laffer curve Flashcards
Draw and explain the Laffer Curve
If taxation is too high it becomes a disincentive to work.
The reasons behind the fall in revenue is:
increased disincentive to work.
An increase in tax avoidance and evasion
a rise in the number of tax exiles (leave the country to avoid paying tax)
What impact will an increase in taxes have on real output and employment?
plus evaluation
An increase in tax will reduce aggregate demand because taxes are a leakage from the circular flow of income . This might reduce real output and cause an increase in unemployment.
However, in the long run changes in tax rate can impact on aggregate supply. Lower direct tax rates can lead to higher incentives, which lead to increased investment by firms and increased participation in the labour market. In effect resulting in an increase in economic growth and a rise in employment.
What impact will an increase in taxes have on the price level?
An increase in indirect taxes can be inflationary if it causes a wage-price spiral. (Increase in prices leads to increased wage demands which increases prices again)
What impact will an increase in taxes have on the trade balance and FDI?
Increase in income tax would reduce disposable income and consumption. In turn this would reduce demand for imports and so result in an improvement in the balance of trade.
A higher rate of corporation tax might deter FDI if rates are lower in other countries.
Discretionary fiscal policy
Government making decisions about its spending or taxes. Not the same as automatic changes that occur.
What is an example of an automatic stabiliser?
Such as an increase in spending on benefits when more people become unemployed.
Fiscal deficit VS national debt?
Fiscal deficit- When government spending exceeds tax revenue in a financial (fiscal) year so the government needs to borrow money.
National debt- The cumulative total of past government borrowing.
Cyclical vs structural fiscal deficit?
Cyclical fiscal deficit- During a downturn in the economy because tax revenue will be falling and government expenditure will be rising.
Structural fiscal deficit- Remains even when an economy is operating at its full potential.
3 factors effecting the size of fiscal deficits?
Economic cycle
Housing Market- during periods of growth in the housing market tax income rises due to the amount of stamp duty.
Political priorities and unplanned events- Government might have to respond to unforeseen events.
What are recent examples of government policy contributing to national debt in the short run?
Crossrail and HS2 which should improve productivity in the long run.
What impact might a rise in government borrowing have on interest rates?
A rise in government borrowing may lead to a rise in interest rates. This is because the demand for funds rises relative to their supply. May lead to crowding out.
What might government spending have on the rate of inflation?
The government needs more money as tax receipts do not cover expenditure, they have 2 options: borrow money or print money. If the government prints more money this would likely lead to inflation.
What impact can the size of fiscal deficits and national debt have on inter-generational equity?
Government borrowing today can lead to future generations having to pay this back, however they might benefit due to the benefits of the infrastructure built as a result of the money. However a country with too large of a debt may be less likely to attract investors due to investment seeming too risky.
What impact can size of fiscal deficit have on a country’s credit rating?
Countries are given credit ratings by private investment companies. They use data such as size of national debt and a country’s financial history.
