Assignment

Chapter 13: Role of Government

Prepared for
Professor Dr. Md. Rafiqul Islam
Course Instructor
Fundamental of Economics

Prepared by
Raquibul Hassan
ID# 51714056
MTM 1st Batch
Masters in Tax Management

December 30, 2017

Department of Banking & Insurance

University of Dhaka
 Section B: Structured Questions

Answer to the Question No. 1

a.

i) Total Direct Taxes= (3.6+4.5+4) RM (million)

= 12.1 RM (million)

ii) Total Indirect Taxes= (2.6+3.1+2.2) RM (million)

= 7.9 RM (million)

b. The three instruments of Monetary Policy are:

1. Open Market Operation

2. Legal Cash Reserve Requirement

3. Discount Rate

These are explained below:

 Open Market Operation:

Open market operations are when central banks buy or sell securities. These are
bought from or sold to the country's private banks.

When the central bank buys securities, it adds cash to the banks' reserves. That
gives them more money to lend. When the central bank sells the securities, it places
them on the banks' balance sheets and reduces its cash holdings. The bank now has
less to lend. A central bank buys securities when it wants expansionary monetary
policy. It sells them when it executes contractionary monetary policy.
1
Page

Chapter 13: Role of Government

 Legal Cash Reserve Requirement:

The reserve requirement refers to the money banks must keep on hand overnight.
They can either keep the reserve in their vaults or at the central bank. A low reserve
requirement allows banks to lend more of their deposits.

It's expansionary because it creates credit.

A high reserve requirement is contractionary. It gives banks less money to loan. It's
especially hard for small banks since they don't have as much to lend in the first
place. That's why most central banks don't impose a reserve requirement on small
banks.

 Discount Rate:

The discount rate is the third tool. It's the rate that central banks charge its
members to borrow at its discount window. Since the rate is high, banks only use
this if they can't borrow funds from other banks.

There is also a stigma attached. The financial community assumes that any bank
that uses the discount window is in trouble. Only a desperate bank that's been
rejected by others would use the discount window.

2
Page

Chapter 13: Role of Government

Answer to the Question No. 4

a.

Tax Rate
Country X Country Y Country Z
10 15 5
10 11 7.5
10 9 15

b.

Country X: Proportional Tax Rate- Tax Rate is constant as income rises

Country X: Progressive Tax Rate- Tax rate increases as the income increases

Country X: Regressive Tax Rate- Tax rate decreases as the income increases

Figure: Proportional, Progressive and Regressive Tax Rate

3
Page

Chapter 13: Role of Government

Answer to the Question No. 5

Individuals Original Original New New Tax Type of Tax

Income Tax Paid Income Paid
A 20,000 4,000 40,000 8,000 Proportional
B 10,000 500 30,000 3,000 Progressive
C 24,000 600 50,000 1,250 Proportional
D 50,000 7,500 80,000 8,000 Regressive
E 22,000 1,100 44,000 3,080 Progressive

4
Page

Chapter 13: Role of Government

 Section C: Essay Questions

Answer to the Question No. 1

According to the government, the budget is of three types:

 Balanced budget
 Surplus budget
 Deficit budget

1. Balance Budget: A government budget is said to be balanced when it is estimated

revenues and anticipated expenditure are equal. i.e. government receipts and government
expenditure.

Economic Condition: The concept of a balanced budget has been evocated by classical
economists like Adam Smith. A balanced budget was considered by them as neutral in its
effects on the working of the economy and hence they are regarded it as the best.

However, modern economists believe that the policy of balance budget may not always be
suitable for the economy; for instance during the period of depression, when economic
activities are at low level, resulting in unemployment.

2. Surplus budget occurs when estimated government receipts are more than the
estimated government expenditure it is termed as surplus budget. When the government
spends less than the receipts the budget becomes surplus that is.

Economic Condition: A surplus budget is used either to reduce government public debt
or increase its savings.

3. Deficit budget occurs when estimate government receipts are less than the government
expenditure. In modern economies, most of the budget are of this nature . that the estimate
government receipts < anticipated government expenditure.

A deficit budget increases the liability of the government or decreases its reserves.
5
Page

Chapter 13: Role of Government

Economic Condition: A deficit budget may prove useful during the period of depression ,
economics activities are at a low level . it results in unemployment , business loss and even
bankruptcy and inflation etc. the government can borrow money and increase the
expenditure on public works through deficit financing.

Answer to the Question No. 2

Governments across the world earn "public revenue" from the following main sources:

 Tax revenue
 Non-tax revenue

Tax revenue is the income that is gained by governments through taxation. Taxation is the
primary source of income for a state. Revenue may be extracted from sources such as
individuals, public enterprises, trade, royalties on natural resources and/or foreign aid. An
inefficient collection of taxes is greater in countries characterized by poverty, a large
agricultural sector and large amounts of foreign aid.

Just as there are different types of tax, the form in which tax revenue is collected also
differs; furthermore, the agency that collects the tax may not be part of central government,
but may be a third party licensed to collect tax which they themselves will use.

Non-tax revenue or non-tax receipts are government revenue not generated from taxes.

 Aid from another level of government (intragovernmental aid):

 Aid from abroad (foreign aid)
 Tribute or indemnities paid by a weaker state to a stronger one, often as a condition
of peace after suffering military defeat. The war reparations paid by the defeated
Central Powers after the First World War offer a well-known example.
 Loans, or other borrowing, from monetary funds and/or other governments
 Revenue from state-owned enterprises (for example, revenue from Public Sector
Unions)
 Revenue (including interest or profit) from investment funds (collective investment
schemes), sovereign wealth funds, or endowments
6

Revenues from sales of state assets

Page

Chapter 13: Role of Government

  Rents, concessions, and royalties collected by the state when it contracts out the
right to profit from some good or service to a private corporation.
 Fines collected and assets forfeitured as a penalty. Examples include parking fines,
court costs levied on criminal offenders
 Fees for the granting or issuance of permits or licenses.
 User fees collected in exchange for the use of many public services and facilities.
Tolls charged for the use of toll roads are an example
 Donations and voluntary contributions to the state

Answer to the Question No. 3

Tax is permanent instrument for collecting revenues. It is a major source of revenue in the
developed world and has been appearing as an important source of revenue in the
developing world as well. It has been an instrument of social and economic policy for the
government. The main objectives of tax are as follows:

1. Raise More Revenue

The fundamental objective of taxation is to finance government expenditure. The

government requires carrying out various development and welfare activities in the country.
For this, it needs a huge amount of funds. The government collects funds by imposing
taxes. So, raising more and more revenues has been an important objective of tax.

2. Prevent Concentration Of Wealth In A Few Hands

Tax is imposed on persons according to their income level. High earners are imposed on
high tax through progressive tax system. This prevents wealth being concentrated in a few
hands of the rich. So, narrowing the gap between rich and poor is another objective of tax.

3. Redistribute Wealth For Common Good

Tax collected by the government is expended for carrying out various welfare activities. In
this way, the wealth of the rich is redistributed to the whole community.
7
Page

Chapter 13: Role of Government

4. Boost Up The Economy

Tax serves as an instrument for promoting economic growth, stability and efficiency. The
government controls or expands the economic activities of the country by providing various
concessions, rebates and other facilities. The effective tax system can boost up the
economy. Similarly, taxes can correct for externalities and other forms of market failure
(such as monopoly). Import taxes may control imports and therefore help the country's
international balance of payments and protect industries from overseas competition.

5. Reduce Unemployment

The government can reduce the unemployment problem in the country by promoting
various employment generating activities. Industries established in remote parts or
industries providing more employment are given more facilities. As a result, the
unemployment problem can be reduced to a great extent through liberal tax policy.

6. Remove Regional Disparities

Regional disparity has been a chronic problem to the developing countries. Tax is one of the
ways through which regional disparities can be minimized. The government provides tax
exemptions or concessions for industries established or activities carried out in backward
areas. This will help increase economic activities in those areas and ultimately regional
disparity reduces to minimum.

8
Page

Chapter 13: Role of Government

Answer to the Question No. 4

BASIS FOR
DIRECT TAX INDIRECT TAX
COMPARISON

Direct tax is referred to as

Indirect Tax is referred to as the tax, levied
the tax, levied on person's
on a person who consumes the goods and
Meaning income and wealth and is
services and is paid indirectly to the
paid directly to the
government.
government.

Nature Progressive Regressive

Incidence and
Falls on the same person. Falls on different person.
Impact

Wealth Tax, Income Tax,

Central Sales tax, VAT (Value Added Tax),
Property Tax, Corporate
Types Service Tax, STT (Security Transaction Tax),
Tax, Import and Export
Excise Duty, Custom Duty.
Duties.

Tax evasion is hardly possible because it is

Evasion Tax evasion is possible. included in the price of the goods and
services.

Direct tax helps in reducing

Inflation Indirect taxes promotes the inflation.
the inflation.

Imposed on and collected

from assessees, i.e. Imposed on and collected from consumers
Imposition and
Individual, HUF (Hindu of goods and services but paid and
collection
Undivided Family), deposited by the assessee.
Company, Firm etc.

Burden Cannot be shifted. Can be shifted

Taxable income or wealth of Purchase/sale/manufacture of goods and

Event
the assessee provision of services
9
Page

Chapter 13: Role of Government

Answer to the Question No. 6

 Proportional Tax System:

A proportional tax system, also referred to as a flat tax system, assesses the same tax rate
to taxpayers regardless of income or wealth. It is meant to create equality between marginal
tax rate and average tax rate paid. Under a proportional tax system, individual taxpayers
pay a set percentage of their income regardless of total income earned.

For example, an income tax of 10% that does not increase or decrease as income rises or
falls results in a proportional tax. In this example, an individual who earns $20,000 annually
pays $2,000 under a proportional tax system, while someone who earns $200,000 each year
pays $20,000 in taxes. Some specific examples of proportional taxes include per capita
taxes, gross receipts taxes, and occupational taxes.

 Progressive Tax System:

The current federal income tax in the US is a progressive tax system, in that the proportion
of tax liability rises as an individual or entity's income increases. Tax burdens are meant to
be more of an imposition to wealthy, high-income earners than they are to low- or middle-
class individuals.

Under a progressive tax system, taxes assessed on income and business profits are based
on a progressive or increasing tax rate schedule. Marginal tax rates under a progressive tax
system are often higher than the average tax rates that are paid. Estate taxes are another
example of progressive taxes, as a greater burden is placed on wealthy individuals.

 Regressive Tax System:

Under a regressive tax system, individuals and entities with low incomes pay a higher
amount of that income in taxes compared to high-income earners. Rather than
implementing a tax liability based on the individual or entity's ability to pay, the government
assesses tax as a percentage of the asset that the taxpayer purchases or owns.
10

For example, a sales tax on the purchase of everyday products or services is assessed as a
percentage of the item bought and is the same for every individual or entity. However, a
Page

Chapter 13: Role of Government

sales tax of 7% has a greater burden on lower-income earners than it does on the wealthy
because the ability to pay is not taken into consideration. Regressive taxes include real
estate property taxes, state and local sales taxes as well as excise taxes on consumables
such as cigarettes, gasoline, airfare, or alcohol.

Figure: Proportional, Progressive and Regressive Tax Rate

11
Page

Chapter 13: Role of Government

Answer to the Question No. 6

 Internal Sources of Public Debt:

1. Borrowing from Citizens

2. Borrowing from Financial Institutions

3. Loans from Central Bank

 External Sources of Public Debt:

1. International Money Market

2. Currency Loans from Foreign Governments

3. Loans from International Financial Institutions

Answer to the Question No. 7

The objectives of monetary policy in detail are as below:-

1. Rapid Economic Growth: It is the most important objective of a monetary

policy. The monetary policy can influence economic growth by controlling real
interest rate and its resultant impact on the investment. Faster economic growth is
possible if the monetary policy succeeds in maintaining income and price stability.

2. Price Stability: All the economics suffer from inflation and deflation. It can also
be called as Price Instability. Both inflation are harmful to the economy. Thus, the
monetary policy having an objective of price stability tries to keep the value of
money stable. It helps in reducing the income and wealth inequalities.
12
Page

Chapter 13: Role of Government

3. Exchange Rate Stability: Exchange rate is the price of a home currency
expressed in terms of any foreign currency. If this exchange rate is very volatile
leading to frequent ups and downs in the exchange rate, the international
community might lose confidence in our economy. The monetary policy aims at
maintaining the relative stability in the exchange rate.

4. Balance of Payments (BOP) Equilibrium: Many developing countries like

India suffers from the Disequilibrium in the BOP. The Reserve Bank of India through
its monetary policy tries to maintain equilibrium in the balance of payments. The
BOP has two aspects i.e. the 'BOP Surplus' and the 'BOP Deficit'. The former reflects
an excess money supply in the domestic economy, while the later stands for
stringency of money. If the monetary policy succeeds in maintaining monetary
equilibrium, then the BOP equilibrium can be achieved.

5. Full Employment: In simple words 'Full Employment' stands for a situation in

which everybody who wants jobs get jobs. However it does not mean that there is a
Zero unemployment. In that senses the full employment is never full. Monetary
policy can be used for achieving full employment. If the monetary policy is
expansionary then credit supply can be encouraged.

6. Neutrality of Money: Economist such as Wicksted, Robertson have always

considered money as a passive factor. According to them, money should play only a
role of medium of exchange and not more than that. Therefore, the monetary policy
should regulate the supply of money. The change in money supply creates monetary
disequilibrium. Thus monetary policy has to regulate the supply of money and
neutralize the effect of money expansion.
13
Page

Chapter 13: Role of Government

7. Equal Income Distribution: Many economists used to justify the role of the
fiscal policy is maintaining economic equality. However in recent years economists
have given the opinion that the monetary policy can help and play a supplementary
role in attainting an economic equality. monetary policy can make special provisions
for the neglect supply such as agriculture, small-scale industries, village industries,
etc. and provide them with cheaper credit for longer term.

Answer to the Question No. 8

In a purely economic sense, inflation refers to a general increase in price levels due to an
increase in the quantity of money; the growth of the money stock increases faster than the
level of productivity in the economy. The exact nature of price increases is the subject of
much economic debate, but the word "inflation" narrowly refers to a monetary phenomenon
in this context.

Using these specific parameters, the term deflation is used to describe productivity
increasing faster than the money stock. This leads to a general decrease in prices and the
cost of living, which many economists paradoxically interpret to be harmful. The arguments
against deflation trace back to John Maynard Keynes' paradox of thrift. Due to this belief,
most central banks pursue slightly inflationary monetary policy to safeguard against
deflation.

Contemporary governments and central banks rarely ever print and distribute actual physical
money to influence the stock of money, instead relying on other controls such as interest
rates for interbank lending. There are several reasons for this, but the two largest are: 1)
new financial instruments, electronic account balances and other changes in the way
individuals hold money make basic monetary controls less predictable; and 2) history has
produced more than a handful of money-printing disasters that have led to hyperinflation
and mass recession.

When interest rates rise, for example, savers can earn more on their demand deposit
accounts and are more likely to delay present consumption for future consumption.
Conversely, it is more expensive to borrow money, which discourages lending. Since lending
in a modern fractional reserve banking system actually creates "new" money, discouraging
14

lending slows the rate of monetary growth. The opposite is true if interest rates are
Page

Chapter 13: Role of Government

lowered; saving is less attractive, borrowing is cheaper, and spending is likely to increase,
etc.

In short, central banks manipulate interest rates to either increase or decrease the present
demand for goods and services, the levels of economic productivity and the impact of the
banking money multiplier. However, many of the impacts of monetary policy are delayed
and difficult to evaluate. Additionally, economic participants are becoming increasingly
sensitive to monetary policy signals and their expectations about the future.

There are some ways in which the Federal Reserve controls the money stock; it participates
in what is called "open market operations," by which federal banks purchase and sell
government bonds. Buying bonds injects new dollars into the economy, while selling bonds
drains dollars out of circulation. So-called quantitative easing, or QE, measures are
extensions of these operations. Additionally, the Federal Reserve can change the reserve
requirements at other banks, limiting or expanding the impact of money multipliers.
Economists continue to debate the usefulness of monetary policy, but it remains the most
direct tool of central banks to combat or create inflation.

15
Page

Chapter 13: Role of Government