Fiscal Policy: measures undertaken by governments in relation to raising revenue through taxation and determining the nature of government expenditure,
aimed at influencing a nation’s aggregate demand; can be discretionary or non-discretionary (automatic stabilisers)

What are the Characteristics of Money:

Budget: a statement of the government’s estimated revenue (taxation, royalties etc.) and expenditure for the coming financial year

Taxation: the revenue that a government obtains from economic activity and participants in that activity; it is a leakage from the circular flow of income

• 1. Government expenditure (G)
• 2. Taxation levels (T)

The flow of funds in an economy can influence the volume of output, income, and employment. Changes in G or T (or borrowing) will affect aggregate demand and total income (Y), and therefore the economy.
Increased government expenditure will expand the economy; increased taxation will contract the economy and vice versa.

Tax: the compulsory transfer of wealth (or funds) from the private sector (households and firms) to the public sector (government).

Principles of Taxation:

• Principle of equity: the rich should pay more tax than the poor
• Principle of economy in collection: the cost involved in collecting the tax should be kept as low as possible
• Quality of certainty: those from whom tax is being collected should be certain of three things – they must know when the tax applies,
  how much tax must be paid, and how the rate of tax is calculated
• Quality of convenience: both the time and the manner of payment should cause the least possible inconvenience to the taxpayer

What are the reasons for taxation?

Raise revenue to finance expenditure:
• The government needs money to fund its annual budget (public services, repay its debt etc.)
• Raising revenue via instead of excessive borrowing reduces the interest expense on creditors
Discourage the production/consumption of certain goods/services:
• Increasing taxation may discourage the consumption/production of demerit goods (goods which have negative externalities)
Redistribute income:
• A progressive tax system allows the government to redistribute tax from the rich to the poor through the annual budget
Manage demand:
• Raising/lowering taxes determines the disposable income, in turn, influencing aggregate demand
Key definitions:
• • Tax base: the item/individual being taxed
• • Impact of tax: the point at which the effect of tax are felt first
• • Incidence of tax: the point at which the tax burden is ultimately felt
• • Tax rate: the amount levied (% of price) on goods/services and income
• • Marginal tax rate: tax levied on additional income earned

So, what are the types of tax?

• • Direct taxes: any tax that is borne by the person/firm on whom it is levied because it cannot be passed on to someone else. Impact and Incidence are the same.
• • Indirect taxes: any tax on aspects of economic activity other than income. Impact and incidence are on different people (GST, customs duty). There are two forms:
• • Ad Valorem: the amount of tax as a % of the value of goods/services
• • Specific Tax: the amount of tax as a set sum of money/unit
What are the main sources of tax revenue in PNG?

1. Personal income tax

2. Corporate tax

3. Import tax (duty/tariff)

4. Stamp duty (tax on document or transactions)

5. Excise duty (locally produced goods)

6. Export tax

The Internal Revenue Commission (IRC) is the statutory organisation that formulates and implements taxation policies in the country.

Students should remember that:

The government can increase/decrease the rate of tax to influence the economic activities

Taxation is a leakage from the circular flow of income – it withdraws income and contracts the economy

Increase (decrease) in tax is restrictive (stimulative) and reduces (increases) aggregate demand thereby contracting (expanding) the economy

Changes in G or T or borrowing will affect aggregate demand and total income (Y), output (O), consumption (C), employment, savings (S) and Investment (I)

Proportional rate of tax: a constant % of income is paid in tax regardless of different income levels – 10% tax on all income levels

Arguments for:
• Encourages people to work hard
• Simple method of taxation
Arguments against:
• People are not paying tax equitably (according to their ability to pay)
• Reduces social and economic equality

Progressive rate of tax: the tax rate increases as income increases. People should pay taxes according to the ability to pay. Income tax in PNG is progressive while company tax is proportional.

• o Based on the ability of people to pay
• o An efficient way to redistribute wealth from the rich to the poor
• o Helps reduce inequalities of income in society
Arguments against:
• o Discourages people from working hard
• o Discourages savings and encourages spending
• o Encourages tax reduction

Regressive rate of tax: the tax rate decreases as income increases

Arguments for:
• o Encourages people to work hard Arguments against:
• o Falls more heavily on the poor (not based on the ability to pay)

Developing countries use taxation as a method of fiscal policy. Tax (T) is a source of revenue for developing countries and contributes significantly to Government Expenditure (G) through annual budgets.

Developing countries utilise taxation to regulate their economies to achieve several goals: redistribution of income, economic stability, or to encourage economic growth.

What are the two revenue collecting agencies?

• 1. Internal Revenue Commission (IRC): The IRC collects all internal taxes
• 2. PNG Customs: PNG Customs collects taxes on international trade

How is taxation used to expand or contract the economy?

• In times of higher inflation, a rise in tax would decrease money supply and demand (reduced disposal income), should lead to lower inflation (and vice versa)
• Taxation holidays, exemptions, and concessions can be used to regulate or stimulate industries by creating favourable economic conditions
• Tax holiday: allows firms to invest in the country without paying tax for a certain period – enables the firm to re-invest the money not taxed
• Tax exemption: allows firms to not pay tax
• Tax concession: allows firms to pay a reduced rate of tax

• Fiscal Policy: the use of government expenditure (G) and taxation (T) to influence the economy (formulated through the annual).
• Three types of budget surplus, deficit, and balanced
• o Surplus budget is when the government’s income is more than its expenditure
• o Deficit budget is when the government’s income is less than its expenditure
• o Balanced budget is when the government’s income is equal to its expenditure
• Taxation is the compulsory transfer of wealth (income) from the private sector to the government
• Governments may impose tax to raise revenue, discourage production and consumption of certain goods/services, redistribute income, or manage demand
• The three methods of tax are proportional, progress, and regressive
• Taxation is a leakage; government expenditure is an injection