4.9 role of the state in the macroeconomy Flashcards
(38 cards)
What are the global economic objectives?
- Economic growth - GDP per capita - GNI/Population
- Environmentally sustainable growh
- Low and stable inflation
- Equilibrium in balance of payments
- Poverty reduction/redistribution of incomes
- Fiscal balance - tax revenue = government spending
- Full employment - low unemployment rates
What is the government expenditure in the UK?
- 2% on defence
- £800bn in 2019-19
- 0.7% on aid
- Increase state pension
- £146bn on health and £89bn on education
What are the 3 types of government spending?
-Current - day to day e.g. wages of doctors, drugs in healthcares, books, road maintenance, arms
Capital: one off investments - hopsitals, schools, equipment, defences
Transfer payments: not in exchange for goods, labour or rent. Often used to redistribute incomes e.g. pensions, JSA, tax credit
What is the significance of governent spending?
- component of AD
- Regional economic impact
- Provides public and merit goods
- Greater equality
- Child/unemployment benefits
- Pensions
- WEflare payments
- Education
- Healthcare
- Soial Housing
- Employment trading
What factors affect government spending?
- GDP
- Demand for public spending
- Demographics
- Business cycle
- Inflation
- Debt interest
- Discretionary fiscal policy
- Political factors
- Available wealth
- Institutions, infrastructure and history
- Demographics
What are the justifications for government spending
- Public goods tend to be under provided
- Improved public services improve human capital, productivity and gains to society - up msc
- Safety net system of welfare benefits to poorest and redistribute income and wealth
- Provide infrastructure
- Meet macroeconomic policy objectives
- Promote equality
- Efficiency and competitiveness improved
What is crowding out - how is it illustrated?
- When government spends money it leads to a transfer of scarce resources from the private sector to the public sector where productivity may be lower
- This leads to higher taxes and interest rates which squeezes profits, investment and employment in the private sector
It can be illustrated using interest rates against quantity of loan able funds. With higher government borrowing the demand for loanable funds rise, thus pushing out the demand curve and pushing up the rice
What is some evaluation of crowding out theory?
- 100% crowding out almost impossible especially if an economy is operating below capacity so there is excess supply of saving available to purchase new state debt instead of borrowing
- Fiscal deficits may actually crowd in private sector demand and investment
- Well targeted increases in spending absorb under utilized capacit and provide multiplier effect
- Supply of loanable funds is not limited to domestic sources
What is crowding in?
Increase in government spending leads to expansion of economic activity incentivizing private sector firms to raise investment and employment.
What are the impacts of cuts in government spending?
- Output, jobs and profits in construction and defence fall
- Effects on real income and poverty
- Effective demand for goods and services change
- Multiplier effects of cuts in public sector spending
- Helps investor confidence and investment
- Risk of deflationary spending if creates excess capacity
- more likely to keep interest at low levels
What are the types of tax?
Direct: income, wealth and profit e.g. income, national insurance, capital gains, corporation tax - burden not passed on
Indirect: on spending - duties on fuel, cigarettes and alcohol and VAT e.g. sugar tax - may be passed on
Progressive tax: marginal rate of tax rises as incomes rise - as you earn more you are taxed more, increasing the average rate of tax
Proportional: proportion of tax same throughout bracket
Regressive: proportion of income paid falls as incomes rise e.g. duties on tobacco and alcohol - this is because lower income earners pay a higher proportion or percentage of their incomes than high income earners.
What are the objectives of taxation?
- Fiscal policy
- Influence consumer choice
- Internalize negative external costs
- Fund public spending - defence and security
- Redistribute income and reduce inequality.
What are the progressive tax rates in the UK?
- 0 tax up to 12,500
- 20% 12501-50,000
- 40% 50,001 - 150000
- 45% above 150k
What are Smith’s ‘canons of taxation’
- Cost effective - cost of collecting lower than yield of the tax
- Clarity - how much and when to pay should be clear for taxpayers
- Convenience - how and when the tax is paid must be convenient
- Fair - levied according to ability to pay
What is fiscal drag?
-nominal pay rise to maintain rael value of wages takes workers into higher tax brackets so increases tax revenue in real terms
What is the laffer curve?
-Shows relationship between economic activity and tax rates, suggesting there is an optimum tax rate maximising tax revenues
It starts to fall because:
- Increased tax avoidance
- Incentive to evade trades
- Disincentivises labour market
- Brain drain effect - firms and people move out
It is a n shaped curve
What is some evaluation of the laffer curve?
- Lower top rate taxes may increase income inequality
- Little evidence high top rates of income tax is a barrier to inward migration as many are on lower income
- Many on fixed contracts
- Tax cuts make them take more leisure time instead of work if taxes are cut
- Other impacts such as direct and indirect taxes increasing real disposable income leading to higher consumer spending and AD
How do taxes influence AD and AS?
AD:
- TAx allowances have effect on growth
- reduce real disposable incomes
- affect post tax profits for businesses
- changes cost of employing workers in labour market
- Changes retail prices and real incomes
AS:
- SRAS and LRAS impact
- Businesss costs rise with VAT
- Changes in direct tax influence work incentive
- Business tax may affect FDI
- Affect confidence and incentive to start a business or spend on R&D.
Evaluation:
- Impact depends on scale of tax/tax cut
- Other factors affect investment e.g. technological advancements
- Some investment may lead to labour replacement e.g. robotics
What are automatic stabilisers?
-Changes in tax revenue and government spending that come about automatically as the economy moves through the business cycle
In a downturn, GDP growth slows, more employment benefits are paid out so AD is raised, partly countering the fall in growth
In an upturn, GDP rises but so will inflation, Wages will also rise, leading to workers losing real incomes to tax, counterbalancing the rise in spending
Tax: when economy expanding, tax revenue increases taking money out of the circular flow of income and spending
Welfare: growing economy means the government does not have to spend as much on means-tested welfare benefits such as income support and unemployment benefits
Budget balance: fast growing economy leads to outflow of money and slowdown government ends up spending more and revenue is lower
What is government borrowing?
The state borrows in the form of bonds. The yield on a bond is the interest rate paid on state borrowing. Purchasers of bonds may include pension funds, insurance and overseas investors.
Public sector net borrowing is the amount the government must borrow each year to fund their spending.
The public sector net cash requirement is the difference between the governments incomes from taxation and cash required to run public bodies.
As such, the PSNB is the PSNCR - any amount the government may fund in other ways that borrowing e.g. selling assets won’t change PSNCR but reduce the PSNB
What is national debt?
-Debt is a measure of the accumulated national debt owed by the state sector.
Public sector debt is owed by central and local governments as well as state owned corporations.
How does the size of a deficit change in the business cycle?
- Boom - GDP expanding, above potential - tax receipts high and spending on benefits low so reduces borrowing
- Recession - borrowing high, rising unemployment and falling real incomes.
A structural deficit is not related to the state of the economy and so will not disappear once recovered from a recession.
What factors influence the size of deficits?
- Unemployment
- Consumer spending - increases VAT revenue
- Business profits
- Automatic stabilisers
Long run factors:
- Size of welfare state
- Relative level of benefits to incomes
- Demographic factors
- Size of tax base and tax rates
- Efficiency of the public sector
What factors influence the size of debt?
- Current spending on public services
- Investment spending
- Spending on welfare
- Size of tax base
- Efficiency of tax collection
- Yield on new and existing government bond (debts)
- Willingness of lenders to give the government new credit
- Government bailouts of businesses add to debt.
