Unit 4-Public Sector

•     What are the three categories of public expenditure?

  • Current
  • Capital
  • Transfer payments
• What is Capital expenditure?

  investments in infrastructure and capital equipment.
• What are Transfer Payments?

  Payments made by the government for which no goods/services are exchanged. E.g. Unemployment benefits, disability payments, subsidies to producers and consumers etc
• What are Current expenditures?

  daily payments required to run the government and public sector. E.g. The wages and salaries of public employees
• Why is the size and composition of public expenditure changing? (Name three factors)

  • Changing incomes
  • Changing age distributions
  • Changing expectations
• How are changing incomes affecting public expenditure?

  • The level of income in a country determines government expenditure as it means an increase or decrease in tax revenues
  • As incomes increase, citizens demand higher quantity and quality of services
• How are changing age distributions affecting public expenditure?

  • Developed countries now have low birth rates = increase in ageing population
  • Life expectancy has increased = increased gov spending on pensions and healthcare
• How are changing expectations affecting public expenditure?

  Change in societal norms pressure governments to meet the new demands of citizens.
• How did the UK handle the 2008 Global Financial Crisis?

  • They increased borrowing to avoid a long-lasting depression
  • Their borrowing demanded repayment with interest
  • The repayment led to a cut in their expenditure and a raise in taxes
• What are the benefits of public expenditure?

  • Improvements to the supply-side of the economy through spending in health, education, and infrastrcuture.
  • Raises standards of living for all
  • Reduces poverty and inequality in the distribution of income
  • Incentives innovation by providing long-term funding for firms
• What are the negative effects of public expenditure?

  • creates opportunity for corruption which can actually decrease the standard of living
  • Tax levels increase
  • If the spending is not spread evenly throughout different regions of the country, it can create inequality of opportunity
  • If the government is in a budget deficit, they'll need to borrow funds from the private sector
• What are the classifications of tax systems?

  Progressive, regressive, proportional.
• Common tax system across nations?

  a mix of progressive (direct taxation) and regressive (indirect taxation) taxes in place
• Progressive tax system

  as income rises, a larger percentage of income is paid in tax
• What are Marginal Tax rates?

  The amount of additional income taxed as income levels increase
• What is the Regressive tax system?

  as income rises, a smaller percentage of income is paid in tax (tax decreases)
• • How do regressive taxes impact low-income households?

  Negatively: As incomes are low, taxes are high which trap them in a cycle of poverty
• What is the Proportional tax system?

  percentage of income paid in tax is constant, no matter what the level of income
• What are the factors affected by tax rate changes?

  • Incentive to work
  • Tax revenues
  • Income distribution
  • Real output and employment
  • Avg. price level
  • Trade balance
  • Foreign Direct Investment
• How do tax rate changes affect the incentive to work?

  higher the tax rate, the lower the incentive for the unemployed to seek work- and vice versa
• How do tax rate changes affect tax revenues?

  • Laffer curve explains this relationship
  • As rates increase, disincentivized workers work less = less income and tax revenue
• What is the Laffer curve?

  illustrates the relationship between increasing tax rates and the level of government revenues received
• How do tax rate changes affect income distribution?

  Aprogressive tax system redistributes from those with higher income to those with lower income and reduces income inequality
• How are the benefits of the Progressive tax system eradicated?

  benefits of a good progressive tax system are eradicated by the penalties imposed through multiple regressive (indirect) taxes
• How are tax rate changes impacted by real output and employment?

  • tax rate increases, more money is withdrawn from the circular flow of income (leakage)
  • reduction of aggregate demand (AD) = less disposable income
  • AD slows down = unemployment rise
  • And vice-versa
• How do tax rate changes impact avg. price level?

  • increase in indirect taxes reduces disposable income and so workers may petition their employer for a salary increase
  • This leads to a wage-price spiral
  • indirect taxes increase COP = cost-push inflation
• What is the wage-price spiral?

  a vicious cycle where rising wages lead to businesses raising prices, which then prompts workers to demand even higher wages to keep up with the increased cost of living, causing prices to rise further, and repeating the cycle, resulting in sustained inflation.
• What is cost-push inflation?

  Increase in prices due to increased production costs, such as wages or raw materials.
• How do tax rate changes affect the trade balance?

  • An increase in taxes can reduce disposable income which is likely to reduce the level of imports
  • This may improve the trade balance
  • And vice-versa
• How do tax rate changes affect the flow of foreign direct investment?

  rate of corporation tax increases relative to other countries, it may result in less inward

  • And vice-versa
• What are Automatic Stabilizers?

  automatic fiscal changes as the economy moves through stages of the business/trade cycle

  • Do not require government intervention as they happen automatically in the background
• What is Discretionary fiscal policy?

  demand-side policy that uses government spending and taxation policy to influence aggregate demand (AD)
• Difference between a fiscal deficit and national debt?

  • Fiscal deficit: occurs when the level of government spending is greater than the government tax revenue in any given year
  • National debt: accumulation of all previous deficits.
• What are Cyclical deficits?

  Deficits that occur due to downturns in the business/trade cycle, usually as a result of a recession

  • Governments receive less tax revenue as profits and income fall - and government spending increases
  • These deficits tend to self-correct as the economy starts to grow again
• What are Structural deficits?

  Persistent budget shortfalls even when the economy is at full employment.

  • Difficult to correct
  • Caused by widespread tax avoidance culture or poor governance
• What factors influence the size of fiscal deficits?

  • State of the economy: Boom or recession
  • Housing market
  • Political priorities
  • Unforeseen events
• How does the housing market influence the size of fiscal deficits?

  he government receives an indirect tax from property sales (stamp duty). This revenue increases when an economy is doing well and helps to reduce fiscal deficits
• What factors influence the size of national debts?

  • Size of fiscal deficits
  • Government policies
• How do the size of fiscal deficits affect the size of national debts?

  • the size of the fiscal deficit each year will grow by the size of the deficit
  • the UK were to run a budget surplus in any year, this additional revenue could be used to pay back some of the debt - or it may be used to fund government spending or investment in the following year
• How do government policies affect the size of national debts?

  • tax revenue and government spending which can change the level of the fiscal deficit leading to a change in the national debt level