 Fiscal policy- policies for government expenditure and revenues  Government expenditure- recurrent and capital or development expenditure  Government revenues- tax and non tax revenues including surpluses from public enterprises and domestic and foreign borrowing  In developing countries- Ministry of Finance is engaged (tax policy and recurrent expenditure) and Ministry of Planning( development expenditure)  In some countries like Botswana they are merged  Should they be separate?  Is the distinction between recurrent and development expenditure quite clear?

 The market can never perform all economic functions efficiently  Example is the case of public goods- non rival in consumption and non excludability  Non-rival- one persons use of a good does not reduce the benefits available to others- free rider problem  Non excludability- it is either impossible or prohibitively expensive to exclude anyone from the benefits once the good is available  Private market cannot provide the good  Some goods can both be provided by the private and public sector- market provides them in a non efficient manner. Eg primary education  But size of public sector extended beyond technical issues to include income distribution, etc  How large should government be?

 Wagner’s law- expenditure grows as per capita income grows  Even though disputable the fact is that poor countries have smaller public sectors than rich ones-measured as ratio of g to gdp  Major expenditure item that makes difference is social protection

 Recur year after year- for day to day running of economic activity  Types- wages and salaries, maintenance and spending on military equipment, interest payment on Govt debt, subsidies, grants, and other social benefits to individuals, producers, etc, and other expenses  Belief is that recurrent expenditure is less important and should have less priority  Why? Not increase productive capacity  But inadequate provision leads to decay of capital  Division is also arbitrary- eg recurrent expenses on human capital, ARVs- recurrent or capital exp?

 Should we be reducing military spending? Accepted wisdom is that we should- coz we can use the money for economic goals  Military expenditure and growth?  For most LDCs interest payment is a major component- service debt- HIPCs asking for debt forgiveness because of the huge effect of servicing debt  Subsidies also important in LDCs, eg subsidies on basic foods  In developed countries subsidies in the form of social welfare programmes  For developing countries driven by the need to redistribute incomes  Reduction of subsidies became a condition for structural adjustment- consequences were very painful as it meant poverty increased, etc  Better to adjust now than later when things are worse?

 Subsidise State owned enterprises which were making losses  Countries are now required to privatize the SOEs as a condition for further assistance  Privatization has been slow as there is resistance from workers, politicians, unions  Political issue where income is unequally distributed- fear that control will fall into the few minority  Transfer of funds from central govt to local government

 Very few ways  Military spending?  Subsidies on SOEs?  Reduce debt?  In the long run allocate more spending to capital?  What else?

 For most developing countries measures to raise tax collection were thought of the most effective ways of boosting public savings  Sub-Saharan countries tend to tax themselves more heavily because of low opportunity for mobilizing other types of savings because of poorly developed and organised financial systems  Measures- increase tax rates on existing taxes, enact new taxes, improvement of tax administration to reduce avoidance and evasion, and major reform in the netire tax structure

 Taxes on international trade- imports and exports- leads to retaliation and tax evasion  For equity reasons usually tax luxurious commodities higher rates- but these are elastic by nature- decrease tax revenue  Personal and corporate income taxes- few people have adequate income for personal tax- paid mainly by a small urban elite who are also politically vocal, also have devised various means of tax evasion and avoidance  Corporate tax covers a small proportion of the private sector- many have no taxable income

 Sales and excise tax- charged by most LDCs  Have been charged as VAT coz it is less distortionary than other forms  Charged mainly on commodities that have low price elasticity-sin tax  But tend to also have low income elasticity and therefore take a larger budget of the poor- regressive

 Some untapped new sources of tax revenue  Examples, motor vehicle registration, urban property tax, service sector taxes  But revenue is limited sometimes making the tax uneconomic  Another option is to improve tax administration- make tax evasion difficult  But sometimes based on the level of economic development and institutions  Bringing in new tax laws and regulations- may take time to implement and become effective

 High taxes tend to reduce incentive to save  High taxes may encourage capital flight- low FDI

 For most LDCs taxes have been justified also on equity grounds- to deal with income distribution- go for progressive taxes- should therefore be based on ability to pay  Problem is tax evasion and tax avoidance- making redistribution difficult  Because it is difficult to use personal income taxes for redistribution most countries have relied heavily on indirect taxes on luxury consumption  Countries also charge customs duties- import substitution  For corporate and property taxes there are problems of shifting the incidence to the final consumer, especially where there is less competition- defeat the whole equity iss

 Generally taxes on inelastic commodities produce less inefficiency than those on elastic commodities  Therefore charge higher taxes on inelastic commodities than elastic ones- Ramsey Rule  But such a tax is regressive

 Even though empirical evidence shows that the rich pay a proportionally higher income in taxes generally, the poor still pay substantial taxes  The limits of tax policy suggest that if the budget is to serve redistribution purposes, the primary emphasis should be on expenditure policy  Budget expenditure may transfer very substantial resources to low income households  Not all govt spending is effective in reducing income inequality though  Therefore some of the expenditure will need to be means tested

 Generally difficult to cut spending  Generally difficult to increase revenue  So how do you reach a balance?

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