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Macroeconomics (Lecture 7) Fiscal Policy ((I. Public Spending and Revenue,…
Macroeconomics (Lecture 7) Fiscal Policy
I. Public Spending and Revenue
Motives for government spending :
Collective provision of goods and services,
Defence
Law and order
Education and health
Roads
Current expenditure on goods and
services and public investment.
Part of value added = GDP.
Redistribution of income between individuals :
Pensions
Unemployment benefits
Support for families
Transfer payments. Do not contribute to GDP.
In the U.S., transfers account for almost half of the federal budget.
This number is even higher in Europe (almost 60 %).
Why do some governments spend more than others?
.Public spending is 30% in Korea, 35-40% in US, 45-60% in Europe.
.Certain level of spending required for national defence, law and order, basic education, etc...
.Beyond that, the level of spending is a question for political choice about the level of collective provision
.Collective spending appears to be a “luxury” good, as incomes increase, we tend to expand an increasing proportion of it, collectively
.Tax revenue is a key constraint for developing countries.
Taxation and revenue
While low taxes don’t produce much revenue. Do high taxes necessarily produce high revenue?
High rates of tax on earned income discourage productive effort because:
People work less hard
They spend their time trying to avoid tax
Brightest people and firms might leave the country
-If these supply effects are strong, then cutting taxes may increase revenue-‘VOODOO’ economics!
The Laffer curve
Is there any truth behind the Laffer curve?
.Yes, beyond a certain point, higher tax rates bring in less revenue.
.It is likely to be very high-estimates suggest above 75%.
.Politicians love “voodoo economics”
.Reagan tried it out in practise:
.Tax cuts led to huge deficit.
.However for wealthy/ high income earners, a Laffer curve
does operate (e.g. football players)
Government debt and deficits
Most countries have higher spending than tax revenues.
Tax revenues and government spending
.Countries with higher spending tend to have higher tax revenues, as government needs to finance their spending.
.But taxation and spending do not have to balance since government can borrow (or accumulate assets).
.Most governments have higher spending than revenues and are indebted.