How governments tax, spend and borrow — and how they use the whole policy toolkit in a connected global economy. This sub-theme builds directly on the macro polic…
How governments tax, spend and borrow — and how they use the whole policy toolkit in a connected global economy. This sub-theme builds directly on the macro policy you met in Unit 2.
🎯 Learning objectives — by the end of 4.5 you can…
- distinguish capital, current and transfer public spending and explain why it changes; - classify taxes and analyse the effects of tax changes, including the Laffer curve; - distinguish fiscal deficits from national debt, and structural from cyclical deficits; - evaluate the use of macro policy in a global context and the problems policymakers face.
4.5.1 Public expenditure
Spec: 4.5.1
Key terms
Three kinds of public spending
Capital expenditure — Investment in long-lived assets — infrastructure, hospitals, schools.
Current expenditure — Day-to-day running costs — public-sector salaries, medicines.
Transfer payments — Payments with no output in return — benefits and pensions (redistribution).
The size and pattern of public spending change with rising incomes (more demand for health and welfare), an ageing population (more pensions and healthcare), and changing expectations. A higher level of public spending as a share of GDP affects productivity and growth (good infrastructure helps; waste hurts), can cause crowding out of the private sector, and requires higher taxation.
4.5.2 Taxation & the Laffer curve
Spec: 4.5.2
Direct taxes fall on income and wealth (income tax, corporation tax); indirect taxes fall on spending (VAT). A tax is progressive if the rate rises with income, proportional if the rate is flat, and regressive if the rate falls as income rises (most indirect taxes are regressive).
Changing tax rates affects incentives to work, income distribution, output and employment, the price level, the trade balance and FDI flows — and, importantly, tax revenue, which is captured by the Laffer curve:
Exam tip
The Laffer curve is an evaluation goldmine: a tax cut can raise revenue only if the economy is to the right of T. We rarely know exactly where T is — so use the Laffer curve to argue "it depends".
4.5.3 Borrowing & national debt
Spec: 4.5.3
Key terms
Four distinctions to get right
- Fiscal deficit vs surplus: a deficit means the government spends more than it raises in a year. - Automatic stabilisers vs discretionary policy: stabilisers (benefits, taxes) smooth the cycle automatically; discretionary policy is a deliberate change. - Deficit vs national debt: the deficit is an annual flow; the national debt is the accumulated stock of all past deficits. - Structural vs cyclical deficit: a structural deficit remains even at full employment; a cyclical deficit is caused by a downturn.
The significance of large deficits and debts lies in their impact on interest rates (more borrowing can push rates up), debt-servicing costs (interest crowds out other spending), and intergenerational equity (today's borrowing is tomorrow's tax bill).
4.5.4 Macro policy in a global context
Spec: 4.5.4
Governments combine fiscal, monetary, exchange-rate and supply-side policies (and direct controls) to reduce deficits and debt, control inflation, respond to external shocks, and reduce poverty and inequality. The 2008 global financial crisis triggered large demand-side responses — fiscal stimulus, quantitative easing and near-zero interest rates.
Key terms
Controlling TNCs & the limits of policy
- Controlling TNCs: measures to reduce tax avoidance and regulate transfer pricing — but TNCs can relocate, so government power is limited. - Policy reaches local, national and global economies — actions in one country spill over to others. - Problems policymakers face: inaccurate information, risks and uncertainties, and an inability to control external shocks (pandemics, oil-price spikes, financial contagion).
4.5 Recap — nail these
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