8 The role of Government in an economy

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Principles of Business

SECTION 8

The Role of Government in an Economy

1. Responsibilities of government in an economy

• Security of state – the provision of law and order and of defense; the

upkeep of legislature and the courts of justice; the maintenance of law and

order internally as well as externally; the provision of facilities for defense;

diplomatic representation in foreign countries

• Protection and general welfare of citizens – provision of defense within

the country e.g. Police and other armed forces, transportation systems,

education, infrastructural services such as electricity, water and proper

roads; the provision of welfare programs for citizens e.g. Social Welfare andDisability allowances

• Job Security and severance benefits to workers – the provision of

employment through its organizations and also by encouraging and assisting

private firms; legislation to ensure that citizens have stable jobs.

Organizations that wish to fire or lay off workers must comply with the law

and where applicable provide severance benefits to dismissed workers.

• Maintenance of a safe environment for investors – international

investors would like to invest in countries with stable economic conditions i.e.

Low unemployment, low crime rates, stable pricing, steady development,healthy balance of payments, low national debt etc. The government needs

to ensure that the country has all these things to maintain the level of local

economic activity and attract foreign investors.

• Protection of the environment – the implementation of laws to prevent

the pollution of the land, air and water from harmful materials e.g. Toxic

Waste. Laws against Deforestation which result in landslides. Laws against

depletion of natural resources e.g. Fishes, Birds (Endangered Species) and

Coral Reefs. Any damage to the environment can severely affect out local

food and water supply and living conditions of the citizens E.g. Litter Wardens

Examples of Government protection of the environment:

Zoning regulations that confine businesses to certain locations

Environmental protection laws that confine waste to restricted areas



Provision of incentives for the increased use of solar energy instead of

fossil fuel

Educating the citizens on how not to harm the environment and

conservation practices

Establishing environmental protection agencies to monitor the

activities of businesses e.g. EMA

Finance Environmental Studies

Budget

The government plans the country’s economic life through the Budget. The

Budget is presented annually by the Minster of Finance. The Budget is debated

in parliament and when the opposition and ruling party are in agreement it is

passed.

The Budget is a proposal of how much money the government plans to spend

and how it plans to collect it. It speaks to taxes to collect money for its

expenditure, which is then allocated as they see fit. It also outlines all grants,

subsidies and welfare programs to be implemented.

Budget Surplus – Occurs when the government takes more in taxation than it

spends, resulting in a net withdrawal of funds from the economy.

Budget Deficit – Occurs when government spends more than it takes in taxes,

resulting in a net addition to the flow of income in the economy

2. Ways in which businesses can help protect the environment:

Design processes - for example they replace toxic substances with lessharmful ones. Create products designed to be multifunctional or reusable.

Energy consumption – the use of more energy efficient, less-pollutingmachinery

Resources – Use more renewable or recyclable materials. Encourage therecycling of waste. More efficient use of resources.

Provide environmental and health and safety training for employees.

The development of greener, more environmentally products

Funding and sponsoring environmental conservation exercises

Business Organizations and the Community



• The observance of labour laws with respect to the welfare of workers,

the protection of the environment and the community as a whole.

• Assisting the community – contributing to charity, health, sport etc

• The avoidance of situations in which consumers are exploited

• Making contributions to national development- creating employment,

paying taxes

• Ensuring that shareholders interests are well served and protected

• Giving attention to the political affairs of the community – businesses

can lobby to have certain policies adopted by government

3. Ways in which the government protects consumers:

Food and Drugs Act – ensures healthy ingredients and the correct recipesare used in sanitary conditions for preparation of foods. This is also appliedfor all products that are consumed or come into contact with the body.

Food Storage and prevention of Infestation act – Food businessesmaintain sanitary conditions for the processing, storage and sale of food. Itrequires business owners to keep proper records of the process and materialsused these are inspected by government officials.

Public Health Act – persons handling food must have a food handler’spermit; butchers require a license and hygienic surroundings

The Standards Act – the business must adhere to standards for safety andquality and labels must have nutritional facts and ingredients e.g. BESTBEFORE

The Hire Purchase Act – ensures that the consumer can voice complaintsand receive treatments or redress as the case may be

4. Ways in which government impact business activity

Infrastructural Services – the government would closely monitor publicamenities such as water, electricity and transportation. Most time thegovernment act as the sole provider for these, if these are outsourced to

private firms who now monopolise the market a license is granted to themand any fluctuations in prices will have to be approved by the Government.

Maintenance of standards for Goods – to ensure a stable standard of living there must be a benchmark for the quality of good produced. Theregulatory body in T&T - Bureau of Standards



Trade Agreements – Policies and guidelines to ensure that citizens of thecountry enter into fair and reasonable trader agreements both locally andinternationally

Provision of research facilities - to identify flaws with existing productsand finding ways of improving them.

Provision of Credit and low interest loans – providing easy access toloans with lower interest rates e.g. Agricultural Development Bank

Providing Assistance with securing Export quotas

Giving Incentives and Grants especially to smaller businesses

Supplying the market with information and intelligence to generatenew business ideas

Provision of Training and Management Assistance E.g. MUST

Ensuring harmonious Labour relations – Ministry of Labour ensures thatthe nation’s work force is satisfied; the implementation of the industrial courtfor labour disputes

5. Taxation

Tax – compulsory payment to be made by a citizen to the government for which

he/she receives no direct benefit in return. The government needs money to

carry out its many functions; taxation is the main source of revenue for the

government.

Adam Smith’s Four Principles of a Tax System:

• Equitable – the burden of the tax should be equally shared by taxpayers;

same sacrifice by all

• Economical – the tax system should not be costly to implement and

administer

• Certain – the taxes to be levied and the amounts to be paid should be clearly

communicated

• Convenient – taxes should be paid in a time and manner agreeable to by thetaxpayer

Additionally:

It should bring Stability to the economy controlling demand and inflation.



Flexibility – taxes should not be rigid, changes should be made possible without

too much red tape.

Reasons/ Objectives of taxes:

MAIN – Finance Government expenditure

Assist in curbing inflation by reducing the money supply

To protect the producers of local goods; higher taxes on imported goods

The increased consumption of local goods (as a result of taxes on imports)

also lowers unemployment.

The decrease in imported goods (as a result of taxes on imports) improves

the country’s balance of payment position

Tax reliefs can be used to provide incentive for increased market activity e.g.lower tax rates on profits made, tax breaks for savings plans, assist in

economic growth granting of subsidies for investment e.g. Farmers

Achieve greater equality in the distribution of wealth; higher income earners

should ideally be taxed more.

6. Direct and Indirect taxes

These are the 2 main types of taxes:

A Direct tax is where the burden of the tax and the payment of it fall on the

same individual usually charged on income and wealth.

E.g. Income Tax – PAYE method

Corporation Tax – Levied on company profits

Capital Transfer Tax and Estate Duties – where property is transferred from

one person to another (Transfer fees when selling cars)

Capital Gains tax – levied on increased value of assets

Advantages of Direct Taxation

Disadvantages of Direct

Taxation

The burden is easy to determine Reduces savings

Anti-inflationary Stifles Initiative and



enterprise

Yield rises as income increases Disincentive effort

Usually progressive

Evasion and avoidance

encouraged

Redistribution is on low-income

individuals

An Indirect tax is where the burden of the tax and the payment of it fall on

different individuals usually charged on goods and services. Usually paid by the

manufactures or imports who in turn passes it on the consumer.

E.g. Customs Duty – Charged on imported goods such as appliances, cars

Excise Duty – Tax on good manufactured in the country such as tobacco,alcohol

Ad Valorem or Value Added Tax – tax imposed on goods at each stage of

production

Stamp Duty – paid when cheques and receipts are drawn

Purchase Tax – charged on manufactured goods within the country E.g

Appliances, Furniture and Equipment, Gas, Wine

General Consumption Tax (GCT) – Variation of purchase tax

Negative Effects of Taxation:

i. Progressive taxes are a disincentive to work

ii. Taxes can start inflation with the increase in prices e.g. VAT

iii. Distort the price mechanism. Price inclusive of the tax will not be determined

purely by demand and supply

iv. Taxation reduces disposable income and thus the amount that could be

saved

v. Lead to poverty traps; after a pay rise some people cannot collect certain

benefits and also pay more in taxes leaving them worse of that before.

Advantages of Indirect Taxation Disadvantages of Indirect Taxation



Convenient since payment is

spread Raises Prices

Less chance of evasion Burdensome to the tax payer

Flexibility Inflation Spiral

Used for specific purposes

7. Types of Taxation Systems

1. Progressive

The higher income earner pays a larger percentage of his income in taxes. Meaning

that apart from paying a higher proportion in taxes, the overall amount paid will

also be higher. Caribbean Taxation system

2. regressive

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A tax is regressive if it represents a smaller proportion of the wealthier person’s

income than the income of the poorer person.

3. Proportional

Each taxpayer pays the same proportion of his income by way of taxes, so that

the higher income earner pays more in absolute terms but only the same

percentage of his income.

8. The Impact of social services provided by the government on the

country:

i. National Insurance Services and Social Security – payments are

deducted while working and the received after retirement

ii. National Health Scheme – health surcharge

iii. Health Care – public hospitals, clinics

iv. Education – an informed and educated population is more capable of

productive entrepreneurial activity

v. Transportation – free transportation for school children and the elderly e.g.

PTSC

vi. Roads – maintenance of the roads and highways and the creation of new

ones

Nationalization vs. Privatization

Nationalization – is the act of taking over of the private industries or

companies by government and putting them in the ownership of the state.

Nationalized industries are usually run by boards and guidelines laid down by

parliament. In some cases the government opts for joint ownership by virtue of

being a majority shareholder

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Reasons for nationalization:

1. The profits made can stay in the country to be re-invested and assist in the

stimulations of economic activity locally.

2. Nationalization can bring cheaper and more efficient services

3. Full ownership of firms makes it easier for expansion, especially if it was in

the best interest of the citizens.

4. Greater standardization in the production of the most profitable and efficient

units

5. More employment can be created when needed

6. State can control certain vital industries which are important for development

e.g. WASA, T&TEC

7. Prevents the formation of monopolies

Reasons against nationalization:

1. Consumers lose freedom of choice if there is no other real competition e.g.

TSTT and Digicel

2. Lack of efficiency

3. Since they are not profit-motivated, they most likely to fail business wise

4. Government may run industries selfishly to meet political motives

Privatization – means the transferring of government owned business to private

ownership.

It can be done via:

Sale of government assets to private sector

Shifting services previously performed by the government to the private

sector

E.g. Privatizing garbage collection, health care, education

Why Privatize:

Sale of assets provides short-term source of revenue

Less government spending especially on non-profitable industries



More levels of abuse if not privatized because they can rely on the

government to bail them out. Nationalized breeds inefficiency because of the

lack of competition

Reasons against privatization:

Breeds monopolization of industries who less socially accountable

Cheap sale of government assets

Release of control of socially needed services E.g. Privatization of WASA could

result in higher water rates.

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8 The role of Government in an economy