Government Spending and Tax Policies

How should the government have spent tax payer's money? This one of the biggest issues facing many nations, especially in developing countries. Developed countries may be better off because they already have established systems that deal with collecting revenues through taxation and clear guidelines on taxation. Besides, they are well developed politically, which makes it easy for the government to account for what it spends money on.

For these reasons, public finance is a crucial subject taught in modern institutions of higher learning. It allows us to understand how public funds are and should be used to boost the economy and improve everyone's lives in these economies. In this subject, one of the main areas of focus is fiscal policy, which can be simply defined as the way a government collects revenues through taxes, and how it uses the same to boost the economy. We know that the relationship between firms and households is vital to the growth and development of markets. Households provide labor and demand for goods while companies produce the supply. Hence, there are no suppliers without consumers, and there would be no consumers without suppliers.

This relationship is defined by various aspects of the economy, which includes pricing. The economic theory of consumption states that people are rational decision-makers who will make investment and consumption decisions based on scarcity – i.e., what is more important. And this is why we have business cycles. At times, you will find the economy booming, and soon after that, it will be depreciating.

Examples of government spending

Consider the 2007-2008 Great Recession times, for instance. Before it hit, the economy was booming everywhere in the world, especially in the USA. The financial market was stable and growing fast, fueled by the real estate industry that way also at its peak. Lenders did not put much focus on who they should lend money to as long as the securities seemed promising. And house prices dropped abruptly. That is when everything went to ashes. Borrowers we no longer able to pay back the loans, and even the assets recovered by financial institutions were not enough to cover the borrowed amounts. Many of these institutions came crumbling down because of this.

But the most affected group was perhaps the households. Many people lost their jobs and could not continue living on the same standards they were used to, which forced them to adjust. Before the recession, consumer goods and services consumption was very high since everyone was comfortable using their money. All this ended when the economy hit the trough phase. 

Household consumption is one of the main contributors to a country's GDP. And this is why many governments rushed to come up with different solutions to this issue as they tried to revive the economy. One of these methods was increased government spending and reduced taxes, which increased demand and encouraged investment.

This one of the ways the government uses public funds. It can initiate a different policy to try and stimulate economic growth.

Government expenditure and tax policies are influenced by the economy's main features, namely: expansion and contraction. Hence, fiscal policy is applied as expansionary or contractionary fiscal policy. Expansionary policy is used when there is a recession. In this case, the government can increase spending and reduce taxes to encourage aggregate demand, which in turn may boost the economy. Contrary to this, contractionary fiscal policy is employed by reducing government spending and increasing taxes. This comes during the expansion period to avoid fluctuation and ensure the economy is growing at a sustainable pace.

Major decisions are taken by governments that effect changes in the economy are founded on spending and taxing. Tax is what gives the government money, while spending is what ensures growth in the economy. A better understanding of this subject includes looking at the policies that guide government expenditure and taxes in detail. We have already mentioned these policies briefly from our previous topics on public finance, but this is a more detailed look at the same topic.

Policies on Government Spending

Three fundamental reasons explain what governments must raise and spend revenues. The first one comes under the legislative process, which must be paid for via proper compensation for elected politicians as well as public servants. These people are responsible for making countries move forward and experience the best economic growth at any given time. They work for the will of the community that employs them and hence, need to be compensated. Those who work under elected politicians, helping them make important decisions also expected to receive wages from the community. The decisions they participate in are necessary for ensuring proper institutional framework construction and their maintenance, under which the private sector can effectively function. A crucial part of this spending goes into the legal structure of any given nation, which ensures that every citizen adheres to the rules set by their society for harmonious coexistence. Whether it is through institutions or by personal conviction, there is a need to have a set of rules that every member of the society needs to follow. The second reason, and also one that carries great significance, is the existence of externalities that come up because individuals, in many instances, do not receive or pay for the social benefits of their action. Both Deontology and Kantian theories suggest that every person should behave in a way that benefits the other person of the whole community. Therefore, they should be rewarded for what they do. There is a need to collect funds and use the same to bring as far as possible these specific costs and benefits into line with other social aspects of the community. To the third and final reason, even is a perfect functionality within the social institutions, the whole community may still not be happy with the distribution of wealth and income. The state is responsible for ensuring that every citizen has achieved a desired state of happiness, which allows them to live as the rest of the community does, with equality. Therefore, the government may want to redistribute income from one part of the community to the other, bringing about equality.

The most important requirement for government taxes comes as an investment in the maintenance of the police force. There are private police forces, which make sure that the employers' rights are kept, but their focus on these individuals' rights, which may not touch them directly or consider the needs of the whole community. The government is mandated with the duty of providing firearms and protection for the police force, as well as the army. The arms and protection gear offered by private firms may not be used for the good of the whole community, which leaves the public police to protect the general population. Again, the externalities that arise from the actions of individuals who may not receive the reward of proper punishment for their effects have to be dealt with. In other words, the provision of national defense is the best example of a complete externality. Each member of society benefits from the national police force's protection, no matter how much a particular individual spends serving in these forces. And the armed forces are controlled by a special representative of the government, which ensures that there is a possible military dictatorship.

 Regulations imposed by the government can get rid of some externalities. But the best example of the government using tax revenues in a free market economy is where it imposes a tax of subsidy on account of the services to the externality it is linked to. Consider, for instance, the toxic emissions that may come from the production of a good that could be otherwise useful to the community. The policymaker can simply impose a tax on the commodity that is sufficient enough to reduce that output until the marginal social benefit level. Normally, this comes down to the market price, where it's made equal to the unit's minimal social. In other words, the sum of the marginal production cost and the social cost of damage that comes from its production is the social cost of the product. These incentives can make enough concerned parties be more careful about their productions.

The provision of roads provides another externality to this effect. If the private sector were to produce and manage the road system, they would have to own the land on which these roads are being constructed and then impose tolls that would enable them to earn revenues that exceed the cost of collecting them. So many cases and legal powers are required to build roads, which can only be invested in by the government. Hence, many of the roads build in communities are largely owned by the government. It is the government too that awards the tenders for building and maintaining these roads.

The education and health sectors are the two main areas of interest for any government. Every community benefit from having people who can be able to read and write and who have some degree of knowledge. Hence, every individual needs to pay and to acquire this education. However, the government plays a huge role in these externalities. In many countries, elementary and secondary education is offered free of charge, and every young person is forced to attend. Sometimes the government even has come control over private institutions of learning where it gives a voucher that these individuals should work for before attending these institutions.

Regulation of the health sector is a nightmare for many governments. There are no externalities when it comes to the free-market health care system where the government is not involved. And this is not even to talk about disease prevention. Those who pay for their own medical advice and treatment from doctors and for hospital costs face high external costs. Many people avoid the health care process because of the cost. The government pays for some of these cases through various health-care bills. Even though individuals pay the insurance premiums, the government makes some services freely available for certain individuals.

The Tax Policy

Where does the government get all the money to invest in the projects mentioned above? Well, it comes from taxation. There are different ways through which the government raises tax revenue to finance this spending. Various policies of taxing the outputs of specific products that are appropriate to reduce different negative externalities are perfect for raising revenue. A good example would be to subsidize any product whose output can produce positive externalities.

Generally, it would seem like a good idea to impose taxes for financing government policies on those who benefit directly from the policies. For example, it would seem fair to impose a tax for gasoline and diesel on those who use roads and let them pay for road maintenance. Properties taxing laws can also be sued on the beneficiaries of sidewalks that service these properties, as well as the lawns and trees that make these roadsides. Also, property taxes can be perfect for financing the government's operation on fire protection and other similar issues. Consider that we have police protection with also benefits property owners and yet serves the whole community. It would seem best that it was paid to be a more general applied tax policy. This also applies to the public school system. Or the Medicare insurance, one would assume that it would be best financed by the flat premium charged on every individual as they are covered, even though there would be some adjustments.

Two main types of taxes, income tax and either generalized or value-added taxes, are used to finance a wide range of government spending. Income tax is taken as a fraction of each person's income. GST or VAT are taxes imposed on the output for a wide variety of goods and services produced and sold with the economy, which includes all intermediate products coming from other regions that are not exempted.

Taxing and government expenditure can be well understood in terms of economic growth. If and economy has proper taxing and public finance systems in operation, it has better chances of growing stronger. But those that have not of these are bound to fail. The government uses the money collected from taxes to stimulate the economy and ensure equity in sharing public resources.