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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 choice
Plan:
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 trap
A 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 deficits
Plan:

Cutting expenditure

Advantages:
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 inefficient
Disadvantages:
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 taxes
Advantages:
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 AD

There 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 expensive
It 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.