Where Government’s Money Comes from and Where it Goes

Author(s): Central Bank Of Barbados

Created 23 Nov, 2022
Tags CBB 101 CBB Blog
Categories General Press Release
Views: 2220

Why do we pay taxes? How much money does Government collect in taxes? What does Government do with the money it collects from those taxes? To answer these questions is to begin a discussion about fiscal policy – how Government handles its revenue and expenditure. This is a discussion worth having, because how Government manages its finances has implications for the health of Barbados’ economy. Read on to get the answers to those questions, plus one more: what happens when Government spends more than it earns?

How Government Gets its Money

Government gets the majority of its revenue through taxes. To illustrate, Dr. Justin Robinson, a Professor of Finance and Dean of the Faculty of Social Sciences at the University of the West Indies, Cave Hill Campus points to the last fiscal year before COVID impacted Barbados’ economy: 2019-2020. Barbados’ fiscal year runs from April 1 of one year to March 31 of the next, and in that period for 2019-2020, taxes accounted for $2.77 billion of $2.98 billion earned by Government.

Those taxes can be broken down into two categories: direct taxes and indirect taxes. Direct taxes are those imposed on people and businesses directly, while indirect taxes are those we pay when we purchase goods and services. Of the $2.77 billion mentioned earlier, indirect taxes contributed the larger portion, $1.69 billion, with VAT (value-added tax) representing $967 million of that.

VAT is generally the largest single source of tax revenue, followed by personal income tax and corporation tax. Excises and import duties, which are taxes applied to imported goods, are also significant contributors, as is property tax.

What Government Spends Money On

So now that we know where Government’s money comes from, the next question is where does it go?

The bulk of Government’s spending is on current expenditure, or routine and recurring expenses. Of this, the single biggest expense is for transfers and subsidies, which is the money transferred to state-owned enterprises such as the Queen Elizabeth Hospital, the Transport Board, and the Sanitation Service Authority that provide services to the public. The entities, while not part of what is referred to as central government, receive funding from it.

The next largest expense is wages and salaries for those people employed directly by Government. After that, Government spends money on the goods and services needed to maintain its operations, including office equipment and utilities, and on interest payments on debt.

There’s also another type of expenditure, capital expenditure, which Professor Robinson actually believes should be higher. That’s because capital expenditure is the money spent on roads and is “something that has longevity, that’s going to have benefits for a long period of time.”

What Happens When Government Spends More than it Earns

The difference between Government’s revenue and its expenditure (both current and capital) is referred to as the fiscal balance. When that balance is positive, or put differently, when Government is earning more than it is spending, that’s called a fiscal surplus. And when the balance is negative and Government’s expenses outweigh its revenue, that is called a fiscal deficit. Both have implications for the overall economy. When Government has a fiscal surplus, it can use that extra money to pay down its existing debt. On the flipside, when it has a deficit, it will need to borrow more to cover the expenses it can’t pay for from its revenue.

Professor Robinson puts it into everyday context:

“Think of revenue as like your salary. If your salary is $4,000 a month. Your current expenditure would be things like your food, light, and water. Your capital expenditure would be like if you do a refurbishment on your house or if you buy a car, which you’re not doing every year. So, when we take the gap between that – your revenue or your salary, minus what you spend, do you have anything extra? If you have anything extra, you could save it. But if you’re spending more than you’re earning, then you have to dip into your savings or you have to use your credit card.”

Just as spending more than we earn leads us to have to find the additional money to pay for expenses elsewhere, “that negative fiscal balance drives a need to borrow.”

There’s another indicator economists use to get an even more accurate picture of the state of Government’s finances. This is called the primary balance and it is the difference between Government’s revenue and its expenditure, not including interest payments. Professor Robinson explains that the primary balance allows policymakers to better understand the country’s borrowing needs.

“If you have a positive primary balance, it’s saying that your revenue, when you take out your expenses, you still have a surplus to go towards paying your interest.” However, “if you have a primary balance that is negative… that means that you are going to be borrowing money just to pay down on the debt that you already have, which is quite problematic…. A negative primary balance is really a perfect example of the old adage that you’re digging a hole to fill a hole.”

It’s clear then that Government’s fiscal policy affects how Barbados’ economy performs. In fact, Professor Robinson argues that “in a small open economy, there are a lot of things that Government can’t control, but the one thing they can control to some extent, and they need to be held accountable for it, is how they manage the public finances.”

How to Track How Government is Managing its Finances

He encourages Barbadians to pay close attention to these matters: how much revenue Government is collecting, where it is coming from, and what it is being used for because it influences how much borrowing it will have to do and by extension, Barbados’ ability to reach the targeted debt-to-GDP ratio of 60 percent.

Professor Robinson says monitoring this is easy to do.

“There’s no excuse in Barbados for not understanding the fiscal. Appendix four in the Central Bank’s quarterly reports lays it out for you very very clearly… It’s there, and it’s arithmetic, it’s not any fancy Maths… Anybody who’s gotten to 11+ can read this table.”

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