4.5.3 Public sector finances

Question 1

What are discretionary fiscal changes?

Answer 1

Discretionary fiscal changes are deliberate changes in direct and indirect taxation and govt spending – for
example, extra capital spending on roads or more resources into the NHS.

Question 2

What are automatic stabilisers?

Answer 2

Automatic stabilisers are changes in tax revenues and government spending that come about automatically
as an economy moves through the business cycle

Question 3

How does tax revenue act as an automatic stabiliser?

Answer 3

When the economy is expanding rapidly the amount of tax revenue increases which takes
money out of the circular flow of income and spending

Question 4

How does welfare spending act as an automatic stabiliser?

Answer 4

A growing economy means that the government does not have to spend as much on
means-tested welfare benefits such as income support and unemployment benefits

Question 5

How does the budget balance and circular flow act as automatic stabilisers?

Answer 5

A fast-growing economy tends to lead to a net outflow of money from the circular flow. Conversely during a slowdown or a recession, the government normally ends up
running a larger budget deficit During a recession, revenue is likely to be lower due to less income earned,
less profits made and fewer goods being bought and at the same time government expenditure on
transfer payments e.g. income support and unemployment benefit

Question 6

What is the yield on a bond?

Answer 6

The yield on a bond is the interest rate paid on state
borrowing.

Question 7

What is government borrowing?

Answer 7

Public sector borrowing is the amount the government must borrow each year to finance their spending

Question 8

What is national debt?

Answer 8

Public sector debt is a measure of the accumulated national debt owed by the government sector

Question 9

What is public sector debt?

Answer 9

Public sector debt is owed by central and local government and also by state-owned corporations.

Question 10

How is the size of a fiscal deficit affected during an economic boom?

Answer 10

During an economic boom, when real GDP is expanding, and the economy is operating above its potential
(i.e. there is a positive output gap), then tax receipts are relatively high and spending on unemployment
benefit is low. This reduces the level of government borrowing

Question 11

How is the size of a fiscal deficit affected during a recession?

Answer 11

The reverse happens in a recession when borrowing tends to be high. This is because a recession leads to
rising unemployment and falling real incomes which leads to an increase in state spending on welfare
assistance

Question 12

What are cyclical factors influencing the size of fiscal deficits?

Answer 12

o Rate of unemployment – higher unemployment reduces tax revenues
o Consumer spending – strong consumer spending increases VAT revenue
o Business profits – rising business profits increases revenue from corporation tax
o Automatic stabilisers – in an economic downturn, the fiscal deficit rises as G increases and T falls

Question 13

What are long run factors influencing the size of fiscal deficits?

Answer 13

o Size of the welfare state – e.g. the scale and breadth of welfare assistance available
o Relative level of welfare benefits e.g. compared to incomes
o Demographic factors e.g. ageing population, the impact of net inward migration of labour
o Size of the tax base and tax rates – i.e. is an economy moving towards a lower or higher tax burden
o Efficiency of the public sector - e.g. the productivity of workers in the NHS and education in delivering
services

Question 14

What are factors influencing the size of national debts?

Answer 14

Scale of government spending
* Current spending on public services
* Investment spending e.g. on infrastructure
* Spending on providing social welfare

Level of tax revenues
* Size of the tax base e.g. how many in work and their incomes
* Efficiency of tax collection, scale of tax avoidance & evasion

Cost of servicing debt + state bail-outs
* Yield on new and existing government bonds
* Willingness of lenders to give the government new credit
* Government rescue of businesses can add to public sector debt

Question 15

What are arguments that rising national debt creates economic problems?

Answer 15

1. High fiscal deficits cause rising debt interest payments
2. This interest burden has an opportunity cost for less interest on debt could free up extra spending on health
   and education. In 2018/19, gross debt interest payments for the UK are forecast to be £53 billion
3. An increase in the national debt is likely to cause higher taxes in the future. This will cut the disposable incomes
   of tax payers and reduce growth in the private sector
4. It might be unfair if the rising tax burden falls more heavily on future generations of tax payers rather than
   people who benefit from government spending now

Question 15

Why is a high level of govt debt dangerous according to the ONS?

Answer 15

A high level of government borrowing will result in money having to be spent repaying that debt. This can lead to both a reduction in investment and a requirement on future generations to continue paying off these debts, which could in turn have a negative impact on national well-being

Question 16

What are counterarguments arguing for govt borrowing?

Answer 16

Since 1970, the UK has run a budget surplus in only six years – it is normal for the government to borrow money.
1. A rise in borrowing to fund extra government spending can have powerful effects on AD, output and
employment when an economy is operating below full capacity output
2. There is an automatic rise in the budget deficit to cushion the fall in AD caused by an external economic
shock. A higher fiscal deficit is needed to lift AD back towards pre-recession levels and support an economic
recovery
3. If a fiscal stimulus works, then the budget deficit will improve as a result of higher tax revenues and reductions
in welfare spending. A growing economy helps to shrink debt as a percentage of GDP
4. It makes sense for a government to borrow money if interest rates are low and if the deficit is being used for
investment to improve a nation’s infrastructure to aid competitiveness. Borrowing to invest can bring about
much needed improvements in public services such as education, health, transport and social housing. It can
lead to an increase in long run aggregate supply and therefore support long-run economic growth