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Chapter 17 Taxes and government spending

Chapter 17 Taxes and government spending. David Begg, Stanley Fischer and Rudiger Dornbusch, Economics , 6th Edition, McGraw-Hill, 2000 Power Point presentation by Peter Smith. Government spending in the UK. The scale of government spending has changed over the past four decades.

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Chapter 17 Taxes and government spending

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  1. Chapter 17Taxes and government spending David Begg, Stanley Fischer and Rudiger Dornbusch, Economics, 6th Edition, McGraw-Hill, 2000 Power Point presentation by Peter Smith

  2. Government spending in the UK • The scale of government spending has changed over the past four decades. • It is now running at just under 40%.

  3. Government spending We may justify government spending on two grounds: • EQUITY • a progressive tax and transfer system redistributes income from rich to poor • EFFICIENCY • correction of market failure may improve resource allocation

  4. Private and public goods • A private good • if consumed by one person, cannot be consumed by another person. • e.g. dental treatment • A public good • even if consumed by one person, can still be consumed by other people. • e.g. street lighting There are strong externalities associated with public goods, so government intervention may be justified to ensure appropriate provision.

  5. Merit goods and bads • Merit goods (bads) • goods (bads) that society thinks everyone ought to have (ought not to have) regardless of whether they are wanted by each individual. • e.g. Education, health services, cigarettes • The government may spend money on compulsory education or compulsory vaccination because it recognizes that otherwise individuals act in a way they will subsequently regret.

  6. Varieties of taxes • Direct taxes • taxes on earnings from labour, rents, dividends and interest. • e.g. income tax, corporation tax • Indirect taxes • taxes levied on expenditures on goods and services • e.g. VAT, duty on alcohol • Wealth taxes • capital transfer tax, tax on property

  7. SS' With a tax, labour supply is effectively at SS', workers receive W'', but firms pay W', the difference being the tax. W' W'' Employers pay the green area, and workers the blue. The red area is a welfare loss for society. L' A tax on wages With no tax, the labour market is in equilibrium at wage W, hours L. SS Wage W DD L Hours worked

  8. The incidence of a tax • Who pays a tax depends upon the elasticity of demand and supply for the product. • This also affects the size of distortion caused by the imposition of a tax.

  9. SS' But if there is a negative consumption externality (e.g. from smoking), the social optimum is at Q*. F A tax of E*F enables this optimum to be reached. E* DD' Q* A tax to offset an externality Given private demand DD and supply SS, free market equilibrium is at Q. SS Price DD Q Quantity

  10. The Laffer curve shows how much tax revenue is raised at each possible tax rate. Beyond t*, higher tax rates reduce revenue because of disincentive effects. Tax revenue 100% t* Tax rate

  11. Economic sovereignty • Increasing integration of countries in the world economy reduces the economic sovereignty of individual nations. • Co-operation is needed to cope with transnational externalities.

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