impact of fiscal policies to reduce fiscal deficit (3)

Question 1

macro impact of increasing tax rate to reduce fiscal deficit

Answer 1

INCOME TAX + CORPORATE TAX
[biggest sources of tax revenue in the UK]
- less disposable income for consumers, less retained profits for businesses -> more tax revenue for the gov. -> reduced fiscal deficit -> more funds available for public expenditure -> improved living standards

INDIRECT TAX e.g. VAT
- increase tax revenues, especially for price inelastic goods -> reduced budget deficit

Question 2

evaluate the macro impact of increasing tax rate to reduce fiscal deficit

Answer 2

• EVAL: -> revenue may not rise due to the Laffer Curve (higher-income earners may leave the country to ones w/ lower tax rates e.g. Qatar, UAE, resulting in brain drain OR individuals may engage in tax avoidance/evasion OR less incentive to work) -> fiscal deficit ot improved
• EVAL: may increase production costs for firms -> less SRAS -> less growth; may increase inequality as VAT disportionately affects low-income households more -> Lorenz Curve shfts further away from line of equality

Question 3

macro 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 -> interest rates fall -> COB falls -> more funds available for private sector investment
• 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 macro 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

Question 5

briefly explain how the gov would react to a fiscal deficit

Answer 5

• engage in austerity measures (e.g. reduced spending and/or increased taxation)

Question 6

what is meant by ‘fiscal deficit’ and ‘national debt’

Answer 6

• fiscal deficit -> where gov. expenditure exceeds gov. revenue
• national debt -> the total amount of money that a country owes to its creditors

Question 7

micro impact of fiscal policies to reduce fiscal deficit

Answer 7

• reduces profits for firms -> higher corporate tax = less retained profits = less funds available for investment in capital, R&D + expansion -> lower profitability can discourage new entrants -> reduced contestability and reduced dynamic efficiency -> limited quality improvements
• less competitive tendering -> cuts in spending on infrastructure projects, education, healthcare -> less public contracts for pirvate businesses e.g. IT providers, textbook publishers, etc.
• reduced profits + incr unemployment -> higher income tax rates = less disposable income = less spending on goods and services = less revenue for firms = less profits -> firms may resort to cost-cutting measures to maintain profit e.g. automation -> job losses

Question 8

evaluate micro impact of fiscal policies to reduce fiscal deficit

Answer 8

• higher taxes may force firms to use resources more efficiently
• austerity may encouage private sector innovation by reducing reliance on gov. contracts
• if austerity is successful -> interest rates may fall in the long-term -> private sector investment likely to boost
• extent of job losses depends on other factors affecting demand for labour
• extent of fall in revenue may depend on YED e.g. if real incomes fall, quantity demanded for inferior goods may rise which would increase revenue for those firms