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The Role of the Government in the Economy
Principles of Business
Topic Nine

The Role of the Government in the Economy

Governments are appointed by citizens to manage the affairs of their country. Their responsibilities include:

  • Management of the economy – governments have the critical task of managing the economy in order to promote growth and development in the economy. Some goals for managing the economy include creation of employment, reduction of inflation and  facilitating for international trade to earn foreign exchange,
  • Provision of Security - government passes laws in order to maintain stability and safety in the country.
  • Protection and general welfare of citizens   - government is responsible for the general health and education of citizens. Welfare programmes must be provided for those who are very poor and vulnerable. Measures to achieve this include food stamps and badges, free transportation, subsidies and national insurance. 
  • Protecting the environment –The government has environmental protection laws and also agencies to enforce these laws such as the Environmental Protection Commission in Trinidad and Tobago. Violators of these laws are also brought to justice.

Purposes of Taxation

Taxes are the main source of income for the government in order for it to be able to financial its operations in achieving its goals.  Government expenses include health care, education, security, infrastructure, transportation, pensions, national insurance, garbage collection and operating government business entities. Taxation is also used by government for several other purposes.

  • To reduce pollution by taxing offending firms.
  • To discourage unhealthy habit such as alcohol and cigarette smoking.
  • To protect local and infant industries by taxing imports.
  • Redistribute income for income equality purposes by taxing the rich at a higher rate than the middle class.
  • Curtailing imports to achieve a surplus in its balance of payments position.
  • To contain inflation by increasing taxes in order to reduce disposable income in an attempt to reduce spending by the population.

Distinction between Direct and Indirect Taxes

In the case of a direct tax, the taxpayer is the person who bears the burden of it. Conversely, in the case of an indirect tax, the taxpayer, shifts the burden on the consumer of goods and services.   

Types of Direct Taxes

  • Income Tax – this is a tax on earned income- individuals pay a percentage of their income.
  • Corporate Taxthis is a tax on the profits of companies
  • Excise Duties – an excise or excise tax is any duty on manufactured goods which is levied at the moment of manufacture, rather than at sale.
  • Customs Duties - this is a tax on imports which are goods entering the country.

Distinction between Proportional, Progressive and Regressive Taxation

  • Proportional tax is one where the rate of taxation is fixed. This means that the amount of the tax is a fixed proportion such as 30 percent of a person’s income.  The rate remains the same whether the person’s income increases or decreases. 
  • Progressive tax is a tax in which the tax rate increases as the income increases. A progressive tax therefore takes a larger percentage of income in taxes from the high-income group than it does from the low-income group.   
  • Regressive tax is a tax imposed in such a manner that the tax rate decreases as the amount of taxable income increases. The higher income group pays less in taxes than the lower income group.  There is greater tax burden on the poor relative to the rich.