PUBLIC FINANCE- ECO 204 For Economic Students

1. PUBLIC FINANCE
1
MACROECONOMICS 1
ECO 204

2. 2
+2349094238602/Ibrahim.bak
are@lasu.edu.ng/bakgiit@yaho
o.com

3. CONTENTS
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 Introduction
 Why government intervention?
 Government Expenditure and Revenue
 Growth in Public Expenditure
 Taxation

4. INTRODUCTION
4
 PF represents a package of those policy problems
that involves the use of tax and expenditure
measures (Musgrave and Musgrave, 2004).
 The finance of the government incorporates the
generation of revenue and allocation of income
generated to various sectors for proper and effective
management of the economy (also see: Bakare,
2014).

5. WHY GOVERNMENT INTERVENTION?
5
 Government intervenes in economic activities out of
market failure or the failure of free market
enterprises system to fulfil the expectations of the
society at large. Other reasons for government
intervention are articulated as follows:
 Due to business fluctuations
 Income inequality

6. WHY GOVERNMENT INTERVENTION?
6
 Uneven Development
 Externalities
 Curbing monopolist practices
 Defence/ National security

7. GOVERNMENT EXPENDITURE AND
REVENUE
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 The Budget
 This is a financial statement of the sources and uses
(i.e revenue and expenditure) of the government. It
is a financial plan of the projected expenditures and
revenues of a unit of government for the ensuring
fiscal period. It is basically a tool for selecting a
particular mix of public and private goods and
services.

8. GOVERNMENT EXPENDITURE AND
REVENUE
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 There are four characteristics a budget must fulfil.
They are:
 Equilibrium: There must be a balance between the revenue and
expenditure;
 Comprehensiveness: It must take care of all facets of the economy;
 Unity: All fiscal operations are spelt out in the budget; and
 Periodicity: The Nigerian budget is usually read at the beginning
of every year.


9. GOVERNMENT EXPENDITURE AND
REVENUE
9
 The budget is an important economic document of a
country. It reveals the state of the economy and what
future trends the country will follow. The budget is
always presented like a balance sheet in a tentative
form after all ministries have submitted their input

10. GOVERNMENT EXPENDITURE AND
REVENUE
10
 It is then sent to the congress, that is, Senate and
House of Representatives to be adopted as a final
budget. The legislative bodies will scrutinize, adjust
or delete or ask the executive to modify some portion
of the budget. Once the house passes the budget; it
becomes operational. In a democracy, no
government can spend money without the approval
of the parliament. Hence, the executive can only
operate the budget after the House has adopted it.

11. GOVERNMENT EXPENDITURE AND
REVENUE
11
 The executive can either operate surplus budget, that
is, when the revenue to be generated is forecasted to
be greater than expenditure, or it can operate a
deficit budget where expenditure is greater than
revenue. A balanced budget is where the government
intend to spend the actual money being received.
That is, the revenue equals expenditure. At the end
of the accounting year, the executive including its
various ministries and parastatals must account to
the whole country how money was realized and spent

12. GOVERNMENT EXPENDITURE AND
REVENUE
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 Budget Concepts
 Recurrent expenditure: These are cost, know as
running cost, which the government undertake in
its-day-to-day activities. These cost includes wages
and salaries, national debt interest, etc.

 Recurrent revenue: These are receipts of monies
from fines, taxes, fees, etc. by the government.

13. GOVERNMENT EXPENDITURE AND
REVENUE
13
 Capital expenditure: These are expenditure on
capital projects. Such projects include: provision of
hospitals, roads, defence, social and community
services, etc.
 Capital receipt: These are loans, aids, grants, etc.
made to the government by foreign government or
international organizations. Other arms of
government can extend such facilities

14. GOVERNMENT EXPENDITURE AND
REVENUE
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 Budget Surplus and Budget Deficit
 The budget can be in surplus or in deficit. The Budget
Surplus is the excess of the government’s revenue,
consisting of taxes, over its total expenditures consisting
of purchases of goods and services, and transfer
payments. That is, the budget surplus (BS) is:
 BS = T – G – R
Where, T = Taxes,
G = Government purchases, and
R = Transfer payment

15. GOVERNMENT EXPENDITURE AND
REVENUE
15
 A negative budget surplus, an excess of expenditure
over taxes, is a payment. A negative budget surplus,
an excess of expenditure over taxes, is a Budget
deficit (BD):
 BD = -BS = G + R – T
 Given an income tax, T = T0 + T1Y, the budget
surplus is
 BS = (T0 + T1Y) – G – R
 Therefore, we can plot the budget surplus as a
function of the level of income for given G = G0, R =
R0, and income tax rate = T1.

16. GOVERNMENT EXPENDITURE AND
REVENUE
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The Budget Surplus
BS BS=(t0+tIY)-G0-R0
0 Y
-(G0 +R0)

17. GOVERNMENT EXPENDITURE AND
REVENUE
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 At low levels of income, the budget is in deficit (the
surplus is negative) because payments G0 + R0
exceed income tax collection. For high levels of
income, the budget is in surplus, since income tax
collection outweighs expenditures in the form of
government purchase and transfers.

18. GOVERNMENT EXPENDITURE AND
REVENUE
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 There can be an increase in customer spending, if an
increase in government spending is being followed
by an equal amount of additional taxes (Balanced
budget). If income is devoted to consumption, any
increase in taxes will reduce disposable income and
consumption will fall. But the rate of the fall in
consumption will not be equal to the rate of tax.
However, government purchasing will increase by
full amount of taxes. Thus government purchases
rises more than consumption purchases and there is
a net increase in the level of purchases in the
economy.

19. GOVERNMENT EXPENDITURE AND
REVENUE
19
 Therefore, the balanced budget theorem states that if
marginal propensity to tax is 0, then the multiplier in
the case of increasing both expenditure and taxes by
the same amount, keeping the budget at balanced if
it is initially balanced, is 1: that is, income could be
increased without incurring a deficit
 In essence, an increase in the level of government
purchases tend to expand the equilibrium level of
purchases in an economy even when they are
accompanied by an equal increase in the amount of
taxes.

20. GOVERNMENT EXPENDITURE AND
REVENUE
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Algebraically: - ∆Y + ∆Y ……………………………………( 1)
∆G ∆T
 But Y = C + I + G ……………………………….(2)
 C = Co + cYd …………………………………… (3)
 I = Ī …………………………………………………(4)
 G = Ġ …………………………………………………(5)
 T = to ………………………………………………….(6)

21. GOVERNMENT EXPENDITURE AND
REVENUE
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 By substituting (3), (4), (5), and (6) into (2), we shall
have:
 Y = Co + cYd + Ī + Ġ
 Y = Co + c (Y – T) + Ī + Ġ
 Y = Co + c(Y – t0) + Ī + Ġ
 Y = Co + cY – ct0 + Ī + Ġ

22. GOVERNMENT EXPENDITURE AND
REVENUE
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 Y – cY = Co – ct0 + Ī + Ġ
 Y (1 – c) = Co – ct0 + Ī + Ġ
 Y = 1 (Co – ct0 + Ī + Ġ) …………………………(6)
 1 – c
 ∆Y = 1 ……………………………...…(7)
 ∆G 1 – c
 ∆Y = -c …………………………………(8)
 ∆G 1 – c


23. GOVERNMENT EXPENDITURE AND
REVENUE
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 Substitute (7) and (8) into (1)
1 + - c
1- c 1 – c
1 – c
1 – c = 1

24. GROWTH IN PUBLIC EXPENDITURE
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 Defence
 Population/Urbanization
 Development projects
 Depreciation and devaluation of currencies
 Interest on debt
 Rising income levels
 National crises/War
 Changes in political/bureaucratic structure
 Technological/Innovative changes

25. THEORIES OF PUBLIC EXPENDITURE
GROWTH
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 1. Adolph Wagner’s Law of Rising Public
Expenditure
 His theory was written in the 1880s
 It was predicated on trends to be realized 50
to 100 years later
 Wagner argues that as per capita incomes of
industrialized countries, the relative share of
of the public sector in national output would
rise.

26. THEORIES OF PUBLIC EXPENDITURE
GROWTH
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 Wagner’s law categorizes government expenditure
into three:
 Administrative and protective functions of the
government,
 The cultural and welfare functions of the government
which includes expenditures on education and
income distribution, and
 Provision of services by the government.

27. THEORIES OF PUBLIC EXPENDITURE
GROWTH
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 2. Peacock and Wiseman Theory/
displacement theory
 The theory was offered by both Allan Peacock
and Jack Wiseman
 The theory provides explanation for t he time
pattern of change in the level of publick
expenditures
 The theorists observed from the time series
data in Britain that public expenditure grew
in step wise manner. But, how?

28. THEORIES OF PUBLIC EXPENDITURE
GROWTH
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 That during periods when there were some
catastrophic occurrences such as wars, famine, large
scale social disaster, public expenditures in Britain
grew rapidly and settled on a plateau in the
catastrophic periods
 Catastrophic expenditures refer to displacement
effect

29. THEORIES OF PUBLIC EXPENDITURE
GROWTH
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 3. Musgrave Theory of Public Expenditure
 The theory found changes in the income elasticity of
demand for public goods in 3 ranges of per capita
income and these are articulated below:
 At low level of per capita income, which was typical
of pre-industrial period, the demand for public
services tend to be very low,

30. THEORIES OF PUBLIC EXPENDITURE
GROWTH
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 When per capita income rises above lower level, the
demand for public utilities such as health, education,
electricity, among others starts rising and as such,
government in reaction will also raise her
expenditure on the provision of these utilities to
meet the needs of the society, and

31. THEORIES OF PUBLIC EXPENDITURE
GROWTH
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 Thirdly, at the high levels of per capita income
typical of developed economies, the rate of public
sector growth tends to fall as the more basic wants
are satisfied.

32. TAXATION
32
 A tax is a compulsory levy imposed by the
government on individuals and business firms as it
relates to their incomes, consumption, and
production of goods and services. Such levies are
made on personal income, this consists of salaries
(Pay As You Earn - PAYEE), business profits interest
income on dividends, royalties; and also on company
profits, petroleum profits, capital gains, etc.

33. TAXATION
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 Why Does the Government levy Taxes?
 Revenue argument
 Re-distribution of income
 Exercise control of the economy
 Modify the influence of the price system
 To discourage the consumption of certain goods and
services
 To promote import substitution

34. TAXATION
34
 To broaden export drive
 To promote growth and development
 To promote balance of payment

35. TAXATION
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 TYPES OF TAXES
 Direct and Indirect taxes
 Direct taxes: These are taxes levied directly on the
incomes of individuals and business firms. The
incidence of tax fall directly on the payer since it is
not possible for the person who pays the tax to shift
the burden to someone else. Hence, each individual
or business firm’s liability is assessed separately.

36. TAXATION
36
 Under direct taxes, we have the following
classifications:
 Income tax: This is a tax levied on individual’s
incomes usually at a standard rate. Personal
allowances on family and other responsibilities are
allowed before the tax is levied on the remainder
called taxable income. The incidence of taxation is
certain, as the individual cannot shift the burden of
tax. It is based on Pay As You Earn (PAYE) system.

37. TAXATION
37
 Corporation or company tax: This is tax levied on the
profit of the company after all expenses have been
deducted. The incidence of tax is uncertain because it
is possible for a company to shift the tax burden to
the consumers. The ability to shift or not depends on
the elasticity of demand for the products of the
company.
 Property tax: This is a tax levied on the property of
the individual. A good example is tenement rates,
etc.

38. TAXATION
38
 Capital gains tax: This is a tax levied on capital gains
(or appreciated value) realized on all assets usually at
flat rate e.g. Owner-occupied houses, cars, goods and
chattels sold in excess of their original value (i.e.
appreciated value) are taxed.
 Poll tax: This is a flat rate levied on every individual
in a country. This type of tax ensures that every one
pays tax in the country
 Estate duty: This is a tax payable on the estate of a
deceased person. Rates charged are progressive
depending on the value of the building.

39. TAXATION
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 Other taxes: These includes motor vehicle duties,
stamp duties, land tax and mineral-rights duties,
Petroleum income tax, capital transfer tax, etc.

40. TAXATION
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 Forms of Direct Taxes
 a. Progressive tax: This is a situation where tax
rate increases as the size of income increases, that is,
the higher the tax base (taxable income), the higher
will be the tax rate. This type of tax reduces income
inequality and increases aggregate demand. It is
non-inflationary and yields more revenue to the
government. A major disadvantage is that it becomes
a disincentive to work as the payer pays more as he
earns more income.

41. TAXATION
41
 Regressive tax: This is a situation where tax rate
reduces as the size of income increases. It is hardly
used in real life as it tends to widen the inequality of
income between the rich and the poor (which is not
good for development) and it result in a fall in
aggregate demand and lower yield of revenue to the
government. Though, it has the advantage of
creating incentive to work as you earn, the lower will
be the tax deducted from your income.

42. TAXATION
42
 Proportional (neutral) tax: This has a constant.
The tax levied is proportional to the tax base or
income of the individual. It does not take into
account the economic situation of the tax payer
whether he is rich or poor. This tax is impartial but it
is insensitive to the economic situations of the payer.

43. TAXATION
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 ADVANTAGES OF DIRECT TAX
 High yield at low cost of collection
 Convenience
 Certainty
 Equity
 Redistribution of income

44. TAXATION
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 DISADVANTAGES OF DIRECT TAX
 Act as disincentive to work
 It encourages tax avoidance
 It repels foreign capital
 It reduces plough back profit
 Reduces saving

45. TAXATION
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 INDIRECT TAXES
 These are taxes levied on goods and services indirectly by
the government, which is collected through the
importers, manufacturers or to the intermediary. The
incidence of tax is, as far as possible, shifted on to the
consumer by including the duty in the final selling price
of the goods. When an importer pays tax (import tax) or
a manufacturer pays tax (excise duty) on goods imported
or produced locally, depending on the elasticity of the
good, the importer or manufacturer adds the tax to the
cost of the goods which it passes to the consumer who
ultimately pays the tax.

46. TAXATION
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 However, it is possible to avoid indirect taxes because it
is payable only if a consumer buys the good on which tax
is levied. There are two types of indirect tax. They are:

 Specific: This is a fixed sum irrespective of the value of
the good. For example; if a sum of N20.00 is fixed on a
shirt, then the fixed tax of N20.00 is the specific tax.

 Advalorem: This is a given percentage of the value of
the good. For example, if a machine tool is N1,000.00
and an advalorem tax of 7 per cent is imposed, then tax
paid is N70.00.


47. TAXATION
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 Under indirect tax we have:
 Custom duties: This refers to export and import
duties.
 Export duties: These are taxes imposed on all
exports from the country. They constitute a source of
revenue of most African countries that rely much on
income from their primary products exported. They
are easy to collect.

48. 48
 Import duties: These are taxes levied on all import
into the country. They are usually levied at the point
of entry of the goods and constitute a source of
revenue in most less developed countries. The
government uses it sometimes to discourage
consumption of certain products or to promote
domestic production.

49. TAXATION
49
 Excise duties: These are taxes on home-produced
goods such as petrol, cigarettes, beer and whisky, milo,
etc. Higher tax rate on locally manufactured goods
discourage domestic production, which makes the
domestic goods costlier than imported goods.

 Purchase tax: This is advalorem tax imposed on goods
at various percentages and which is generally collected at
wholesale point. It is imposed on a wide range of
products, such as, confectionery, clothing, household
equipments, etc.


50. TAXATION
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 ADVANTAGES OF INDIRECT TAXES
 Convenience
 Reduces imposition of the high direct taxes
 It can be used to discourage consumption
 It serves as automatic stabilizer of the
economic
 It does not disturb initiative and enterprise

51. TAXATION
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 DISADVANTAGES OF INDIRECT TAXES
 Double taxation
 It is regressive
 Discourages domestic production
 It can create inefficient industries
 It might have inflationary influence

52. TAXATION
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 CANON/ PRINCIPLES/ ATTRIBUTES OF TAXATION
 Economic principle
 Production of revenue
 Certainty
 Equity
 Convenience
 Neutrality
 Flexibility
 Acceptability
 Unharmful to enterprise
 Consistency

53. TAXATION
53
 TAX CONCEPTS
 Tax Base: This is defined as the legal
description of an object with reference to which taxes
applies. For example, the base of an excise tax is the
production, packaging or processing of a specific
item. While the base of an income tax is the income
of the taxpayer, which is defined in line with specific
rules, which are: legality, being quantifiable and time
frame.

54. TAXATION
54
 Tax Buoyancy: These concepts are used to
describe increase in tax revenue overtime. Buoyancy
refers to increase in tax revenue due to the growth of
tax base but without the extension of tax coverage or
upward review of tax rate. For example, if there is an
increase in tax revenue from excise tax due to
increase in production, it is a case of buoyancy.

55. TAXATION
55
 Tax Impact: This is the first point of contact of a
tax with the tax payer. It refers to those legally
required to make payment to the government.

 Tax Shifting: This refers to the mechanisms of
adjustment and passing of the burden from one
economic unit to another. Tax shifting will be
possible if only an economic relationship exist
between the two economic entities. Tax shifting may
either be backward or forward.


56. TAXATION
56
 Tax Effect: This refers to the resulted responses
and changes in the economy after imposition and
collection of tax. Without taxation, the market
economy will attain certain production employment,
consumption, savings, output, etc. This pattern will
be distorted either for good or bad with the presence
of taxation and it is the collective distortion that is
usually referred to as tax effect.

57. TAXATION
57
 Tax Evasion: This is a deliberate attempt by a tax
paper not to pay tax. It is a criminal act. Petty
traders, self-employed, etc always try to evade
payment of tax.

 Tax avoidance: This is an intentional or deliberate
act of exploiting the loopholes in the tax regulations
to manipulate economic situation in order to pay
lower tax. Example is when a taxpayer claims he has
children or aged parents to get tax relief when
actually he has none.

58. CONCLUSION
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 THANKS FOR READING!