionary (or deflationary) fiscal policy could mean:
• Increasing taxation, either direct or indirect-Cutting government
expenditure.
• Reducing government expenditure while increasing taxes is what
leads to a government surplus.
 THE PUBLIC DEBT
This is the total amount of accumulated borrowing by the local and central
governments including public corporations, to its various creditors both local and
foreign, the International Monetary Fund (IMF), the World Bank etc. Note that
debt increases, interest rate payments form a large portion of government
expenditure. Debt management in terms of contracting, servicing and repayment
is a major element of the overall fiscal policy.
The debt instruments are of two types:
b. Marketable debt-this is either short-term debt that consists of treasury bills or
long-term debt that consists of Government bonds or by agreement in writing.
c. Non-marketable debt consists of any other debt raised by the Government
either internally or externally. In addition, the debt can be reproductive, that is,
used to purchase a real asset or it can be a deadweight debt, meaning that no
assets are covering the debt.
THE PUBLIC DEBT Cont

Source: World Bank WDI

Debt Service on External Debt

Total debt service is the sum of principal repayments and interest actually paid in currency,
goods, or services on long-term debt, interest paid on short-term debt, and repayments
(repurchases and charges) to the IMF. Data are in current U.S. dollars.
 POLICY CONSTRAINTS
• Previous policy decisions taken by the previous government, especially the fiscal and regional
policies.
• The Government may lack perfect knowledge/information of the economy. The statistics may be
outdated or based on estimates.
• Policy changes take time to implement and time to be effective, a time lag.
• There is no ceteris paribus, this means that there is no technique that to hold other variables
constant. Zambia has extremely free trading with borders very wide open compared to countries
like Zimbabwe and South Africa.
• Political factors often supersede prudent policy economic judgment, especially in a developing
country like Zambia with not enough checks and balances and unplanned by-elections!
• In addition to the constraints of information and time, the methods may be inefficient in that
they do not achieve their targets, or the pursuit of one policy instrument may limit the
effectiveness of the other.
• The fluctuating patterns of booms and recessions, the trade cycle, can affect the achievement of
macroeconomic objectives. For example, when there is international recession, there is no
economic growth.
~THE END~
References
• Libby Rittenberg and Tim Tregarthen (2012). Macroeconomics
Principles V.2.0. Open access textbook under Creative Commons.