Question Tag: Fiscal Policy

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  • 5 Marks

TF – May 2018 – L3 – Q1c – Tax planning

Explain automatic stabilizers and discretionary fiscal policies.

The decision to change the level, composition, or timing of government expenditure or to vary the burden, the structure, or frequency of tax payment is a fiscal policy. Fiscal policies could be automatic stabilizers or discretionary.

Required:
Explain automatic stabilizers and discretionary fiscal policies.
(5 marks)

Automatic Stabilizers

  • Some tax and expenditure programs change automatically with the level of economic activity. These are called automatic stabilizers. Automatic stabilizers refer to how fiscal instruments (taxes and government spending) will influence the rate of growth and help counter swings in the economic cycle.
  • In a period of high economic growth, automatic stabilizers will help to reduce the growth rate. With higher growth, the government will receive more tax revenues – people earn more and so pay more income tax. With higher growth, there will also be a fall in unemployment so the government will spend less on unemployment benefits.
  • In a recession, economic growth becomes negative. However, automatic stabilizers will help to limit the fall in growth. With lower incomes people pay less tax, and government spending on unemployment benefits will increase. This increase in benefit spending and lower tax helps to limit the fall in aggregate demand.

(2.5 marks)

Discretionary Fiscal Policy

  • Discretionary fiscal policy refers to deliberate changes in taxes or spending. The government cannot control certain aspects of the economy related to fiscal policy. For example, the government can control tax rates but not tax revenue. Tax revenue depends on household income and the size of corporate profits.
  • Government spending depends on government decisions and the state of the economy. Discretionary government spending and tax policies can be used to shift aggregate demand.

(2.5 marks)

  • 5 Marks

TF – May 2018 – L3 – Q1b – Tax planning

Explain five goals of government spending as a fiscal policy instrument.

One of the factors that helps determine the country’s economic direction is fiscal policy. Government uses fiscal policy to influence the economy by adjusting revenue and spending levels.

Required:
Identify and explain FIVE goals of government spending as a fiscal policy instrument.
(10 marks)

The goals of public expenditure are the following:

  • Provide social goods: The theory of social goods is important to the economy of the public sector. Public goods like roads, bridges, and educational facilities are necessary for societal welfare but are often underprovided by the market.
  • Remove unemployment: Public expenditure helps fight unemployment by creating job opportunities. This can be achieved by government spending, especially during periods of depression when private investment is insufficient.
  • Increase production: Public expenditure contributes to production by investing in essential sectors such as agriculture and industries. Government support for infrastructure also boosts productivity.
  • Exploitation and development of mineral resources: Public investment in mining and mineral exploitation plays a critical role in the economic development of a country.
  • Promote price stability: By varying public expenditure, the government can help stabilize prices. In times of inflation, reduced government spending can control price rises, while increased spending during deflation can stimulate economic activity.
  • Promote Balanced Growth: There is a tendency to use economic resources for the further development of already developed regions. But for overall growth, special attention needs to be paid for the development of backward areas and underdeveloped regions. This requires huge amounts for which reliance has to be placed on public expenditure.
  • Reduce Inequality of Income: Another objective of public expenditure is to reduce the inequality of income. Expenditure on old age pensions, unemployment relief, free education, free mid-day meals etc. benefits the poorer classes of the community at the expense of the
    rich.

(Any 5 points well explained for 10 marks)

  • 6 Marks

AT – Nov 2017 – L3 – Q1b – Tax planning

Evaluating the use of taxation as a tool of fiscal policy.

Fiscal policy involves the use of government spending, taxation, and borrowing to influence both the pattern of economic activity and also the level and growth of aggregate demand, output, and employment.

Required:
Evaluate how taxation is used as a tool of fiscal policy. (6 marks)

  • There are two main types of taxes: direct taxes and indirect taxes. A tax cut increases disposable income, leading to increased consumption spending. The income will increase by a multiple of the decrease in taxes.
  • Taxation is an essential fiscal policy tool because it creates revenue for government public expenditure. The first goal in a development strategy for taxation policy is to ensure adequate revenue generation.
  • Taxes can be used to reduce inequalities through income redistribution. For instance, higher rates of income, capital transfer, and wealth taxes are adopted for this purpose.
  • Social objectives are also pursued by taxation, such as discouraging activities deemed undesirable, e.g., excise taxes on liquor, tobacco, and luxury goods, along with Betting and Gaming Levy.
  • Taxes influence growth by affecting the aggregate supply of production factors and resource utilization efficiency.
  • The taxation policy can promote equitable wealth distribution by providing social services that benefit lower-income groups.
  • 15 Marks

AT – May 2017 – L3 – Q1b – Tax administration in Ghana

Define public debt and discuss its general meaning in the context of government financing.

i)  What is public debt?

ii)  Critically examine public debt as an alternative to taxation and its effect on the economy.

i)

Public debt is defined as how much a country owes to lenders outside of itself. These lenders can include individuals, businesses, and even other governments. The term “public debt” is used interchangeably with the term “sovereign debt.” Public debt is the accumulation of annual budget deficits and results from years of government spending exceeding tax revenues. It includes Treasury bills, notes, and bonds, which are typically purchased by large investors.

In the short run, public debt is a good way for countries to acquire additional funds to invest in economic growth. It also serves as a safe investment for foreigners in a country’s growth by purchasing government bonds.

ii)

When public debt is used as an alternative to taxation, it offers several advantages:

  • Public borrowing has an advantage over taxation because taxation beyond a certain limit can negatively affect economic activity by creating disincentives. Public borrowing, however, does not carry the same risk as it is voluntary and carries the expectation of return and repayment.
  • Public debt allows governments to invest in infrastructure and social sectors where tax revenues may be insufficient. Debt-financed investments can create additional productive capacity in the economy that would not otherwise have been possible.
  • Public debt also supports tax smoothing and counter-cyclical fiscal policies, which help reduce output volatility. It allows governments to align benefits and costs for long-term projects by shifting the tax burden away from current generations.
  • Foreign investment through government bonds, which form part of public debt, is a safer alternative to direct foreign investments in domestic businesses.

Consequences of Public Debt on the Economy:

  • High public debt leads to large interest payments, which are ultimately borne by taxpayers. This can result in future taxation increases without corresponding economic growth.
  • Public borrowing increases demand for credit in the economy, driving up borrowing costs, making it more expensive for businesses to invest in equipment and other capital goods, increasing the cost of doing business.
  • Excessive public debt can lead to currency collapse or depreciation if governments resort to printing money to finance the debt.
  • 6 Marks

AT – Nov 2016 – L3 – Q2a – Tax administration in Ghana

Evaluate the effects of government borrowing on Ghana's economy and discuss how taxation serves as a fiscal tool in fiscal policy.

a) The current level of government borrowing has become a topical issue for discussion, causing observers to wonder whether borrowing is good or bad. In the light of this, you are required to:

i) Evaluate the effect of government borrowing on the economy of Ghana. (4 marks)
ii) Discuss how taxation can be used as a fiscal tool in fiscal policy. (6 marks)

i) Effects of Public Debt on the Economy of Ghana:

  • Effects on Production: Public debts are raised to finance productive enterprises of various kinds, such as steel works, cement, multipurpose projects, construction of ships, railway lines, highways, heavy electrical and engineering works, mining, and oil refining.
  • Effects on Consumption: When people subscribe to government loans, they generally have to curtail consumption. Since investment of funds raised by borrowing raises the level of employment, it consequently raises the level of consumption.
  • Effects on Distribution of Wealth: Public loans transfer money from the rich to the government. The fiscal operations of the government are primarily to benefit the poor. The incomes of the poor increase directly through increased employment or benefit them indirectly through the enlargement of social services.
  • Effects on the Level of Income and Employment: Public borrowing is used to raise funds for financing agriculture, industry, mining, transportation, communication, etc. It increases employment opportunities, the level of income, and the standard of living.

ii) Fiscal Policy and Taxation:

  • Revenue Generation: The primary function of a tax system is to raise revenue for the government for its public expenditure. Ensuring this function is discharged adequately is the first goal in the development strategy concerning taxation policy.
  • Reduction of Inequalities: Taxes are used to reduce inequalities through a policy of redistribution of income and wealth. Higher rates of income taxes, capital transfer taxes, and wealth taxes are some means adopted for achieving these ends.
  • Social Purposes: Taxes are used to discourage certain activities considered undesirable. Excise taxes on liquor and tobacco, special excise duties on luxury goods, and Betting and Gaming Levy are examples of such taxes, which, apart from being lucrative revenue sources, also have social goals.
  • Impact on Growth: Taxes affect growth in two ways: by influencing the aggregate supply of the main factors of production by raising or lowering their net (after-tax) returns; and by influencing the efficiency of resource utilization (total productivity).
  • 6 Marks

AT – Nov 2019 – L3 – Q4d – Minerals and mining

Explain the purpose and benefits of stability agreements for mining companies in Ghana.

Mining companies are given some benefits in their operations in many countries to help them create benefits for their host governments and shareholders. One of the benefits of the mineral operation is the stability agreement that mining companies sign with host governments the world over.

Required: What does stability agreement seek to achieve for mining companies in Ghana? (6 marks)

Mining companies want to be able to plan over a long period of time but this can be affected by changes in fiscal system they operate under.

To protect mining companies from fiscal changes, the mining companies enter into stability agreement so ensure that any adverse fiscal system (such as changes in levies, royalties among others) does not affect the mining companies. The stability agreement allows such companies to benefit from any favourable fiscal system.

  • 10 Marks

PSAF – May 2019 – L2 – Q3b – Public sector fiscal planning and budgeting

Explain the primary fiscal policy objectives, guiding principles, and post-budget management activities under the Public Financial Management Act.

Budgeting is an important process by which government plans its programmes and activities for a given fiscal period. For a budget to be effective in the delivery of the economic and social agenda of the government, the budgeting process should be linked to the macroeconomic and fiscal policies of the country. No wonder the Public Financial Management Act, 2016 (Act 921) has made extensive provision on macroeconomic and fiscal policies to guide the government in its budget formulation and execution. The budgeting process is preceded by fiscal policy planning to serve as a foundation for the realization of the inspiration of the budget. A national budget is a means to an end and not an end in itself; therefore, it should be controlled and managed holistically to achieve the desired economic, fiscal, and social outcomes. The Minister of Finance, the Principal Account Holders, and Principal Spending Officers are actively involved in post-budget management and control activities at various levels to ensure that the budget targets are achieved.

Required:
i) Explain the primary fiscal policy objective of the government and identify THREE (3) guiding principles in the formulation and implementation of a fiscal policy objective.
(3 marks)

ii) Explain FOUR (4) post-budget management and control activities prescribed under the Public Financial Management Act, 2016 (Act 921).
(4 marks)

i) Primary Fiscal Policy Objective and Guiding Principles

  • Primary Fiscal Policy Objective:
    The primary fiscal policy objective of the government is to ensure macroeconomic stability within the macroeconomic and fiscal framework of the country. This involves maintaining a balance between revenue mobilization and expenditure, controlling public debt, and achieving sustainable economic growth.
  • Guiding Principles:
  1. Sufficient Revenue Mobilization: Ensuring that enough revenue is mobilized to finance government programs and projects without excessive borrowing.
  2. Maintenance of Prudent and Sustainable Levels of Public Debt: Managing public debt in a way that does not jeopardize fiscal stability and economic growth.
  3. Efficiency, Effectiveness, and Value for Money in Expenditure: Ensuring that government expenditures are managed in a way that maximizes output and achieves the best outcomes with the resources available.
  4. ensuring that the fiscal balance is maintained at a sustainable level over the
    medium term.

ii) Post-Budget Management and Control Activities

  1. Mid-Year Review:
    A mid-year review is conducted to assess the performance of the budget in the first half of the fiscal year. This review helps identify any deviations from the planned budget and allows for adjustments to be made to ensure the budget remains on track.
  2. Budget Performance Report:
    Regular budget performance reports are prepared to track the progress of budget implementation. These reports provide insights into how well the budget is being executed and highlight areas that may require corrective actions.
  3. Supplementary Budget:
    In cases where the initial budget is insufficient to cover all government activities or unforeseen circumstances arise, a supplementary budget may be introduced to allocate additional resources.
  4. Virement and Reallocation of Funds:
    Virement involves the reallocation of funds within the budget to different expenditure items based on changing priorities or unforeseen needs. This ensures that funds are utilized efficiently and in line with government priorities.
  5. Cash Forecasting:
    Regular cash forecasting is conducted to ensure that sufficient cash is available to meet the government’s obligations. This involves predicting cash inflows and outflows to avoid liquidity issues.
  • 20 Marks

FM – MAY 2016 – L2 – Q3 – Business valuations

Discuss fiscal and monetary policies, adverse effects of contractionary fiscal policy, and valuation of Papa’s Skin Ltd.

a) Governments take certain measures with a view to influencing aggregate demand in their economy.
Required:
i) Distinguish between fiscal policy and monetary policy. (2 marks)
ii) Explain TWO adverse effects a contractionary fiscal policy could have on businesses. (4 marks)

b) Papa’s Skin Ltd is an Accra-based clothing company owned and managed by its two founders. The company has been selling to only domestic consumers in Ghana since inception. The founders think it is time to extend the operations of the company to foreign markets, particularly those in neighbouring West African countries. Moving into foreign markets requires additional financing and capabilities, which the company does not have. The owners have agreed on ceding 40% stake in their company to a strategic investor who would provide the additional financing and capabilities needed to compete successfully in the international business environment. However, they are not sure of what range of prices to accept for the shares they would give up.

Below is a summary of financial data for Papa’s Skin Ltd for the recent financial year:

  • Issued shares: 2 million
  • After-tax profit: GH¢9,600,000
  • Total dividends: GH¢1,920,000
  • Property, plant and equipment: GH¢50,500,000
  • Current assets: GH¢25,300,000
  • Long-term borrowings: GH¢9,100,000
  • Current liabilities: GH¢11,100,000

The following information is relevant to the position and value of Papa’s Skin Ltd:

  1. The assets of Papa’s Skin Ltd were valued just after the recent financial statements were published. Inventories and trade receivables, which are included in current assets, were written down by GH¢80,000 and GH¢95,000 respectively. Property, plant and equipment were valued at GH¢52,400,000.
  2. Papa’s Skin Ltd falls into the fabrics and clothing industry. The average P/E ratio for listed equity stocks in the industry is 10. The average required return on listed equity stocks in the industry is 16%.
  3. Marketability of shares in Papa’s Skin Ltd is limited as its equity stock is not listed on the stock exchange. Consequently, investors demand a marketability risk premium of 7% above the industry average required return on equity in order to invest in the equity stock of Papa’s Skin Ltd.
  4. Earnings and dividends of Papa’s Skin Ltd are expected to grow by 5% every year to perpetuity.

Required:
i) Estimate an appropriate required rate of return on the equity stock of Papa’s Skin Ltd. (2 marks)
ii) Estimate a range of suitable considerations for a 40% stake in Papa’s Skin Ltd using the net assets method, P/E ratio method, and dividend valuation method. (12 marks)

a) Fiscal Policy vs. Monetary Policy

i) Distinction Between Fiscal Policy and Monetary Policy

  • Fiscal Policy: Involves the use of government spending and taxation to influence the economy. Fiscal policy is typically aimed at achieving macroeconomic goals such as controlling inflation, reducing unemployment, and encouraging economic growth by influencing aggregate demand.
  • Monetary Policy: Involves the management of the money supply and interest rates by a central bank to influence the economy. Monetary policy aims to maintain price stability, control inflation, and achieve high levels of employment.

ii) Adverse Effects of Contractionary Fiscal Policy on Businesses

  • Reduction in Sales Revenue and Profit: A contractionary fiscal policy, which involves increasing taxes or reducing government spending, can lead to a decrease in aggregate demand. This reduction in demand can result in lower sales and, consequently, lower profits for businesses.
  • Reduction in Reinvested Profits: Higher taxes reduce the amount of disposable income available to businesses, limiting the funds available for reinvestment. This can force businesses to seek external financing, which may come at a higher cost.

b) Valuation of Papa’s Skin Ltd

i) Appropriate Required Rate of Return on the Equity Stock of Papa’s Skin Ltd
The average required rate of return on industry-listed stocks is 16%. Given the limited marketability of Papa’s Skin Ltd’s shares, investors require a marketability risk premium of 7%.

Required Rate of Return = Industry Return + Marketability Risk Premium
= 16% + 7% = 23%

ii) Range of Suitable Considerations for 40% Stake

  1. Net Assets Method:
Item Amount (GH¢)
Property, Plant & Equipment 52,400,000
Current Assets 25,125,000
Long-Term Borrowings (9,100,000)
Current Liabilities (11,100,000)
Net Assets 57,325,000

Value per share = Net Assets / Number of shares
= GH¢57,325,000 / 2,000,000 = GH¢28.66

  1. P/E Ratio Method:
Item Amount (GH¢)
After-tax Profit 9,600,000
Number of Shares 2,000,000
Earnings per Share (EPS) 4.8
Justified P/E Ratio 5
Value per share 24
  • P/E Ratio = Industry P/E ratio × 0.5
    = 10 × 0.5 = 5
  • Value per share = EPS × Justified P/E Ratio
    = GH¢4.8 × 5 = GH¢24
  1. Dividend Valuation Method:
Item Amount (GH¢)
Dividend per Share (DPS) 0.96
Required Return on Equity 23%
Growth Rate of Dividends 5%
Value per Share 5.6
  • Value per share = (DPS × (1 + g)) / (Required Return – g)
    = (GH¢0.96 × (1 + 0.05)) / (0.23 – 0.05) = GH¢5.6
  1. Summary of Valuation Methods
Method Value per Share (GH¢) Total Equity Value (GH¢) Consideration for 40% (GH¢)
Net Assets Method 28.66 57,320,000 22,928,000
P/E Ratio Method 24 48,000,000 19,200,000
Dividend Valuation Method 5.6 11,200,000 4,480,000

Conclusion: The valuation of Papa’s Skin Ltd for a 40% stake could range between GH¢4,480,000 and GH¢22,928,000 depending on the method used.

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