Chapter 5 - Public expenditure Flashcards
Definition of Public expenditure
Funds and rescources allocated by the government to social goods and services
Role of public expenditure
Stimulate economic growth
Satisfy needs
Capital expenditure
Investment in goods and assets
- Infrastructure
- Equipment
- Streetlight
Current expenditure
Final consumption in spending on goods and services consumed in a short period of time and transfer payments and debt interests
- Wages
- Heating
- Lighting
Transfer payments
Payments made to individuals by the government that doesn’t give output
- Unemployment
- State pensions
How is government spending measured
As a percentage of GDP
Debt interest
The interest that needs to be paid for previous borrowing accumulated in the past
Reasons for changing size and pattern of public expenditure
Changing incomes - VAT is regressive and promotes inequality
Changing GDP - recession leads to an increase in public expenditure
- Expansionary fiscal policy
- Increase welfare benefits
Changing age
Changing expectations - increase the income of a country leads to increase in demand of better quality products
Significance of changing public expenditure as a proportion of GDP
Tax - if government expenditure is a high proportion of GDP, it is only sustainable if tax revenues are also a high proportion of GDP
Productivity and growth
- Free market: private is better than public - cutting government expenditure can lead to a rise in productivity + growth
- Planned: government can be efficient
Crowding out
As government spending rises, private spending falls, so IR rise and borrowing decreases.
Why do we tax?
Government revenue for expenditure
Correct market failure
Manage the economy
Redistribute income
Direct taxes
Taken from the income of individuals
- Income: on earnings (usually progressive)
- Corporation: on business profits
- Wealth: on value of properties
- Capital gains: on profits from sales
Indirect taxes
Taken from goods and services spent
- VAT: on business (usually passed on to consumers)
- Tariffs: on imports
. Excise duty: on quantity buyed
Proportional
Same tax for all
Encourages people to earn more as tax doesn’t change
- Also known as flat tax
Progressive
As income increases, tax rises - direct taxes usually
- Should help reduce inequality
Regressive
As income rises, tax falls - indirect taxes usually
- Less equitable distribution of income
Tax avoidance
Reporting deductions in income, to pay less/no tax
Tax evasion
Breaking the law to avoid paying tax - hiding money
Increase tax (as an economic effect)
Less employed
Tax avoidance/evasion
- EVAL: depends on magnitude of increase - Laffer Curve
Income distribution (as an economic effect)
Improves with tax
- EVAL: depends on
1. VAT increases, so inequality increases
2. Income tax increases, so inequality falls
EVAL: tax avoidance
3. Corporation tax increases, so equality rises
EVAL: unemployment may rise
Prices (as an economic effect)
Indirect taxes - cost push inflation
Expansionary fiscal policy - demand pull inflation
BOP (as an economic effect)
Tariffs imposed = improvement
- EVAL: retaliation
Stables taxes (as an economic effect)
Encourage FDI
Employment (as an economic effect)
Incentive to work up until a point when tax is too high
Expansionary fiscal policy:
- RNO: increases
- Economic growth: increases
- Employment: increases
Contractionary fiscal policy:
- RNO: decreases
- Economic growth: decreases
- Employment: decreases
Fiscal deficit
Government expenditure > Tax revenue
- Borrow money to cover costs
Fiscal surplus
Government expenditue < Tax revenue
National debt
Fiscal deficits accumulated over years
- EVAL: The size of the deficit/debt as a proportion of GDP is important to see if the country can cover it
Automatic stabilisers
Mechanisms that increase spending or decrease taxes
- Recession: decrease tax
Discretionary fiscal policy
Deliberate changes in government expenditure + taxes to influence AD
- Keynes: recession: increase spending
Structural deficit
Deficit due to an imbalance in the revenue and expenditure of the government
- Boom and recession
Cyclical deficit
Deficit during a recession when governments increase spending to stimulate the economy
Factors influencing the size of deficits
Business cycle: increase spending during recessions
- Tax falls
- Employment falls
Interest payments: IR rise - deficit increases
Privatisation: improve budget deficit
Government policy: expansionary fiscal policy - bigger deficit
Demographic change: ageing population - bigger deficit
- Less tax, less employed
- EVAL: migration of economically active
The factors influencing the size of deficits will also affect
The size of debt
When does debt fall
When there is a surplus
Significance of the size of deficits and debts
Cost of borrowing increases
Higher taxes
Higher IR - crowding out
Demand pull inflation
Intergenerational equity - increasing debt benefit current citizens, but will be payed by future taxpayers
- EVAL: debt value falls over time due to inflation
Macroeconomic policies
Fiscal: use of tax and government expenditure by the government to achieve its policy objectives
Monetary: changes to interest rates and the monetary supply to achieve the government’s objectives
Exchange rate
Direct controls: measures imposed on the price/quantity of goods
- Min and max price
- Quota and tariff
Supply side policies: government policies to increase productive potentials
Reduce fiscal deficits and national debts
Less government spending + high taxes - fiscal austerity
- EVAL: leads to lower economic growth and unemployment may rise if tax is too high
Economic growth: increase revenue from taxes
Governments can issue bonds to raise finance or can default on debts - this makes it difficult to access credit in the future
Monetary policy
Includes interest rates, quantitative easing and exchange rates
Deflationary: reduce inflation
Inflationary: create inflation
Interest rates (monetary policy)
Fall in base rate will lead to a rise in AD
Quantitative easing (monetary policy)
Pump money into the economy
Used when inflation is low, and it isn’t possible to lower interest rates further
Policies to respond to external shocks in the global economy
Commodity prices: a raw material used in the production process/consumed on its own
- Supply is inelastic in the short run
- Demand is inelastic
- Supply can vary due to the weather
Accomodating prices: raise to full employment and protect household incomes
Deflationary fiscal and monetary policy: remove inflation
- AD falls = fall in demand pull inflation
Policies to reduce poverty and inequality
Expansionary fiscal and monetary policy
- Government expenditure rises
- Tax cuts
- Direct controls
Measures to control TNCs
Reducing tax avoidance - move revenues and profits into low tax countries
Regulation of transfer payments
Limit to government’s ability to control TNCs
Impact of policy changes on different economies
Local economic: important to implement policies in rural areas
National economies: most policies aim to change the whole economy
Global economies: changes nationally affect globally
Problems facing policy matters
Inaccurate information
- EVAL: impractical to gain every bit of information
Risks and uncertainties
Inability to control shocks
