Public finance Flashcards
What are the 4 main areas of public finance?
- public expenditure
- taxation
- public sector net borrowing
- public sector net debt
How can expenditure by central and local governments (public expenditure) be categorised?
- current expenditure (day-to-day expenditure on goods e.g. salaries of teachers)
- capital expenditure (expenditure on long-term investment projects e.g. new hospitals, roads)
- transfer payments (payments made by state (from tax revenues) in form of benefits for which there is no production in return) (involve redistribution of income ∴ not relevant to calculation of country’s national income)
What are the main objectives of public expenditure?
- the provision of public goods
- defence and internal security
- provision of merit goods
- redistribution of income
- expenditure to deal with external costs e.g. pollution
What issues should be considered when analysing public expenditure?
- increase in expenditure in one area will involve an opportunity cost
- increasing expectations relating to healthcare and education are associated with increasing real incomes ∴ arguably income elastic
- inc. in public expenditure represents an injection into the circular flow and so will have a multiplier effect on GDP
- public expenditure could result in gov. failure
- could result in crowding out (either resource or financial)
What is the difference between resource and financial crowding out?
- resource crowding out is when the economy is operating at full employment and an increase in public expenditure results in insufficient resources being available for the private sector
- financial crowding out occurs when increased public expenditure/ tax cuts are financed by increased public sector borrowing, in turn increasing demand for loanable funds ∴ driving up interest rates
What are the main factors influencing the size and pattern of public expenditure?
- level of GDP
- size and age distribution of population
- political priorities
- redistribution of income
- discretionary fiscal policy
- debt interest
How will the level of GDP influence the size and pattern of public expenditure?
higher incomes mean demand for gov. services e.g. education, health rises more than proportionally as demand for them is income elastic
How will the size and age distribution of the population influence the size and pattern of public expenditure?
inc. in population e.g. through immigration places extra pressure on public services, whilst ageing population will inc. demand for medical services and social services for elderly
What are the two main types of taxes?
direct - levied on income/ wealth
indirect - levied on expenditure
What are the three main categories of tax?
- progressive tax (proportion of income paid in tax rises as income rises)
- proportional tax (proportion of income paid is constant as income rises)
- regressive tax (one in which the proportion of income paid in tax falls as income increases) e.g. VAT
What are the main issues that should be considered when analysing the effects of taxation?
- inc. in axes represents leakage from circular flow ∴ downward multiplier effect on GDP
- inc. in indirect tax on good causes leftward shift in supply curve (depends on PED)
- indirect tax would inc. prices above marginal cost, resulting in allocative inefficiency (unless external costs are associated with good)
- inc. in indirect taxes could cause inflation via wage-price spiral
What is the main effect of an increase in income tax rates?
- the tax system would become more progressive ∴ helping tackle income distribution
- may discourage unemployed from finding work, and discourage employed from working longer
- arguably higher tax rates will result in lower tax revenues as disincentives to work are so great - tax avoidance, evasion and no. of tax exiles may all increase - illustrated by Laffer curve - however a lot of evidence that runs contrary to this
- would reduce disposable income ∴ reduce AD - also been argued disincentive effects cause inward shift of AS curve
What are the main effects of an increase in indirect taxes e.g. VAT?
- VAT is regressive ∴ helping worsen income distribution
- may encourage people to work harder so that they can maintain their standard of living
- tax revenues will rise (provided demand for goods is price inelastic)
- will raise price of goods, inc. inflation. If workers demand inc. wages in response to this, it could trigger inflationary wage-price spiral
- would act as leakage from circular flow of income ∴ fall in real incomes ∴ fall in AD, CoP will rise, cause fall in AS
What is an abbreviation for public sector net borrowing?
PSNB
What is public sector net borrowing?
difference between public expenditure (current + capital) and tax revenue
