CHAPTER 02 : PUBLIC FINANCE

By the end of this TOPIC YOU should be able to:

• Explain the meaning and role of Public finance; and explain the functions and objectives of any government.
• Describe taxation and the canons of a good tax; explain the three systems of taxation; classify tax according to its types describe Value Added Tax; explain the Incidence of tax; and impacts of taxation and examine the economic effects of taxation
• Explain the meaning of Government Expenditure; discuss the types of Government Expenditure and describe the objectives of Government Expenditure;
• Discuss present a definition of National budget, describe the existing types of a National budget; discuss the functions of a National budget; and examine different National budgets
• Explain the meaning of a Public debt; classify public debt; describe the causes and effects of a Public debt AND explain the management of a Public debt;

Public finance is part of economics policy which is concerned with the way the government obtains revenue and spends it, so as to improve and promote the economic and social welfare of the citizens.

The Need and Role of the Public Finance Public finance has the following roles:

• The governments need to finance certain public utilities i.e. public services such as, security, power, education, etc. This requires money which has to be raised through public finance.

• Through public spending, the government can redistribute income and wealth more evenly.

• The government has to participate and effectively contribute to the production, marketing and distribution of goods and services. This can only be successful through the required capital which is raised from public finance.

• The productive infrastructure such as roads, railways, communication systems, etc, must be properly maintained. Public finance should provide sufficient funds to maintain and develop the necessary infrastructure.

• Public finance enables the government to establish and run risky projects that require large capital, e.g. Civil Aviation.

• Mobility of labour is quite important. Public finance, through wage policies, enables the government to distribute the available labour force, so as to increase efficiency. • Research units. The government, through public finance, is able to establish research units.

• Public finance is important in the process of economic developments, because it is a supplement to the limited private capital.

• The private sectors enterprises need to be correctly directed. Public finance enables the government to influence and guide the level and direction of the private sectors economic activities.

• In the absence of privatization and liberalization programmes, public finance sets up the state enterprises, supplies funds for improvement, modernization and expansion of various productive projects in the economy.

• Domestic resource exploitation. Public finance enables the government to exploit domestic natural resources e.g. fisheries, minerals, forests, etc, which might otherwise be idle.

Functions of the government

The government performs various functions which necessitates it to have funds. These functions are as follows:

(a) Administrative Functions: This is the day-to-day activities running of the government through established structures in the civil service.

(b) Protection Functions: In this function, the government needs funds to maintain peace and security.

(c) Social Functions: In this function, the government needs funds to provide the population with social services such as education and health.

(d) Development Functions: In this function, the government needs funds to finance various development projects such as roads, railways, research, irrigation, electricity and other infrastructural needs.

Objectives of the Government

The objective of the government is to achieve the following:

(i) To create full employment: In this objective, the government makes sure that all resources, including human and non-human resources, are fully employed.

(ii) Control of inflation: Inflation has adverse effects to the economy. Therefore, it is the responsibility of the government to put it under control.

(iii) To achieve economic growth: The government must ensure that the economy grows at the desired rate.

(iv) To raise the living standard: The government must ensure that the standards of living of its citizens are improved.

(v) To have a balance of payment: The government must ensure that its balance of payments is neither in deficit nor in surpluses, because both have negative effects to the economy.

(vi) To achieve social and political stability: The government must ensure that law and order is maintained in the country.

Divisions of Public Finance

Public finance is divided into four dominions, namely:

• The government revenues

• The government expenditures

• National budget

• Public debts

The government Revenues

This refers to the revenues that are received by the government from various sources to meet expenditures.

Sources of the Government Revenues

The government collects money from internal and external sources.

1. Internal Sources

The following are internal sources of the government revenues:

(a) Tax: A tax is a compulsory payment by individuals and firms to the government.

(b) Fees: These are payments made by the users of public services to the government like cost sharing in health and education.

(c) Fines: These are penalties imposed by the government against law breakers.

(d) Borrowing: The government can borrow money from banks or the public by selling sureties.

(e) Profit: The government can get revenues from profit realized from the public enterprises.

(f) Selling of Public Enterprises: The government gets revenues by selling or privatizing public enterprises and firms.

2. External Sources

(a) Borrowing from international financial institutions and donor countries

(b) Grants and gifts

(c) Foreign investments

Principles or Canons of a Good Tax

• Equity: A good tax must be equitable or fair, that is the amount of tax must be proportional to the level of income. People with higher income must be taxed higher amounts than people with lower incomes, i.e. pay as you earn (PAYE).

• Convenience: The methods of tax collection must be convenient to both the tax payers and tax collectors.

• Certainty: The tax payers must be aware of exactly how much to pay, and the tax collectors, likewise, must also know how much to collect.

• Economy: The cost of collecting tax should be relatively low, and the government should receive all the income collected. • Productive efficiency: A good tax should stimulate the establishment of resources and must not discourage allocation of resources.

• Difficult of evasion: A good tax must be difficult to evade by the tax payers.

Systems of taxation

These are organized methods through which tax is levied. There are three systems of taxation:

- Progressive tax system

- Proportional tax system

- Regressive tax system

- Progressive Tax System: This is a system of taxation in which the amount of tax depends on the level of income (PAYE) i.e. the amount of tax levied is proportional to the level of income increase. This system is very useful in reducing income inequalities among income earners.

Figure 2.1: Progressive tax system

 In figure 6: 1 above, at a lower income, Y1, the amount of tax is 10%. At a higher income, Y2, the percentage of tax is 20.

- Proportional Tax System: This is a system of tax in which the percentage of tax is the same for all the levels of incomes. For example, when a person who earns Tshs. 20000 per month pays 10% of the income as tax, and a person who earns Tshs.30000 per month also pays 10% of the income as tax.

Figure: 2.2: Proportional tax system

In figure 2.2 above, income levels of 20000/= and 30000/= are charged the same 10% of the income as tax.

- Regressive tax system: This is a system of tax in which the percentage of tax levied varies inversely with the tax payer's income. The higher the income, the lower the proportion of the income is paid as tax and the lower the income, the higher the proportion of the income is paid as tax. This kind of tax applies when indirect tax is imposed on goods and services which are consumed by both the high income earners and the low income earners. When the poor person purchases a commodity, the amount of indirect tax she/he pays is the same as that that paid by a rich person. In this case, the tax paid is said to be regressive, because the poor person pays a larger proportion of his/her income than the rich person.

Figure: 2.3: Regressive tax system

In figure 2.3 above, a higher percentage of tax, 20%, is imposed to a lower income level, Y1, and a lower percentage of tax, 10%, is imposed to a higher level of income Y2.

Why is Regressive Tax Justified?

Regressive tax is justified on the following grounds:

The low income earners are the main consumers of the public goods which are provided by the government, since most of the rich people consume private services.

The rich people are the investors; therefore, they have bigger contribution to the national economy than the poor people.

Types of Taxes

There are two main types of tax

A. Direct tax and

B. Indirect tax.

A: Direct tax

This is a type of tax which is imposed on people's income. The following are the examples of direct taxes are:

(i) Graduated Tax: This is the tax which is levied on one's income, mostly for the employed income earners, on wages or salaries.

(ii) Pay as You Earn Tax: This is paid by means of directly deducting from one's salary, by the employer, who regularly sends the collection to the tax authority.

(iii) Corporation Taxes: These are taxes imposed by the government and paid by the companies with respect to profits, turnover or percentage of total sales.

(iv) Property Tax: A property tax is assessed by the local authorities on property, such as house, land, etc.

(v) Estate or Death Duty: This is assessed on the wealth of person at the time of death.

(vi) Surtax: This is payable by the rich people in the society .It is usually assessed for those who earn beyond a certain level of income. It is paid on top of the graduated tax.

(v) Capital Gain Tax: This occurs when the value of capital asset increases, especially when the asset is being sold .It is imposed on assets which have appreciated.

Advantages of direct tax

Direct tax has several advantages over indirect tax:

• It is easy to tell in advance the amount to be paid and collected as tax from individuals and firms, because it is deducted directly from their income.

• This type of tax is very helpful in reducing the income gap between the rich and the poor people, since it applies the pay as you earn rule (PAYE).

• Direct tax is also helpful in controlling the demand pull inflation, since when direct tax is imposed, the disposable income of the income earners decline, which leads to a decrease in their purchasing power, hence control of demand-pull inflation

• Economical in collection. This type of tax is economical to collect in the sense that the cost of collection is proportionally low compared to the revenues collected.

Disadvantages of Direct Tax

- High direct tax can discourage people from working hard. This type of tax can discourage people from working hard, because people will have the feeling that, if they work hard and earn more income, they are liable to pay more tax.

- This type of tax discourages savings, because it reduces the disposable income of the income earners. Decrease in savings may discourage investments and economic growth.

- It discourages investments in case it is imposed on profits which results from investments. Investors are discouraged, in this case, because they are aware that the profit they earn would be taxed.

- This type of tax can result into tax evasion (tax avoidance). This happens when tax payers hide some information about their income.

- Direct tax is discriminatory in nature since it is paid by few people in the society; only those who earn income from formal sectors.

- Direct tax has high incidences of tax, that is, the burden of direct tax falls wholly to the tax payer.

- Reduce the disposable income of the income earners, thus reducing their purchasing power.

- Easy to avoid since people might under state their income.

B: Indirect Taxes

It is a type of tax which is imposed on goods and services. Examples of indirect tax are:

(i) Custom duties: These are taxes collected at the borders or port, by customs duties officials.

(ii) Octoroi Tax: It is a tax imposed on goods which are on transit through the territory of another country.

(iii) Sumptuary Tax: It is a tax imposed on the consumption of certain commodities in order to discourage their consumption.

(iv) Export Duties: These are taxes on exports, probably meant to discourage the export of certain goods

(v) Excise Duty: These are sales or purchase taxes imposed on goods that are locally produced and domestically consumed.

(vi) Value Added Tax: This is the consumption/expenditure tax levied or assessed on the value of a commodity in each of the stages of production, exchange and distribution.

Advantages of Indirect Taxes

Indirect tax has the following advantages over direct taxes:

• Effects of indirect taxation are spread to all the consumers, that is, all consumers pay indirect tax.

• More revenue is collected in this type of tax than in direct tax, because indirect tax is paid by everybody who consumes goods and services. It means that it has a wider tax base (source) than a direct tax.

• It is very difficult to evade paying indirect tax, because it is imposed on every purchase of goods and services.

• It is paid unknowingly, by the tax payers; hence it is less painful to the tax payer and does not discourage people to work hard.

• Unlike the direct tax, indirect tax is paid by final consumers. In this case, producers are not affected directly by this type of tax. Unlike direct tax, indirect tax does not discourage investments.

• Indirect taxes guide the allocation of resources in the country by increasing savings and priority areas, and it discourages investments in non-priority areas of production.

• They help to stabilize the economy. High import duties help to control imports, thus reduce balance of payment problems and improve terms of trade of the country.

• It has a wider coverage than direct tax, since it is paid by all the consumers of the goods and services on which the tax has been levied.

• It can be used by the government to either encourage or discourage the production and consumption of certain commodities.

Disadvantage of Indirect Tax

• Indirect tax is regressive in nature, because the low income earners pay a larger proportion of their income, as tax, than the higher income earners.

• It is inflationary in nature, because when it is imposed, it increases the cost of production and prices (it leads into a cost-push inflation)

• It is inconvenient. It is very difficult to collect this tax, since a lot of information is needed from business people including follow ups.

• It is not economical. There is a lot of costs of administering the collection of this type of tax. This makes this type of tax to be uneconomical to collect.

• The cost of collection and administering may be higher than the amount collected.

• Indirect taxes may have bias against certain groups of consumers like smokers and alcoholic beverage consumers, these groups of consumers are heavily taxed.

• High indirect tax may discourage demand, because it leads to increase in the prices of goods.

• Misallocation of resources may occur, since investors may opt to invest in industries which are less taxed, and leave industries which are more productive and important to the economy, but are heavily taxed.

Value Added Tax (VAT)

What is VAT?

VAT is an indirect tax which is levied on the supply of any taxable goods and / or services by any business that is registered for VAT purposes. These goods/services must be sold or supplied in the course of or for the furtherance of the businesses. VAT is also levied on the importation of goods and services (Tanzania revenue Authority VAT general guide April 2007)

How does VAT work?

Each registered person in the chain between the first supplier and the final purchaser/user is charged tax on taxable supplies made to him (input tax), and charges tax on taxable supplies made by him (output tax). They pay over to the Commissioner the excess of output tax over input tax, or recovers the excess of input tax over output tax from the Commissioner. The broad effect of the scheme is that, businesses are not affected by VAT except in so far as they are required to administer it, and the burden of the tax falls on the last purchaser/final consumer.

The following example illustrates how VAT is charged as goods move from one registered person to the next in the manufacturing and distribution chain, until they reach the final user. It is assumed, for the purposes of illustrations that the manufacturer makes no purchase and that VAT is charged and accounted for at the rate of 20%:

Table 2.1: VAT General Guide

Source: Tanzania Revenue Authority (VAT general guide April 2007)

Who collects VAT?

VAT is collected by businesses and organizations that are registered by the commissioner of tax. A business or organization, which is registered or required to be registered for VAT is called a taxable person.

What are taxable supplies?

Taxable supplies are the supplies of goods or services made by VAT registered persons in the course of or for the furtherance of the business.

Taxable supplies include the following:

The sale or delivery of taxable goods by taxable persons to another person, including imports.

The sale or provision of taxable services by a taxable person to another person.

The appropriation, by a registered person, of taxable goods for his personal use or for use by others like the family or friends;

- The making of gifts or loans of any taxable goods in the course of business.

- The letting of taxable goods on hire, leasing or other transfers. - Barter trade, i.e. exchange of goods for other goods.

What are goods?

(a) Tangible movable things - goods in the ordinary sense of the word.

(b) Immovable property - land, buildings, etc.

Note: Money is not goods for the purpose of VAT

What are services?

Services include:

(i) Professional and commercial services - services include accountants, engineers, architects, lawyers, secretarial, electricians, plumbers, builders, motor vehicle repairs, employment agencies, advertising agencies, transport services etc.

(ii) Intellectual property rights - patents, trademarks, copyrights know - how etc. Any other supply, which is neither goods nor money.

The role of the business people registered with VAT

The business people who are registered with VAT are supposed to do the following:

(i) Records: Proper and adequate records must be kept to enable a responsible revenue office to check on the self-assessment of their VAT liability. Records should be kept for a minimum of five years.

(ii) Tax invoices: A VAT registered person must provide a tax invoice to another VAT, registered, person at the time of selling taxable goods or services.

(iii) Debit and credit Notes: These must be provided where required.

(iv) VAT Account: For each ‘tax period’, they must keep a summary of the totals of their output tax and input tax.

(v) Returns: A VAT return must be completed and submitted to the tax Commissioner by the due date, i.e. the last working day of the month after the month of business.

(vi) Accounting for VAT payable: Tax payable must be calculated and accounted for by the "due date".

(vii) Changes of business particulars: Whenever there are changes in their business circumstances, they should notify the tax Commissioner within thirty days of such change.

(viii) Retained Assets on cancellation of Registration:

VAT must be accounted for on any assets of a registered person retained upon ceasing to be registered.

How do business people account for VAT?

VAT is normally accounted for at the time of supply, i.e. VAT is generally accounted for when:

• Tax invoice for the supply is issued, or

• Payment is received for the supply or part of the supply, or

• The goods are removed from the premises or from other premise where the goods are under your control, or the goods are made available to the person to whom they are supplied or when services are rendered or performed; whichever occurs first.

What is a tax period?

A tax period is the length of time covered by VAT return i.e. one calendar month.

Advantages of Value Added Tax (VAT)

- It is a broad-based tax which falls over a wide range of consumers through their consumption expenditure.

- VAT promotes efficiency in production since firms cannot be taxed in case of losses or profits, because the tax is based on the gross value produced.

- The tax has neutral distributive effects, and can guide the allocation of resources.

- VAT is simple in administration. The tax liability can easily be assessed and the tax revenue effectively collected.

- It minimizes tax evasion, since each production unit accounts for taxes paid by other firms from which inputs are obtained, so as to avoid tax payment by one individual firm. This cross auditing enables tax authorities to avoid the possible occurrences of tax evasion.

- It enables some goods to enjoy tax exemption, and yet uniform taxes are assessed on other goods.

- VAT widens the tax base, because the tax has to be ultimately paid by the final consumers.

- It is non-discriminative to factors of production, since they are equally taxed.

- It is quite easy to calculate among business people, if they keep and maintain proper records.

Disadvantages of VAT

There is need for appropriate record keeping and frequent cross-checking, which is not common in LDC's.

VAT is not popular, especially among the illiterate and, therefore cases of evasion are likely to occur.

This tax tends to affect small firms and consumers, since it is often proportional. Large scale enterprises are definitely less affected.

The tax is regressive, since all taxable goods and services are treated equally. The VAT is complicated and difficult to be understood in some countries, like Tanzania, it calls for massive education to create awareness among the citizens.

It is a consumption tax; therefore it may affect the level of consumption in the country.

Usually, tax liabilities are not submitted to the tax authorities and yet this could result into difficulties in tax collection.

The public is often ignorant about the commodities that are zero rated and exempted from the VAT system.

There are sometimes delays in submission of revenue by tax collectors and payers to the government.

Why the government of Tanzania introduced VAT?

The government of Tanzania introduced VAT due to the following reasons:

- To improve tax administration in the country.

- To increase the percentage of taxable Gross domestic product.

- To widen the tax base and, consequently, reduce the tax rate, so as to achieve equality, tax compliance and minimize tax evasion

- To protect domestic industries against foreign competition.

- To minimize tariffs that affects her exports.

How VAT is computed?

V.A.T is only claimed and accounted for from registered tax payers /businessmen. VAT is usually remitted to Revenue Authority within a business period of a month, by the tax payers, at the time of purchase. VAT can only be offset on sales with purchases at each stage of supply. This is eventually met by the ultimate consumer. Therefore, the unregistered (the buyer) meets the tax in form of the final price of the commodity. V.A.T payable = Output tax-Input tax.

Why should individuals and firms pay tax?

There are several reasons as to why taxes are imposed. Some of these reasons include;

(a) Raising the government revenue: The government impose taxes in order to get revenue that is necessary for meeting its expenditure on public services and administration of the government.

(b) Income redistribution: Taxes are imposed in order to reduce the income gap between the rich and the poor people in the society. The rich people are heavily taxed, and the income collected is used to uplift the poor in terms of providing them with public services.

(c) Encourage investment and growth: Tax on imports is aimed at discouraging imports, in order to stimulate domestic production.

(d) To reduce deficit in the balance of payments: Tariffs are imposed on imports in order to reduce imports and, therefore, reduce deficit in the balance of payments.

(e) To discourage consumption of harmful products: Tax is sometimes aimed at controlling the production and consumption of harmful products, such as cigarettes and beer.

(f) To stabilize the economy: Tax can also be imposed in order to control economic instabilities, such as inflation. During inflations, the government increases direct tax, in order to control excessive demand, and reduce indirect tax in order to reduce the prices of goods.

Incidence of Tax

This refers to the burden of paying tax. When tax is imposed, who actually pay the tax? Is it the producer, the consumer or both?

(i) Case of direct tax: For the case of direct tax, the whole incidence of tax goes to the tax payer i.e. the income earner. He/She has to pay the full amount of tax, since tax burden cannot be shifted to anyone else.

(ii) Case of indirect tax: For the case of indirect tax, the burden of tax depends upon the elasticity of demand for a commodity.

• Tax on Goods with Perfectly inelastic Demand: These are the goods which are demanded in the same quantity at all levels of price. In this case, the incidence of tax falls more heavily on the consumers, because the consumers buy the same amount at whichever the level of price.

In figure 2:4 above, before the imposition of tax, price was P_O, and the quantity demanded was Q_1, after the imposition of tax, the price increased to P_O+ t (where t is tax), but the quantity demanded remained the same at (Q1), therefore, the consumer shouldered the whole tax incidence.

• Tax on goods with perfectly elastic demand: These are the goods which are sold at the same price, whatever the quantity demanded.

Figure 2.5: Tax on goods with perfectly elastic demand

In figure 2:5 above, the producer sells different amounts at the same price, P₁.So, when tax is imposed by the government, the producer will bear the whole amount of tax. Under this situation of perfect competition, the producer cannot influence the price of the commodity.

• Tax on goods with inelastic demand: These are the goods which the quantity demanded changes by a small proportion when price change. In this case, when tax is imposed, price increases by the amount of tax levied, but quantity demanded decrease by a small proportion. So, the tax burden goes to the consumers, because they will be buying almost the same amount, but at a higher price.

Figure 2.6: Tax on goods with inelastic demand

In figure 2:6 above, before the imposition of tax, the price was Po and the quantity demanded was Q1. After the imposition of tax, the price increased to Po+t, and the quantity demanded decreased by a small proportion to Q1. Hence, the consumers bear the burden of paying tax, since the quantity they demand decreased by a small amount when the price increased.

Tax on goods with elastic demand: These are the goods which the quantity demanded changes by a small amount when the price changes. When tax is imposed, the price increase by the proportion of tax, resulting in a large decrease in the quantity demanded. The tax burden, therefore, fall more heavily on the producers because of the big decrease in the quantity demanded by the consumers.

Figure 2.7: Tax on goods with elastic demand

In figure 2:7 above, an imposition of tax on a commodity resulted into an increase in the price of the commodity from Po to Po+t, and a large decrease in the quantity demanded from Q4 to Q1, hence a big burden to the producers due to the large fall in the quantity demanded and revenue.

Incidence of tax and systems of tax

The incidence of tax can also be discussed according to the systems of tax.

- The case of progressive Tax: In the case of progressive tax, the incidence of tax fall on both high income earners, and low income earners, because tax increases as income also increases.

- The case of regressive Tax: In this case of regressive tax, the incidence of tax falls more heavily on low class people because they pay a large proportion of their income, as tax, than the rich people.

- The case of proportional Tax: For the case of proportional tax, the burden of tax falls more heavily on the low income earners than the high income earners, since both these groups pay the same percentage of tax.

Economic effects of tax

Taxes have both negative and positive effects:

A. Negative Effects

The negative effects of taxes are as follows:

(i) Discourages people from working hard: Heavy direct tax discourages people from working hard, since it reduces their disposable income i.e. the amount of money that remains for consumption after the deductions of tax.

(ii) Discourages savings: Heavy direct tax reduces disposable income, hence the savings of the income earners.

(iii) Discourages investment: Large tax, on firm's profits, is a disincentive against the entrepreneurs to reinvest their profit in production.

(iv) Diversion in allocation of resources: Investors may deviate the allocation of resources from heavily taxed but more productive sectors, to less taxed and low productive sectors or to the production of illegal products, like cocaine, which are not taxed.

(v) Tax may cause inflation: Large income tax may animate workers to demand for more wages and, therefore, lead to demand-pull inflation. Likewise, large indirect tax is inflationary because, when imposed, it leads to an increase in the prices of goods and services.

B. Positive effects of taxes

The positive effects of taxes are as follows:

(i) It can be used to control inflation: By increasing direct tax, the purchasing power of the people decrease. This may reduce demand-pull inflation.

(ii) Discourage harmful products: Certain kinds of indirect tax can be used to control the production and consumption of harmful products such as cigarettes.

(iii) Control of balance of payment disequilibrium: Heavy import duties can be a disincentive against imports and, therefore, a means of controlling the deficit in the balance of payments.

(iv) Revenue generation: Tax is an important rootstock of the government’s revenues, that is, the government depend on tax for most of its revenues.

(v) Redistribution of income: Tax redistributes income by taking part of the income of the rich people. The government, therefore use the money collected to provide for social services to the poor people.

Taxable capacity

Taxable capacity is the ability of the tax payers to pay the tax assessed on them, and at the same time, retains a reasonable level of income to enable them live the life they are accustomed to. So, taxable capacity of a nation is the percentage GDP, which is within the capacity of the country to contribute to the public tax revenues. It can also be referred to as the ability of the nation to obtain, from the tax payers, the revenues necessary from the imposed taxes.

Factors affecting Taxable Capacity

The factors underlying taxable capacity are as follows:

• Inflation: This lowers the people’s purchasing power; hence it greatly affects the taxable capacity, especially from indirect taxes.

• The level of economic progress: The taxable capacity is influenced by levels of economic development.

• Population size: The number of inhabitants can increase the taxable capacity and the amount of tax revenue to the government.

• Income distribution: Usually, equitable distribution of wealth leads to a less tax revenue as compared to a situation where the wealthy are more and accordingly taxed. Political stability increases the taxable capacity, since the public is confident due to the conducive environment.

• Attitude of the taxpayers: A positive attitude towards development will increase the taxation potential among the people and vice-versa.

• The tax procedure: An appropriate tax procedure or collection methods will promote tax diversification and comprehensive taxes, which will expand the tax revenue.

• The objective of taxation: There is no doubt that the tax revenue/capacity will increase if there are specific aims for which the revenue is directed. For example, if it is meant to promote education, culture, industrialization, health, poverty eradication, tourism, sports etc.

• The level of income: The stability of income will generate more tax revenue and increase production, and vice-versa.

• Reduction of conservative tendencies: Traditionalism and conservatism may hinder the taxable capacity of the country while mordernization and liberalisation improves taxable capacity.

Why is the taxable capacity low in LDCs?

The taxable capacity is limited by the following of factors:

- Political limits. For political reasons, the governments of LDCs often limit the taxable level to a reasonable extent in order to gain popularity.

- The prevailing low levels of income among the people who are predominantly subsistence producers cannot boost the taxable capacity in LDCs.

- In developing countries, cases of tax evasion and avoidance are common, and this cannot expand the taxable capacity.

- Corruption. The taxable capacity is also limited by the corrupt tax assessors and collectors.

- The size of production. The size and, therefore, the taxable earning of enterprises are quite limited.

- Transportation bottlenecks. Collection of the desired/targeted tax revenues is further hampered by inadequate transport, because some areas are still remote.

- Language limitation. The diversity of languages among the rural communities often poses a serious communication problem, especially between he tax authority payers.

- The taxable capacity, in LDCs, is further limited by lack of proper record-keeping, upon which taxation is based.

- The fear to interfere with international trade also tends to limit the level of taxation in developing countries.

- The taxable capacity, in LDCs, is further affected by some cases of tax exemption.

- The rampant unemployment also affects the taxable capacity in LDCs, since this would imply limited sources of income.

- Regressive taxation. The taxable level or capacity is limited and affected by the regressive nature of taxation in LDCs, which mostly affect the poor.

- Inflation. This also scares the government from increasing taxes, since during an inflationary period, people's real income tend to fall.

- Smuggling. Rampant smuggling of both products and finance, to neighbouring countries, also affects the volume of tax revenues collected.

- In developing countries, taxable capacity is also limited by the prevailing unclear social, political, commercial and institutional frameworks.

- In most LDCs, including Tanzania, the agricultural sector is dominant. This implies that there are few industries from which adequate tax revenues can be collected.

- High population growth rates. High population lowers the taxable income, because of the high dependency ratio.

- The need to attract foreign investors, who are crucial for national development. The government has no choice but to offer tax relief, tax rebates, tax holidays, etc, in order to encourage investors foreign. This, too, may lower the taxable capacity.

- The shift from the traditional sectors to the informal sectors, whose activities are quite difficult to determine, makes it hard to determine appropriate taxes that should be imposed on them.

- The taxable capacity is further limited due to the narrow definition of some illegal activities, such as smuggling, prostitution, local brewing, private student’s tuitions etc.

Measures that can be adopted to widen the tax base and taxable capacity 

There are many ways of improving the country's tax base and taxable capacity as follows:

• The government should improve its administrative machineries as far as tax collection is concerned, with an aim to minimize tax evasion and avoidance.

• Income generating activities should be encouraged, especially in rural areas, to provide opportunities for employment so as to expand the nation’s taxable capacity.

• Diversification is further encouraged so as to expand avenues for the taxable potentials.

• Taxes on imports should be increased, especially on luxury items, so as to increase the amount of tax revenues.

• Reduction of income inequalities. The existing income disparities tend to lower the taxation potentials. The government is, therefore, urged to reduce income inequalities among most of the sections of the society, so as to expand the tax base.

• Education. There is need for education and awareness among the general public about the importance of taxation for national development.

• Specific institution, such as the TRA, should be put in place with considerable degree of autonomy to review the loopholes in tax collections, so as to raise the required tax revenues for the state.

• Improvement in economic activities should be enhanced, e.g. in the manufacturing sectors, informal employments, monetary expansions, etc, so as to raise the level of tax collection.

• Tax diversity. New taxes have to be introduced, like VAT, the land tax, etc, in order to widen the tax base. • Fight corruption. Measures against corruption need to be greatly strengthened, e.g. through the Inspector General of the government, The Public Accounts Committee, the general Public, the press, etc.

• Adequate facilities to easily enhance the process of tax collection. There is need to acquire the necessary operational facilities like transport; computers to store the required tax information, etc so as to improve the efficiency in tax collection. • A comprehensive tax payer’s data. This can enables survey on tax payers, so that the tax collectors are kept in constant touch with the potential tax payers. This guides tax policy formulation and tax actions designed to achieve an effective policy on taxation. • The tax base can further be improved by constant review of the existing tax structures, policies and programmes, so that they become compatible with the required targets.

THE GOVERNMENT EXPENDITURES

This refers to the spending of the government in various areas.

Types of The government Expenditures

The government expenditures can be categorized into the following groups:

(i) Recurrent Expenditures: This refers to the government spending on public consumption, such as education, health, maintenance of peace and security, salaries to civil servants, etc.

(ii) Development Expenditures: Refers to the government expenditures on development projects, such as the construction of roads, railways, communication networks and subsidies to economic sectors like agriculture.

Objectives of the government expenditures

The government expenditures are intended to meet the following objectives:

• To provide essential goods and services to the public, such as education and health services. • Regulation of economic activities for the public interest. For example, control of monopoly.

• Influence allocation of resources in order to improve efficiency. For example, providing subsidies to small scale firms.

• Redistribution of income by providing loans and free social services to the poor. • Stabilization of the economy, for example, controlling unemployment problems by increasing expenditures on economic and social services, which help to stimulate investments.

NATIONAL BUDGET

The national budget refers to the estimates of the government revenues and expenditures in a given year. In Tanzania, the national budget is presented to the national assembly, by the Minister of finance, in June each year. The minister makes a review of the government revenues and expenditures for the previous year, and makes forecast of the government revenues and expenditures for the coming financial year. The budget starts to be implemented after it has been approved by the national assembly.

Types of National Budget

There are three types of national budget:

(a) Surplus Budget

A surplus budget is a budget in which the collected revenue is greater than the estimated expenditures. To achieve a surplus budget, the government increases the tax rates. Therefore, surplus budget reduces the purchasing power and investments.

Uses of the Surplus Budget

The surplus budget has the following uses:

(i) To correct inflation: The surplus budget can be used to control inflation because of the high tax rate, which reduces disposable income and the purchasing power.

(ii) Correct balance of payments problems: By increasing tax on imports, the surplus budget reduces the volume of imports and, thus controls deficit in the balance of payments.

(iii) Discourages the consumption of harmful products: Increase in tax rate, may also control the consumption of harmful products.

(iv) To pay debts: The surplus budget may be used to pay the government debts

Surplus budgeting

A surplus budgeting occurs when the government plans to spend less than the revenue available in a given financial year.

Aims and objectives of surplus budgeting

Surplus budgeting aims at achieving the following objectives:

• To reduce aggregate demand, so as to curb inflation.

• To finance development programmes in the country.

• A surplus budget also aims at accumulating resources/funds for the purposes of future investment.

• To reduce money in circulation.

• Enables the nation to give grants to other countries.

• It enables the establishment of development projects, within and outside the country.

However, a surplus budget may lead to:

- A depression in the economy.

- Excessive taxation of the people.

- Unemployment due to lack of incentives to save and invest.

- A decrease in money supply.

- Inadequate/insufficient aggregate demand due to high levels of taxation

(b) Deficit Budget

A deficit budget is a budget in which the estimated the government revenues fall short of the estimated the government expenditures. A deficit budget has the following effects.

(i) It stimulates consumption and investments due to low tax.

(ii) It stimulates recovery from a recession.

Deficit Financing

Deficit financing occurs when the government planned expenditure is estimated to be in excess to the expected revenue.

Aims of Deficit Financing Deficit financing aims at:

(i) Reducing the burden of taxation from the people.

(ii) Increasing the level of supply.

(iii) Increasing the level of aggregate demand.

(iv) Encouraging savings among the general public.

(v) Curbing down deflation.

(vi) Stimulating the level of economic activity.

(vii) Encouraging borrowing, which may be a faster and cheaper way of financing the government projects.

(viii) Lifting the economy from a slump or depression.

Causes of Budgetary Deficits in LDCs like Tanzania

Budgetary deficits are common deficits, basically arising from high the government expenditures and limited avenues of revenue collection.

• Low taxable capacity. This has not enabled LDCs, like Tanzania, to raise adequate revenues to balance their budget. • High levels of tax evasion and avoidance. This, too, has limited prospects by the government to acquire the required revenues.

• High population growth rates. The ever increasing population in LDCs, like Tanzania, has led to high the government expenditures, thereby leading to budgetary deficits. • Uneven distribution of incomes. This has further affected the taxation potential of the country leading to limited revenue.

•Limited size of enterprises. In Tanzania and indeed many LDCs, the sizes of the enterprises are still small and cannot raise enough tax revenues to balance the budget.

•Corruption. Budgetary deficits have been attributed to high rates of corruption among the politicians and some categories of the civil society. This has resulted into loss of revenues which would have otherwise been used to cover the budgetary needs. • Unemployment. Rampant unemployment, coupled with the current retrenchment programmes, has worsened the situation, whereby a reasonable majority of the unemployed can hardly contribute revenues to the national treasury.

•Poor planning. There is often lack of proper planning, financial discipline and commitment, which has consequently led to wastage and misuse of public funds. • Price fluctuations. Poor countries, being mainly dependent on agriculture, are subjected to price fluctuations. This will imply unpredictable revenues from the agricultural sector, which may consequently lead to deficits in the budget.

•  High Marginal propensity to import. A lot of revenues in form of foreign exchange are spent to import necessities. This has always resulted into fewer revenues available to meet the domestic budgetary requirements.

• Subsistence sector. Poor countries are characterized by a relatively large subsistence sector, with low productivity, output and income (revenue).

•  Political reasons. The taxation potential is further limited by the desire for some politicians to attain their political aspirations which greatly reduces the revenues base of the country.

•  Political instability. Poor countries are entangled in political turmoil. This compels them to indulge into excessive expenditures to finance them (wars). However, a number of revenues are lost in the process.

• High and unproductive expenditure by the government on its programmes have further adversely affected their revenue base, causing temporary deficits in the budget.

• Limited tax revenue due to poor methods of collection. This has also led to reduced sources of finance to balance the budget.

• Low savings and limited levels of capital accumulation have also affected the balancing of the budget, because this limits the revenues potential of the country.

• Poor national and global economic performance, unfavourable terms of trade, etc has affected most LDCs' potential to earn the required revenue to finance their budgets.

•  Debt servicing. Poor countries have a heavy debt burden, which often take a substantial proportion of their revenues which could have catered for the budgetary requirements. • Inflation. The ever increasing price of goods and services has also affected the national budget. With inflation, it is quite difficult to predict future budgetary planning. • Unpredictable external funding has led to low and unreliable revenue, which consequently affects the government budget.

(c) Balanced Budget

This is a budget in which the collected revenue is equal to the estimated expenditures.

Effects of a Balanced Budget

A balanced budget implies the following:

(i) That the government cannot borrow.

(ii) That there are stable prices, i.e. there is neither inflation nor deflation in the economy.

(iii) Money supply does not increase, i.e. it remains constant.

(iv) Aggregate demand does not change.

(v) The central bank cannot print any more money.

(vi) There is a constant level of employment.

Functions of the National Budget The budget has the following main functions:

•  To redistribute income: Through the national budget, the government may redistribute income by increasing expenditures in social services and providing subsidies to small scale businesses.

• To correct deficit in the balance of payments: Through the budget, the government can discourage imports and correct deficit in the balance of payments by increasing import duty.

• To control inflation: Through the budget, the government can control demand-pull inflation by increasing direct tax in order to reduce the purchasing power of the people.

• To stimulate employment: The government can create more employment opportunities through the budget by increasing expenditures on economic and social services, and providing subsidies to sectors which increase the level of employment such as agriculture. Also, by reducing tax on inputs in order to encourage investments and, therefore, create jobs.

• Economic stabilization: The budget can be used as an instrument for stabilizing the economy. For example, during economic recession, the government can reduce tax and increase expenditures to stimulate consumption and create employment.

(d) Public Debts

His refers to the money that the government owe individuals, firms within the country, or to institutions outside the country, and donor countries.

Classifications of Debts

Debts can be categorized into the following groups:

A: Internal or External debts

(i) Internal Debts: This refers to the money that the government owe institutions or individuals within the country.

(ii) External Debts: This refers to the money that the government owe to institutions outside the country or donor countries.

B: Long Term and Short Term Debts

(i) Long Term Public Debts: These are debts which are repaid after a long period of time, between 5 to 20 years.

(ii) Short Term Debts: These are debts which are repaid after a short period of time.

C: Reproductive and Non Reproductive Debts

(i) Reproductive Debts: These are debts in which the government use the money borrowed for productive expenditures, such as for the construction of roads or for the provision of other social services.

(ii) Non-Reproductive Debts: These are the debts in which the government use the money borrowed for non-productive expenditures, such as buying arms.

Causes and Justification of Public Debts

Quite often, the governments in less developed countries have greatly depended on borrowing. This can be justified by a number of reasons:

•  Inadequate tax revenue: Poor countries incur debts because the revenues collected from taxes is insufficient to finance the all the government programmes. At times, the expected revenues tend to fluctuate.

•  To reduce the burden of taxation: Borrowing is often resorted to as a means of reducing the tax burden from the people. • Overcome natural calamities: Debts are also incurred to meet the unexpected occurrences such as floods, drought, etc.

•  Raising revenues: The government incurs public debts so as to raise adequate revenue that is required for development purposes. • B.O.P deficit: Public debts, especially external debts, are incurred in a bid to correct the

B.O.P deficits which is common in LDCs.

• Financing ambitious development plans: The governments of poor nations tend to draw ambitions plans that are often financed through borrowing, e.g. road construction, industries, etc.

• To attain economic growth: Effective exploitation of the potential domestic resources needs to be financed so as to increase GNP. Therefore, public debts are inevitable in accomplishing this task.

• Public debts are also incurred in order to enable LDCs to fill the manpower, foreign exchange and savings gaps.

• To balance the budget: Public debts are incurred to help in covering unforeseen or unpredictable budgetary deficits which are common in developing countries. • Curbing economic depression: Public debts are quite significant in raising production, aggregate demand, employment and the level of economic activities in general. • Debt servicing: It is a common practice, by some developing nations to incur new debts in order to repay the old ones.

•  Political instability: Some prevailing political turmoil in developing countries, especially in Africa, has greatly necessitated the government borrowing, hence incurring public debts.

Negative Consequences of Public Debts Public debts have the following negative consequences:

- The volume of imports into the country tends to reduce. This is because of the high outflow of foreign exchange to repay the debts.

- The burden falls on the citizens, who are taxed to cover up for internal debts, such that the size of the debts may influence the level of taxation.

- The effect is great on the level of consumption because high taxes on individuals deprive them of consumption.

- The future generation is affected as a result of the debt incurred many years back, to finance services that it never enjoyed or will never enjoy.

- Debt repayment reduces expenditure on capital goods for investment and, thus, limited capital formation.

- Dead weight debts e.g. financing wars may prove to be inflationary and can affect the distribution of incomes, savings and investments.

- Wastage may be encouraged. Dead weight debts results into wastage of resources, especially at the time of repayment.

- Public debts encourage over-dependence on external sources; hence this does not promote the spirit of self-reliance.

- The debt incurred in form of tied aid is always accompanied with strings (conditions) attached which often conflict with the development programmes of the recipient country.

- B.O.P position. External borrowing tends to worsen the country’s B.O.P position leading to severe B.O.P deficits.

- High administrative costs. In case of internal debt, the costs of debt redemption are quite high. This is made worse by the condition to pay a reasonable rate of the interest required.

- Unemployment, deteriorating living standards, etc are likely to occur, because the debts incurred tend to affect the level of investment and production.

Positive Consequences of Public Debts

The Public debts may have some positive consequences to the country.

The debt incurred can lead to an increase in the GDP increase it is used appropriately to exploit and mobilize the domestic production for increased output.

The debt, if it is reproductive in nature, is quite significant in increasing the government’s revenues.

More employment prospects can be generated, if the debt is a self-liquidating one, i.e. aimed at stimulating production activities.

Increased foreign exchange earnings. More foreign revenues can come in, especially through borrowing from external sources, or when used to promote and expand the export sector.

The debts incurred can expand the levels of production within the domestic economy, and this can generate economies of scale.

Improve the standards of living. Public debts incurred can enable the production and importation of a wide variety of goods and services. This will, consequently, improve the standards of living of the people.

The public debts (borrowings) tend to reduce political resistance to high taxation which is likely to be done by the citizens of developing countries.

Borrowing is not deflationary; since it reduces the tax burden so as to increase people's consumption expenditure, and therefore aggregate demand.

The public debts can reduce political instability, e.g. through borrowing to finance wars. A stable political atmosphere, there is no doubt, encourages production for development.

Debt finance acquired can help to cover the manpower, savings investment gaps, for which poor nations tend to solicit for foreign aids.

Redemption of Public Debts/Management of Public Debts

This refers to attempts by the government to pay public debts. These attempts are as follows:

- Surplus budget: In this method, the government estimates more revenues than expenditures in the budget and use the surplus to pay debts.

- Sinking fund method: In this strategy, certain amount of money is invested in the bank, and after some years, the money increases through compound interests and the money generated through this interest is used to pay debts.

- By conversion: In which the government takes a new loan of lower interest to pay the previous debts.

- By repudiation: In which the government refuses to pay the debts

- Capital levy: In this method, the government imposes tax on assets such as buildings to generate more revenues for paying debts.

- Use of accumulated foreign reserves: The government can use its reserve of foreign currency to pay its debts.

- Selling securities: The government can pay the existing debts by selling its stock of securities such as treasury bills and securities.

- Receiving grants and gifts: The government can repay some of its debts through the grants and gifts received from donor countries.

- Privatization and profits from public enterprises: The government can privatize some of the public enterprises to get revenues to pay some debts and use profits from its enterprises to pay some of its debts.

- Barter trade: The government can influence traders to use the barter system of trade in foreign trade to reduce the use of foreign exchange.

- Negotiation on debts cancellation: The government can negotiate with donors to waive -off some debts.

- Selling of foreign investments: The government can sell some of the investments that it may own abroad.

Measures That Can Be Used to Reduce Debt Burden in Less Developed Countries Apart from the above debt management policies, the following measures can be used to reduce the debt burden in developing nations:

(a) Self-reliance: LDC's can reduce dependency on foreign debts by boosting their domestic production to have a self-reliant economy, hence reduce foreign dependency.

(b) Import control measures: The government can apply import control measures, such as tariffs, to reduce spending on imports which is one of the reasons that increase foreign debt.

(c) Reduction in the government’s expenditures: The government can reduce its expenditures on non-priority goods to avoid borrowing money.

(d) Strengthening of tax collection: The government should increase its efforts in tax collection to get enough revenues to finance its expenditures instead of depending on foreign aid.

Burden of Public Debts

The burden of public debts depends on the nature of the public debts, and whether the debt is an internal or external debt, reproductive or non reproductive debt.

(i) Burden of internal debt: The burden of internal debt rests on the citizens of the country because they are repayable through tax. The government is forced to increase more tax in order to collect more revenues to pay the debts.

(ii) Burden of external debt: The burden of external debt rests on balance of payments because they necessitate the country to pay foreign currency without return of goods and services.

(iii) Burden of reproductive debt: The burden of reproductive debt is not entirely on citizens because income generated by the investments in question can be used to redeem such debts.

(iv) Burden of non-reproductive debts: For the non-reproductive debts, the burden rests on the citizens who are forced to pay more tax in order to enable the government to get revenues to pay debts, since the money borrowed does not yield to any investment.

Why External Debt Increase?

Factors that increase external debts are as follows:

• Increase in the amount to be repaid due to the high interest rates.

• Fall in the demand for exports reduces the ability of the government to repay debts.

• Increase in the price of imports force the government to use its foreign currency on imports, instead of repaying debts

• Rescheduling of debt repayment increase the amount of debts due to cumulative interest rates.

• Wasteful expenditures on non-reproductive expenditures reduce the ability of the economy to generate revenues for repayment of debts.

Fiscal Policy

It is a macro economics policy which is used by the government to attain some economic objectives, such as control of inflation, correcting unfavourable balance of payments and achieving economic growth.

Tools of Fiscal Policy

The followings are the tools of fiscal policy.

- The government expenditures.

- Taxation.

- Transfer payments.

Mechanisms of Fiscal Policy

There are two mechanisms of fiscal policy, these are;

• Expansionary fiscal policy
• Contractionary fiscal policy

Expansionary Fiscal Policy: In this policy, the government increases its expenditures and reduce the amount of tax in an attempt to increase the aggregate demand. Expansionary fiscal policy is designed to influence the aggregate demand, since when expenditures are increased on things such as education, health, road construction and salaries to civil servants; it results into an increase in income to the people. This act as a stimulant to the aggregate demand.

In figure 2:8 above, before the increase in expenditures, the level of aggregate demand is Y=C+I, and the national income was Y₁.After the increase in expenditures from E₁ to E₂,

Aggregate demand rose toY2= C+I₂, and the level of the national income increased fromY₁ to Y_2.

Contractionary Fiscal Policy: This is a policy in which the government attempts to reduce aggregate demand by increasing tax and reducing expenditures. Its aim is to control inflation.

Figure 2: 9: A contraction fiscal policy

In figure 2:9 above, before the decrease in expenditures from E₂ to E₁, the National Income is Y₂,but after the decrease in expenditure, National income decrease to Y₁

Foreign Aid

Foreign aid is any form of assistance from foreign countries or foreign institutions.

Forms of Aid

(a) Technical assistance

(b) Capital (funds, machinery)

(c) Grants

(d) Gifts

(e) Consultancy

Advantages of Foreign Aid

Foreign aid can have some benefits as listed below.

(i) The recipient country may obtain technology from the donor countries.

(ii) The country can get foreign exchange.

(iii) Aid is very useful during natural calamities such as floods.

(iv) Aids promote cordial relationships between the donor country and the recipient country

(v) In the short run, aid can help to clear deficit balance of payments.

Disadvantages of Foreign Aid

Foreign aids have several disadvantages as follows:

• Aid increase the debt burden of the recipient country

• Aid cultures economic dependency

• Some aid are not provided on time therefore may not be utilized efficiently • Some aid is accompanied by some conditions which may be harmful to the economic and social interest of the recipient country

• Some aid is of poor quality and therefore useless. • Aid may be a disincentive for domestic production.

Review Questions

1. What is public finance?

2. Describe the types of taxes.

3. Discuss the merits and demerits of each type of tax.

4. Explain how the government may finance a deficit budget.

5. Discuss the types of budget.

6. Explain how a budget can be used as an instrument of economic policy

7. What are the uses of a surplus budget?

8. Discuss the main objectives of the government expenditures.

9. How can a national debt be redeemed? 10.Discuss the effects of deficit financing.

CHAPTER 03 ; FINANCIAL INSTITUTIONS

Financial institutions are the institutions which involve themselves with financial transactions such as mobilizing of savings, provision of credits, accepting deposits, providing advice to the traders and the government.

Types of Financial Institutions

There are two types of financial institutions, namely;

(i) Banks

(ii) Non-banks

(i) Banks

These are financial institutions which perform the following functions:

• Mobilising of funds from the public and opening different types of accounts like savings accounts, fixed deposit and current accounts

• Other functions include, advancing of loans; providing various commercial services to the public, e.g. settling of debts through cheques, keeping valuable items, transferring of funds from one area to another, or from one person to another, through travellers’ cheques and telegraph transfers.

(ii) Non-Banks

These are institutions which do not perform banking functions such as opening of accounts to customers or provision of commercial services, but they provide specific services to the customers or members, such as insurances and pensions. Non- banks do not mobilize savings like the banks. They obtain funds from the members through contractual savings, and these savings are normally in voluntary, they are compulsory. For example, all employees in Tanzania have a legal obligation to submit a certain amount of money each month from their salaries as contribution for their pensions to either the National Social Security Fund (NSSF) or to the Parastatal Pension Fund (PPF)

Differences between Banks and Non-Banks Banks and non-banks differ in the following ways:

• Non-banks do not operate accounts for their customers' savings, while banks open different types of accounts such as savings, current and fixed deposits for their customers.

• Non-banks do not use savings to advance loans to the public, while Banks use savings mobilised from the customers to advance loans to immediate borrowers.

• Banks make profits through the loans advanced to their customers, while non -banks depend on revenues that they obtain through investments such as buildings, dividends on shares bought, etc.

• Banks, especially the commercial banks are established mainly to make profit, while non-banks are established mainly to provide social security to their clients.

Mobilisation of savings by non-banks is made contractual and compulsory, while banks use persuasion to induce the public to save money.

• Commercial banks operate cheque accounts, which make them members of the Central Bank Clearing houses, whereas non-banks financial institutions are not members of the central banks clearing house, since they do not operate cheque accounts.

• Commercial banks operate bank accounts with the central bank, which is the banker's bank, whereas non-banks intermediaries do not have such a facility. • Some deposits of customers in the commercial banks, such as in current accounts, do not get interest, whereas all deposits in the non-banks bear interest.

Types of banks

The following are the types of banks:

(a) Central Bank: This is the government’s bank which is established to assist the state to control its money. It also gives financial advice to the government, and acts as a banker for the commercial banks.

(b) Commercial Banks: These offer a wide variety of banking services and are usually owned by share holders.

(c) Savings Bank: This is mainly intended to provide a safe place for keeping small deposits and pays interests on them, e.g. Post Office Savings Bank.

(d) Specialized Banks: These are banks which serve a special type of customers or aim at providing special types of services or functions to the general publics e.g. Development Banks.

(e) Co-operative Banks: These are Banks which are established to mobilize funds within a co-operative movement. The banks help co-operatives to finance for their activities.

(f) Merchant Banks: These are banks which specialize in accepting and discounting bills of exchange, and assisting traders in international trade.

Central bank

The Central Bank is the government’s institution established to control, guide and assist other banks in the country, and also to provide banking services and financial advice to the government.

 Bank of Tanzania (B.O.T)

Historical background

The central Bank of Tanzania (B.O.T was established by an act of parliament on 23rd December, 1965 to replace the East African currency board. The Bank of Tanzania started its functions in 1966 and issued its own currency in the same year. The central Bank of Tanzania has the following roles which can be grouped into four main functions.

(a) Banking functions

(b) Domestic monetary management functions

(c) External monetary management functions

(d) Development functions

(a) Banking Functions

Under banking functions, the B.O.T has the following functions:

Fiduciary issue/currency issue: The Central Bank has the role of printing notes and minting coins and issuing them into the economy.

• It is the Bankers Bank: The Central Bank is the custodian reserve of other Banks. All banks and non-banks are supposed to keep a certain specific amount of their capital as reserves in the Central Bank, and it is the responsibility of the Central Bank to keep, the reserves safely.

• It is the Banker of the government: The Central Bank keeps the government’s money. It is also the major advisor to formulation and implementation of monetary and fiscal policies of the country, the Central Bank can sometimes advance loans to the government in case it faces budget deficit.

• It is a lender of last resort: If commercial banks are short of money and cannot get them from any source, then it is the responsibility of the Central Bank to advance loans to the commercial banks

• It is the central clearing house for commercial banks: If any dispute concerning settlement of debts arises between two banks, then it is the responsibility of the Central Bank to settle this dispute.

(b) Domestic Monetary Management Functions

Under this function, the Central Bank has the following functions:

• Financing the government budget deficit: In case the government faces a budget Deficit, the Central Bank finances the deficit by providing loans to the government. • Management of the government debts: The Central Bank manages the government debts both local and foreign debts, by keeping the amount and pays on behalf of the government.

• It is a financial adviser: The Central Bank gives advice to the government on all monetary issues, such as money supply, inflation, public debts, taxation, expenditure, etc.

(c) External Monetary Management Functions

Under this function, the Central Bank has the following functions:

• Management of the country's foreign exchange reserves: Under this function, the Central Bank controls all the foreign currencies which are received through exports and which are paid through imports and other payments.

•  Control exchange rate and importation of goods: The Central Bank is responsible for determining the value of domestic currency in relation to foreign currencies. It also controls the importation of goods and services from abroad.

•  Export promotion: The Central Bank helps in promoting the exports sector so as to increase the government’s foreign exchange.

• Participation in discussion with international financial institutions: The Central Bank on behalf of the government, participates in discussion with International Financial Institutions and the World Bank on the stability of its currency, payments of debts and other financial assistance.

(d) Development Functions

Under this function, the Central Bank has the following functions:

• It provides medium and long-term loans to commercial banks.

• It supervises commercial banks and non-banks.

It is involved with the formulation and implementation of monetary and fiscal policies of the country.