THE ROLE OF THE GOVERNMENT•Economic Functions of the

Government•The Federal Budget •The Constraints on

Government•Influences on Government

Policies in Australia

The Economic Functions of

Government• Reallocation of resources through

taxation and government expenditure• The stabilisation of the economy

through Fiscal and Monetary Policy• The provision of goods and services

through PTE’s• Competition and Environmental

policies to improve allocative efficiency in specific markets

The Reallocation of Resources

• The government funds its expenditure

through the collection of taxation revenue.

• Taxation is compulsory for individuals and businesses.

• This revenue then is utilised by the public sector to finance welfare and infrastructure spending.

The Reallocationof Resources

Changes in the level and composition and of

government taxation and expenditure can affect

resource allocation in the following ways: 1. Expenditure on public goods and services will shift expenditure away

from private to public sector. How the government allocates its expenditure will also alter resource allocation.

2. Taxation of some goods and services and not others will alter relative prices and the demand for them. This will impact on the allocation of resources in the production of various goods by the private sector.

3. Governments may give selective assistance to t industries e.g. subsidies, tariffs, quotas and tax incentives to encourage or discourage the production and thereby cause resource allocation

Taxation Criteria

Adam Smith, the father of economics proposed the following as a criteria to evaluate taxation systems.

• Is the tax equitable?

Has it got vertical equity?

Does it meet horizontal equity criteria

• Is the system efficient?

• Is the system simple?

FEDERAL BUDGET

Income and expenditure for the 2007/08 budget year.

Refer to p.248

The Tax Base and Tax Rate

• Tax base- refers to what is being taxed – i.e. individual and business income, consumption spending, company profits, capital gains and fringe benefits

• Tax rate- - refers to the percentage of the tax base that is paid in tax

TOTAL REVENUE = Tax base x Tax Rate

DIRECT & INDIRECT TAXATION

Direct taxes- are paid by individuals and companies and cannot be passed onto others. The incidence and impact are the same

e.g. Wage and salary earners pay tax on their taxable income

Indirect Taxes- are imposed on one group but passed onto the consumer partly or wholly. The incidence and impact are not the same.

e.g. sales tax, GST, customs duties

Main types of FEDERAL TAXATION

Income TaxCompany TaxSuperannuation fund tax -15%Withholding taxPRRTWholesale Sales TaxExcise DutyCustoms dutyCapital gains TaxFringe benefits taxGST

Impact and Incidence of Taxation

• Impact of tax- refers to the point at which the tax is levied

• The incidence of tax -refers to the group that ultimately pays the tax

For direct taxes the impact and incidence by upon is the same

For indirect taxes the incidence and impact is not the same as it is usually passed onto consumers by those upon whom the tax is levied such as retailers and manufacturers

TAXATION REFORM and The new tax system

TAXATION REFORM and The New Tax system

Changes to Personal Income Tax Thresholds

2005, July 1 Tax Rate July 1, 2006 Tax rate July 1, 2007 Tax Rate

0-$6,000 0% 0-$6,000 0% $0-$6,000 0%

$6,001-$21,600 15% $6,001-$25,000 15% $6,001-$30,000 15%

$21,6001- $63,000 30% $25,001- $75,000 30% $30,000-75,000 30%

$63,001-$95,000 42% $75,001- $150,000 40% $75,001- $150,000 40%

$95,001+ 47% $150,00+ 45% $150,000+ 45%

As of July 1, 2008 - 40% from $80,000 and over

- 45% from $180,000 and over

TAXATION REFORM and the New Tax system

New system introduced July 1,2000. Focus

to reduce income tax and increase indirect

taxation i.e. broadening the tax base to

include GST and changes the tax mix by

placing greater emphasis on indirect

taxation.

TAXATION REFORM and the New Tax system

Specific changes to the tax system:• Income tax cuts of $12b a year• Tax free threshold raised to $6,000• Marginal tax rates (MRT) for most 30% (i.e. 80%)• Introduction of GST of 10%- exempt basic food• Abolition of wholesale sales tax• Family benefits increased by $2.9b annually• Review of Commonwealth state financial relations with revenue

from GST going to to States directly.• PAYG replaced all other form of income tax• Cut in company tax rate to 30% and introduction of ABN and BAS

for tax`reporting and tax compliance• In 2004,2005, 2006 and 2007 tax thresholds were raised.

TAXATION REFORM and The New Tax system

OBJECTIVES OF THE TAX REFORMS:• A higher MPS would help raise national

savings• A lower company tax rates would encourage

business investment • Greater competitiveness for exports as they

are exempt from GST- exporters can claim input tax credits reducing their costs

• Higher economic and employment growth due to more efficient and competitive tax system

Government Revenue and Expenditure 2007-08

• Refer to 2007/08 Budget handouts from The Financial Review

Taxation and its role in Redistribution of Income

• Tax policy is the most common method used to reduce inequality in income distribution. That is higher tax payers contributions can be redistributed to lower income earners through transfer payments and thereby assisting the reduction of poverty.

• Income taxes are levied on a progressive scale, but it can also be regressive or proportional

• To analyse the tax system you need to calculate the ART and MRT

Taxation and its role in Redistribution of Income

ART (Average Tax Rate)= Tax Payable x 100

Taxable Income 1

MRT (Marginal Tax Rate)= Change in Tax payable x 100

Change in taxable Income 1

HYPOTHETICAL TAX SCHEMES

Total Taxable Income

TAX A ART MRT TAX B ART MRT TAX C ART MRT

$2,000 $160 8% - $100 5% - $400 20% -

$4,000 $400 10% 12% $200 5% 5% $600 15% 10%

$6,000 $720 12% 16% $300 5% 5% $750 12.5% 7.5%

$8,000 $1,120 14% 20% $400 5% 5% $800 10% 2.5%

$10,000 $1,660 16.6% 27% $500 5% 5% $840 8.4% 2.0%

The ART on $4,000 in Scheme B = $200 x 100 =5% $4,000 1

The MRT in TAX SCHEME A for total income between $4,000 and $6,000 is:

MRT = $320 x 100 =16% $2,000 1

FOCUS QUESTIONS

• Go to worksheets and do exercises

Progressive, Proportional and Regressive Taxation

Progressive- ART and MRT rises as taxable income rises and the MRT>ART as taxable income increases

Proportional – ART and MRT are equal and remain stable as taxable income rises

Regressive- ART and MRT fall as taxable income increases and MRT<ART

Taxation and its role in Redistribution of Income

ART/ MRT

TAXABLE INCOME

Progressive Tax System(Scheme A)

Proportional Tax System(Scheme B)

Regressive Tax System(Scheme C)

Social Security and Welfare

• The majority of social security assistance is paid as direct benefits to recipients and families

• Payments are indexed to CPI• Delivery is made through CENTRELINK• Other benefits are provided indirectly through the tax transfer

system, including concessional rebates for pensioners, dependent spouse, family tax assistance and sole parents.

• Social policy since 1996 has aimed to reduce welfare dependency through Means Testing;utilising assets Retirement Income Policy; reductions in social security fraud; support for single parents & unemployed through Work for the Dole schemes (Welfare to Work package) and rationalising Youth Allowance and parenting payments

Stabilisation of Economic Activity

• MACROECONOMIC POLICY –stabilistaion of Fiscal and Monetary Policy to achieve goals of full employment, price stability and economic growth in the economy.

• The government uses a policy mix to counter the effects of severe fluctuations in the business cycle.

• INFLATIONARY BOOM – it uses contractionary macroeconomic policies by tightening the monetary stance through the RBA. The cash rate rises thereby leading to increased interest rates, which would discourage spending.

• Budgetary Policy is used G<T, causing spending to decrease and thereby a contraction in economic activity reducing price rises.

Stabilisation of Economic Activity

During a recession when there are high rates of unemployment the government could use expansionary monetary and fiscal policies to stimulate spending and economic growth. The monetary policy stance would be to ease the cash rate by the RBA and reduce interest rates. Additionally the government could use fiscal stimulus by budgeting for a deficit G>T. This would help stimulate economic activity and reduce unemployment.

Public Trading Enterprises

PTE’s provide infrastructure and provide revenuein the form of dividends. State and localgovernments are the biggest operators of PTE’s.Corporatisation and privatisation have contributedto small surpluse. The emphasis has been tooperate PTE’s with greater market orientationPTE’s that have privatised include electricity,gas,transport and communication (QANTAS and partialsale of Telstra). These sales enable more competition toenter the market.PPP’s have also become popular.

Competition and Environmental Policies

• The basis of Competition policy is focused around the Trade Practices Act 1974 and enforced by the ACCC.

• The ACCC deals with consumer protection, anti-competitive conduct of firms, access to essential facilities and mergers and takeovers that are likelty to reduce competition.

• 1995 the Competition Reform Act was passed which implemented a national competition policy for all government and private businesses.Its effect has been to strengthen competitive pressures and help contain inflation.

Environmental Policies

Governments at all levels try to contain negative externalities to the environment.The method include:1. Tax polluters2. Licences3. Quotas4. Permits5. Fines6. ‘user pay’ principle7. Subsidies used to use recycling, clean technologies

and alternative sources of energy production

THE FEDERAL BUDGET

• The budget is an estimate of the revenue and expenditure of the Federal Government for the forthcoming fiscal year

• It is presented by the Treasurer to Parliament in May

• The use of the Federal Budget is to achieve economic objectives such as resource allocation, the redistribution of income and economic stabilisation- this is known as FISCAL POLICY

There are TWO main components of Fiscal Policy:• Structural or Discretionary which

is______________________________________________________________________________________________________________________________________

• Non-discretionary or cyclical component which is _______________________________________________________________________________________________________________________________________

Budget Outcomes:

1. Contractionary fiscal policy

2. Neutral fiscal stance

3. Expansionary fiscal policy

Refer to text p.256-257 and prepare notes

Possible Budget OutcomesG/T

0NATIONAL INCOME

T

G

Balanced Budget

BUDGET DEFICIT (G>T)

BUDGET SURPLUS

• Fiscal Consolidation Strategy is based on cuts to discretionary spending and rises to cyclical revenue.

• Government has aimed to increase budget surpluses in order to achieve higher public savings which will reduce our dependence on foreign savings.

• The Charter of Budget Honesty 1998 Prepare your own notes-p.257

• Intergenerational Report p. 258

• Economic Implications of an Ageing Australia p.258

Prepare your own notes

CONSTRAINTS ON GOVERNMENT

• Constitutional Powers

• Political Support

• International Agreements

Prepare your own notes

INFLUENCES ON GOVERNMENT POLICIES IN AUSTRALIA

• Role of Political Parties• Interest Groups• Business• Trade unions• Environmenmtal Groups• Welfare Agencies• Media• International Influences