impact of fiscal policies to reduce fiscal deficit (3)

Question 1

impact of increasing tax rate to reduce fiscal deficit

Answer 1

DIRECT
- inc income/corporate tax -> less disposable/less retained profits -> more tax revenue -> reduces deficit -> [biggest source of tax revenue in UK]

INDIRECT
- VAT -> higher tax revenue [mainly from price inelastic gods] -> reduced budget deficit
- can increase cost of production for firms -> less SRAS -> less growth

Question 2

evaluate the impact of increasing tax rate to reduce fiscal deficit

Answer 2

• inc. in VAT -> may increase inequality -> those on lower incomes are more than proportionately affected
• LAFFER CURVE -> tax revenue falls after a certain point due to:
• incentive to work fall
• rise in tac evasion and avoidance
• brain drain -> emigrate to countries with lower tax rates e.g. Qatar, UAE

Question 3

impact of reducing government spending to reduce fiscal deficit

Answer 3

• less gov. spending -> improved gov. balance -> less borrowing needed -> less crowding out -> reduces national debt through less borrowing
• cut welfare benefits -> increase incentive to work -> increase in employment -> they earn incomes -> increased tax revenues -> ALSO more consumption (AD impact)
• less spending on infrastructure e.g. investment into renewable energy -> reduce gov. expenditure relative to income -> contraction in G -> less AD -> lower price level -> less inflationary pressure -> could make exports more price-competitive -> offsets fall in AD

Question 4

evaluate impact of reducing government spending to reduce fiscal deficit

Answer 4

• less gov. spending + C -> AD falls -> less growth -> less employment -> -ve multiplier effect -> in the LR could have worse effects
• depends on where we start on LRAS and size of the multiplier -> may not reduce price level due to a lot of spare capacity
• lower welfare benefits may increase inequality