Public Finance Flashcards
What is public expenditure?
Expenditure by central government, local authorities & public-sector organisations. 3 broad elements:
1) Current expenditure
2) Capital expenditure
3) Transfer payments
What is current expenditure?
This is day-to-day expenditure by the government on goods & services
e.g salaries of teachers, nurses & drugs used by NHS
What is capital expenditure?
Expenditure on LT I projects
e.g new hospitals & roads
What are transfer payments?
Payments made by state (from tax revenues) to individuals in form of benefits for which there’s no production in return
e. g child benefit, state pensions & jobseekers’ allowance
- involve redistribution of income therefore not relevant to calculation of a country’s national income
What are the 6 objectives of public expenditure?
1) Means of managing the economy (part of fiscal policy)
2) Provision of public goods
3) Defence & internal security
4) Redistribution of income
5) Deal with external costs from production & C e.g pollution & waste
6) Provision of goods yielding external benefits or where there’s information gaps e.g health & education
What are 4 factors effect the size and pattern of public expenditure?
1) The level of GDP - as incomes increase, D for many government-provided services e.g health & education, rises more than proportionately because D is income Elastic
- LR: amount that gov. can spend depends on amount can raise in taxation which in turn depends on level of GDP
- SR: gov’s can borrow to finance an excess of public expenditure over tax revenues
2) Size & age distribution of population - increase in size of population (e.g through immigration) likely to place extra pressure on public services, while an ageing population will increase D for medical & social services for elderly
3) Political priorities - gov. may wish to improve public services or redistribute income from rich to poor, inevitably lead to increase in public expenditure
e. g labour particular emphasis on improving quality of health & education
4) Redistribution of income - expenditure on those in relative poverty & those with disabilities increased significantly in recent years
e. g increase in means-tested benefits i.e family tax credits & pension credits
What are another 4 factors effect the size & pattern of public expenditure?
1) Discretionary fiscal policy - credit crunch has led to resurrection of fiscal policy as a means of managing the economy
- sharp division of opinion whether gov’s should follow austerity measures to reduce budget deficits or follow reflationary policies e.g. increase public expenditure to stimulate GDP
2) Debt interest - massive increase in fiscal deficits form 2008 leading to sharp rises in PSND, in turn result in higher interest payments on national debt
3) State of the economy- when in recession, public expenditure likely to rise due to automatic stabilisers
e. g job seekers allowance & housing benefits paid to people who have been made redundant
4) Rate of inflation - normal terms: public expenditure increase during periods of inflation as many benefits are index-linked i.e linked to rate of inflation. Further, many public services labour intensive so wage costs tend to rise significantly if workers receive wage rises to compensate for price rises
What are the objectives of taxation?
1) Means of managing the economy (part of fiscal policy)
2) Raise revenue to finance public expenditure
3) Defence & internal security
4) Redistribute income
5) Internalise external costs
6) Influence pattern of expenditure
What are the 3 categories of taxes? Define them.
1) Progressive tax - the proportion of income paid in tax rises as income increases
2) Proportional tax - the proportion of income paid in tax remains constant as income increases
3) Regressive tax - the proportion of income paid in tax falls as income increases
What is a direct tax? Give examples.
Tax levied directly on an individual or organisation
Income tax: progressive tax levied at 20%, 40% & 45%
Corporation tax: proportional tax on company profits 20-21%
Inheritance tax: proportional tax on inherited assets levied at rate of 40% on estates > £325,000
Capital gains tax: on increase in value of assets between time bought & time sold e.g shares & I property
What is an indirect tax? Give examples.
Tax levied on goods or services
Value added tax (VAT): ad valorem tax i.e percentage of price of the product
Excise duties: usually specific taxes i.e set amount per unit
Tariffs: taxes on imported goods
What synoptic issues should be considered when analysing the effects of taxation?
1) Increase in taxes represents leakage from circular flow so would have downward multiplier effect on GDP,
2) Increase in indirect tax:
- On product could cause leftward shift in supply curve, incidence of tax on C and producers depends on PED for product
- Could cause inflation via wage-price spiral e.g if VAT is increased prices rise, this could be inflationary if it results in workers demanding higher wages to compensate for increase in prices
3) Indirect taxes:
- Would increase prices above MC so resulting in allocative inefficiency, unless external costs associated with production of the product
- Might be applied to products that cause external costs
What are the effects of an increase in income tax rates?
In the UK there has been an extra tax band of 50% from 2010 CHECK THIS!
1) On income distribution: tax system more progressive, so Y distribution more equitable
2) On incentives to work: disincentive effects
- unemployed less willing to take jobs
- those currently ‘inactive’ less willing to join workforce
- workers currently employed less willing to do overtime, more likely to reduce their working hours/ retire early & less willing to apply for promotion
3) On tax revenues: some economists argue if tax rates increased too much, tax revenues may fall due to disincentives to work are so great
- if the higher rate of Y tax is increased then likely to be increase in tax avoidance (legal); tax evasion (illegal) & rise in number of tax exiles (Laffer curve explains)
4) On rate of economic growth: some economists argue that disincentive effects might have adverse impact on enterprise, causing fall in AS
- higher rates of Y tax would cause fall in disposable income, fall in C & fall in AD
What are the effects of an increase in indirect taxes (e.g VAT)?
1) On income distribution: research suggests that impact of VAT broadly regressive, so increase in VAT would cause Y distribution to become less even
2) On incentives to work: indirect taxes less obvious impact than direct taxes
- however possible that increase in indirect taxes would encourage people to work harder so they can maintain their standard of living
3) On tax revenues: increase tax revenues to gov as long as PED1 tax revenue would fall
4) On rate of inflation: raise price of most goods & services
- if workers & trade unions respond by demanding wage increases to compensate for price rises then inflationary wage-price spiral could result
5) On rate of economic growth: act as leakage from circular flow of income
- real incomes of consumers would fall, causing fall in AD
- from business perspective, costs would rise causing fall in AS
What is public sector net borrowing (PSNB)/ fiscal (budget) deficit?
Where public expenditure (both current & capital) is greater than tax revenue
