This page considers the way that governments collect tax revenue as well as how they spend that revenue on a range current expenditures, capital expenditures and transfer payments.
How does the government raise revenue and what does it do with the money it collects?
Lesson time: 80 minutes
Explain that the government earns revenue primarily from taxes (direct and indirect), as well as from the sale of goods and services and the sale of state-owned (government owned) enterprises.
Types of government expenditures: Explain that government spending can be classified into current expenditures, capital expenditures and transfer payments, providing examples of each.
Distinguish between a budget deficit, a budget surplus and a balanced budget. Explain the relationship between budget deficits/ surpluses and the public (government) debt.
1. Beginning activity - begin with the opening video which takes 5 minutes to watch and then complete activity 1 based on the information contained in the video. (Allow 10 minutes in total)
2. Processes - technical vocabulary - the students can learn the background information from each of the videos attached to the activities on this page and the list of key terms. Allow 10 minutes for the key terms.
3. Applying knowledge - complete the short response activities 2 - 4, illustrating the types of government taxation and revenue (20 minutes)
4. Group discussion - Activities 4 and 5 should be completed together. Begin with the video in activity 5, which argues that no correlation exists between public debt and taxation. Your class should attempt to answer this discussion point in conjunction with activity 6 - which implies a different conclusion. (15 minutes)
5. Applying knowledge - activity 7 develops the argument, with a focus on Donald Trump's presidency. The current President appears to combining higher rates of public spending (on military, infrastructure e.t.c.) with significant cuts to taxation. Is this possible? (20 minutes)
6. Final reflection - activity 8 contains a short fun simulation, showing the % of GDP collected in tax by the highest taxing nations. (5 minutes)
Government budget - derived from government income from taxation and sales of public assets minus total expenditures, including debt interest payments.
Fiscal policy - refers to the use of government spending and tax policies to influence economic conditions, including demand for goods and services, employment, inflation and economic growth.
Budget deficit - when government income from taxation and sales of public assets is lower than its total expenditure, including debt interest payments, within a fiscal year.
Budget surplus - when government income from taxation and sales of public assets is greater than its total expenditure, including debt interest payments, within a fiscal year.
Budget balance - when government income from taxation and sales of public assets is equal to its total expenditure, including debt interest payments, within a fiscal year.
Public (national) debt - the cumulative level of debt measured at a specific point in time and is the accumulation of all prior deficits.
Direct taxation - tax paid directly by an individual or organisation to the government, e.g. property tax, personal property tax, income tax or taxes on assets.
Indirect taxation - taxes collected by an intermediary (such as a retail store) from the person who bears the ultimate economic burden of the tax e.g. the consumer.
Government expenditure - government or public spending and can be classified into current expenditures, capital expenditures and transfer payments.
Transfer payments - a payment made to a person with no service or good provided in exchange e.g. pensions, student grants or unemployment benefit. Transfer payments are used by governments to redistribute money to those in society most in need.
The activities on this page are available as a PDF file at: Government budget
Activity 1: Tax revenues
Using information from the following video answer the questions about taxation:
(a) In USA which is the largest source of government taxation?
Personal income tax which makes up 46%of all revenue.
(b) Which nations have the highest income tax rates in the world?
Western European nations - Germany, Denmark, Belgium.
(c) The USA has one of the highest rates of corporation tax in the world yet only receives around 10% of its revenues from corporations. Explain why this is so?
Corporations hide their profits, moving their headquarters to low corporation tax nations e.g. Ireland, Luxemburg and Switzerland.
(d) What % of tax revenue comes from excise duty import and property taxes in the USA?
Activity 2: Sales tax
The following table illustrates the level of sales tax and income tax in a range of nations:
|Sales tax rate %||Income tax rate %|
|Denmark||25%||55 - 66%|
|Italy||21%||43 - 51%|
|UK||17.5%||40 - 50%|
|Germany||18%||42 - 57%|
|USA||0 - 5%||35 - 40%|
|Canada||6%||29 - 33%|
(a) Explain some of the advantages of collecting tax revenue from income tax than sales tax?
Unlike sales taxes, income taxes are progressive meaning that the wealthiest individuals pay a larger proportion than low income households e.g. in USA the wealthiest 5% of earners pay almost 50% of income tax revenue.
(b) Explain some of the advantages of collecting tax revenue from sales taxes than income tax?
Unlike corporation and income tax, sales taxes do not discourage hard work or entrepreneurship as they are regressive.
Sales taxes can be used to discourage the consumption of certain kinds of goods - cigarettes, alcohol, petrol e.t.c.
Activity 3: Government spending
Watch the following short video about where the UK government spends its current budget. What % goes to current expenditures, which to capital expenditures and what % is handed over as transfer payments?
Current expenditure - 10% on education, 10% Police and defence combined, 5% on interest payments
Transfer payments - 50% which goes on social security payments and health care plus the 2% of the budget which goes to foreign aid.Capital expenditure - the portion of those budgets spent, not on running costs, but on the acquisition of physical capital such as offices or other buildings, rather than salaries and supplies which are included in current expenditure.
Activity 4: Sale of public assets
Watch the following short video, set in the UK at the height of the financial crisis and then comment on the sale of public assets, as a source of government revenue.
(a) According to the video what is the size of the UK budget deficit for that fiscal year?
£ 175 bn
(b) How much is the government hoping to generate from the sale of public assets?
The government was putting up for sale, £16 bn of national assets including student loan debt, The Dartford tunnel, Channel tunnel link and a property portfolio. The government is expecting to make £3bn this year.
(c) Outline the advantages and disadvantages of the sale?
Receiving the full market value for the assets is unachievable, given the state of the economy and the fact that potential buyers are aware of the government's desperation to sell
It raises revenue in the short term but then deprives the economy of revenue in the long term. Individually students and car drivers are concerned that their costs will rise following the sale.
On the other hand, the government stresses that the alternative would mean savage cuts to public services.
Activity 5: Will raising taxes help reduce national debt?
Start watching the following short video and then answer the question, will raising taxes reduce the size of government deficit.
The video argues that rather than reducing national debt reducing taxes actually makes the problem worse. This is because taxation reduces hte incentive for businesses to invest and individuals to work. Therefore, the video claims that higher taxes reduce income in the economy which means that government ends up taking a larger and larger slice of an increasingly smaller cake. The video instead suggests that governments should instead focus on reducing the size of government spending. They point to the fact that government revenue is now 3 times higher than 1950s, because of increases in spending. Therefore, the USA's problem can be summarised as excessive spending, rather than falling taxation.
Activity 6: US national debt (HL only)
The following table illustrates the level of taxation, as a % of GDP as well as the size of the national debt. Does this support the claims in activity 5 or not?
|Year||% increase in public debt||Average income tax rate % of GDP|
|Donald Trump||2017 - 2020||110 (before covid-19)||15|
|Barack Obama||2009 - 2017||74||17|
|George W Bush||2001 - 2009||101||19|
|Bill Clinton||1993 - 2001||32||19|
|George Bush||1989 - 1993||54||18|
|Ronald Reagan||1981 - 1989||186||17|
|Jimmy Carter||1977 - 1981||43||18|
|Gerald Ford||1974 - 1977||47||18|
|Richard Nixon||1969 - 1974||34||19|
The table appears neither to confirm of rule out the claims made in activity 5. The presidencies of Barrack Obama and Ronald Reagan saw significant rises in US debt and both also made tax cuts a central plank of their economic policy. Donald Trump has done likewise and his term in office has already witnessed more than $2 Trillion added to the nation's debt. An up to date record of the nation's debt can be viewed on the following simulation: National debt clock
(b) Why is it that none of the US Presidents were able to reduce the size of the national debt, despite presiding over the world's largest economy?
As the New York Times addressed in February 2019, when the federal debt ticked past $22 trillion this week, neither political party appears to be making a priority of debt reduction. In part this is because the nation is able to borrow in its own currency (unlike many other nations) and the US is also able to attract some of the lowest interest rates in the world on the money it borrows.
Larry Kudlow, the director of President Trump’s National Economic Council, for example stated that 'the scale of the debt was not a problem'. Similarly, leading Democrats also have left the issue largely untouched. Several members of the emerging field of presidential candidates have proposed tax increases, but they have generally presented those plans as antidotes for economic inequality, not measures aimed primarily at curbing the debt.
Activity 7: Government budget under Donald Trump
Watch the following short videos and then explain the impact of tax changes, made by the previous administration on America's:
(i) budget deficit
(ii) national debt.
The video highlights Donald Trump's economic policies as:
- very large tax cuts, especially in corporation and income tax
- changes to the law on exemptions so that the tax base is broadened.
This means that without significant cuts to public spending, which there appears to be no sign of, both the US deficit and therefore long term debt are likely to grow further.
Activity 8: Theory of knowledge
In one sense the imposition of taxes by government on individuals amounts to a restriction of individual freedom. How can we know when such government interference in individual freedom is justified?
Some conservative Libertarians make the argument that taxation amounts to a restriction of individual freedom, on the grounds that governments are effectively taking their citizens hard earned money and spending it on what they believe is in the national interest. This claim states that this is wrong because citizens are more likely to know how to spent their own money more than governments do. While this claim makes some sense, without government taxation there would no provision of public goods, merit goods would be under demanded, demerit goods over demanded and income wealth and inequality would sore.
Activity 9: Final simulation
End this lesson by watching the following simulation which illustrates the tax revenue collected by the nations with the highest tax rates as a share of GDP.