Economics essays

A) Many countries have experienced a substantial rise in their fiscal deficits since 2008. Assess the factors which might explain this trend in the public finances of a country of your choicePlan: Economic crash of 08 leads to high unemployment as businesses cut costs, so fewer income tax receipts have to pay out unemployment benefits Banks reluctant to loan money due to uncertainty and low confidence, therefore less spending and again fewer tax receipts, also had to bail out the banks. The UK spends a lot of money on supply side measures like education + health and a lot on welfare benefits poverty trapA fiscal deficit is described as being when a government spends more money than it has. When its expenditure exceeds tax receipts. The financial crash of 2008 would have had a significant impact on worsening the fiscal deficit due to a number of reasons, primarily because government income fell coupled with increased government spending. A lot of firms and businesses had to cut costs, leading to a lot of unemployment. This is a huge contribution towards the worsening of the budget deficit, because it means that the government misses out on income tax receipts, while at the same time having to hand out unemployment benefits to those made redundant. Also, a person who is unemployed is less likely to spend money on big purchases, so again the government misses out on indirect taxes such as VAT and other taxes on spending. This again contributes towards the worsening of the fiscal deficit.Another significant factor would be the reluctance of the banks to lend money following the financial crisis. The financial crisis was really brought about by the banks by over-lending, so the uncertainty and lacking confidence of the banks to lend again is understandable. This means that consumers spend less money on goods, even though the interest rates were set at 0.5% to make borrowing money cheaper, and to try and stimulate AD to increase. The UK government had established austerity measures by extremely harsh budget cuts to the public sector, such as NHS and education funding. The decrease in both consumer and government spending will depress AD, putting the economy into a recession. The fact that the government also had to bail out the banks during the financial crisis would also contribute towards the rising fiscal deficit.The UK has quite a high propensity to spend money on supply side measures, like the NHS and education. This could be another reason why the budget deficit is so deep. The fact that the government had to make such steep spending cuts would mean that, with the consideration of time lags, our potential output capacity has been harmed, since the NHS and education were the hardest hit by spending cuts by the UK government.However, having a budget deficit may not actually be a problem, so long as the debt can be serviced and is kept under relative control. Spending more money than you actually have means borrowing to invest in supply side measures like education, healthcare and infrastructure which will increase labour productivity and output capacity in the long run. The most important factor contributing towards the UKs fiscal deficit would be the banks reluctance to loan more money, meaning consumption and investment decreases considerably, yielding less tax receipts for the government.B) Evaluate the case for cutting expenditure rather than raising taxes as a means of reducing fiscal deficitsPlan: Cutting expenditureAdvantages: Taxes remain at current level, may also be reduced (dependant on degree of spending cuts) so consumer demand not affected, continue to spend Large influential corporations remain in UK if taxes arent increased, less gov expenditure may lead to deregulation Effective and direct way to balance deficit (short run) Public sector inefficientDisadvantages: May lead to further inequality because welfare benefits may be cut Damaging in the long run, as could potentially reduce productive capacity for the UK as education + health is hit (long run) consideration of time lags Decrease in AD, causing output to decrease and price to increase Effective short term, but not a terribly resourceful approach in consideration of the long run

Raising taxesAdvantages: Increase tax receipts for government, reducing the fiscal deficit Gov expenditure need not be cut, avoiding the aforementioned problems Can aid with redistribution of wealth with progressive taxation Disadvantages: Big firms and corporations may leave the UK to avoid higher taxes Acts as a considerable disincentive to work, leads to stagnation of employees People consume less, depressing ADThere is no clear cut side to take, as both measures would seem to an equally effective, while at the same time detrimental impact on the UK economy. Cutting public expenditure would be an effective and quick way to reduce the fiscal deficit, giving the UK government the resources it needs to start paying off its debts. Cutting expenditure would mean that taxes can stay at their current level, giving big firms no reason to leave the country. Also the public sector can be very inefficient, as there is no profit motive, and so not as powerful incentive to cut costs. Running such a large public sector will continue to be a drain on resources in the long run, and will require us to continually borrow in order to fund it.However, cutting expenditure in the public sector may have many externalities. So much money is spent on NHS and education in the UK, to reduce expenditure on these two vitally important institutions would assuredly damage our economies productive capacity, which would be detrimental to society in the long run. However, it may take a while for these problems to be noticeable in the economy, due to considerable time lags associated with education and healthcare. To cut government expenditure would also mean cutting welfare benefits, leading to somewhat pernicious social consequences and would only increase the income inequality gap.Raising taxes, although unpopular in the estimation of many, particularly those on the fringes of tax brackets, may prove just as effective in servicing the fiscal deficit. More tax receipts would aid in closing the deficit gap, and would also help close the income inequality gap, if the government increased the rate of progressive taxation. Also, clamping down on those corporations who avoid tax such as Starbucks and Google might help alleviate the burden of direct taxation of the average Joe. An alternative would be to focus in on increasing direct taxation, so consumers feel as if they have more money. However, if placed too high, consumers are likely to import cheaper alternatives, and so the government would miss out on the tax receipt altogether. Raising taxation would also mean that the aforementioned problems of cutting public expenditure could be bypassed.However, it is never a popular option to increase taxation. Firms may leave the UK market to avoid heavy taxation, taking their revenues and business with them, meaning the government would then not be able to tax the profits. Higher taxation also leads to disincentives to work and go for those promotions, leading to stagnation of employees, as higher income would mean more tax, particularly true of those earners on the fringes of tax brackets. Raising taxes would also depress AD as consumers consume less, as consumption becomes more expensiveIt may be worth considering introducing tariffs on certain goods as a form of taxation. This depends largely on the price elasticity of imports, and seeing as the UK has quite a large propensity to import, an increase in the price of imports is unlikely to offset people too much. It also depends on the exchange rate and the strength of the pound against the respective currency.