CHAPTER 21

Financial System

& Fiscal Policy

Fundamentals of Public Finance in a Market Economy

Topics Covered

• Finance: Nature & Functions

• State Budget & Structure

• Taxes in Market Economy

• Uzbekistan Tax Reforms

AGENDA

Chapter 21 Overview

21.1

Nature of Finance

& Financial System

21.2

State Budget

& Its Structure

21.3

Taxes in Market

Economy

21.4

Uzbekistan Tax

System Reform

21.1 — WHAT IS FINANCE?

Finance is a system of relations governing the use and movement of monetary funds — through which money funds are formed and distributed to meet the needs of reproduction and other social needs.

Latin Origin

The word 'finance' comes from Latin, meaning payment or income.

Historical Category

Finance is a historical economic category that evolves with state functions and needs.

Core Role

The state implements all its functions through the financial mechanism — managing enterprises, public institutions, and citizens.

Market Scope

Finance forms the production structure, inter-sector and territorial relationships in the economy.

TYPES OF FINANCIAL RELATIONS

Financial relations include all economic relations arising between state, enterprises, organizations, regions and individuals due to movements of monetary fund accumulations.

1

Inter-state financial relations

2

State ↔ International organizations & foreign firms

3

State ↔ Enterprises and businesses

4

Between state organs at different management levels

5

State ↔ Associations and public organizations

6

State ↔ Population (citizens)

7

Inter-enterprise financial relations

8

Enterprises ↔ Banks

9

Intra-enterprise: departments and workers

FOUR FUNCTIONS OF FINANCE

1

Financial Provision

Provides economic processes, projects, and activities with monetary resources. Covers state governance, defense, law enforcement, healthcare, and cultural services.

2

Distribution Function

Distributes and redistributes GNP created in material production sectors — between the state, enterprises, industries, sectors, and regions.

3

Stimulation Function

Operates through the process of distributing created product value, and through the mechanism of forming and spending monetary funds.

4

Control Function

Finance serves as a tool for controlling production, distribution, and consumption through financial discipline, tax collection, and funding systems.

THE FINANCIAL SYSTEM

The financial system encompasses financial relations and the financial institutions serving them at various levels.

State Finance Components

Market Finance Components

State and multi-level budgets

Social, property, and personal insurance funds

State foreign currency reserves

Banking system

Monetary circulation & credit system

Tax system

Monetary funds of enterprises & firms

Other special monetary funds

FINANCIAL RESERVES: MACRO & MICRO

Financial reserves are monetary funds formed on the basis of various expenditures, profits, wages, taxes, debt payments, insurance premiums, duties, and similar payments.

MACROFINANCE

Centralized financial reserves

�Formed at the national level via the state budget or extra-budgetary funds.��Spent on general public needs

such as defense, education, public administration, and healthcare.

MICROFINANCE

Decentralized financial reserves

�Belong to enterprises, firms, companies, conglomerates, institutions, and public associations.��Spent on own needs

including borrowed funds directed to specific economic entities.

THE FINANCIAL MARKET

Temporarily idle funds that are not used in the production process are sold on the financial market.

Currency Market

Buying and selling of foreign currencies and exchange operations.

Securities Market

Trading in shares, promissory notes (bills), and certificates.

Investment Market

Buying and selling of investment capital assets.

Loan Capital Market

Banks buying and selling loan capital (credit operations).

Market intermediaries: Brokers (earn commission fees) • Dealers (buy/sell securities for profit)

STOCKS & BONDS — KEY SECURITIES

SHARES (Stocks)

A share is a valuable security that earns its holder dividend income. It represents a certain stake in the capital of the company that issued it.��Ordinary Shares�Dividend depends on company profits. Grants voting rights at shareholder meetings.��Preferred Shares�Guarantees a fixed percentage dividend but does NOT grant voting rights.

BONDS (Obligations)

A bond is a valuable document confirming a company's debt obligation.��Key Features:�• Issued for a specified term�• Monthly interest payment guaranteed in the form of winnings�• Holder is a creditor, not an owner�• More stable than shares — fixed return��Risk Profile: Lower risk than shares; no ownership stake but guaranteed periodic payment.

SECTION

21.2

State Budget

& Its Structure

THE STATE BUDGET — DEFINITION & ROLE

State Budget — the annual plan of state expenditures and sources for their financial coverage. The state budget is the main centralized fund of monetary resources and serves as the primary element of the financial system.

Main Revenue Vehicle

The main portion of state revenues and expenditures passes through the state budget.

Economic Development Tool

Its primary function is to create conditions for effective economic development using financial instruments.

Dual Structure

Has two sides: (1) composition and sources of revenues flowing in; (2) composition and amount of key expenditures.

Social Mission

Provides the financial base for resolving national-level social tasks and challenges.

STATE BUDGET STRUCTURE

REVENUES

Direct taxes

Indirect taxes

Natural resource & property fees

Social infrastructure development taxes

Other revenues

STATE

BUDGET

EXPENDITURES

Centralized investments funding

Economic development spending

Healthcare & sports

Social sector spending

Social protection

State governance & courts

GOVERNMENT FINANCE SYSTEM

State Budget

Core of the financial system

The main centralized monetary fund of the state. Major portion of revenues and expenditures passes through it. Facilitates redistribution of national income.

Social Insurance Fund

Workers' welfare

Covers pension, disability, unemployment, and medical insurance obligations for workers and citizens.

Property & Personal Insurance

Risk management

Applied to enterprises and citizens of all ownership forms. Can be mandatory or voluntary. Funded by enterprise and citizen payments.

Extra-Budgetary Funds

Special purpose funds

Pension Fund, Employment Fund, Nature Protection Fund, Historical Monument Preservation Fund, Entrepreneur Support Fund, and others.

BUDGET DEFICIT & SURPLUS

BUDGET DEFICIT

When expenditures EXCEED revenues��Causes:�• Continuous expansion of state role in society�• Growing economic and social obligations�• Rising defense and security costs��International standard: Deficit should not exceed 5% of GDP��Covered by:�• Selling state securities

• Borrowing from extra-budgetary funds

• Domestic and foreign debt

BUDGET SURPLUS

When revenues EXCEED expenditures��Uzbekistan Experience:�• 2000: Budget deficit = 1% of GDP�• 2005: First surplus achieved�• 2008: Budget executed with 1.5% surplus vs GDP�• 2015: Budget executed with 0.1% surplus vs GDP��Benefits of surplus:�• Reduces public debt

• Builds foreign reserves

• Signals fiscal stability

• Strengthens credit rating

STATE DEBT: INTERNAL & EXTERNAL

State Credit — the totality of all financial-economic relations where the state appears as borrower or creditor. The main form of state borrowing is the issuance of government debt obligations and loans.

INTERNAL DEBT

Domestic borrowing through:

​

• Issuance of loans and other securities within the country

• Borrowing from various extra-budgetary funds: Insurance Fund, Unemployment Insurance Fund, Pension Fund

​

The state can also deposit its obligations with the Central Bank, which issues additional money not backed by commodity growth.

EXTERNAL DEBT

Debt obtained from:

​

• Foreign states

• Foreign individuals and legal entities

• International financial organizations

​

Risk: If external debt payments exceed 20-25% of export revenues, it lowers the country's credit rating, making new borrowing increasingly difficult.

THREE PRINCIPLES OF BUDGET REGULATION

1st Principle

Annual Balancing

The state budget must be balanced every year. This requires constant adjustments based on external and internal environmental changes. However, this approach reduces the effectiveness of the state's fiscal policy.

2nd Principle

Cyclical Balancing

The budget should be balanced not annually, but over an economic cycle. During economic downturns, tax rates are lowered and production expenditures are increased, leading to budget deficits. During recovery, the surplus compensates.

3rd Principle

Self-balancing Economy

The main goal is not balancing the budget itself, but improving the internal self-balancing of the economy. During economic boom: raise tax rates and cut state expenditures to generate surplus and prevent inflation.

Key insight: Finance's primary role is ensuring macroeconomic stability. Economic growth increases budget tax revenues; macroeconomic stability stimulates it further.

OVERCOMING BUDGET DEFICIT

The state develops budget policy based on its economic conditions — requiring strict deficit control, covering mechanisms, and efficient allocation of resources.

↑

Expand Production

Achieve growth in gross national income by expanding production capacity and raising labor productivity.

↓

Reduce Expenditures

Reduce administrative-managerial, defense, and other costs to ensure budget revenues exceed expenditures.

⚡

Leverage Technology

Apply achievements of Scientific-Technical Progress (STP), implement advanced technologies, and equip industries with innovative techniques to sharply increase national income.

🌍

Export Value-Added

Instead of exporting raw materials to the world market, process them and export finished, competitive products to increase national income.

SECTION

21.3

Taxes in Market

Economy

TAXES: DEFINITION & ROLE

Tax — the form of mandatory payments collected from physical and legal entities into the budget for the purpose of forming the financial resources necessary for the state to carry out its functions. Taxes are the primary source of state budget revenues, representing a share of net income collected into the budget.

#1

Budget Revenue Source

Taxes are the primary and most important source of state budget revenues

~20%

GDP Share Distributed

National income portion distributed and redistributed through taxes (Uzbekistan 2011)

3

Three Key Functions

Fiscal, Social, and Regulatory functions all served by the tax system

Direct

Economic Influence

Taxes directly shape investment decisions, business behavior, and employment patterns

THREE FUNCTIONS OF TAXES

01

FISCAL FUNCTION

Financing State Expenditures

The most important function — taxes provide the primary source of funds for financing all state expenditures. As the scale of state spending grows, this function demands an increasing volume of tax collection. Modern trends driving growth: population increase, higher service quality demands, urbanization, environmental protection, income inequality programs, and defense costs.

02

SOCIAL FUNCTION

Alleviating Social Tension

Taxes redistribute income across society, reducing inequality between rich and poor. Progressive taxation systems charge higher rates on higher incomes, funding social protection programs, education, healthcare, and welfare payments to vulnerable groups.

03

REGULATORY FUNCTION

Regulating the Economy

Taxes are among the most important regulatory tools in market economies. By adjusting tax rates, the state can stimulate or restrain certain economic activities, promote investment, influence production structure, and manage macroeconomic stability.

PRINCIPLES OF TAXATION

General Principles for Regulating Enterprise Activity:

Mandatory collection from all income regardless of their source

Uniform national tax policy for all subjects

Incentive significance of tax standards for efficient enterprises

Financial control over all subjects' tax payment obligations

Principles for Setting Tax Rates:

1. Benefit Principle

Different persons should pay taxes according to their degree of use of state-funded programs.

2. Ability-to-Pay

The amount of tax must correspond to the taxpayer's wealth and income level.

3. Fairness Principle

Persons with equal incomes and equal use of state programs must pay equal amounts of tax.

TAX RATE & CALCULATION

Tax Rate (R') = the percentage expression of the ratio of the tax amount (R) to the taxable amount (D):

R' = (R / D) × 100%

PROGRESSIVE TAX

↑

As income grows, the average tax rate INCREASES. Higher earners pay proportionally more. Example: Income tax with multiple brackets.

PROPORTIONAL TAX

→

As income grows, the average tax rate REMAINS UNCHANGED. Everyone pays the same percentage regardless of income level.

REGRESSIVE TAX

↓

As income grows, the average tax rate DECREASES. Lower earners pay proportionally more. Common criticism of flat consumption taxes.

DIRECT vs. INDIRECT TAXES

DIRECT TAXES

Levied on income and property of enterprises or population.��Source: Income of enterprises and citizens.��Benefits:�• Ensures savings of material costs�• Conserves property and assets�• Promotes efficient use of labor resources�• Monetary resource economy��Examples: Income tax, corporate profit tax, property tax, land tax.

INDIRECT TAXES

Paid by enterprises, but largely collected from consumers through price markups.��Economic purpose: After goods/commodities circulate, they flow into the state budget.��Functions:�• Strengthens the circulation function of money�• Prevents currency depreciation��Examples: Value-added tax (VAT), excise on restricted goods, export-import taxes.

TAX PRIVILEGES & EXEMPTIONS

Tax privileges are established by legislative agreement according to defined procedures and conditions. They are widely applied in practice to incentivize economic and social behavior.

Minimum Threshold

Establishing the minimum non-taxable level for objects. Income or property below this threshold is fully exempt from tax.

Individual Exemptions

Freeing specific individuals or certain groups from tax payment obligations based on social or economic criteria.

Rate Reduction

Lowering the tax level or rate. Enables incentivizing specific sectors, regions, or activities through reduced tax burden.

Deduction from Base

Allowing deductions from the taxable amount. This reduces the base on which the tax is calculated.

Tax Credit

Deferring tax collection, or reducing the tax amount by a specific amount. Helps businesses manage cash flow and reinvest.

THE LAFFER CURVE

Key Insights

Arthur Laffer's Discovery:�American economist A. Laffer first proved that reducing taxes leads to economic growth and rising state revenues.��At 100% tax:�State revenue = 0, because no one wants to work for free.��Optimal rate (R₁):�Provides maximum budget revenue (V₁).��Long-term effect:�Reducing excessively high taxes increases savings, investments, employment, and total taxable income — reducing deficit and inflation.

MEASURING THE TAX BURDEN

Tax burden indicators help compare tax pressure across different regions and countries. UNESCO recommends comparative methods for measuring tax burden.

Per Capita Method

K = ΣNₓ / P or K = DN / PN

Nₓ = avg. taxes per capita

DN = after-tax income

PN = population payment capacity

GDP Share Method

K = ΣN / ΣGDP

N = total tax amount

GDP = Gross Domestic Product

Uzbekistan: Tax Burden Reduction Trend (% of GDP)

FISCAL POLICY: DEFINITION & TYPES

Financial Policy — a set of measures on organizing and using finance for the state to carry out its functions. Fiscal (Budget-Tax) Policy refers to measures applied in taxation and state expenditure composition to influence the economy.

DISCRETIONARY POLICY

Involves deliberate changes in taxes and state spending to influence the economy.

​

During RECESSION:

• Increase state spending

• Reduce taxes

→ Stimulates economic activity

​

During EXPANSION:

• Reduce state spending

• Increase taxes

→ Prevents inflation and overheating

AUTOMATIC STABILIZERS

Based on regulatory mechanisms that activate automatically in response to economic changes — without deliberate government action.

​

Examples:

• Progressive income taxes (collect more in boom)

• Unemployment benefits (increase automatically in recession)

• Social transfers

​

Advantage: No time lag — immediate counter-cyclical effect.

GOALS OF TAX POLICY

Key Regulatory Tool

In market economies, taxes must remain the most important control mechanism for implementing economic policy.

Triple Function

The tax system must fully perform its fiscal (treasury), redistributive, and stimulation functions.

Revenue Generation

The revenue side of the state budget must be formed in the amount necessary to resolve the most important national socio-economic tasks.

Structural Change

Together with targeted financial policy, the tax system redistributes part of GNP, thereby directly participating in changing economic structure and ensuring social protection guarantees.

Incentivize Production

The most important task of the tax system is to have an incentive effect on efficient use of material, natural, financial, and labor resources in developing production.

SECTION

21.4

Uzbekistan Tax

System Reform

UZBEKISTAN: TAX REFORM OVERVIEW

Improving the budget and tax system is one of the central issues of economic reforms and state economic policy in Uzbekistan. Consistent tax-budget policy implementation creates additional tax objects through new income sources while covering budget losses.

Tax Burden Reduction

Expanding tax privileges through lower tax burden, attracting foreign investments, and widening economic modernization.

Simplified Tax System

Simplifying the tax system and reducing tax rates expands the private property sector, creates a favorable business environment and strengthens its guarantees.

Higher Household Income

Funds remaining with taxpayers are reinvested and directed to worker wages; reducing personal income tax expands employment and household income.

Boosting Consumer Demand

Effective use of funds from reduced tax burden — through higher income and employment — ensures rapid growth of purchasing demand.

Export Promotion

Deepening tax reforms reduces burden on exporters, promotes foreign exchange savings, and ensures rational and efficient use of reserves.

Energy Efficiency

Tax reforms support measures related to housing-communal sector reforms and ensuring economy in use of energy resources.

TAXES IN THE REPUBLIC OF UZBEKISTAN

Legal and physical persons engaged in entrepreneurial activity pay the following taxes in the territory of the Republic of Uzbekistan:

Profit Tax

From legal entities

Value-Added Tax (VAT)

On goods and services

Excise Tax

On restricted/luxury goods

Water Resources Tax

For water usage

Beautification & Social Infrastructure Tax

Municipal development

Subsoil Use Tax & Special Payments

Bonus; Additional profit tax (precious metals)

Property Tax

Legal entities & physical persons

Land Tax

On land ownership

Personal Income Tax

From physical persons' income

MANDATORY PAYMENTS & CONTRIBUTIONS

In addition to the above taxes, the following mandatory payments and levies are applicable in Uzbekistan:

S

Unified Social Payments

Employer contributions to the social security system covering retirement, disability, and other social insurance obligations.

P

Republican Pension Fund Contributions

Mandatory contributions to the Republican Pension Fund (Jamgʻarma). Ensures pension payments for citizens upon retirement.

C

Citizens' Pension Fund Payments

Individual contributions from citizens to the pension fund, creating personal pension savings alongside employer contributions.

R

Republican Road Fund Contributions

Contributions and levies directed to the Republican Road Fund for development, maintenance, and repair of road infrastructure.

SIMPLIFIED TAXATION FOR SMALL BUSINESS

For the purpose of developing small business and entrepreneurship, Uzbekistan has simplified tax types through the following special regimes:

Unified Land Tax

🌾

Agriculture / Farming

Applied in agricultural sector and farming enterprises. Simplifies the tax obligation for farmers by consolidating multiple taxes into a single unified land-based tax.

Unified Tax Payment

💼

Small & Medium Enterprises

A consolidated tax applicable to small businesses and individual entrepreneurs, replacing multiple separate tax obligations with a single, simplified payment.

Fixed Tax

📋

Specific Entrepreneurial Activity

A flat fixed amount applied to certain types of entrepreneurial activities. Provides certainty for small-scale entrepreneurs operating in specific defined sectors.

TAX PRIVILEGES FOR ENTERPRISES

Preferential Tax Payers (Reduced Tax)

Enterprises registered (excluding exchanges, procurement, wholesale, supply-sales, intermediary and trade-commerce enterprises) pay 25% tax in the first year and 50% in the second year.

FULL TAX EXEMPTIONS — Qualifying Enterprises

Enterprises where 50% of serving employees are people with disabilities

Enterprises where up to 75% of employees are school teachers or university students

Enterprises producing products necessary for people with disabilities

Social organizations and institutions

Youth foundations and similar organizations

Tax-privileged enterprises help incentivize social employment and inclusive business models

DIGITIZATION OF FINANCE, BANKING & TAX SYSTEMS

Finance, banking, and tax systems are integral components of market infrastructure where vast amounts of diverse data naturally accumulate. Resolving data collection and processing challenges requires telecommunications and computer technology.

1993

Cabinet of Ministers Resolution No. 388 (August 3)

Resolution on creating a unified computer system for processing data in tax committees of Uzbekistan Republic.

1994

Cabinet of Ministers Resolution No. 146 (March 18)

Resolution on improving the banking system and stabilizing monetary-credit relations — computerization of banking.

2017

Presidential Decree PF-4947 (February 7)

Decree on 'Action Strategy for Further Development of Uzbekistan' — direction 3.1: Continue policy of reducing tax burden, improve tax administration, expand incentives.

2019

New Tax Code Concept

The core idea: reduce tax burden, apply simple and stable tax system. Increases economic competitiveness and creates favorable conditions for entrepreneurs and investors.

NEW TAX CODE 2019: KEY PRINCIPLES

The core idea of the new tax concept (introduced from 2019): reduce tax burden, apply a simple and stable tax system. This increases economic competitiveness and creates favorable conditions for entrepreneurs and investors.

Equal Tax Regime

Introduce a fair, equal tax regime for all — gradually abolishing tax privileges. The given privilege negatively affects the competitive environment.

Reward Honest Taxpayers

The new Tax Code must provide for incentivizing honest, fair taxpayers who are the backbone of national development, while penalizing those operating in the shadows.

Effective Tax Administration

When tax rates are reduced or certain taxes abolished, revenues to budget will decrease. This can be overcome through effective tax administration while maintaining budget stability.

Shadow Economy Elimination

Reducing tax burden and creating more favorable conditions for doing business is the only way to put an end to the shadow economy. A special program with impactful measures is needed.

Transparent Taxation

Paying special attention to unification of taxes and payments contributes to transparency of taxation mechanisms, simplification of enterprise activities in calculating and paying taxes.

Price Stability

Tax administration must be such that even with broad introduction of VAT, this should not lead to a rise in prices of consumer goods.

KEY TERMS & DEFINITIONS

Finance

Relations arising from the formation, distribution, and use of monetary funds.

Financial System

Financial relations and financial institutions serving them at various levels.

State Budget

An organized plan of state expenditures and sources for their financial coverage.

Taxes

The form of attracting part of the net income created in society into the budget.

Tax Rate (R')

The percentage expression of the ratio of the tax amount to the taxable amount.

Laffer Curve

The graphical representation of the relationship between state budget revenues and tax rates.

Fiscal Policy

Measures for collecting taxes and using budget funds to ensure macroeconomic balance and resolve social issues.

Budget Deficit

A situation where state expenditures exceed revenues; international standard: deficit should not exceed 5% of GDP.

REVIEW QUESTIONS

1

Explain the economic content of finance and describe its economic functions.

2

Give characteristics of the main links of the society and state financial systems. What is the role of the state budget in the financial system?

3

How does the state budget play a role in distributing and redistributing national income? What methods are used?

4

What is budget deficit? Explain positive and negative budget balance.

5

Explain the economic essence of taxes and indicate their types and main functions.

6

Describe the similarities and differences of financial policy and fiscal policy.

7

Explain the sources of state internal and external debts.

8

What is the tax burden? Show its effect on the economy.

9

What is the content of the Laffer curve?

10

Describe the measures being implemented in Uzbekistan in recent years to improve the budget and tax system.

CHAPTER 21 — KEY TAKEAWAYS

💰

Finance is the Foundation

Finance encompasses all monetary relations governing fund formation, distribution, and use. It serves as the primary mechanism through which the state implements its functions.

📊

Budget is Central

The state budget is the core element of the financial system — an annual plan balancing revenues and expenditures. Deficit must not exceed 5% of GDP by international standards.

⚖️

Taxes Serve Three Masters

Taxes simultaneously serve fiscal (revenue), social (equity), and regulatory (economic steering) functions. The tax system's design directly shapes economic behavior.

📉

Laffer Principle Matters

Excessively high tax rates reduce economic activity and ultimately lower tax revenues. An optimal rate exists that maximizes state income while preserving economic incentives.

🇺🇿

Uzbekistan's Reform Path

Uzbekistan has systematically reduced its tax burden from 37.1% of GDP in 2000 to 20.9% in 2011, simplifying the system, unifying taxes, and creating better conditions for business.

🖥️

Digital Transformation

Computerizing the integrated finance-banking-tax information system is essential for effective governance of market economies in the modern era.

Chapter

21

Financial System

& Fiscal Policy

Thank You

Citizens should be interested not in evading taxes, but in paying them on time.

— President of Uzbekistan

Topics Covered in This Presentation:

Nature and functions of finance (§21.1)

State budget structure and balance (§21.2)

Tax types, principles, and Laffer curve (§21.3)

Uzbekistan tax reform and digitization (§21.4)