BUDGET:Components of Public Income, Use of Taxes, Types of Taxation

<< PUBLIC FINANCE:Background, Components of Public Finance, Dissimilarities

PUBLIC BUDGET:Incremental Budget, Annual Budget Statement, Budget Preparation >>

Introduction To Public AdministrationMGT111

LESSON 27

BUDGET

At the end of the lecture students will:

Understand the concept of budget

Examine the Revenue raising of the government (taxes Vs. Fee)

Examine the purpose, quality of good taxation, types of taxation, impact of taxation and

objectives and impact of public spending

First of we will see and try to explain the budget as a concept. A budget is a statement of income

and expenditure. By normal standards the expenditure should equal expenditure, so that the economic unit

(house-hold, government, firm etc.) stays in its mean. We will look at the example below to understand the

concepts involved in budget.

Example

In this example we have taken a household whose income is Rs. 7000 per month and its family

members are four. Let us see their budget for one month. This is given below

Expenditure

Income

Salary

5000

Food

3000

Rent on

Education

3000

Property

1000

Health

1000

Overtime

1000

Loan

Repayment

2000

Installment

2000

Other

2000

Total

7000

Total

13000

What we see here is that the expenditure exceeds income. When expenditures exceed income in a

given period of time, the budget is in deficit. What we observe in the example is that household has

borrowed money and loan is repaid every month. This loan was taken for creating asset, like a house, or a

piece of land, or motorbike etc. Another form of loan for which Rs.2000 installment is paid was also taken

to create another asset.

Expenditures are usually incurred to create assets or maintain assets like for education, health etc.

On the other hand an income is either the wages for labour or rent on property or return on assets. From

budget we can analyze where to reduce expenditure or increase income.

Why Organizations Need Budget

A household is a small economy, which uses inputs and gives output in the form of services that it

provides. Likewise organizations use inputs and process inputs to give outputs. Organizations need to

control the use of resources to ensure that these are utilized for the purpose of achieving the goals of

organization. Budgets also indicate what the organizations plan to do in future.

Budget

For any organization financial resources are an important input to the running of organization.

Organization generates resources to make expenditures to produce goods & services. Private

organization price their product or services on the basis of value of the product or service and cost in

producing product and in this way generate income. But organizations also create assets to produce output

which are source of income.

Definition of Budget

Budget is an instrument of financial control and management. It is summary of intended

expenditures along with proposals for how to meet this expenditure.

Introduction To Public AdministrationMGT111

It is also detailed plan of income and expenses expected over a period of time. It provides

guidelines for managing future investment and expenses.

Components of Public Income

Just as households have income, governments also have source of income. The source of income

for the government is taxes. Taxes are of various types. Besides taxes government have non tax receipts.

Following are the component of government income:

Tax Receipt: can be divided into direct and indirect taxes. Direct tax is levied on income. Indirect

tax is not directly on income but is paid through a product or service being consumed by user. You might

have purchased a bottle of Coca Cola or some other drink on which the rice is written plus sales tax. The

sales tax is indirect tax.

Non Tax Receipt: Non tax receipts comprise Income from Property & Investment and Receipt

from civil administration.

Use of Taxes

During the Moghul period and later British period government pursued the policy of laissez-faire

(leave alone) which meant that government chooses not to interfere with the economy or society. The taxes

that were collected were for the purpose of defence or law and order and the welfare concept was non

existent

Principle purpose of taxation

The governments of today have many sources of income but taxes remain an important source of

income. Today government's expenditures have also increased manifold. The main expenditure purpose is:

1. Redistribution of income (from rich to poor) or help finance welfare activities and

2. To achieve economic objectives such as control of inflation, economic growth, employment and

reduction of balance of payment deficit.

Principles of good Taxation

Since the foundation of modern economy was laid, there has been many changing ideas and

philosophy on the role of government. Along side the idea and principle of good taxation has also evolved.

Adam Smith the economist who wrote Wealth of Nation in 1776 said that a good tax has following four

principles:

A good tax should be equal: an individual should be called upon to pay tax according to his/

her ability to pay tax. This is called progressive taxation, where the rich pay the higher

percentage of taxation then poor;

A good tax should be certain: people are certain about how the tax works and how much

has to be paid as well as when to pay;

A good tax should be convenient: People should be able to pay without any inconvenience.

The Pay as You Earn (PAYE) system of income tax complies with this principles and

A good tax should be economical: the cost of collecting and administering should not exceed

revenues

There are several other principles of modern taxation. These are:

Tax should be impartial, two citizen who earn equal income and have same size of family

should be taxed the same;

It should not be disincentive to hard work and therefore should not penalize for hard work

i.e. that those who work hard and earn income should not be heavily taxed.

The tax should be consistent with government policy. If for example the government is

trying to reduce inflation, it should not pursue the policy of taxation which increases demand

too much in the economy

Introduction To Public AdministrationMGT111

Types of Taxation

Taxes tend to fall in two categories: direct and indirect taxation. Direct taxation is a tax levied

directly on individual's income. Whereas indirect taxation is levied on consumers' expenditure or outlay.

Following are the types of taxation:

1. Direct Taxes

Income Tax

Wealth Tax

Workers Welfare Tax

Capital tax

2. Indirect Taxes

Custom Duty

Sales tax

Excise Duty

3. Non- tax Revenue

Income from Property and Enterprise

Profit from Railways

Profit from PTCL

Profit from Post office

Miscellaneous: Foreign travel, passport fee, airport tax, sale proceed on oil and tax etc.

The government of Pakistan levies all the above type of taxes.

Advantages of Direct Taxes

Direct taxes tend to be progressive. People in the higher income groups pay greater taxes than poor

people, i.e. income tax is graduated so that high income earner pays a larger tax. Also projected wealth tax

would apply to those owing more than a certain level of wealth

It is cheap and easy to collect. Consider for example PAYE system which is used to collect income

tax from wages and salary earner

Impact of Taxation

Taxes have variety of impact of following:

On income: Higher taxes reduce disposable income (what people have to spend after taxation). Direct

taxes by directly reduce the income.

On savings and investment: Higher direct taxes reduce individuals' and firms' ability to save and invest.

To a certain extent it depends on how much of the increase in taxes is financed from savings and how

much from consumption.

On prices: Higher direct taxes have deflationary effect on prices by reducing demand. However trade

unions may ask for higher wages to compensate for higher taxes and effect of this will be inflationary.

Introduction To Public AdministrationMGT111

On economy: Higher taxation will, other things being equal, reduce demand in the economy which will

have deflationary effect on the economy.

Output

The affect of taxes is shown in figure 1 below. On the vertical axis is shown price and on horizontal

axis is shown output. With price `a' the demand for output is `b'. When demand decreases the output will

also decrease. So the tax increases price and reduce demand which reduces out put and which reduces

investment.

Concepts

Budget:

a document showing income and expenditure in case of

household; and an instrument of financial control and future

plans in case of organization.

Taxes:

levies charged by government as its source of income.

Non tax

Revenue:

fee, penalties, user charge etc., which constitute the income of

government

100

Table of Contents: