Introduction
Every morning across the United Kingdom, millions of people use services funded by the government. Children arrive at school, ambulances respond to emergencies, trains carry commuters, police officers begin their patrols and refuse is collected from homes and businesses.
Behind each of these everyday activities lies one simple question:
Who pays for all of this?
In the previous page, we learned that the UK Budget is the government’s financial plan. It sets out how the government intends to raise money, how it plans to spend it and how it will manage the country’s finances.
This naturally leads to the next question:
Where does all that money actually come from?
None of these public services are free to provide. They require buildings, equipment, technology and, above all, people. Teachers, doctors, nurses, firefighters, engineers, scientists, soldiers and thousands of other public servants all need to be paid for the work they do.
Before government can spend money, it must first raise it.
Most of that money comes from taxation. Every time someone earns a salary, buys everyday goods, fills up their car with fuel or runs a profitable business, they may contribute in some way towards funding public services. Millions of individual contributions, many of them quite small, are brought together to finance services used by the whole country.
However, taxation is not the government’s only source of income. Governments also receive money through various fees, charges and returns from publicly owned assets. In some years they also borrow money, although, as we shall see, borrowing is different from income and serves a different purpose.
Economists and governments often use the word revenue to describe the money received by the government. Throughout this section, you will sometimes see the terms government income and government revenue used interchangeably. Both simply mean the money the government receives before it decides how to spend it.
The One Big Idea
Every government needs a reliable source of income.
Just as a household depends on wages or a business depends on sales, governments need money before they can provide services, invest in infrastructure or respond to unexpected events.
For the UK Government, taxation is by far the largest source of income. Millions of people and businesses contribute through different taxes, with each tax collecting money in a different way. Some taxes are linked to income, others to spending, property ownership or business activity.
Broadly speaking, economists often group taxes into direct taxes, which are paid on income, profits or wealth, and indirect taxes, which are collected when people buy goods and services. This distinction is useful, but you do not need to understand it in detail yet—we will return to it in later pages.
No single tax pays for the NHS, schools or any other individual service. Instead, most tax revenue flows into a central fund from which the government finances a wide range of public services and responsibilities.
Although governments receive income from several different sources, taxation provides the overwhelming majority of the money available for day-to-day public spending.
Understanding where government money comes from is important because it helps explain why taxation is such a central part of political debate. Decisions about tax affect government income, public services, businesses and households alike. Before exploring those debates, however, it is helpful to understand the different ways in which governments raise revenue.
Why Government Needs Income
Governments perform many roles that are essential to the functioning of modern society. They provide public services, maintain infrastructure, uphold the law, protect the country, support vulnerable people and invest in the nation’s future. None of these responsibilities can be carried out without money.
Unlike most businesses, governments are not trying to make a profit. Their purpose is to provide services and create the conditions in which society and the economy can flourish. Nevertheless, they still have to pay wages, buy equipment, construct buildings and maintain public assets. Running a country involves many of the same financial realities as running any large organisation.
Consider a typical day in the UK. Ambulances respond to emergencies, trains carry commuters, teachers educate children, refuse is collected, courts hear legal cases, weather forecasts are produced and the armed forces remain ready to respond to threats. These activities take place every day, whether or not most people notice them, and all require continuous funding.
The government therefore needs a reliable and predictable source of income. Without it, public services could not operate effectively, long-term projects could not be planned and the country would be less able to respond to unexpected events such as floods, pandemics or economic downturns.
This is why governments devote considerable attention to forecasting how much income they expect to receive each year. If income is lower than expected, difficult decisions may need to be made about spending, borrowing or raising additional revenue. If income is higher than expected, governments may have greater flexibility to invest, reduce borrowing or introduce tax changes.
Understanding where government income comes from is therefore one of the foundations of understanding public finance.
The Main Sources of Government Income
The UK Government receives money from a variety of different sources, but taxation provides by far the largest share of its income.
Rather than relying on a single tax, the UK uses a combination of different taxes that apply to different types of economic activity. Some are paid mainly by individuals, others by businesses, while some are collected whenever people buy particular goods or services.
Using a range of taxes helps spread the responsibility for funding public services across the economy. It also means that government income does not depend entirely on one source.
Let’s look at the main sources of government income.
Income Tax
For many people, Income Tax is the tax they are most familiar with.
It is paid on earnings from employment, self-employment, pensions and some other forms of income. Employers usually deduct Income Tax automatically through the PAYE (Pay As You Earn) system before wages are paid, meaning many employees rarely have to think about the process.
Income Tax is one of the government’s largest and most important sources of revenue. As more people work and wages increase over time, the amount collected through Income Tax generally increases as well.
The next pages will explain exactly how Income Tax works, who pays it and why different tax bands exist.
National Insurance
National Insurance is another major source of government income.
Originally introduced to help fund benefits such as the State Pension, National Insurance is now an important part of the UK’s public finances. Both employees and employers normally make National Insurance contributions, although the rules vary depending on employment status and income.
Because National Insurance is closely linked to employment, the amount collected is influenced by the number of people in work and the level of their earnings.
A later page will explain how National Insurance differs from Income Tax and why the two systems continue to exist separately.
Value Added Tax (VAT)
Unlike Income Tax and National Insurance, which are linked mainly to earnings, Value Added Tax—or VAT—is connected to spending.
Many goods and services purchased in the UK include VAT as part of the price. When people buy clothes, household items, restaurant meals or many other products and services, a proportion of what they pay goes to the government through VAT.
Because millions of purchases take place every day, VAT raises a significant amount of revenue each year.
Future pages will explore which goods and services are subject to VAT and why some items are treated differently from others.
Corporation Tax
Companies that make profits may also contribute through Corporation Tax.
Rather than taxing individuals, Corporation Tax applies to the profits earned by many businesses operating in the UK. Profitable businesses therefore contribute alongside individuals in helping to fund public services.
The amount collected through Corporation Tax can change considerably depending on economic conditions. During periods of strong economic growth, business profits often increase, while recessions may reduce the amount collected.
Later pages will examine Corporation Tax in greater detail, including why governments sometimes change the rate to encourage investment or increase revenue.
Other Taxes
Although Income Tax, National Insurance, VAT and Corporation Tax are among the largest sources of government income, they are not the only ones.
The government also raises revenue through a wide range of other taxes, including taxes on fuel, alcohol and tobacco, taxes connected with buying property, taxes on capital gains and various environmental taxes.
Local authorities separately collect Council Tax to help pay for local services such as waste collection, libraries, parks and many aspects of local government.
Each of these taxes has its own purpose and operates in a different way, but together they contribute to the overall funding of public services across the country.
The UK tax system may appear complex at first, but one reason for using many different taxes is that different parts of the economy generate income in different ways. A combination of taxes helps create a broader and generally more stable source of government revenue than relying on a single tax alone.
Other Sources of Government Income
Although taxation provides the overwhelming majority of government income, it is not the only source of revenue.
Like many large organisations, the government also receives money from a variety of fees, charges and commercial activities. Individually these sources are much smaller than taxation, but together they contribute billions of pounds each year and help fund public services.
Fees and Charges
Many government services involve a fee paid by the person using them.
For example, people normally pay to apply for a passport or driving licence, register a patent, submit certain planning applications or use some court services. These charges help cover some or all of the cost of providing the service.
It is important to distinguish these fees from taxes. A tax is generally paid regardless of whether an individual directly uses a particular public service. A fee, by contrast, is usually linked to a specific service requested by the individual.
For example, everyone benefits from having a police force or a justice system, whether or not they personally use those services. However, only someone applying for a passport pays the passport application fee.
Income from Government-Owned Assets
The government also owns land, buildings and other assets that can generate income.
These include income from renting or leasing government property, licensing the use of natural resources, and returns from certain publicly owned investments or organisations.
For example, companies wishing to extract oil and gas from the UK Continental Shelf must obtain licences and pay various charges and taxes associated with those activities. Companies also pay substantial sums to use parts of the radio spectrum for mobile phone networks. More recently, offshore wind developers have paid to lease areas of the seabed managed by the Crown Estate so that new wind farms can be built. These are all examples of publicly owned assets generating income for the public sector.
These sources of income are valuable but are generally much less predictable than taxation. They may change significantly depending on economic conditions, energy prices or government policy.
Fines and Penalties
Governments also receive money through fines imposed by courts and public authorities.
These might include speeding fines, penalties for breaking environmental regulations or fines imposed on businesses that fail to comply with certain laws.
However, raising revenue is not the purpose of these penalties. Their primary role is to encourage people and organisations to follow the law and to help maintain a fair and orderly society. Any income generated is a secondary consequence rather than the main objective.
Investment Returns
From time to time, the government may also receive returns from investments or shares that it owns.
These can include dividends from companies in which the government has a financial interest or returns from certain public investments.
Although these sources may occasionally generate significant sums, they usually represent only a small proportion of total government income.
Borrowing Is Different from Income
At this point, it is worth making an important distinction.
Governments sometimes borrow money, but borrowing is not the same as income.
When someone receives their salary, they have earned new income. If they take out a loan from a bank, they may have more money available to spend, but they have also taken on an obligation to repay that money in the future.
The same principle applies to governments.
When the government collects taxes or receives fees, that money becomes part of its income. Borrowing is different because it creates a future commitment to repay the money, usually with interest.
This distinction is important because news reports sometimes talk about governments “raising money” through borrowing. While borrowing does provide money that can be spent, it does not increase the government’s income in the same way that taxation does. Instead, it allows spending to take place today while postponing repayment until the future.
Borrowing can be an entirely sensible choice in some circumstances. Governments may borrow to respond to emergencies, support the economy during a recession or invest in projects that are expected to benefit future generations. Equally, borrowing has costs and cannot continue indefinitely without consequences.
Exactly when governments choose to borrow, who lends them the money and how government bonds work are explored later in this section. For now, the important point is simply that income and borrowing are two different ways of obtaining money, and understanding that distinction is essential to understanding the UK’s public finances.
Why Government Income Changes
Government income does not remain the same from year to year.
It rises and falls as the economy changes and as people’s lives change.
One of the biggest influences is employment. When more people are in work, more Income Tax and National Insurance are usually collected. If unemployment rises, government income from these taxes may fall.
Economic growth also affects government revenue. When businesses become more profitable, Corporation Tax receipts often increase. When consumers spend more money in shops and restaurants, VAT receipts may also rise. During a recession, the opposite often happens, with lower profits and reduced spending leading to lower tax revenues.
Inflation can also influence government income. As wages and prices increase, the amount of tax collected may rise even if the number of workers or the quantity of goods sold changes very little. However, inflation can also increase the government’s own costs, meaning that higher income does not necessarily leave more money available to spend.
Changes in the population can have an effect too. A growing population may mean more people working and paying taxes, but it may also increase demand for schools, healthcare, transport and other public services. An ageing population can similarly affect both the amount of tax collected and the amount the government needs to spend on pensions, healthcare and social care.
Finally, government policy itself influences revenue. Decisions to change tax rates, introduce new taxes or alter tax thresholds can all increase or reduce the amount of money collected.
For these reasons, estimating future government income is never an exact science. The figures published in the Budget are based on forecasts, and those forecasts are regularly updated as economic conditions change.
Why Taxation Is Often Debated
Few subjects generate as much public discussion as taxation.
Most people agree that public services such as healthcare, education, policing and national defence are important. At the same time, few people enjoy paying more tax than they need to. This creates an unavoidable tension that governments must manage.
The challenge is not simply deciding how much tax should be collected, but also deciding who should pay it and how it should be raised.
Some people believe taxes should be kept as low as possible, leaving individuals and businesses with more of their own money to spend or invest. They argue that lower taxes can encourage economic growth, create jobs and give people greater financial freedom.
Others believe that collecting more tax allows governments to provide better public services, reduce inequality and invest more in the country’s future. They may argue that strong public services benefit everyone and help create a fairer society.
Between these positions lies a wide range of opinions. Many people support low taxes in some areas but higher spending in others. Others believe that the way taxes are collected is just as important as the total amount collected.
There is rarely one answer that satisfies everyone because people place different value on competing priorities. Some may prioritise economic growth, others fairness, others financial stability or improved public services.
This is why taxation is ultimately about more than money. Questions about taxation quickly become questions about fairness, responsibility and the role of government. How much should individuals contribute? How much should government provide? These are some of the biggest questions in public life and they lead naturally into the next section of Fair Society, where we explore different ideas about what makes a society fair. It reflects the kind of society people want to build and the balance they wish to strike between individual responsibility and collective provision.
Throughout Fair Society, we will explore these different viewpoints fairly and objectively. Our aim is not to persuade you to support a particular level of taxation or a particular political philosophy, but to help you understand the reasoning behind different perspectives so that you can form your own informed conclusions.
Conclusion
Every public service depends on one simple principle: before governments can spend money, they must first raise it.
In the United Kingdom, taxation provides by far the largest share of government income. Millions of individuals and businesses contribute through a variety of different taxes, while smaller amounts come from fees, charges, licences and returns from government-owned assets.
Using several different sources of income helps create a more stable and resilient system. Just as a business rarely relies on a single customer, governments benefit from receiving income from a range of different sources rather than depending entirely on one tax. If one source of revenue falls during difficult economic times, others may continue to provide support, allowing essential public services to keep operating.
It is also important to remember that government income does not remain fixed. It changes as the economy grows or contracts, as employment rises and falls, as people spend more or less, and as governments make different policy decisions. Managing these changing sources of income is one of the central responsibilities of the Budget process.
Understanding where government money comes from is an important step towards understanding how the state functions. It helps explain why taxation matters, why economic conditions influence public finances and why discussions about tax are often closely connected to debates about public services and government spending.
In the next page, we follow the money one step further by exploring where government spends it. Together, these two pages provide the foundation for understanding the choices every government must make when preparing the Budget.
Continue Learning
We have now answered the question of where government gets its money.
The next page follows that money through the system by exploring Where Government Money Goes. You’ll discover how governments decide how much to spend on healthcare, education, pensions, defence, transport and many other public services.
Once you understand both government income and government spending, the next chapters explain what happens when the two no longer match. Deficit vs Debt introduces two of the most frequently misunderstood terms in economics, before Government Borrowing and Bonds explains how governments borrow money and why borrowing plays an important role in managing the public finances.
Finally, How Taxes Work begins a closer examination of the UK tax system, introducing the principles behind taxation before exploring Income Tax, National Insurance, VAT and Corporation Tax in greater depth.
By following these pages in sequence, you’ll gradually build a complete picture of how governments raise money, allocate resources and make the financial decisions that affect every part of society.