Macroeconomics: Taxation and Budget Deficit (Definitions: (A budget…
Macroeconomics: Taxation and Budget Deficit
Takes some % of income, whatever income band
Is taken from peoples earnings directly (e.g income tax)
Occurs when an increase in income leads to a smaller % of their income going on the tax
: Is paid by firms selling goods (e.g VAT)
Occurs when those on higher income levels pay a higher % of their income in the tax.
Reason for tax:
Promoting redistribution of income and wealth
Discouraging consumption/production of goods with negative externalities or demerit goods
Impact of increasing the rate of income tax:
Higher income tax may encourage tax evasion as higher rates could increase the incentive for people to work abroad
Higher marginal tax rates may reduce incentives to work and do overtime. The substitution effect states higher income tax will make work relatively less attractive.
Higher income tax should increase tax revenues. The government can spend more on public services and benefits to reduce inequality and fun capital investment
Higher rates of income tax can help redistribute income from high earners to low earners and create more equality
Higher tax rates will reduce disposable income and lead to lower consumer spending. Ceteris paribus, this could lead to lower economic growth and lower inflation.
Evaluation of higher income taxes:
If income tax revenue is invested in improved infrastructure, it can the benefit long-run productivity capacity. If income tax revenue is needed for the welfare payments, there will be no increase in productivity capacity.
The Laffer curve suggests there comes a point where higher income tax rates leads to a decline in tax revenue, because people stop working if tax is to high
Some fear higher income tax rates could create disincentives to work. But other economists suggest evidence is mixed. The substitution effect of a tax rise may make people work less, but the income effect encourages them to work more.
A budget surplus
occurs if government spending is less than tax revenue
A balanced budge
t occurs if government spending equals tax revenue
The budget deficit
is the annual amount the government needs to borrow from the private sector. it is the difference between government spending and tax revenue
refers to the budget position
Primary budget balance
refers to budget position ignoring interest payments.The primary deficit includes just current expenditure and current tax revenue.
The overall budget
includes interest payments and all types of spending
Factors influencing the sizeof the budget deficit
Fiscal policy: If a government pursued expansionary fiscal policy, it will cause a budget deficit, at least in the short run
Demographics: If a country has an ageing population, this will cause a higher demand on pension spending and healthcare. This may cause a rise in borrowing.
Government spending decisions: If the government wanted to spend more on health/education without increasing taxes
Rules on borrowing levels: Countries in the Eurozone are oblige to meet certain criteria to keep structural borrowing less the 3% of GDP.
State of the Economy: A booming economy will help reduce the deficit through improving tax receipts and less need for welfare payments
Economic effect of higher Government borrowing:
A budget deficit implies lower taxes and increased government spending; ceteris paribus, this will increase AD and may cause higher real GDP and inflation
Higher taxes and lower spending:
In the future, the government may have to increase taxes or cut spending in order to reduce the deficit. Higher taxes may cause reduced incentives to work.
: Increased government spending to increase AD may cause a corresponding decrease in the size of the private sector because of crowding out.
Loss of confidence:
Countries with high levels of government borrowing may struggle to attract foreign investors.