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.
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?
(b) Which nations have the highest income tax rates in the world?
(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?
(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?
(b) Explain some of the advantages of collecting tax revenue from sales taxes than income tax?
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?
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?
(b) How much is the government hoping to generate from the sale of public assets?
(c) Outline the advantages and disadvantages of the sale?
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.
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|
(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?
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.
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?
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.