4.5 Role of the state Flashcards
Define public expenditure
The govt spending for and on behalf of the citizens
3 types of public expenditure
> capital expenditure: long term investments - HS2
current expenditure: day-to-day expenditure on goods/services (salaries of civil servants and medicines for NHS)
transfer payments: payments to individuals, no products for these payments, doesn’t contribute to the GDP (JSA, child benefits)
Examples of public expenditure
29% - social protection
20% - health
11% - education
Reasons for changing size and composition of public expenditure
state of the global economy (financial crisis): huge increases of govt expenditure to recover the economy, they had to increase their borrowing and even used taxpayer’s money. Since 2010 the govt followed an austerity policy in an attempt to reduce debt
- economic pressure on the UK (wheat and petrols were impacted due to the Ukraine war)
(demographic demands) changing in population age: many developed countries have experienced a fall in birth rates, TMT the population is ageing so they will need to increase expenditure on pensions. If there is a younger pop, govts will need to increase expenditure on education (i.e tech in schools).
changing incomes: the lower the average income of the country, the lower is likely to be the percentage of GDP spent by the government. TIB poorer countries tend to have a lower tax revenue , due to avoidance, inefficiency at collecting and a smaller amount of wealth to tax. Moreover, citizens in higher income countries demand more services from their governments ; government provided goods are income elastic
changing expectations: As societal norms change, expectations change, putting pressure on governments to change the substance &
delivery mechanism of many of their services (i.e NHS app, smart boards in schools)
In the context of Japan, explain how the population demographic might impact govt spending and the economy.
Japan’s birth rate is declining and the ageing population is increasing. The sinking population means that there will be a shortage of care workers for the older generation. This means that the government has increased the expenditure on technology and has innovated to making robots which interact with the older population - enhances the standards of livings for the retired population. As well as this, the govt is paying people to live in certain areas and to have children
The significance of differing levels of public expenditure as a PROPORTION (%) of GDP on:
o productivity and growth
o living standards
o crowding out
o level of taxation
o equality
impact of changes of public expenditure
o Spending on infrastructure (roads, tech, energy) will lead to a better supply-side performance of an economy — FM economists believe reducing PE will lead to spending in the private sector leading to more productivity and efficiency
o Living standards: no PE will lead to market failure as absolute poverty would rise - they will find it difficult to survive
o crowding out: see crowding out flashcard
o equality: increased spending will create equal opportunities and close the gap between people - transfer payments, TP doesn’t always close the gap (IDO on what the people spend on - buying demerit goods won’t close the gap )
Crowding out: definition, explanation and graph
an economic theory arguing that rising public sector spending
when expansionary fiscal policies decrease (crowd out) private spending. FoP operating at near capacity
intervention (ie. building new things) will take away capital from other sectors of the economy. In the SR, GDP wouldn’t increase as there is already at full employment. Govt will need to borrow to compensate for their spending.
As interest rates rise, savings [withdrawal] will increase and consumption will fall [because borrowing is now more expensive]
Advantages of public expenditure
- Improvements to supply-side of the economy through expenditure on health, infrastructure, education etc.
- Improves the equality of opportunity
- Raises the standards of living
- Reduces poverty & decreases inequality in the distribution of income
Increases economic growth - Drives innovation by providing long-term seed funding for firms & investing in
applied research
Disadvantages of public expenditure
No profit incentive, urgency of labour diminishes, resources used more inefficiently, corruption, decreased standard of living,
If the government is running a budget deficit they will need to borrow funds from the
private sector. This can create a crowding out
It may require taxation levels to increase in order to pay for the expenditure
If the spending is not spread evenly throughout different regions of the country, it can create inequality of opportunity e.g. North/South divide
Define tax
a compulsory contribution to the government
direct: levied on income, wealth and profits
indirect: levied on expenditure
Define and differentiate between progressive regressive and proportional tax
● Progressive - those who are on higher incomes pay a higher marginal rate of tax; they pay a higher percentage of their income on tax. (Often direct taxes)
● Regressive - proportion of income paid in tax falls as the income rises. Those on higher incomes pay a smaller percentage of their
income on the tax. Most indirect taxes are regressive, for example everyone pays the
same rate of VAT and for those on higher wages this represents a small proportion of
their earnings compared to those on low wages. (Scandinavian countries use this)
● Proportional tax - proportion of income paid on tax remains the same, whilst the income changes e.g. 10% of income is spent on tax, regardless of income. Everyone pays the same percentage of their income on the
tax.
Taxes on small businesses example
direct: income, NI (fell by 2%), corporation
indirect: VAT (20%)
Tax revenues and the laffer curve
(sad face graph y-axis: tax revenue x-axis: tax rate)
illustrates the relationship between increasing
tax rates & the level of govt revenues received
Tax revenue will initially rise as the tax rate is increased but it will come to a point where revenue is maximised and then will fall, after this workers are disincentivised to work. TIB there is a trade-off between leisure and supplying labour.
TMT there will be a fall in output and there is an increased incentive to emigration (ie to UAE), tax avoidance/evasion.
Increase in taxes leads to
- unequal income distribution, progressive tax will help to redistribute income from rich to poor
- firms invest less, productivity falls, quality and quantity falls
- Tax is a withdrawal from the CF, less disposable income, less incentive to work, consumption falls, AD shifts left, firms suffer from less rev and profits, less economic g.
however, decreased C isn’t always a bad thing, TIB consumers are less likely to import, this improves the BoP
+ Increased govt revenue, increased gov expenditure, more injections, more productive
+ Low taxes on profit and investment tend to encourage businesses to invest in a
country since it will help them to see a higher level of return. However, this may result in countries continuously lowering taxes to encourage investment; the eventual result is a fall in revenues for all countries.
