4.5 Role of the State in the Macroeconomy Flashcards
What are reasons for public expenditure?
- Macroeconomic management of AD
- Achieve macroeconomic objectives
- Correct market failure
- Equality e.g welfare state benefits
What is capital government expenditure?
Capital expenditure signifies spending on investment goods e.g infrastructure, education, hospitals
What is current expenditure?
Current expenditure is the daily payments required to run government and the public sector e.g
What is transfer payments?
Payments made by the government where no goods/services are exchanged e.g welfare benefits
How does increased public expenditure affect productivity and growth?
- Better infrastructure; allows economy to be more efficient
- Better education; more skilled workforce; better human capital/employment
- Better healthcare; less workers missing out work
How does increased public expenditure affect living standards?
- Provide public goods; improves social welfare
- Provision of state benefits; reduces poverty
- Investment in education/infrastructure; more employment, less poverty
- Investment in healthcare; higher life expectancy; healthier population
What is crowding out?
When increased government borrowing leads to a reduction in private sector investment
- Govt borrow from financial markets
- Increased demand for loanable funds
- Increased interest rates
- More expensive to borrow
- Firms may cancel plans for increased investment
How does increased public expenditure affect level of taxation?
- High tax to sustain increased expenditure. Oil-Rich countries exception
Eval of increased public expenditure
- May lead to budget deficit due to high spending
- Debt Accumulation
- High tax may lead to less people working
- Corruption may mean money spent in wrong places
How does the government use tax?
Government can use tax to;
- pay for goods and services they provide
- Correct market failure
- Redistribute income
What are the 3 different tax systems?
Progressive tax
- Higher incomes pay higher rate of tax
Regressive tax
- Income paid in tax falls as income rises
Proportional tax
- All incomes pay same rate of income
What is the impact of higher tax on incentives to work?
- Discourages employment; less hours, less new employees
- Workers move abroad; less tax revenue for govt.
- Poor people fall in poverty trap
Eval of impact of higher tax on incentives to work
- Nordic countries have high tax and welfare benefits but similar rates of growth as lower tax countries like US and UK.
- Higher tax means people work longer hours to maintain income
What did the Adam Smith Institute calculate regarding earners in the UK paying their tax?
In 2022, the Adam Smith Institute calculated that average earners in the UK work from the 1st January to the 8th June (Freedom Day) to pay their taxes - all income after that point belongs to them.
What does the Laffer curve say about relation with tax revenues and tax rate?
Rise in tax does not necessarily mean rise in tax revenue
If ppl were taxed 100%, no one would work.
Tax revenue initially rises as tax rate increases; but will come to a point where rev is max and will fall.
As tax rises, less incentive to work/increased incentive to tax avoid/evade.
What is the impact of higher tax on income distribution?
-
Progressive tax system will improve income distribution; more money taken from rich, less taken from poor
e.g inheritance tax/high corporation tax
Eval of higher tax on income distribution
- Higher tax does’t directly redistribute income. Needs to be supported by benefit system
What is the impact of higher tax on RNO and employment/ AD&AS?
- Rise in direct tax reduce disposable income; reduce spending; fall in firms profits; reduction in investment; reduce AD
- Less employment; decreased SRAS
- Workers go abroad to work; decreases LRAS
What is the impact of higher tax on Price level?
- An increase in indirect taxes reduces disposable income; workers demand wage increase; cause cost-push inflation
What is the impact of higher tax on Trade balance?
- Reduce disposable income, reduce imports, improve trade balance
- In LR, lower AD reduces business need to invest; reduce competitiveness; exports decrease
What is the impact of higher tax on FDI flows?
- Less incentive to business to invest, lower ROI
Eval of the impact of lower tax on FDI flows?
‘Race to the bottom’ - countries continue to lower tax; increase investment; fall in rev for all countries.
What is an automatic stabiliser?
Automatic fiscal changes as economy moves thru stages of cycle
Benefits increase in recession; fall in AD reduced
Tax increases in boom; fall in AD increase
What is discretionary fiscal policy?
Deliberate manipulation of government spending/tax to influence economy
