Cambridge IGCSE Economics: Government budget, spending and taxation (0455)

This guide teaches sections 4.3.1 to 4.3.6 of the Cambridge IGCSE Economics 0455 syllabus for examination in 2026: the government budget, government spending, taxation and its classification, the qualities of a good tax and the impact of taxation. The syllabus is not tiered. The later fiscal policy statements (4.3.7 to 4.3.9) sit in a separate unit. Every country, firm and figure below is invented for practice and is not a real statistic.

Related pages: revision notes, practice questions, the Cambridge IGCSE Economics hub, the printable checklist, the free diagnostics and the general exam preparation guide.

What you must be able to do

Section	Outcome
4.3.1	Define the government budget
4.3.2	Describe the main areas of government spending; explain reasons for and effects of spending in these areas
4.3.3	Explain why taxation is the main source of government revenue and why governments levy taxes
4.3.4	Classify taxes as progressive, regressive, proportional, direct or indirect, with examples
4.3.5	Explain the qualities of a good tax
4.3.6	Explain the impact of taxation on consumers, producers, the government and the economy as a whole

The syllabus assesses knowledge, analysis and evaluation. In this topic that means defining terms precisely, using the numbers you are given, building chains of reasoning, and weighing up whether an effect is large or small, short run or long run.

4.3.1 The government budget

The government budget is a plan, usually for one year, of the government’s expected revenue and its planned spending. Revenue comes mainly from taxes. Spending goes on goods, services and transfers to households.

Here is the budget of Country A (invented), in millions of units.

Revenue	Units	Spending	Units
Income tax	70	Health	48
Sales tax	60	Education	42
Tax on company profits	30	Social security	40
Customs duties	10	Defence	20
Other (fees, charges)	10	Infrastructure	25
		Interest on past debt	12
		Other	8
Total	180	Total	195

Revenue is 180 and spending is 195, so spending exceeds revenue by 195 − 180 = 15. The government would have to borrow or use savings to cover the gap. Calculating and judging such gaps belongs to the fiscal policy unit.

4.3.2 Government spending

Main areas

Governments typically spend on health, education, social security (benefits for the unemployed, elderly and poor), defence and public order, infrastructure such as roads and power, and interest on past borrowing. Each can be shown as a share of the total.

Worked example, Country A: education share = 42 / 195 × 100 = 21.5%. Health is 48 / 195 × 100 = 24.6%. Debt interest is 12 / 195 × 100 = 6.2%.

Reasons and effects

Area	Reason for spending	Possible effects
Health	Many people cannot pay for care; healthy people work more	Better health, higher labour productivity, lower sick days
Education	Gives skills; benefits society as well as the learner	Better quality labour, higher incomes, more growth over time
Social security	Supports people with low or no income	Less poverty, more equal incomes, steadier consumer spending
Defence	Protects the country; a service no private firm can sell to individuals	Security that encourages investment; fewer resources for other uses
Infrastructure	Private firms may not build roads or power grids	Lower business costs, easier trade, more jobs in construction
Debt interest	Past borrowing must be paid for	Leaves less money for new projects

Chain of reasoning for education: the government builds more schools, so more people gain skills, so workers are more productive, so firms can produce more per worker and wages can rise. For evaluation, add that the benefits take years to appear, and that the money has an opportunity cost: 10 more units for education means 10 fewer for another area unless taxes or borrowing rise.

4.3.3 Reasons for taxation

Taxation is the main source of government revenue. In Country A, tax revenue is 70 + 60 + 30 + 10 = 170 out of 180, which is 170 / 180 × 100 = 94.4%.

Governments levy taxes in order to:

• raise revenue to pay for public spending
• redistribute income, taking more from high earners to help low earners through benefits and services
• discourage demerit goods such as tobacco, so that consumption and harm fall
• protect domestic producers, using duties on imports
• influence the economy, for example by leaving households with more or less income to spend
• raise money to cover external costs, such as pollution, which markets ignore.

4.3.4 Classification of taxes

Direct and indirect

A direct tax is paid straight to the government by the person or firm it is aimed at, and is charged on income or wealth. Examples: income tax, tax on company profits, property tax.

An indirect tax is charged on spending, collected by sellers and passed to the government. Consumers bear it through higher prices. Examples: sales tax, customs duties on imports, tax on fuel.

In Country A, direct taxes are 70 + 30 = 100 and indirect taxes are 60 + 10 = 70.

Progressive, regressive and proportional

These describe how the share of income paid in tax changes as income rises.

Type	Share of income paid as income rises	Example
Progressive	Rises	Income tax with higher rates on higher bands
Regressive	Falls	A flat charge on spending, because poorer households spend more of their income
Proportional	Stays the same	A single rate on all income

Worked example, progressive tax. Country A taxes the first 10,000 of income at 0%, the next 20,000 (from 10,001 to 30,000) at 10%, and anything above 30,000 at 25%.

Income	Working	Tax	Average rate
8,000	all in the 0% band	0	0%
20,000	(20,000 − 10,000) × 10%	1,000	1,000 / 20,000 = 5%
50,000	20,000 × 10% + 20,000 × 25% = 2,000 + 5,000	7,000	7,000 / 50,000 = 14%

Richer earners hand over a larger share of income (0%, then 5%, then 14%), which makes this tax progressive. Disposable income for the 50,000 earner is 50,000 − 7,000 = 43,000.

Worked example, regressive tax. A sales tax of 10% applies to the goods bought. Household L has an income of 12,000 and spends 10,000 on taxed goods. Household H has an income of 60,000 and spends 24,000 on taxed goods.

• L pays 10% × 10,000 = 1,000, which is 1,000 / 12,000 = 8.3% of income.
• H pays 10% × 24,000 = 2,400, which is 2,400 / 60,000 = 4.0% of income.

H pays more in total, but L pays a bigger share of income. The tax is regressive even though the rate is the same for everyone.

Worked example, proportional tax. A 15% tax on all income takes 15% × 12,000 = 1,800 from L and 15% × 60,000 = 9,000 from H. Both pay 15% of income.

An indirect tax is often regressive, but a direct tax can be progressive, regressive or proportional. Do not treat direct as progressive and indirect as regressive in every case.

4.3.5 Principles of taxation: the qualities of a good tax

Textbooks use slightly different labels, but the qualities below are the usual ones.

Quality	Meaning	Test
Equitable (fair)	Based on ability to pay	Do those with higher income pay a fair share?
Certain	Taxpayers know what, when and how much to pay	Are rules clear?
Convenient	Easy to pay	Is payment simple and well timed?
Economical	Cheap to collect	Collection cost as a share of revenue
Efficient/productive	Raises enough revenue without harming incentives	Does it reduce work or enterprise?
Flexible	Can be changed easily when needs change	Can the rate be altered quickly?

Worked example. Tax P raises 400 and costs 12 to collect: 12 / 400 × 100 = 3%. Tax B raises 150 and costs 18 to collect: 18 / 150 × 100 = 12%. Tax P is more economical.

No tax is perfect. A highly progressive income tax is fair but may reduce the incentive to work, and a tax that is cheap to collect may be regressive. Evaluation means saying which quality matters most in the situation.

4.3.6 Impact of taxation

Consumers

An indirect tax raises prices, so consumers buy less and have less real income. A direct tax lowers disposable income, so spending falls.

Producers

An indirect tax raises the cost of supplying. The firm either raises the price (and loses sales) or accepts a lower profit per unit. A tax on profits reduces the money available to reinvest.

Government

Revenue from a per-unit tax = tax per unit × quantity sold after the tax. Revenue depends on how responsive demand is.

Worked example. A tax of 2 per unit is placed on a good that sold 1,000 units at a price of 10. Assume the whole tax is passed on, so the price becomes 12. The price rises by 2 / 10 = 20%.

	Demand inelastic	Demand elastic
Quantity after tax	950	700
% change in quantity	−5%	−30%
Price elasticity of demand	−5 / 20 = −0.25	−30 / 20 = −1.5
Government revenue (2 × quantity)	1,900	1,400
Consumer spending (12 × quantity)	11,400	8,400
Producer revenue after tax (10 × quantity)	9,500	7,000

Producers earned 10 × 1,000 = 10,000 before the tax. They lose 500 where demand is inelastic and 3,000 where it is elastic. Government revenue is larger where demand is inelastic. If sellers absorb part of the tax, consumers pay less extra: if the price rises only to 11.20, consumers carry 1.20 / 2 = 60% of the tax and producers 40%.

The economy

• Higher taxes reduce disposable income and spending, which can slow growth and reduce employment.
• Indirect taxes can raise the general price level.
• Progressive taxes narrow the gap between rich and poor, especially when the revenue is spent on benefits and services.
• High rates may reduce incentives to work and invest, and may encourage tax evasion or smuggling.
• Taxes on demerit goods reduce harmful consumption.
• Spending the revenue well, for example on schools and roads, can raise productive capacity in the long run.

Evaluation: the size of the effect depends on the tax rate, the elasticity of demand, how the revenue is used, and the time period.

Common errors

• Writing that a regressive tax means the rich pay less money. It means they pay a smaller share of income.
• Describing the budget as only the tax collected. It covers planned revenue and spending.
• Defining an indirect tax as one paid by someone else. It is collected by the seller, and the burden can fall on consumers, producers or both.
• Listing effects of tax without saying who is affected and how.
• Calculating government revenue using the quantity before the tax.

Official syllabus

Source: Cambridge IGCSE Economics 0455 syllabus for examination in 2026, version 2, Cambridge University Press & Assessment, section 4.3 Fiscal policy (4.3.1 to 4.3.6).