Chapter 12 – Fiscal Policy, page 1 of 8• fiscal policy and investment:• fiscal policy refers to government policy regarding revenue and expenditures• fiscal policy is under the capital resources section of the text because it used to bebelieved that government was a major saver in the economy; government can contributeto saving through a surplus in the government budget and profit from governmententerprises• government and taxation:• LDC governments have less taxing capacity than industrialized countries; LDCs alsoearn more from taxing trade than income taxes, unlike industrialized countries• developed countries have lower taxes on profits than on wages, which may increaseinequality; however, in LDCs, income taxes might increase equality because only a smallproportion of people (usually those who work in the formal sector) pay them• the incidence and efficiency of taxation is also an important consideration• government as a major saver in an economy:• it was believed at one time that people in poor countries do not save; because capitalformation depends on saving, if this were true, then poor countries would be stuck inpoverty; it was argued that in order for a developing country economy to save, thegovernment should tax as much as possible and reallocate the revenue to investmentprojects; this idea has gone out of fashion because there is no evidence that governmentshave a higher propensity to save than private individuals• the classification of expenditures by government as investment or consumption can bearbitrary – for example, the wages of teachers and healthcare workers are consideredconsumption, although they could be considered investment• governments can still be effective at aiding development; differences in growth couldbe due to the government’s capacity to be efficient and foster development; for example,economists generally agree that a government should provide public goods becauseprivate firms will not find it profitable to sell them and people will not pay for them(because they are nonrival and nonexcludable) – government can fund schooling,healthcare, transportation, communication, infrastructure, etc.• differences in the size of government, government revenue, and government expenditurebetween industrialized and developing countries:• page 422, table 12-1 – government expenditure as a share of GNP:government expenditure as a share of GNP is an indicator of the government’s size;government expenditure as a share of GNP in developing countries is less in poorcountries than it is in rich countries – it rises from 17% in low-income countries to 32% inhigh-income countries; this follow’s Wagner’s law, which states that as an economygrows, the relative size of government does alsosocial spending as a proportion of GNP is higher in rich countries than in poor countries;it rises from 1% in low-income countries to 11% in high-income countries (about 1/3 oftotal government expenditure in rich countries)military spending in high-income countries is a greater proportion of GNP than in low-income countries; however, low-income countries spend a greater proportion of theirgovernment revenue on military spending than do high-income countriesChapter 12 – Fiscal Policy, page 2 of 8• page 424, table 12-2 – government recurrent expenditure:transfers to subnational governments refer to payments to provincial governments, etc.(not found in unitary states)• page 443, table 12-6 – sources of tax revenue:income taxes are a larger share of government revenue in developed countries than indeveloping countries (from 28% in developed countries to 18.8% in low-incomecountries); it is difficult for LDCs to collect income taxes because 80+% of the populationis not in the formal sector and does not report its earnings, and the cost of enforcingincome taxes in the informal sector is prohibitively hightaxes on international trade are a larger share of government revenue in developingcountries than in developed countries (from 25% in LDCs to 0-1% in OECD countries);although taxes on international trade are inefficient and policy advisors encourage LDCsto lower them, developing countries rely on them as a source of tax revenue; taxes oninternational trade are easier to collect and enforce because the government canconcentrate its administration at a few ports• equity and efficiency of a tax system:• there are two types of costs to taxation:1) administrative – the cost of imposing, collecting, and enforcing the tax2) the discouragement of economic activity – deadweight loss• to be efficient, a tax should raise revenue in the least costly way• equity considers the fairness of a tax by looking at the distribution of the ultimateburden of a tax• if a tax is progressive, people with higher incomes pay a larger proportion of theirincome than do people with lower incomes; if a tax is regressive, people with lowerincomes pay a larger proportion of their income than do people with higher incomes• a poll tax (a head tax), which requires all people to pay the same amount, is regressivebecause poorer people pay a larger fraction of their income (although everybody paysthe same absolute amount)• an excise tax (a sales tax), which is levied on the purchase of a basic consumptiongood, is regressive because poorer people pay a larger fraction of their income for the taxon a good (although all people must pay the same tax for a given good); according to theKeynesian model of saving, richer people spend a smaller proportion of their income onconsumption than poorer people – if both have to pay an excise tax equal to a certainfraction of their consumption, then the poorer people will pay a larger fraction of theirtotal income as a tax, and the tax is regressive• government expenditure and equity:• government expenditure could be regressive, if it funds urban hospitals, highereducation, etc.; however, government could use its expenditure to reduce inequalitythrough progressive spending, such as by subsidizing necessities, funding primaryeducation, etc.• governments might not have much ability to control the progressivity of the tax systembecause it is constrained in its ability to earn tax revenue, but it can achieve equity goalsChapter 12 – Fiscal Policy, page 3 of 8on the expenditure side; thus, the text suggests the government tax neutrally and useexpenditures to reduce inequality• excess burden (deadweight loss) of