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.
fluctuations in tax
lower confidence in consumers and investors
differentiate between fiscal and monetary policy
f: the use of govt spending and taxation to influence the economy
m: refers to the actions central banks take to pursue objectives such as price stability and max employment
Income tax bands thresholds and tax rates (2023-24)
personal allowance: upto £12,570
basic rate: £12,571-£50,270 - 20%
higher rate: £50,271-£125,140 - 40%
additional rate: over £125,140 - 45%
Adam Smith - Cannon of Taxation
1) costs of collection should be low for the govt
2) everyone should know when to pay it
3) collection methods should be convenient for taxpayer
4) should be levied according to taxpayers’ ability to pay
When VAT increased from 17.5% to 20% effects on income inequaltiy and expenditure
price of all commodities increased
TMT each household faced increased prices
Comparatively lower income households’ buying power was affected more than those higher income households
TIB they already had limited disposable income prior to the taxation increase, as a result they suffered more
What is the central bank
A central bank is a financial institution which controls the production and distribution of money and credit for a nation or group of nations
Its priveliges are established and protected by law
Functions of the central bank
Inflation target
Sets interest rates
Lender of the last resort to govt and banks
Produces hard cash
Aims for macro targets
Define austerity
difficult economic conditions created by government measures to reduce public expenditure
Define discretionary fiscal policy
Involves the government making decisions manually about government spending and taxation
(i.e. increasing taxes)
Define Automatic stabilisers
Fiscal policy which happens automatically
(during recession, unemployment will increase and this will increase spending on benefits, meaning AD won’t fall too much)
Examples of discretionary fiscal policy
- An increase in excise duties on cigarettes and alcohol due to new research highlighting dangers of it
- furlough payments in covid
Examples of automatic stabilisers
- Reduced requirement for mental health services during a period of growth
- Increase in the number of people claiming JSA in a recession, leading to more spending on welfare
- Increased VAT revenues during a period of growth
Difference between fiscal deficit and national debt
national debt - accumulation of fiscal deficits over time (the amount the govt owes)
fiscal deficit - the govt spending is greater than the tax revenue in a financial year
Distinction between structural & cyclical deficits
structural deficit - present even when an economy may be operating at the full employment level of output (embedded into the structure)
cyclical deficit - Occurs during a downturn as tax revenues would be falling and welfare payments will be increasing.
structural are difficult to correct and cyclical is self-correcting as the industry grows
Explain a cyclical deficit in a time of growth (5)
A cyclical deficit occurs during a downturn as the tax revenue is falling and welfare payments are increasing. If the economy is growing, tax revenue will increase and welfare payments will decrease, this is because AD increases and unemployment falls. This means that, the cyclical deficit reduces.
Factors influencing the size of fiscal deficits
(draw diagram and explain) economic cycle - during recessions fiscal deficits usually increase due to less tax revenue collected and increased welfare payments [cyclical deficit]
housing market - During periods of growth in house prices, these tax revenues would increase due to the amount of stamp duty being collected
political situation/govt policy -
unplanned events - unforeseen circumstances and the impact of them (spending on furlough in covid)
privatisation - a one-off payment which can improve the budget deficit
Factors influencing the size of national debts
govt policy - if they have policies which will have high borrowing (ie. investing into producing infrastructure), the national debt will increase.
→LR, This may boost the productive potential of the economy (LRAS) - money will come back to gvt
state the 6 factors affected by the size of the fiscal deficit and national debt
inflation rates
interest rates
debt servicing
credit ratings
Inter-generational equity
Foreign direct investment (FDI)
How might the size of the fiscal deficit and national debt affect variables such as interest rates/tax?
[significance of the size]
inflation rates - if tax revenues aren’t sufficient, the govt can borrow or print
borrowing: Higher IR mean borrowing costs more and saving gets a higher return, less spending, which brings down the rate of inflation. When we need to support the economy by boosting spending, we lower interest rates, inflation increases. No increase in AD and little impact on in inflation
printing: lead to increased AD, growth with higher inflation. If the money supply increases faster than output then, ceteris paribus, inflation will occur. If a govt prints extra money, households will have more cash and more to spend on goods, AD right. But, if the amount of goods stays the same, the extra cash will just cause firms to put up prices.
How might the size of the fiscal deficit and national debt affect variables such as interest rates/tax?
[significance of the size]
Debt servicing: as debt grows so does the interest that needs to be paid, this will come out of the fiscal spend each year
higher debt = higher interest payment = higher fiscal deficit
credit ratings: Credit scores then affect the level of interest at which governments can borrow
How might the size of the fiscal deficit and national debt affect variables such as interest rates/tax?
[significance of the size]
interest rates - increased govt borrowing, IR will rise as demand for money increases. Cost of borrowing, reward for saving → High IR = low AD
Summary of fiscal policy
the fiscal policy manages the level of AD through taxation and govt revenue. there is expansionary and contractionary policies
e: increased spending, reduced taxation - AD ^
c: decreased spending, increased taxation - AD falls
Summary of monetary policy
