Economic View of Public Finance - Statistics Project Example

Economic view of public finance Public Finance is a field that tracks government action on taxing and spending. It isconcerned with getting the right balance between the two critical activities of every government. Taxes comprise the largest source of every government’s revenue. Thus it becomes critical for every government to monitor this crucial avenue to ensure that it delivers the required resources to drive government projects and ensure welfare for the people. This brings in the other crucial part of public finance, spending. Spending is probably the most monitored element of public finance as it determines the well being of every country’s population. However, public finance is not as simplistic as defined here as it involves much more processes and decisions. The subject is further complicated by political interference and public demands. Sometimes, it becomes difficult for any government to balance the demands of all the concerned parties. This may explain the ever present bickering and criticism for any government’s approach in public finance. Therefore, it is important to evaluate public finance objectively, that is, not based on political or sentimental opinions. One objective way of achieving this is through economic analysis; this allows one to look at both elements of public finance (taxing and spending) and figuratively determine their effect on the tax payer and on his welfare. This offers an economic view of public finance which will be discussed exhaustively in this study. As may have been mentioned briefly in the introductory paragraph, public finance is about revenue, expenditure and debt operations of the Government and the impact of these measures. This squarely explains that the government has the sole responsibility to control these aspects; however, the greatest question is how it is supposed to dispense these crucial responsibilities. This is bearing in mind that each of the broadly defined responsibilities has multiple other options under each. In regard to government expenditure, it is expected that the government should offer unemployment benefits, pension reform, welfare benefits, education, and health insurance among others (Auerbach, A. J., & Feldstein, 1999: 1642). In regard to revenue collection (taxation), it is expected that the government should levy taxes competitively considering the economic well being of the individuals, also consider the type of taxes whether income or consumption taxes, VAT, income tax, capital gains among others sources of government revenue. The answer may lie in evaluating the performance of past government actions, actions either to cut tax or increase tax. Evaluating the effects resulting from such action may shed light on the appropriate action. In this case, appropriate action is that which allows the government to achieve its revenue targets and discharge its prime responsibilities and at the same time allow the tax payer enough disposable income to achieve their primal responsibilities. Focus on tax is informed by the fact that this forms the largest revenue base for the government. Besides, it is tax that determines the disposable income of a country’s population and thence determines their purchasing power. A country’s economy is driven by the powers of demand and supply figuratively; supply exists because there is demand. Taxes affect the demand side of the economy, if there is an adequate tax cut people have more to spend or the goods they demand are cheaper and thence are able to demand for more. The significance of taxation as a source of government revenue is illustrated through the following summation of UK government revenue in 2009. The above summation illustrates that for the year 2009-2010 the UK government collected £515 billion from taxation. To understand better the criticality of this revenue let us compare it against government expenditure for the same period of time. The expenditure chart illustrates expenditures for the period 2009-2010, aggregating expenditure from all sectors one realizes that the UK Government expedited £671 billion, £515 billion of which was gotten from taxation. This represents about 75% of the total Government expenditure; this is not unique to the UK Government but is the case across all countries. This explains the reason public finance is viewed as primarily a tax issue. However, spending is also a critical aspect of public finance. The concern being that the increased spending was channeled to projects of little imporatnce. Such concern and need to keep the government on track also contributed to the transformation of public finance into a predominantly public economics discipline. This looked at the effect of government taxation, and most importantly government spending on a wide range of programs. Greater importance of public economics came to be during the recent global recession. This is because policy makers and politicians sought to analyze the impact of the measures taken by the government to help people out of the recession (Auerbach, A. J., & Feldstein, 1999: 1645). This period provides the best analysis period on the impact of taxation and evaluation of government action in regard to taxation. The recession which was first felt in United States, had started to affect UK economy by early 2008. This had gotten most people worried and this translated to enormous pressure for the government to take action to cushion consumers from the eminent hard times. Besides consumers, who as mentioned earlier constitute the demand side of the economy (in consumption) the government was also worried about the supply side. The supply side is chiefly made up of industries and other producers who avail goods or services to the market. If the consumers spending power dips then the producers are bound to feel the pinch as they never get to recover their production costs. This forms a cycle which inevitably slows up the economy, and if the situation does not change it becomes impossible to spur an economy back to growth. Such was the situation in the UK during the 2008 recession. Faced with such a situation, the Government had to take appropriate action to help increase demand. Economically, there are several ways through which a government can spur demand; one way is through consumer incentives, through employment and through tax cuts. Tax cuts provide the tax payer with additional money, economically described as increased disposable income. Increased disposable income provides the tax payer with additional money to spend. Therefore, when a Government cuts taxes it hopes the tax payers will utilize the additional money to demand for more goods. This was the approach that the UK government took; it hoped cutting taxes would be a short term fiscal stimulus to help the country of the recession. In the following part we examine the impact of the tax cuts on the UK economy and determine whether this offered reprieve to the people and whether it helped spur growth during the recession. The Government’s decision to cut taxes was announced on November 24, 2008 and this remained in force for about a year that is from 1st December 2008 to 31st December 2009. The tax cut reduced VAT from 17.5% to 15%, which basically represented a 14% reduction on tax. The Government hoped that this would spur the declining consumer demand and would eventually help the country out of the eminent recession. Looking at the expected effect on the price of goods and services, it was hoped that the tax cut would translate to a price reduction of about 1.275% points or averagely 1.2%. Economic analysis of a temporary tax cut Technically, when a tax cut is enforced there is always the question of whether the consumers will benefit from such cuts. This is because the retailers may decide not to pass the tax advantage to the consumers, and in such a case they are the only beneficiaries. However, the reduction is passed on to the consumers. The most immediate effect of such a measure is increased demand, as the consumers will now have increased purchasing power. As is characteristic of all price changes, a reduction on the VAT brings forth effects which results from the fact that, with unaltered purchasing, the consumers have extra money to spend. The substitution effect results from the anticipated increase in prices. Lower prices at the moment, in comparison to tomorrows, prompt consumers to bring forward their spending in order to benefit from the low prices. This type of substitution is referred to as inter-temporal substitution. However, not all classes of goods are expected to benefit from demand brought forward, the greatest beneficiary in this case are non perishable goods which can be stored for later consumption. Effect of the tax cut Determining the effect of the tax cut was not easy as it required a proper tracking of consumer spending immediately after the tax cut and over the entire period that VAT rates remained at 15%. Therefore in determining the tax cuts there was considerable reliance on consumer related data collected over the period. The first consideration was on a consumer survey (Consumer Confidence Index) .The Consumer Confidence Index sought to determine the consumer’s feelings on the economy at the time and their view of the situation six months later. The questions posed were; how would you describe your country’s current economic & employment status? The second was, what do you think your country’s economic situation, your employment situation and income will be six months from now? Most consumers were not so optimistic about the situation of the economy but hoped that it would with time stabilize following Government’s action. The proceeding question, question 2, should focus on consumers considering buying a home appliance (representative of non perishables) after the tax cut as a good, neither good or bad, bad, don’t know idea. Average views are represented under the following table. View Good Neither Good/Bad Bad Don’t know Average % 50 35 12 3 From the above summary, one realizes that a majority of the consumers 50% considered buying a home appliance after the tax cuts a good idea. This was against a 35% who considered such a purchase ill timed. These findings (household appliance relative value) were graphed against the present situation index. However, this effect was thought to have been affected by the action of the Bank of England which had in September 2008 significantly reduced the Base rending rate. A further reduction of the Base rate coincided with a reduction in the VAT rate. This reduced the nominal return to household saving but never eased borrowing, thought, it brought a marginal interest rate effect on spending. Therefore, to understand the actual effect of the tax cuts there was need to isolate the effect of the actions by the Bank of England. To achieve this, the household appliances relative was plotted with credit card balances and time deposits, this is illustrated below. Further evaluation on the impact of the tax cuts was done by looking at the relative changes of retail sales; these were computed quarterly from December 2004 to March 2009, however, the focus period for this analysis is that starting from December 2008 (the time of tax cuts). The following is a graphical summary of the retail sales. The graph shows that there was an immediate positive reaction after the Tax cuts for all retails and Non food items. This however seemed to slump for a while before assuming an upward trend once more beginning March 2009. Conclusion It is evident that a good number of consumers reacted to the tax cuts. This is first illustrated by the opinion on buying of non perishables (home appliances) a majority favored buying these after the tax cuts. The second analysis shows that these effects, increased purchase, were not a result of the Bank of England actions. The last analysis indicates that there was momentary response on tax cuts as overall retail sales increased immediately after the announcement. These responses indicate that the tax cut policy was relevant. It is therefore safe to conclude, that taxation is a strong factor in public finance. Its alteration has profound economic impact as evident from this analysis and dependent on its effect on Government revenue it can be used to spur demand and help end a recession. Bibliography AUERBACH, A. J., & FELDSTEIN, M. S. (1999). Handbook of public economics. New York, Elsevier. Read More