Understanding Taxes, Money Supply, and Financial Systems
Direct Taxes and Income
Direct taxes are levied on sources of wealth, property, or income. Income taxes (Impuesto sobre la Renta de las Personas Físicas – IRPF in Spain) are imposed on the income of individuals, companies, or other entities.
Indirect Taxes and VAT
Indirect taxes are levied on consumption. VAT (Value Added Tax) or Impuesto General Indirecto Canario (IGIC) in the Canary Islands, is an indirect tax imposed on goods and services.
Consumption and its Elements
Consumption is the application of wealth to satisfy needs and promote economic movement. Its factors include:
- Income: Amount of money generated.
- Prices: Payment for goods or services.
- Saving: Reservation of part of income.
Saving and Marginal Propensity to Save
Saving is the income remaining after taxes and consumption. The marginal propensity to save is the increase in income that goes into savings.
Investment and its Factors
Investment is the value of the sale of capital factors to companies. Factors include:
- Expenditure on consumer goods and services
- Public sector exports
- Imports
The investment multiplier effect refers to the impact of investment on employment, consumption, and income. The relationship with the marginal propensity to consume depends on income and interest rates.
Money and Types of Money
Money is an accepted medium of exchange for goods and services. Types of money include:
- Commodity Money: Goods or services accepted as payment.
- Fiat Money: Notes and coins, or bank balances, used as currency.
- Paper Money: Represents a promise to pay a certain amount of precious metals.
Functions of money include: medium of circulation, unit of account, store of value, and standard of deferred payment.
The Money Supply
It is the sum of cash in public hands and bank deposits.
- M1: Cash, current accounts, and demand deposits.
- M2: M1 + savings deposits.
- M3: M2 + time deposits.
- M4: M3 + quasi-money.
What Determines the Demand for Money?
Demand for money depends on the price level (inflation), income level, interest rates, risk, and expectations.
Money Multiplier
The money multiplier effect indicates how many times the money deposited in a bank has increased. Banks cannot create unlimited money; they must maintain reserve ratios.
Interest Rate and its Factors
It is the percentage applied to the principal of a loan to calculate interest. Factors include:
- Period: Longer-term loans typically have higher interest rates.
- Risk: Higher risk implies higher interest rates.
- Liquidity: Higher liquidity implies lower interest rates.
Inflation and its Classes
Inflation occurs when the money supply exceeds the available goods and services, leading to a sustained rise in prices. Classes of inflation include:
- Moderate: Prices rise by 2-3% annually.
- Galloping: Prices rise above 10% annually.
- Hyperinflation: Prices rise over 100% annually.
The CPI: Measurement and Calculation
The Consumer Price Index (CPI) measures inflation. It is compiled by the National Statistics Institute through surveys of family budgets, creating a “basket” of commonly consumed goods and services, and applying a weighting process.
Financial Intermediaries
Financial intermediaries can be banking or non-banking entities.
- Non-Banking: Investment funds, pension funds, insurance companies, leasing agencies, factoring companies.
- Banking: Banks (private companies), savings banks (intended to cover social credit works), and credit unions (owned by depositors/partners).