Government & The Macroeconomy Flashcards
Question: What is a budget in fiscal policy?
Answer: A budget is a financial statement forecasting government revenue and expenditure for the upcoming fiscal year. It outlines expected revenue from taxes and other sources and how it will be used to finance government spending, with the aim of achieving a balanced budget.
Question: Why do governments engage in spending?
Answer: Governments spend to provide public goods and services that the private sector may neglect, such as defense, infrastructure, education, and healthcare. They also spend to improve labor productivity, address negative externalities like pollution, support struggling industries like agriculture, redistribute income, and stimulate economic growth.
Question: What are the main areas of government spending?
Answer: The main areas of government spending include defense, transportation infrastructure, utilities like electricity and water, education, healthcare, food reserves, salaries, pensions, subsidies, and grants.
Question: What are the effects of increased government spending?
Answer: Increased government spending boosts demand in the economy, aiding economic growth. However, it can also lead to inflation if demand rises faster than output. Spending on public and merit goods enhances long-term productivity and growth, while welfare spending improves living standards and reduces inequality. Yet excessive spending can crowd out private sector investments, potentially lowering private investment due to increased taxes and borrowing, which may lead to higher interest rates and decreased private investment.
Question: What are taxes, and why does the government levy them?
Answer: Taxes are compulsory payments made by individuals and businesses to the government. Governments levy taxes to generate revenue for public goods and services, redistribute income, discourage consumption of demerit goods, protect domestic industries, and manage the economy.
Question: How are taxes classified?
Answer: Taxes are classified as direct or indirect and progressive, regressive, or proportional. Direct taxes are levied on incomes, directly impacting individuals responsible for payment. Examples include income tax, corporate tax, capital gains tax, inheritance tax, and property tax.
Question: What is income tax?
Answer: Income tax is paid from an individual’s income, reducing disposable income available for spending. When income tax rates rise, disposable income decreases, leading to lower demand for goods and services, decreased production, and potentially increased unemployment. Conversely, lower income taxes encourage spending and higher production levels.
Question: How does corporate tax impact businesses and investments?
Answer: Corporate tax is levied on a company’s profits. Increased corporate tax rates reduce businesses’ profits available for reinvestment, hindering expansion and production growth. Additionally, higher corporate taxes lead to lower dividends for shareholders, potentially discouraging investment and slowing economic growth. Conversely, reducing corporate taxes stimulates production and investment.
Question: What is capital gains tax, inheritance tax, and property tax?
Answer: Capital gains tax applies to profits from selling assets held for over a year, inheritance tax is levied on inherited wealth, and property tax is imposed on property or land.
Question: What are the advantages and disadvantages of direct taxes?
Answer: Direct taxes, such as income tax, can generate high revenue and reduce income and wealth inequalities. However, they may reduce work incentives, discourage enterprise, and face challenges like tax evasion.
Question: What are indirect taxes, and what are some examples?
Answer: Indirect taxes are added to the prices of goods and services and are paid during purchase. Examples include GST/VAT, customs duty, and excise duty.
Question: What are the advantages and disadvantages of indirect taxes?
Answer: Indirect taxes are cost-effective to collect, have a broad tax base, and can achieve specific aims. However, they can be inflationary, regressive, and prone to tax evasion.
Question: What are progressive taxes, and what is an example?
Answer: Progressive taxes burden the rich more than the poor, with tax rates increasing as incomes rise. Income tax, with higher rates for higher income brackets, is an example of progressive taxation.
Question: What are regressive taxes, and how do they impact different income levels?
Answer: Regressive taxes burden the poor more than the rich, with tax rates decreasing as incomes rise. An example is GST, where the tax burden is higher for lower-income individuals compared to higher-income individuals.
Question: What are proportional taxes, and what is an example?
Answer: Proportional taxes burden both the poor and the rich equally, with the tax rate remaining the same regardless of income levels. Corporate tax, where all companies pay the same proportion of their profits, is an example of proportional taxation.
Question: What are the qualities of a good tax system according to the canons of taxation?
Qualities of a good tax system (the canons of taxation):
Equity: the tax rate should be justifiable rate based on the ability of the taxpayer.
Certainty: information about the amount of tax to be paid, when to pay it, and how to pay it should all be informed to the taxpayer.
Economy: the cost of collecting taxes must be kept to a minimum and shouldn’t exceed the tax revenue itself.
Convenience: the tax must be levied at a convenient time, for example, after a person receives his salary. Elasticity: the tax imposition and collection system must be flexible so that tax rates can be
easily changed as the person’s income changes. Simplicity: the tax system must be simple so that both the collectors and payers understand it well.
Impacts of taxation
Taxes can have various direct impacts on consumers, producers, government and thus, the entire cconomy.
The main purpose of tax is to raise income for the government which can lead to higher spending on health care and education. The impact depends on what the government spends the money on. For example, whether it is used to fund infrastructure projects or to fund the government’s debt repayment
*Consumers will have less disposable income to spend after income tax has been deducted. This is likely to lead to lower levels of spending and saving. However, if the government spends the tax revenue in effective ways to boost demand, it shouldn’t affect the economy.
Higher income tax reduces disposable income and can reduce the incentive to work. Workers may be less willing to work overtime or might leave the labour market altogether.
However, there are two conflicting effects of higher tax:
Substitution effect: higher tax leads to lower disposable income, and work becomes relatively less attractive than leisure-workers will prefer to work less.
Income effect: if higher tax leads to lower disposable income, then a worker may feel the need to work longer hours to maintain his desired level of income-workers feel the need to work longer to earn more. The impact of tax then depends on which effect is greater. If the substitution effect is greater.
then people will work less, but if income effect is greater, people will work more Producers will have less incentive to produce if the corporate taxes are too high.
Private firm aim on making profits, and if a major chunk of their profits are eaten away by taxes, they might not bother producing more and might decide to close shop.
Question: What is a budget surplus, and what are its implications?
Answer: A budget surplus occurs when government revenue exceeds government spending. While it indicates fiscal responsibility, a large surplus can signal an economy below its full potential, potentially triggering an economic slowdown.
Question: What actions does the government take during a budget surplus and deficit?
Answer: During a budget surplus, the government employs expansionary fiscal policy, increasing government spending and cutting tax rates. Conversely, during a budget deficit, contractionary fiscal policy is employed, where government spending is reduced, and tax rates are increased.
Question: How does fiscal policy influence economic growth and price stability.
Answer: Fiscal policy influences economic growth by influencing demand and spending in the economy. Expansionary fiscal policy stimulates growth, employment, and prices, while contractionary fiscal policy controls inflation resulting from excessive growth.
Question: What are the potential consequences of using contractionary fiscal policy to control inflation?
Answer: While contractionary fiscal policy can help control inflation, it may lead to increased unemployment as output and production decrease due to reduced growth.
Question: What is the money supply?
Answer: The money supply is the total value of money available in an economy at a point in time.
Question: How can the government control the money supply?
Answer: The government can control the money supply through tools such as open market operations (buying and selling of government bonds) and changing reserve requirements of banks.
Question: What is the interest rate?
Answer: The interest rate is the cost of borrowing money, incurred when individuals borrow money from a bank, with interest also earned on money deposited in banks.
Question: How do higher interest rates affect borrowing and investments?
Answer: Higher interest rates discourage borrowing and investments while encouraging saving, leading to a decrease in consumption and discouraging firms from investing and producing more.
Question: How do lower interest rates impact borrowing and investments?
Answer: Lower interest rates encourage borrowing and investments, as well as consumption, leading to an increase in economic activity and prompting firms to invest and produce more.
Question: How does the monetary authority influence interest rates in the economy?
Answer: The monetary authority indirectly influences interest rates by changing the interest rates of borrowing between the central bank and commercial banks, as well as the interest on its bonds and securities, thereby affecting the interest rates provided by commercial banks on loans and deposits to individuals and businesses.
Question: What is monetary policy?
Answer: Monetary policy is a government policy that controls the money supply in an economy to achieve growth and stability, often conducted by the country’s central bank to maintain price stability, low unemployment, and economic growth.
Question: What is expansionary monetary policy?
Answer: Expansionary monetary policy involves increasing the money supply by cutting interest rates, leading to increased spending, investment, economic activity, economic growth, an improved balance of payments, and higher employment.
Question: What is contractionary monetary policy?
Answer: Contractionary monetary policy involves decreasing the money supply by increasing interest rates, resulting in reduced spending, investment, economic activity, economic growth, and inflation, potentially leading to unemployment due to a fall in output.
Question: What are supply-side policies?
Answer: Supply-side policies are microeconomic policies aimed at increasing supply and productivity in the economy to enable long-term economic growth.
Question: What are some examples of supply-side policies?
Answer: Examples include public sector investments in infrastructure, improving education and vocational training, spending on health, investment in housing, privatization, income tax cuts, subsidies, deregulation, removing trade barriers, and labor market reforms.
Question: How does public sector investment contribute to supply-side policies?
Answer: Public sector investments in infrastructure such as transport and communication facilitate faster growth by improving resource flow and aiding productivity.
Question: What is the role of education and vocational training in supply-side policies?
Answer: Education and skills training investments by the government improve labor quality and quantity, enhancing productivity in the economy.
Question: How does spending on health support supply-side policies?
Answer: Accessible, affordable, and good quality health services reduce illness-related productivity losses, thereby increasing overall productivity.
Question: What is the impact of investment in housing on supply-side policies?
Answer: Increased housing spaces enhance population mobility, leading to increased output and productivity.
Question: How does privatization contribute to supply-side policies?
Answer: Privatization increases efficiency and output by transferring some public corporations to private ownership, leveraging the profit motive absent in the public sector.
Question: What effect do income tax cuts have on supply-side policies?
Answer: Income tax cuts increase people’s willingness to work and earn more, thereby boosting supply in the economy.
Question: How do subsidies support supply-side policies?
Answer: Subsidies provide financial grants to industries, enabling producers to increase output and supply.
Question: What role does deregulation play in supply-side policies?
Answer: Deregulation reduces business operational costs and hurdles, encouraging investments and increasing output.
Question: How do trade reforms contribute to supply-side policies?
Answer: Trade reforms, such as reducing import duties and quotas, improve productivity by facilitating resource, goods, and services imports, and encourage exports, thus boosting domestic production.
