real world examples Flashcards
(23 cards)
The role of taxation in reducing poverty, income and wealth inequalities
Effective Taxation to reduce Poverty
Mexico’s Prospera Programme 1990s - 2010s
Mexican Government used tax revenues to fund Prospera Programme via income taxes (both corporate & personal), and value-added taxes (indirect)
The tax revenue funded targeted cash transfers towards specifically indigenous, rural, low income families which often suffer more from poverty due to discrimination and lack of opportunity
Furthermore, poorer households received greater cash transfers
To ensure these cash transfers also increased human capital via health, and education, the cash transfers were provided based on conditions that children attended school, had health check-ups, and had more nutritious food, wherein, these conditional cash transfers to rural families were significant as these groups were most likely to leave school prematurely, and neglect health
This had SR impacts of immediate relief to families, and LR impacts of breaking the poverty cycle through incentivising education and healthcare which provides opportunities to these disadvantaged groups
Effectiveness: decreased the extent, and severity of poverty, increased human capital through greater child health, nutrition, and education rates, and reduced income inequality gaps via direct redistribution of wealth
The role of taxation in reducing poverty, income and wealth inequalities
Ineffective Taxation to reduce Poverty
New Zealand’s Tax System
Although NZ has a progressive income tax system, as their tax system excludes a capital gains tax, the wealthier individuals end-up paying less tax than middle-class families as wealthier individuals have the majority of their income is in the form of capital gains, thus in effect, a regressive tax.
According to the IRD from a report in 2023, the wealthiest families pay an effective tax rate of under 10%, whereas, middle-classes pay an effective tax rate of 20.2%—thus potentially disincentivising increasing ones tax bracket to middle class
Capital gains are often the primary form of income for the top 1% of earners, yet they go untaxed in New Zealand. This loophole allows wealthy individuals to accumulate wealth more rapidly while paying proportionally less in taxes—worsening wealth inequality.
Insufficient tax revenue from wealthy is forgone revenue which could have been used for poverty, and inequality reduction
Ineffective wealth distribution causes the cycle of poverty to be perpetuated
This demonstrates that tax systems may not always be effective in addressing inequality, as the structure of the tax system is important, depending on whether the structure targets income of wealthy individuals, or that of middle-class individuals
Expansionary monetary policies to close deflationary gaps
Effectiveness
Abenomics Japan 2010s
In an attempt to combat deflation, the Japanese government pursued a mix of monetary easing by the BoJ, fiscal stimulus and structural reforms.
Although the expansionary monetary policy was effective in combating deflation, it took time and required complementary policies
Expansionary monetary policies to close deflationary gaps
Ineffectiveness
Japan’s Lost Decade 1990s
Japan faced prolonged deflation and stagflation.
The BoJ lowered interest rates to near zero and engaged in large asset purchases (quantitative easing).
Despite these efforts, borrowing and investments did not increase because Japan was in liquidity trap where individuals were preferring to hold cash due to low confidence.
Japan experienced persistent deflation, which created a vicious cycle of falling prices leading consumers to delay purchases, expecting goods to be cheaper in the future. This reduced demand, causing businesses to cut prices further, reinforcing the deflationary trend.
The real value of debt increased over time, discouraging borrowing even at low interest rates
Contractionary monetary policies to close inflationary gaps
Effectiveness
Volcker Shock in US 1979-1982
The US was facing extremely high inflation in double digits
The federal reserve raised interest rates significantly tightening money supply and curbing lending
By 1983 interest dropped to 3%
It laid the foundation of low inflation and steady economic growth
However, unemployment increased to 10% and economic activity was reduced
Expansionary fiscal policy to close deflationary gaps
Effectiveness
The Great Recession US 2007-2009
The Great Recession occurred as a result of high housing debts and failure in financial regulation.
Combination of tax cuts and increased government spending, especially to support house owners and the mortgage market to combat the housing crisis during the time, was implemented to support the economy.
Helped stabilise the economy by promoting recovery
Additionally, unemployment benefits served as an automatic stabiliser as more individuals were laid off, they were qualified for unemployment compensation which helped to support AD.
Decreased government revenue and increased spending resulted in significant government debt increases
Expansionary fiscal policy to close deflationary gaps
Ineffective
Japan’s Lost Decade 1990s
As well as expansionary monetary policies, the Japan government also implemented several fiscal stimulus packages such as tax cuts and provision of merit and public goods during the Lost Decade.
However, this was ineffective as the tax cuts were inconsistently implemented and not targeted. Additionally, a lot of the fiscal spending went towards public work projects which had low productivity and did not stimulate the economy.
The government also misunderstood the cause of the recession, treating it as cyclical instead of structural. This led to ineffective fiscal stimulus instead of structural reforms.
Between 1993 and 2000, average growth was slightly above 1%, and tax revenue remained almost flat, leading to larger fiscal deficits.
Government debt as a percentage of GDP rose from around 60% in 1990 to over 140% by 2000
Contractionary fiscal policies to close inflationary gaps
Effectiveness
Argentina government 2024
There are deep cuts in government spending on public expenditures, including a 35% reduction in real primary expenditures compared to the previous year.
Deficit Reduction: The government set an ambitious goal to cut the budget deficit by 5% points of GDP in 2024.
Pension Reductions: Pensions decreased by 36% year-over-year, contributing 43% of the total reduction in government budget deficit. The minimum monthly pension is approximately $233, while the cost of a standard basket of goods and services exceeds $300 per month. This has pushed many retirees below the poverty line. The pension cuts have contributed to rising poverty levels, with more than half of the population now living in poverty.
Subsidy Reductions: Economic subsidies, particularly for energy firms, have been reduced.
Although a slow recovery of real wages and an improved 2023/24 agricultural harvest may provide short-term relief, the government must seek alternative fiscal strategies to mitigate the heavy toll on the private sector to ensure economic growth.
Disproportionate impact of austerity: More than 33% of President Milei’s fiscal adjustment has fallen on the retirement and pension system, which benefits seven million people.
Legal challenges: The complexity of pension reforms and non-compliance with constitutional provisions for pension mobility has resulted in numerous legal actions by beneficiaries, creating uncertainty in the system.
Interventionist supply side policy
South Korea 1960s - 1990s
Government invested heavily in education and skills development to build a highly skilled workforce
Focus on technological education fostered a culture of innovation. Leading to the sustained growth of high-tech industries.
Annual GDP growth rate increased to 8.6% from 1962 to 1989
Literacy rates increased from 71% to 98%
Unemployment rate decreased from 8.1% to 2.4%
The country’s export-oriented industrialization strategy, implemented through five-year plans, led to significant increases in GDP and export revenues. This economic expansion provided the government with increasing tax revenues, reducing the need for extensive borrowing.
Additionally, the flexibility of the south korean labour market due to minimal government intervention, lack of bargaining power and employee rights allowed its economy to rapidly grow further reducing the need for the government to borrow and not experience a time lag.
The South Korean government closely managed its external borrowing by borrowing domestically from the chaebols (large conglomerates) which led to their outsized influence on the economy and inefficient allocation of resources.
Market based supply side policy
The Reagan administration in the US 1980s
Incentive based: The administration reduced tax on business and consumers to incentivise unemployed workers and existing workers to work harder. Manufacturing productivity grew 3.8% annually and the real GDP had an annual growth rate of 3.6%
Deregulation: Deregulation in telecommunications and electricity allowed an increase in competition which increased efficiency and resource allocation in these sectors. Thus leading to economic growth.
Unemployment fell from 7% to 5.4% in 1988
Tax cuts disproportionately benefited high income earners and stock owners, income inequality increased significantly. By 1986, over 30% of black Americans had income below the official poverty level and the Gini coefficient increased significantly, reaching 0.45 compared to white Americans with 0.382.
To try and balance the reduced government revenue, Reagan reduced funding to multiple domestic welfare programs, including Social Security, Medicaid, Food Stamps, education, and job training programs. This likely had a negative impact on lower-income Americans who relied on these programs.
Although more jobs were created through labour market reform and incentives, there was a shift in job quality. Instead of more highly paid jobs, there was an acceleration of lower-paying, non-union, often part-time jobs. Almost half of the new jobs created during the Reagan years were part-time
Relative costs of unemployment versus inflation
Cost of high unemployment
2008 U.S financial crisis is an example of high unemployment which then lead to the great recession
The unemployment rate doubled and remaining elevated years after the recession
This unemployment had severe and LR costs for American workers and their families as job losses and wage cuts occurred and persisted over a 3-year period which displaced workers, and reduced earnings
Household net worth dropped significantly, causing many to forgo spending on essentials such as healthcare causing displaced workers to have reduced life expectancy, and worsening inequality as African Americans were disproportionately affected by unemployment
High levels of underemployment and discouraged in the future after the recession & took over 10 years for unemployment to restore to before recession
Housing market collapsed significantly decrease household wealth, and decreasing aggregate demand
GDP fell by over 4% causing business failure
Long-term the government realised the importance of labour market reforms that needed to occur and unemployment benefits to safeguard against the consequences in significant surges in unemployment from occurring again
Relative costs of unemployment versus inflation
Cost of high inflation
The Great Inflation in the US between 1960s-1982 is an example of consequences of high inflation rates
Inflation was in double-digits, which eroded purchasing power which is regressionary, and disproportionately impacted already disadvantaged groups, such as retirees, lower income households.
Inflation reduced disposable income, and increased prices of goods including groceries, utilities, and petrol which are essential goods. This also caused consumer behaviour changes where people cut back on non-essential spending, and rushed to buy goods before prices increased further.
As workers felt the decline of their real wages, labour unrest occurred causing labour disputes and strikes
Higher interest rates to nearly 20% to combat inflation made borrowing extremely expensive
Slowed economic growth resulted from economic uncertainty and interest rates as businesses found it difficult to expand
Long-term effects of this high inflation shifted the policy of monetary policy in U.S., as the importance of maintaining price stability was gained, and allowed the public to gain trust in the Federal Reserve
Appropriateness of using GDP or GNI statistics to measure economic well-being
Comparing between countries
Costa Rica consistently ranks high in global happiness indices despite having a much lower GDP per capita than many developed nations. In 2019, Costa Rica ranked 12th in the World Happiness Report while having a GDP per capita of about $12,000, compared to the United States ranking 19th with a GDP per capita of about $65,000.
In Sub-Saharan Africa, the informal economy is estimated to account for about 40% of GDP. This means that a significant portion of economic activity is not reflected in official GDP figures, potentially underestimating the true level of economic activity and well-being.
Appropriateness of using GDP or GNI statistics to measure economic well-being
Comparing over time
Assumptions and implications of the monetarist/new classical and Keynesian models
Monetarist/new classical
Government intervention to close deflationary gaps
During the 1920-1921 depression in the US, the government allowed the market forces to operate freely which led to a rapid recovery. The government significantly reduced spending by cutting the federal budget by 65% from 1919 to 1920.
The government also did not implement policies to prevent wages and prices from falling which allowed wage and price adjustments according to market forces. This allowed the economy to reallocate resources to more productive uses. Falling wages helped prevent mass unemployment by allowing firms to maintain profitability.
The recovery from this depression was remarkably fast as by 1922 the industrial production returned to its peak levels, unemployment fell rapidly to reach 2.4% by 1923. This allowed the economy to enter a period of strong economic growth.
AD/AS policies
Additionally, new classical views believe that AD increases can only lead to inflation and that economic policies should focus on achieving long term growth via increases in LRAS. An example of this is the Reagan administration in the US 1980s.
Incentive based: The administration reduced tax on business and consumers to incentivise unemployed workers and existing workers to work harder. Manufacturing productivity grew 3.8% annually and the real GDP had an annual growth rate of 3.6%
Deregulation: Deregulation in telecommunications and electricity allowed an increase in competition which increased efficiency and resource allocation in these sectors.
Thus leading to economic growth.
Unemployment fell from 7% to 5.4% in 1988
Assumptions and implications of the monetarist/new classical and Keynesian models
Keynesian
Government intervention to close deflationary gaps
The Keynesian model argues that government intervention is needed for the economy to come out of a deflationary gap as it can get stuck in the short run.
An example of Keynesian thinking is Abenomics in Japan 2010s, where the Japanese government emphasised government intervention, amongst other approaches, to stimulate the economy.
Abenomics focused on stimulating short term growth, fiscal stimulus, as one out of its three ‘arrows’. Under this ‘arrow’ Abenomics involved increasing government spending which is a Keynesian approach to boosting AD. This included over 10.3 trillion yen in direct government spending on infrastructure projects. The government also intervened to create 600,000 jobs in two years to reduce unemployment and stimulate economic activity.
AD/AS policies
Additionally, Keynesians believed that stimulating AD is a crucial driving factor in allowing the economy to recover from a deflationary gap and achieve economic growth.
This fiscal stimulus aligns with the belief that AD boosts from the government are needed to break out of the short run. The positive effects of the fiscal stimulus is seen as unemployment rate fell to 2.7% which was the lowest in 23 years, and ratio of public debt to GDP stabilised after years of rapid increase. Japan’s GDP grew for seven consecutive quarters, its longest spell of uninterrupted growth in 16 years.
However, Abenomics also included monetary easing and structural reforms to complement the fiscal stimulus. This could suggest that AD stimuli are not enough.
Potential conflict between macroeconomic objectives
Trade-off between unemployment and inflation (short run vs long run philips curve)
Short run Philips curve
Short run Phillips curve - Volcker Shock in US 1979-1982
This shows an inverse relationship between unemployment and inflation rates
The US was facing extremely high inflation in double digits
The federal reserve raised interest rates significantly tightening money supply and curbing lending
By 1983 interest dropped to 3%
However, unemployment increased to 10% and economic activity was reduced
Potential conflict between macroeconomic objectives
Trade-off between unemployment and inflation (short run vs long run philips curve)
Long run Philips curve
Long run Phillips curve - Stagflation
The long-run Phillips curve suggests that there is no permanent trade-off between inflation and unemployment. In the long run, the economy tends to return to its natural rate of unemployment regardless of the inflation rate.
The U.S. experienced both high unemployment (above 8% by 1975) and high inflation (over 12% by 1974).
Potential conflict between macroeconomics objectives
High economic growth and low inflation
China managed to maintain relatively low inflation while achieving high economic growth rates. In 2022, China’s inflation rate was 1.8%, one of the lowest in the world. Meanwhile, the country has consistently achieved high GDP growth rates over the past decades, often exceeding 6% annually.
China was able to achieve this due to strategically developing specific sectors such as advanced technology and manufacturing and new infrastructure, these sectors support the quality and sustainability of economic development and growth. They also have market-oriented reforms which introduced profit incentives to rural enterprises which increased economic efficiency.
Potential conflict between macroeconomics objectives
High economic growth and environmental sustainability
Refer to consequences of growth Japan 1960 - 1990 to see the conflict
However, high economic growth and environmental sustainability can be pursued together when the government takes appropriate measures. An example of this is Costa Rica.
From 1960 to 2019, Costa Rica’s GDP per capita has more than tripled from 2000 to 12000. Despite this growth, nearly 100% of Costa Rica’s electricity comes from renewable sources and forest cover increased from 26% in 1983 to over 50% today, thanks to policies that incentivize forest protection and reforestation. This allows Costa Rica to have successfully developed a sustainable tourism industry that contributes to both economic growth and environmental conservation.
Potential conflict between macroeconomics objectives
High economic growth and equity in income distribution
Refer to consequences of growth Reagan administration to see the conflict
The conflict between equity in income distribution and high economic growth can be avoided according to the type of policy countries adopt. The Asian tigers had extremely high economic growth rates and income distribution remained relatively stable, especially in South Korea. Due to the interventionist supply side policies the government implemented, South Korea experienced annual GDP growth rate increases to 8.6% from 1962 to 1989. This was accompanied by a gradual decrease in the Gini coefficient from 0.344 in 1965 to 0.281 in 1995. This was made possible by investments in primary and secondary education which allowed the development of workforce productivity and created a larger and more skilled labour force.
Consequences of economic growth
impact on the environment
South Korea 1960s - 1990s Supply-side interventionist policy
Rapid industrialization as a result of rapid economic growth led to unsustainable environmental degradation, as development was prioritised over environmental protection. A dramatic increase in energy demand was met through fossil fuels. This resulted in air pollution, water contamination, and deforestation, and increased carbon emissions.
Despite recent efforts such as the Green Growth Initiative in 2008, South Korea was still the 10th largest energy consumer globally in 2010, importing 97% of its total energy needs.
Consequences of economic growth
impact on income distribution and living standards
Reagan’s administration US 1980s
Tax cuts disproportionately benefited high income earners and stock owners, income inequality increased significantly. By 1986, over 30% of black Americans had income below the official poverty level and the Gini coefficient increased significantly, reaching 0.45 compared to white Americans with 0.382.
To try and balance the reduced government revenue, Reagan reduced funding to multiple domestic welfare programs, including Social Security, Medicaid, Food Stamps, education, and job training programs. This likely had a negative impact on lower-income Americans who relied on these programs.
Although more jobs were created through labour market reform and incentives, there was a shift in job quality. Instead of more highly paid jobs, there was an acceleration of lower-paying, non-union, often part-time jobs. Almost half of the new jobs created during the Reagan years were part-time
Widening income gap despite economic growth, wherein, top income earners experience significant income gains, whilst middle and lower classes reap relatively modest growth.
