a.

Macro-economic policy objectives

The major macro-economic policy objectives which the governments strive to

achieve are:

i. Full employment

One of the main objectives of all governments is the control of employment or

full employment. However economists are not agreed on what constitutes full
employment. But we can say full employment exists when everyone who
wants a job and is capable of doing a job is able to find one.

ii. The control of inflation

Since most monetarists believe that inflation has a negative effect upon
economic growth as it increases uncertainty and discourages savings,
maintaining stable prices usually is a major objectives of most governments.

These two foregoing objectives can be regarded as “good housekeeping”.

iii. High Growth rates

For most people, economic growth remains the prime objective of policy as it
allows everyone to enjoy a better standard of living.

iv. Balance of payments equilibrium

Most governments like to have an equilibrium position in the BOP accounts

as there are
problems associated with both sides of disequilibrium.

v. Equitable distribution of income

2. PUBLIC BUDGET
 The budget is a summary statement indicating the estimated amount of
revenue that the government requires and hopes to raise. It also indicates the
various sources from which the revenue will be raised and the projects on
which the government intends to spend the revenue in a particular financial
year. The budget in Kenya is presented to parliament by the Minister of
Finance around mid June. In the budget the Minister reviews government
revenue and expenditure in the previous financial year. The minister presents
tax proposals i.e. how he intends to raise the proposed revenue from taxation
for parliament to approve.

Functions of the Budget

The budget fulfils three main functions:

● To raise revenue to meet government expenditure

The government of a country provides certain services such as administration,

defence, law and order, environmental services and economic services. Also it
must meet the public debt. Sufficient revenue must be raised to pay for this.

● It is a means of redistributing wealth

In many countries, a situation has arisen where a small proportion of the

population own a more than proportionate share of the nations wealth, while the
majority of the population own only a small proportion of it. One method of
redressing such inequalities of wealth is through a progressive system of
taxation on income and capital. A progressive system is one whereby the
wealthy people do not only pay more tax than the poor, but also pay a greater
proportion of their income or wealth.

● To control the level of economic activity

 The government uses the budget to implement fiscal policy, i.e. the regulation of
th

e economy through governments expenditure and taxes.

TYPES OF BUDGETS

1. Deficit budget

If the proposed expenditure is greater than the planned revenue from taxation and
miscellaneous receipts, this is a budget deficit. The excess of expenditure over
revenue will be met through borrowing both internally through the sale of Treasury
Bills and externally from other organisations.

2. Balanced budget

If the proposed expenditure is equal to the planned revenue from taxation and other
miscellaneous receipts, this is a balanced budget. Usually, balanced budgets are
not presented, unless the expenditure is very limited. It would mean the
government would have to over-tax the population which can create disincentives.
It is to avoid this that the tax revenue is supplemented by borrowing.

3. Surplus budgets

If the proposed expenditure is less than the planned revenue from taxation and
other miscellaneous receipts, this is a surplus budget. Usually, surplus budgets are
not presented for they are deflationary and can create unemployment as the
government takes out of the economy more than it puts back.

TAXATION

Taxation is the process of imposing compulsory contribution on the private sector

to meet the expenses which are incurred for a common good.

Functions or Purposes of Taxation

The functions of taxation can be discussed from the activities of the government it
is meant to achieve.

These are:

a. Raise revenue

The revenue is required to pay for the goods and services which the government
provides. These goods are of two types – public and merit goods. Public goods,
such as defence and police are consumed collectively and no one can be prevented
from enjoying them if he wishes to do so. These goods have to be provided by
governments. Merit goods, such as education and medical care, could be, and
often are, provided privately but not necessarily in the amounts considered socially
desirable and hence governments may subsidize the production of certain goods.
This may be done for a variety of reasons but mainly because the market may not
reflect the real costs and benefits of the production of a good. Thus, the public may
be subsidized because the market does not take account of all the costs and benefits
of the public transport system.

b. Economic stability

These are imposed to maintain economic stability in the country. During inflation,
the government imposes more taxes in order to discourage the unnecessary
expenditure of the individuals. During deflation, taxes are reduced in order to
enable the individuals to spend more money. In this way, the increase or decrease
helps to check the big fluctuations in the prices and maintain economic stability.

c. Fair redistribution of income

A major function of taxation is to bring about some redistribution of income. First,

tax revenue provides the lower income groups with benefits in cash and kind.
Second, the higher income groups, through a system of progressive taxation, pay a
higher proportion of their income in tax than the less well-off members of the
society.
d. Pay interest on National debt

Taxes are also levied by the government to pay interest on national debt.

e. Optimum allocation of resources

Taxes are also imposed to allocate resources of the country for optimum use of
these resources. The amounts collected by the Government from taxes are spent on
more productive projects. It means the resources are allocated to achieve the
maximum possible output in the given circumstances.

f. Protection policy

Taxes are also imposed to give protection to those commodities which are
produced in the country. The government thus imposes heavy taxes on the import
of such commodities from the other countries. In the view of these taxes, the
individuals are induced to buy local products.

g. Social welfare

The government imposes taxes on the production of those commodities which are
harmful to human health e.g. excise duty on wines, cigarettes, etc.

PRINCIPLES OF AN OPTIMAL TAX SYSTEM

When taxes are imposed certain conditions must be fulfilled. These conditions are
known as Principles or canons of taxation. According to Adam Smith who first
studied the principles of taxation, these are equity, certainty, economy and
convenience.

CLASSIFICATION OF TAXES

Taxes can be classified on the basis of:

a. Impact of the taxes

It means on whom the tax is imposed. On the other hand, incidence of the tax
refers to who had to bear the burden of the tax. In this case the taxes may be:
 ● Direct or
● Indirect

b. Rates of tax

The rate of tax is the percentage of the tax base to be taken in each situation. In
this case the taxes may be:

● progressive or
● proportional or
● regressive or
● digestive

DIRECT TAXES

A direct tax is one where the impact and incidence of the Tax is on the same
person e.g. Income Tax, death or estate duty, corporation taxes and capital gains
taxes. It can also be defined as the tax paid by the person on whom it is legally
imposed.

● Impact of tax

This means on whom the tax is imposed.

● Incidence of tax

This means who has to bear the burden of the tax, i.e. who finally pays the
tax.

Merits of direct taxes

a. They satisfy the principle of equity as they are easily matched to the tax
payers capacity to pay once assessed.

b. They satisfy the principles of certainty and convenience to tax payers as they
know the time and manner of payment, and the amount to be paid in the case
 of these taxes. Similarly, the government is also certain as to the amount of
money it shall receive from these taxes.

c. They satisfy the Canon Simplicity as they are easy to understand.

d. Because most of them are progressive, they tend to reduce income inequalities
as the rich are taxed heavily through income tax, wealth tax, expenditure tax,
excess profit, gift tax, etc. so long as they are alive; and through inheritance
taxes or death duties when they die. The poor and the income groups which
are below the minimum tax limit are exempted form these taxes. These taxes
thus reduce income and wealth inequalities because of their progressive
nature.

e. Because the public are paying taxes to the government, they take an interest in
the activities of the state as to whether the public expenditure is incurred on
public welfare or not. Such civic consciousness puts a check on the wastage
of the public expenditure in a democratic country.

Demerits of direct taxes

a. Heavy direct taxation, especially when closely linked to current earnings, can
act as a serious check to productivity by encouraging absenteeism and making
men disinclined to work.

b. Heavy direct taxation will clearly reduce people’s ability to save since it leaves
them with less money to spend. Taxation may, therefore, act as a deterrent to
saving. Heavy taxation of profits makes it more difficult for business to build up
reserves to cover replacement of obsolete or worn-out capital and thus
investment.

c. Direct taxes possess an element of arbitrariness in them. They leave much to

the discretion of the taxation authorities in fixing the rates and in interpreting
them.

d. They are not imposed on all as incomes earned on subsistence and non legal
activities are left out.

e. Cost of collection is generally high.

f. These taxes are easily evaded either by understating the source of income or by
any other means. Such taxes thus cultivate dishonesty and there is loss of
revenue to the state.

INDIRECT TAXES

These are imposed on an individual mostly producers or traders but they can be
passed on to be borne by others usually the final consumers. They can also be
defined as taxes where he incidence is not on the person on whom it’s legally
imposed. They include excise duties, sales tax, Value Added Tax and others.

Advantages

a. They are less costly to administer because the producers and sellers themselves
deposit them with the government.

b. If levied on goods with inelastic demand with respect to price rises, it will result
in high revenue collection.

c. Indirect taxes reach the pockets of all income groups. Thus, they have a wide
coverage, and every consumer pays to the state exchequer according to his
ability to pay.

d. They can check on the consumption of harmful goods like wine, cigarettes and
other toxicants.

e. Can be used as a powerful tool for implementing economic policies by the

government. If the government wants to protect domestic industries from
foreign competition, it can levy heavy import duties. This will help to develop
domestic industries. If the government wants to encourage one industry on a
priority basis, it may not levy any taxes on its products but continue the taxes
imposed on other industries. The government may do so in order to encourage,
a particular technology or employment in a particular industry.

Disadvantages
a. Most indirect taxes are regressive as they are based are not based on ability to
pay.
The rich and the poor are required to pay the same amount of tax on such
commodities as matches, kerosene, toilet soap, washing soap, toothpaste,
blades, shoes, etc.

b. They may lead to inflation as their imposition tends to raise the prices of
commodities, thereby leading to higher costs, to higher wages, and again to
higher prices. Thus a price-wage cost spiral sets in the economy

c. They sometimes have adverse effects on production of commodities, and even

employment. When the price of a commodity increases with the levy of a tax,
its demand falls. As a result, its production falls, and so employment.

d. The revenue from indirect taxes is uncertain because it is not possible to

accurately
estimate the effect of such taxes on the demand for products.

PROGRESSIVE TAX

A progressive income tax system is one where the higher the income, the greater
the proportion paid in taxes. This is effected by dividing the taxpayers’ incomes
into bands (brackets) upon which different rates of tax are paid – the rates being
higher and the band of income. For example, in Kenya, the bands are as follows:

Monthly Tax Rates

Income Bracket Tax

(K£ per month) (Kshs per Kshs 20)

1 – 325 2
326 – 650 3
651 – 975 4
976 – 1300 7
1301 – 1625 7
excess over 1625 7.50

Source: Income Tax Department, 1996

Examples of Progressive taxes in Kenya are Income Tax, Estate Duty, Wealth Tax
and Gift Tax.

Advantages

a. It is more equitable. The broader shoulders are asked to carry the heavier
burden.

b. It satisfies the canon of productivity as it yields much more than it would under
proportional taxation.

c. It satisfies the canon of equity as it brings about an equality of sacrifice among

the taxpayers.

d. To some extent it reduces inequalities of wealth distribution.

Disadvantages

o The effect on incentives

High progressive tax makes work and extra effort become less valuable.

o The effect on the willingness to accept risk

High marginal rates of tax are likely to make entrepreneurs less willing to
undertake risks.

o Effects on mobility

Some financial inducement is usually required if people are to be asked to

change their location, or undergo training, or accept promotion. Progressive
taxation by reducing differentials is likely to have some effect on a person’s
willingness to any of the above.

o Encourages tax avoidance and evasion.

o Outflow of high achievers to other countries with lower Marginal tax rates.
o It can lead to fiscal-drag where wage and price inflation cause people to pay
higher proportion of income as tax.

PROPORTIONAL TAX

Is where whatever the size of income, the same rate or same percentage is charged.
Examples are commodity taxes like customs, excise duties and sales tax.

Its advantage is that it’s much simpler than progressive taxation.

REGRESSIVE TAX

A tax is said to be regressive when its burden falls more heavily on the poor than
on the rich. No civilized government imposes a tax like this.

DIGRESSIVE TAX

A tax is called digressive when the higher incomes do not make a due contribution
or when the burden imposed on them is relatively less.

Another way in which digressive tax may occur is when the highest percentage is
set for that given type of income one which it is intended to exert most pressure;
and from this point onwards, the rate is applied proportionally on higher incomes
and decreasing on
lower incomes, falling to zero on the lowest incomes.

ECONOMIC EFFECTS OF TAXATION

a. A deterrent to work

Heavy direct taxation, especially when closely linked to current earnings, can act as
a serious check to production by encouraging absenteeism, and making men
disinclined to work. However, indirect taxation may actually increase the incentive
to work, since the more money is then required to satisfy the same wants, indirect
taxes having made goods dearer than they were before.
b. A deterrent to saving

Taxation will clearly reduce people’s ability to save since it leaves them with less
money to spend. Taxation may, therefore, act as a deterrent to saving. However,
this will not always be the case, as it will depend On the purpose for which people
are saving.

b. A deterrent to enterprise

It is argued that entrepreneurs will embark upon risky undertakings only when
there is a possibility of earning large profits if they are successful. Heavy taxation
of profits, it is said, robs them of their possible reward without providing any
compensation in the case of failure. As a result, production is checked and
economic progress hindered. It may be, too, that full employment provides
conditions under which even the less efficient firms cannot fail to make profits, and
so there may be greater justification for taxation of profits, and so there may be
greater justification for taxation of profits under such conditions.

c. Taxation may encourage inflation

Under full employment increased indirect taxation will lead to demand for higher
wages, thereby encouraging inflation. A general increase in purchase taxes pushes
up the Index of Retail Prices, and so brings in its train demands for wage increase.

d. Diversion of economic resources

Only if there are no hindrances to the free play of economic forces will resources
be distributed among occupations in such a way as to yield that assortment of
goods and services desired by consumers. Taxation of commodities is similar in
effect to an increase in their cost of production. Thus, the influence of a change of
supply has to be considered, effect depending on their elasticity of demand. In
consequence of taxation, resources will more from heavily taxed to more lightly
taxed forms of production. This result may, of course, be desired on
Non-economic grounds.

3. PUBLIC EXPENDITURE

The accounts of the central government are centered on two funds, the
Consolidated Fund, which handles the revenues form taxation and other
miscellaneous receipts such as broadcasting license fees, interest and dividends,
and the National Loans Fund which conducts the bulk of the governments
domestic borrowing and lending.

Each government ministry works out how much money it wants to spend in the
coming Financial Year which, in Kenya starts on 1st July in each year and ends on
30th June on the following year. This is known as preparing estimates. There are
two types of estimates, -estimates of Capital Expenditure and estimates of
Recurrent Expenditure.

Capital Expenditure refers to the money spent on government projects such as the
construction of roads, bridges, health facilities, educational institutions and
other infrastructure facilities. Recurrent expenditure refers to money spent by the
government on a regular basis throughout the Financial Year e.g. the salaries of all
civil servants, or the cost of lighting a government building.

Government departments also have to prepare estimates for the next financial year
for presentation to parliament. Any department which earns revenue for sales of
goods or services to the public shows this as an appropriations-in aid, which is
deducted from its estimated gross expenditure to show net expenditure, that is, the
actual amount required of the Exchequer.

The estimates also include Grants-in aid i.e. grants made by the central
government to local authorities to supplement their revenue from their levying of
rates.

4.