4.5 Role of the State in the Macroeconomy Flashcards
Define current expenditure
Maintainence of public sevices and payment of public sector wages
e.g. Teachers, police, members of parliment
Define capital expenditure
Invesment in infrastructure and capital equipments, which have long term rewards
e.g. hospitals, schools etc
Define transfer payments
Payments made by the govt for which no G/S are exchanged
e.g. benefits and pensions
Define debt interest payments
Spend £ on interest payments for national debt
What is the public sector net cash requirement
The finance required to pay for a budget deficit- the difference between expenditure and income
Wagners law (Adolph Wagner)
How does changing incomes affect the composition of public expenditure
- Countries with low incomes–> low tax revenue–> low govt expenditure
- As incomes increase, demand for govt G/S increase, increasing public expenditure (demand was very responsive to changes in income= income elastic) E.g. library services better recycling facilities
- Lower in average incomes of a country= lower % of GDP spent by the govt
How does changing age distributions affect the composition of public expenditure
- Many developed countries have had lower birth rates for decades= large and growing age population
- Life expectancy has increased due to advances in medicine and nutrition
- Govt spending on pension payments and healthcare will increase to support this elderly population
How does changing expectations affect the composition of public expenditure
As societal norms change, expectations change and this puts pressure on governments to change the substance and delivery mechanism of many of their services. This often results in increased spending e.g. NHS patients wanted online access to their medical records and the Government had to spend significant sums on creating the platform to do that
How did the Financial crisis affect the composition of public expenditure
- UK Government borrowing increased significantly in order to facilitate the government spending required to avoid a long-lasting depression
- This borrowing had to be repaid (with interest) and in the years following the crisis, the UK government cut their expenditure and raised taxes (austerity)
How does govt expenditure impact productivity and growth
- Education creates human capital, healthcare system decreases number of days workers lose from serious illness
- Spending on R&D to give businesses a long term competitive edge + drives innovation (some estimates say that global innovation has in the majority been created by public sector funding e.g. the mission to put a man on the moon or the need to keep a soldier safe in a particular scenario)
- Through spending, govt can create multiplier effects
- Free market argues govt spending is wasteful and causes inefficiencies. However, govt is able to to enjoy E.O.S when it provides G/S, improving productivity
- It can have a negative impact on productivity and long-term growth as without a profit incentive the urgency of labour diminishes and resources are used more inefficiently
How does govt expenditure impact living standards
- Corrects market failure & provides public goods which improves social welfare
- Reduces absolute poverty by providing benefits and basic goods
- Principal agent problem–> govt make decsions on behalf of the people and individuals may have spent £ differently
How does govt expenditure impact crowding out
- Govt is competing with the private sectorfor finance which leads to higher I.R, discouraging firms from investing and individuals from buying credit
- Limited no.of resources in economy= less resources available for private sector
How does govt expenditure impact level of taxation
In most cases, where government spending is high, levels of tax must be high in order for spending to be sustainable. High levels of tax may have a disincentive effect.
How does govt expenditure impact equality
Spending should increase equality as it leads to redistribution and helps to providea minimum standard of living for the poorest in society. It ensures everyone hasaccess to basic goods, such as education and healthcare, which will help to give them a fair start in life.
If the spending is not spread evenly throughout different regions of the country, it can create inequality of opportunity e.g. the North/South divide in the UK
Define and give the equation of average rate of tax (ART)
Tax paid as a proportion of income earned
ART (%)= (tax paid/ income) x 100
e.g. progressive income tax
Define progressive tax
As Y rises, average r.o.t increases
e.g.flat income tax
Define proportional tax
As incomes rise, r.o.t stays the same
e.g. indirect taxes (fuel duty, VAT)
Define regressive tax
As incomes rise, average r.o.t fall
burdens those on low incomes
Impact of tax changes on incentives to work
Higher tax rate lowers incentive to work: to strive for promotions, to work long hours, work into old age (retire early)
Free market economists argue that the supply of labour is relatively elastic and a reduction in marginal taxes on income will lead to a significant increase in work as individuals work longer hours, accept promotions and more people join the workforce.
High taxes on high income earners could encourage them to move abroad (capital flight) and taxes on the poor–>poverty trap.
However, higher taxes mean people have to work longer hours in order to maintain their income and so even increases the incentive work.
Laffer curve
Impact of tax changes on tax revenues
Relationship between ↑ tax rates and the level of tax revenues received
As tax rate ↑, govt tax revenue ↑ until a certain point where revenue is maximised and then will fall.
This is due to disincentivised workers work less, leading to less income and less tax revenue + the rich have increased incentive to use tax avoidance + tax evasion
Impact of tax changes on income distribution
A progressive tax system redistributes from those with higher income to those with lower income and reduces income inequality
Regressive (indirect) taxes may increase income inequality
Inheritance taxes are the most progressive form of taxation
Impact of tax changes on real output and employment
If tax rate increases, increase in leakages of circular flow of incomes. AD falls as consumers have less yD and firms have less profits so C+I fall
SRAS may fall as CoP increase
Income taxes cause a disincentive to work and therefore reduce LRAS as the most skilled workers go overseas and more people become inactive
Impact of tax changes on trade balance
● A rise in taxes will decrease income and therefore decrease consumption, so consumers spend less on imports . Imports in the UK have been found to be highly income elastic. As a result, the trade balance will
improve in the short run.
● However, in the long run, lower AD will reduce businesses’ need to invest and this could reduce competitiveness meaning that exports decrease.
Impact of tax changes on FDI flows
● 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.
● The problem with this is that it can be a ‘race to the bottom’ where countries have to continue to lower their taxes in order to make them the lowest to encourage investment; the eventual result is a fall in revenues for all countries.
Define fiscal deficit
Govt spending > taxation
