Government Finance
Government finance (public finance) studies how the government raises revenue and spends it for public welfare. Government expenditure is classified as recurrent (salaries, interest, subsidies — recurring every year) or capital (roads, hydro, schools — creating assets). Revenue is tax-based (income tax, VAT, customs) or non-tax (fees, fines, dividends from NEA, NTC). Taxes are direct (income, wealth — burden falls on payer) or indirect (VAT, excise — burden shifted). Tax rate structures are progressive (rate rises with income), proportional (same rate), or regressive (rate falls with income). Adam Smith's four canons of taxation are equity, certainty, convenience, and economy. The government budget shows estimated revenue and expenditure — surplus (R > E), deficit (R < E), or balanced (R = E).
In this chapter
Public Finance — Meaning & Scope
- Public revenue — sources of govt income;
- Public expenditure — govt spending on goods, services, transfers;
- Public debt — borrowing when expenditure exceeds revenue. The Government of Nepal's budget for Fiscal Year 2023/24 (2080/81 BS)** was Rs 1.751 trillion (Rs 1,75,100 crore) — total expenditure, with revenue estimates of only Rs 1.422 trillion, leaving a deficit of about Rs 329 billion to be financed by domestic and foreign borrowing. This makes public finance central to Nepal's daily economic life
Government Expenditure — Recurrent vs Capital
- Recurrent (current) expenditure — recurring expenses that do not create assets — e.g. salaries of civil servants, pensions, interest payments on public debt, subsidies on fertiliser and LPG, office operating costs. In 2080/81 BS, recurrent expenditure was Rs 1.186 trillion.
- Capital expenditure — spending that creates long-term assets — e.g. building the Mid-Hill Highway, Upper Tamakoshi hydro, Melamchi Water Project, school buildings, irrigation canals. Capital expenditure in 2080/81 BS was Rs 302 billion. A third category is financial management / loan financing** — repayment of principal and lending to provinces. Capital expenditure boosts growth; recurrent expenditure keeps the system running
Recurrent vs Capital Expenditure with Nepal examples
| Basis | Recurrent Expenditure | Capital Expenditure |
|---|---|---|
| Nature | Recurring every year | One-time asset creation |
| Asset creation | No new asset | Creates long-term asset |
| Examples | Salaries, pensions, interest, subsidies | Roads, hydro, schools, irrigation |
| Nepal example (2080/81) | Rs 1,186 billion | Rs 302 billion |
| Effect on growth | Maintains services, less growth | Boosts long-run growth |
| Effect on debt | Pressure to borrow if revenue low | Returns pay back over time |
Government Revenue — Tax vs Non-Tax
Government revenue is the total money the government collects from all sources. It has two main parts — tax revenue and non-tax revenue. Tax revenue comes from compulsory payments without direct quid pro quo — income tax, Value Added Tax (VAT), customs duty, excise duty, property tax, vehicle tax. VAT is the largest single source for Nepal (around 36% of total tax). Non-tax revenue comes from fees, fines, forfeitures, dividends from state enterprises (Nepal Telecom dividend of about Rs 8 billion yearly, NEA, RBB), interest on loans, and sale of government services (passport fees, driving licence fees). In 2080/81 BS, Nepal's total revenue was Rs 1.422 trillion — of which tax revenue was Rs 1.230 trillion (86.5%) and non-tax was Rs 192 billion (13.5%).
Tax vs Non-Tax Revenue of the Government of Nepal
| Basis | Tax Revenue | Non-Tax Revenue |
|---|---|---|
| Compulsion | Compulsory payment | Voluntary / fee-based |
| Direct benefit | No direct benefit | Some direct service |
| Major sources | VAT, income tax, customs, excise | Fees, fines, dividends, interest |
| Share in Nepal (2080/81) | Rs 1,230 billion (86.5%) | Rs 192 billion (13.5%) |
| Examples | Income tax on salaries; VAT on goods | NEA dividend; passport fee; NEB bill |
| Predictability | More stable, predictable | Less predictable |
Direct vs Indirect Tax
Taxes are classified by who bears the final burden. Direct tax — the burden falls on the person who pays it; impact and incidence are on the same person. Examples: income tax (a teacher in Butwal pays 1% on salary — that is her burden), property tax, vehicle tax, capital gains tax. Direct taxes are progressive and promote equity. Indirect tax — the burden is shifted to another person (usually the final consumer). Examples: VAT (a shopkeeper in Asan charges 13% VAT to a customer, then deposits it to IRD — the customer bears the burden), customs duty, excise duty on cigarettes and alcohol. Indirect taxes are easy to collect but regressive because the poor pay the same rate as the rich on essential goods.
Direct vs Indirect Tax Comparison
| Basis | Direct Tax | Indirect Tax |
|---|---|---|
| Incidence (burden) | Same person who pays | Shifted to another (consumer) |
| Examples | Income tax, wealth tax, property tax | VAT, customs, excise, GST |
| Equity | Progressive — more from rich | Regressive — same rate for all |
| Collection cost | Higher (assessment needed) | Lower (collected at point of sale) |
| Visibility | Visible to taxpayer | Hidden in price |
| Nepal example | Income tax on Rs 5 lakh salary | 13% VAT on a Rs 100 biscuit packet |
Tax Rate Structures
- Taxes can be classified by how the rate changes with income. Progressive tax — the rate of tax rises as income rises
- the rich pay a higher percentage than the poor. Nepal's income tax on individuals is progressive: 1% on the first Rs 5 lakh, 10% on Rs 5-7 lakh, 20% on Rs 7-10 lakh, and 36% above Rs 20 lakh (FY 2080/81 rates). This is the most equitable form. Proportional tax — the same rate for everyone regardless of income
- e.g. Nepal's corporate tax rate is 25% on profits, whether the company earns Rs 10 lakh or Rs 10 crore. Regressive tax — the rate falls as income rises
- the poor pay a higher percentage of their income than the rich. VAT is regressive in effect — a daily-wage labourer in Dhangadhi earning Rs 800/day spends it all on food and pays 13% VAT effectively, while a rich banker saves much of her income and pays VAT on a smaller share.
Tax rate structures (average tax rate t = T/Y)
Canons of Taxation — Adam Smith (1776)
- Canon of Equality / Equity — every person should pay tax in proportion to their ability to pay; rich pay more, poor pay less. (Nepal's progressive income tax follows this.)
- Canon of Certainty — the time of payment, manner of payment, and amount to be paid should all be clear and certain to the taxpayer — not arbitrary.
- Canon of Convenience — the mode and timing of tax payment should be convenient for the taxpayer. (Nepal's TDS — Tax Deducted at Source — from salary each month is convenient.)
- Canon of Economy — the cost of collecting the tax should be a small fraction of the tax revenue; the tax should not discourage production.
Government Budget — Types
- Surplus budget — Revenue > Expenditure (R > E); used to control inflation by sucking excess money out of the economy; rare in Nepal.
- Deficit budget — Revenue < Expenditure (R < E); the most common type in Nepal — the 2080/81 BS budget had a deficit of Rs 329 billion; deficit is financed by domestic borrowing (savings certificates, development bonds) and foreign aid/loans.
- Balanced budget** — Revenue = Expenditure (R = E); rarely achieved in practice. Deficit budgets are needed for developing countries to fund infrastructure, but too large a deficit causes inflation and debt burden
Budget balance equation
Nepal's Fiscal Position (2080/81 BS)
Total expenditure Rs 1,751 billion, of which recurrent Rs 1,186 billion (68%) and capital Rs 302 billion (17%). Total revenue Rs 1,422 billion (tax Rs 1,230 bn + non-tax Rs 192 bn). Budget deficit = 1,751 − 1,422 = Rs 329 billion (about 6.3% of GDP), financed by Rs 240 billion domestic borrowing and Rs 89 billion foreign loans/grants.
Practice Problem
A shop in New Road, Kathmandu sells a laptop for Rs 80,000 (excluding VAT). The VAT rate is 13%. (a) Calculate the VAT amount and the total price the customer pays. (b) If the shopkeeper had purchased the laptop from the wholesaler for Rs 60,000 (excluding VAT) and already paid 13% VAT to the wholesaler, how much VAT does the shopkeeper actually deposit to the Inland Revenue Department (IRD)?
Practice Problem
A bank manager in Biratnagar earns a taxable annual income of Rs 16,00,000 in FY 2080/81. Nepal's individual income tax slabs are: 1% on first Rs 5,00,000, 10% on Rs 5,00,001–7,00,000, 20% on Rs 7,00,001–10,00,000, 30% on Rs 10,00,001–20,00,000, and 36% above Rs 20,00,000. (a) Calculate her total tax liability. (b) Find her average tax rate and marginal tax rate. (c) Comment on whether the structure is progressive.