Chapter 7

Public sector
Topics covered
Why government is involved in economic activity
Government failure
Nationalization vs privatization
Fiscal policy
Types of taxes: Direct and indirect
Forms of taxes: Progressive, regressive and
proportional
Criteria of a good tax
Financing government spending
Why government is involved in economic activity

1. Due to market failure

2. To provide public goods.
3. Due to monopoly & imperfect competition
4. Externalities
5. Asymmytric information
6. To protect Common property resource
 Government failure
Government failure occurs when government
intervention causes a more inefficient allocation of goods
and resources than would occur without that intervention.
Govt failure due to :
1. interests of politicians and Beurocrates
2. inefficiency
3. corruption
4. Rent seeking : refers to attempts by pvt firms , house
holds , organized business, organized labour and other
interest groups to benefit at the expense of society at large.
Interest group use their political influence to seek economic
rent from government.
Nationalization vs privatization
Nationalisation is the act of taking property
previously owned by individuals or other legal entities
such as companies or municipalities into the
ownership of the state.  Conversely privatisation is the
act of transferring property previously owned by the
state into the ownership of individuals or other legal
entities.
Fiscal policy
A policy implemented by Government to
attain macro economic objectives.
Tools of Fiscal policy
Taxation
Public expenditure
Public borrowing.
Types of taxes: Direct and indirect

Direct tax 
a tax exacted directly from the persons who
will bear the burden of it (without
reimbursement to them at the expense of
others), eg : an income tax. 
Indirect tax 
a tax levied indirectly, as one levied on
commodities before they reach the consumer
but ultimately paid by the consumer as part
of the market price.
Forms of taxes: Progressive, regressive and
proportional
Taxes can be distinguished by the effect they have on the
distribution of income and wealth.
 A proportional tax is one that imposes the same
relative burden on all taxpayers—i.e., where tax liability
and income grow in equal proportion. A proportional
tax (sometimes called a flat tax) is a tax where everyone,
regardless of income, pays the same fraction of income
in taxes. (Proportional taxes can also be thought of as
taxes where marginal and average tax rates are the
same.)
 Aprogressive tax is characterized by a more than proportional
rise in the tax liability relative to the increase in income. A
progressive tax is a tax where lower-income entities pay a lower
fraction of their income in taxes than do higher-income
entities. (Progressive taxes can also be thought of as taxes
where the marginal tax rate is higher than the average tax rate.)

aregressive tax is characterized by a less than proportional rise

in the relative burden. Thus, progressive taxes are seen as
reducing inequalities in income distribution, whereas
regressive taxes can have the effect of increasing these
inequalities.
A regressive tax is a tax where lower-income entities pay a
higher fraction of their income in taxes than do higher-income
entities.
Criteria of a good tax

 EQUITY: Every tax payer in a country should be treated fairly and equally in all matters pertaining tax.

CERTAINTY: There should be some elements of certainty in a good tax system . In this regards, tax
payers should not be placed in doubt also the amount to be paid as tax, and when it should be paid.

CONVENIENCE: Tax system should be designed in a manner that it will be convenient to both tax
payers and tax administrators. Tax payment should be demanded when the payer is in a better position to
pay.

COST OF COLLECTION: The cost of collection of any tax should be kept at the barest minimum so
that the benefits that may accrue to the society from it is not wipe away.

NEUTRALITY:A good tax is a tax which does not have effects on consumption and production decisions
of the payers that is, does it alter their consumption and production decisions.

TAX ADMINISTRATIVE EFFICIENCY: A good tax system should be simple and easy to administer
and understand by both tax officers and payers.