Chap 26

Question 1

Define Budget

Answer 1

the relationship between government revenue and government spending

Question 2

Define Budget deficit

Answer 2

government spending/public expenditure is higher than government revenue

Question 3

Define Budget surplus

Answer 3

government revenue is higher than government spending.

Question 4

Define Balanced budget

Answer 4

when government spending and revenue are equal

Question 5

Reasons for government spending

Answer 5

1. To influence economic activity
2. To reduce market failure
3. To promote equity
4. To pay interest on national debt

Question 6

How can govt spending influence economic activity

Answer 6

To increase aggregate demand in the hope that the higher aggregate demand will stimulate higher output and so result in economic growth

Question 7

How can govt spending reduce market failure

Answer 7

Public goods as this would not be financed by the private sector

Merit goods as market forces would not allocate sufficient resources to their production.

Regulating markets where there is a difference between social and private costs and benefits and abuse of market power.

Question 8

How can govt spending promote equity

Answer 8

Governments provide benefits and products to vulnerable groups and the unemployed.

Eg state pensions to the retired, subsidised housing for the poor and free education to children.

Question 9

How can govt spending pay interest on national debt

Answer 9

If a government has borrowed in the past to finance a gap between its spending and its tax revenue, it will have to pay interest on the loans

Question 10

Define multiplier effect

Answer 10

the final impact on aggregate demand being greater than the initial change;

any initial increase in spending will eventually cause a greater increase in a aggregate demand

Question 11

Reasons for levying taxation

Answer 11

1. To redistribute income from the rich to the poor.
2. To discourage the consumption of demerit goods
3. To raise the costs of firms that impose costs on others by, for example, causing pollution.
4. To discourage the consumption of imports and hence protect domestic industries
5. To influence economic activity

Question 12

How does levying taxation redistribute income from the rich to the poor?

Answer 12

Higher income groups usually pay more in tax than the poor and some of the revenue raised is used to pay benefits to the poor.

Question 13

How does levying taxation discourage the consumption of imports and hence protect domestic industries?

Answer 13

By placing tariffs on rival imported products, the country’s inhabitants may buy less foreign and more domestic products.

Question 14

How does levying taxation influence economic activity?

Answer 14

If an economy is experiencing rising unemployment, its government may cut taxes to stimulate an increase in consumption and investment.

Question 15

Categories of taxes

Answer 15

1. Direct
2. Indirect
3. Progressive
4. Proportional
5. Regressive

Question 16

Define Direct taxes

Answer 16

Taxes on income and wealth.

Question 17

Define Indirect taxes

Answer 17

taxes on expenditure

Question 18

Define Proportional tax

Answer 18

one which takes the same percentage of the income or wealth of all taxpayers.

Question 19

Define Regressive tax

Answer 19

one which takes a larger percentage of the income or wealth of the poor.

Question 20

Define Progressive tax

Answer 20

one which takes a larger percentage of the income or wealth of the rich

Question 21

Difference bw direct & indirect taxes

Answer 21

1. Indirect taxes are levied on spending
2. The firms that actually make the tax payment to the government may pass on at least some of the burden of the tax, to other people

Question 22

Main types of direct taxes

Answer 22

1. Income tax
2. Corporation tax
3. Capital gains tax
4. Inheritance tax

Question 23

Income tax

Answer 23

Tax on income that people receive from their employment and investment income.

People are given a tax allowance, which is an amount of income they earn free of tax. Income above this level is referred to as taxable income.

Question 24

Capital gains tax

Answer 24

Tax on the profit made on assets when they are sold for a higher price than what they were bought for.

Question 25

Corporation tax

Answer 25

Tax on the profits of firms.

Question 26

Inheritance tax

Answer 26

Tax on wealth above a certain amount which is passed on to other people, when a person dies.

Question 27

Common types of indirect taxes are:

Answer 27

1. Sales tax is a tax imposed when products are sold. The main examples of sales tax are GST (general sales tax) and VAT (value added tax).
2. Excise duties are taxes charged on certain domestically produced goods, most commonly on alcoholic drinks, petrol and tobacco. They are charged in addition to VAT.
3. Customs duties are taxes on imports and are also called tariffs.
4. A licence may be needed to use a range of products including a television and a car.

Question 28

Qualities that a good tax should possess

Answer 28

1. Equity: The amount of tax people and firms have to pay, should be based on their ability to pay.
2. Certainty: Easy to understand, should be able to calculate the amount
3. Convenience. A tax should be easy to pay.
4. Economy. The cost of collecting a tax should be considerably less than the revenue it generates.
5. Flexibility: Should be possible to change the tax if economic activity changes or
   government aims change.
6. Efficiency. A tax should improve the performance of markets or at least not significantly reduce the efficiency of markets.

Question 29

What is the tax base & relevance

Answer 29

The source of tax revenue

A wide tax base may enable tax rates to be relatively low. High tax rates, particularly corporate tax rates, can reduce the tax base. This is because they may cause firms to move out of the country.

Question 30

Tax burden

Answer 30

Amount of tax paid by people and firms.

Expressed as a percentage of the country’s total income (Gross Domestic Product, or GDP). The higher the tax burden, the greater the percentage of people’s and firms’ income taken through tax

Question 31

Impact of taxation

Answer 31

1. Inelastic demand- consumers bear most of the tax- can pass on a high proportion of the tax as they know it will not reduce the demand significantly.
2. Elastic demand-producers who bear most of the tax- they know that they cannot pass on much of the tax to consumers as such a move would bring down the sales significantly.

Question 32

Taxation

Answer 32

The distribution of the burden of an indirect tax, shared between consumers and producers

Question 33

Impact of direct taxes

Answer 33

1. May discourage effort: Stop some people from working overtime, taking promotion and prevent some people from entering the labour force.
   May encourage some people to work harder (fixed financial commitments, such as mortgages& contracted hours of work)
2. May discourage enterprise: Discourage entrepreneurs from expanding their firms and investing in new markets
3. May discourage saving: As they reduce the return from saving, they may cause some people to save less but they may encourage target savers to save more.

Question 34

Define Automatic stabilisers

Answer 34

Forms of government expenditure and taxation that reduce fluctuations in economic activity, without any change in government policy.

Question 35

Pros of indirect taxes

Answer 35

Easy and cheap to collect as firms do some of the work.

Can be used selectively to achieve particular aims such as reducing the consumption of alcohol.

Harder to evade than direct taxes and easier to adjust.

People also have more choice with indirect taxes. The amount of tax paid by them depends on what they buy. They may decide not to buy products which are highly taxed.

Indirect taxes are also a useful source of income, especially in countries where it is difficult to raise much from income tax because a significant number of workers work in the informal economy.

Also in countries with low literacy rates, people might face problems while filling in the tax forms.

Question 36

Cons of indirect taxes

Answer 36

Proportionately falls more heavily on the poor. bc it’s regressive

Will also raise prices- may stimulate workers to press for wage increases and set off a trend of rising prices, that is inflation.

Question 37

Define Inflation

Answer 37

the rise in the price level of goods and services over time

Question 38

Define Informal economy

Answer 38

that part of the economy that is not regulated, protected or taxed by the government.

Question 39

Define Flat taxes

Answer 39

taxes with a single rate.

Question 40

Pros of flat taxes

Answer 40

Simple to administer for governments and firms
Less incentive to evade paying tax
More incentive for workers and entrepreneurs to earn and produce more

Question 41

Define Fiscal policy

Answer 41

Decisions on government spending and taxation designed to influence aggregate demand.

Question 42

Calculate a government’s budget balance

Answer 42

Revenue - government spending

Question 43

Define Expansionary fiscal policy

Answer 43

rises in government expenditure and/
or cuts in taxation designed to increase aggregate demand.

Question 44

Define Contractionary fiscal policy

Answer 44

cuts in government expenditure and/ or rises in taxation designed to reduce aggregate demand

Question 45

Government wants to raise aggregate (total) demand in order to increase economic growth and employment

Answer 45

Will increase its expenditure and/or cut taxation by lowering tax rates, reducing the items taxed or raising tax thresholds.

Cut income tax rates which will raise people’s disposable income
Enables them to spend more
Higher consumption is also likely to raise investment
More goods and services being produced, employment is likely to rise.

Question 46

Contractionary fiscal policy to reduce inflationary pressure

Answer 46

A cut in government expenditure on, for example, education would reduce aggregate demand.
May lower the rise in the general price level.
Reduce an excess of import expenditure over export revenue.
Because spending is likely to fall, including spending on imports.
Domestic firms, facing lower demand at home, may also put more effort into exporting.