How do governments make money? | CNBC Explains

These are challenging times. Governments are trying to keep their economies alive
by injecting billions of dollars across the board. However, they are trying to do so
while receiving less money, a very difficult task, especially for nations where public debt
was already high before the pandemic. So, how do governments make money? For most governments,
the main source of revenue is taxes. Here in the U.K., the biggest chunk
comes from taxes on people’s earnings, known as Income Tax and
National Insurance Contributions. If you are employed in the U.K.,
these come out of your paycheck even before it lands in your bank account,
while in the United States, salaried workers often have to pay a retrospective
tax bill based on their previous year’s earnings. There are also plenty of indirect taxes
levied when goods and services are sold. When you buy a coffee, a chocolate bar
or a car, well that’s taxed too. These consumption taxes,
such as the U.K.’s VAT or India’s Goods and Services Tax
are another important source of revenue. In fact, taxes on income and consumption
amount to about two thirds of tax revenues in the U.K.

They are also used as a way for governments
to influence people’s behaviour. For example, the U.K. introduced a “sugar tax”
aimed at tackling childhood obesity in 2018. This means that consumers are
discouraged from buying sugary soft drinks as these become pricier in comparison
with healthier alternatives. Besides being levied on other unhealthy products,
such as alcohol and tobacco, duties can also be used to discourage environmentally damaging activities,
such as driving petrol- or diesel-powered vehicles. The next chunk of government income
comes from taxes on property, whether on your own
or on commercial spaces. There are a number of other smaller duties too,
when selling or inheriting real estate, which end up boosting the government’s coffers. It’s a similar picture in the U.S.
About half of federal revenue comes from individual income taxes,
while about a third of the total comes from payroll taxes that fund social insurance programs.
Companies are also taxed on their profits.

However, corporate tax in the U.S. has fallen
as a proportion of government receipts since the 1950s, reflecting how the United States has tried
to encourage business activity with lower rates. While taxation patterns are mostly
similar in developed countries, low-income nations are more reliant on trade
and consumption taxes due to the nature of their economies. For example, agricultural workers
rarely have fixed or regular incomes, making it hard to
calculate income taxes. The tax collection system in low-income economies
also tends to be less efficient, which in turn makes
generating revenue harder. Even for an oil-rich country like Saudi Arabia,
which has no income taxes, its increased spending in 2020 forced it
to triple its consumption tax to 15%. Traditionally, governments have tried to
match their expenditure with the money they receive from all of these sources of income,
also known as running a balanced budget. However, they can run a deficit and borrow money
from financial markets to make up the shortfall. But this is a delicate balancing act because interest
payments can mount up, effectively increasing spending. If lenders worry about the total level of
debt getting out of control and threatening the ability of a government to repay them,
they charge a lot more for these loans.

In the eurozone, for instance, Italy’s bonds offer a
higher yield than Germany’s, even though they share a currency, because lenders have more confidence
in Germany’s ability to repay its debt. While central banks can just print more money in theory,
either to repay these loans directly, or to swap for foreign currency
if they borrowed in dollars, adding more money to the economy risks stoking inflation
and has devastated economies in the past. Although some economists have
recently started to question whether this is the inevitable
consequence of higher spending, especially for big economies such as the U.S.,
it’s going to take a lot of convincing before lawmakers feel confident
running huge deficits for a long time. However, U.S.

President Joe Biden has said
he supports setting aside concerns about the country’s deficit so more money
can be spent now to prop up the economy. This brings us to why we are now
more likely to pay even more in taxes. Governments have had to step up their
spending in the wake of the pandemic. The health emergency halted a lot of economic activity,
and governments across the world have been paying companies
to keep workers on their payrolls, increasing unemployment benefits
and supporting health services. They have also delayed tax bills for businesses
so they have a bit longer to find the cash. These measures, though necessary, are emptying
the coffers of many treasury departments around the world.

Given how important citizens’ contributions
are for their income, governments are expected to increase taxes
in the coming years to restore their finances. The U.K.’s independent watchdog for public finances
said that tax rises or spending cuts of between $29 billion and $63 billion
will be needed just to stop public debt levels from rising relative to GDP.
In his latest plans for the economy, the U.K.’s finance minister has already announced
an increase in corporate tax. It’s going to take this country,
and the whole world, a long time to recover from this
extraordinary economic situation. This is why we hear more leaders discussing new taxes,
such as on profits made by digital giants and on pollution. While we don’t know when taxes will rise, and by how much,
it is likely these levies will be passed on to consumers, which means there’s a good chance
we’ll paying more to the government before very long. Hi everyone,
thank you so much for watching. How do you feel about potentially paying more taxes?
And what should governments be taxing? Let us know in the comments section,
and I’ll see you soon.

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