Role of the profit tax formation of public finances

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Discuss the view that the use of fiscal / monetary / supply side policy is the most effective way to achieve Economic growth / reduce inflation / reduce unemployment. [15] Demand Side policy - affectAD.Fiscal policy: Increase / decrease taxation, Increase / decrease government spending.Monetary Policy: Increase / decrease interest rate, Increase / decrease Money supply.

fiscal policy to achieve economic growth. [15] Lead In - expansionary fiscal policy to increase AD Reduce income tax, higher Disposable income, higher consumption for household (C). Reduce corporation Tax, more retained profit, more funds for investment (I). Increase govt Spending (G). C, IG, are components of AD. AD increases from AD1 to AD2. Real GDP increase. Production of goods and services hire more labour (reduce unemployment). Economic growth – a sustainable growth of real GDP. Limitation - Crowding out, time lag, political constraint (pick one). Disadvantage - demand Pull inflation.

Ability to increase econ growth Depends on: Level Of consumer and business. Usually low during recession. They would rather save Than spend. Ability to reduce Unemployment depends on: Types of unemployment. Demand side works better to Reduce cyclical unemployment. Not effective towards structural. Ability to reduce inflation depends on: Types of inflation. Demand side works better to reduce demand pull. Not Effective in reduce cost push inflation. Alternative: Monetary / supply side. (+) direct impact on AD. (-) compared to monetary, Political constraint

monetary policy to achieve economic Growth. [15] Reduce Interest rate, Reduce cost of borrowing → firms borrow more to invest, increase Investment (I). Reduce mortgage payment for household → more income left for Consumption, higher C. Reduce capital inflow, as money will flow to other Currency to enjoy a higher saving return, the currency would depreciates, Country’s export becomes more competitive, increasing X revenue. AD increases From AD1 to AD2. Real GDP increases from Y1 to Y2, increasing EG. Time lag, Depends on the ability for central bank to reduce interest rate. Disadvantage Of expansionary. Inflation. Disadvantage of contractionary: AD decreases, real GDP decreases, reduce EG and increase unemployment, Trade off. (copy from Above). Alternative, (+) Independence. (-) Compared to fiscal policy, monetary Policy has less direct impact.Due To the reduction in AD during recession, AD decreases from AD1 to AD2, real GDP Decreases from Y1 to Y2, since the production of goods and services decreases, Firms would hire less labour, causing cyclical unemployment.

Fiscal to reduce unemployment: Fiscal Policies refers to the adjustment of taxation and government expenditure to Affect AD to achieve macroeconomic objectives. Unemployment, It is effective to A large / small extent. Cut income tax → increase disposable income → increase Spending (C). Cut corporation tax → increase retained profit → firms would have A higher incentive to increase I (investment). Increase government expenditure On infrastructure investment. C, I, G all components of AD, causing AD to the Right, (Diagram), real GDP increases. Successfully boost economy, create more Job opportunities. Time lag. Isadvantage of the policies - income Inequality may increase, bring inflationary pressure. Effectiveness of the policies on reducing unemployment depends on: Size Of the reduction in tax rate. Size of stimulus package, since it only takes 2% Of the Germany’s GDP, it may not be big enough to boost the German economy. The Level of consumer and business confidence. Usually consumers and businesses are Not confident towards the future economy, they are reluctant to spend and Invest. Firms may not hire more labour, reducing the effectiveness of the Policy. May not work in SR - due to the lack of confidence. May work better in LR when people are seeing the govt policies to be effective. More likely to Spend

Explain the effects on AD when the Government decides to have a budget deficit instead of budget surplus. [10] Budget surplus G < revenue. Budget deficit G > Revenue. Changing from budget surplus to deficit Represents there is an increase in govt spending / a reduction in tax revenue. (AD increases + Diagram)

Explain why crowding out effect may Arise when the government increases its spending. [10] It Happens when the government has to borrow funds from money market to finance Its spending, the interest rate would be driven up and crowd out private sector Investment. G increases, G is a component of AD, increasing Ad from AD1 to AD2, But govt does not have enough fund to spend. Need to borrow from money market, Increase MD from MD1 to MD2, R increases from i1 to i2 (diagram interest rate Md and Ms), Higher cost of borrowing would deter C & I. Reduction in C & I would Decrease AD from AD2 to AD3 (3 AD and 1 LRAS and SRAS). Public sector crowd out Private sector.

Supply side policy - increase LRAS 1)Interventionist Supply side policy - increase the government’s role in resources allocation. a)Investment in human resources (education / health care). Skilled, Higher Productivity. Increase productivity Capacity. Shift LRAS to the right. Investment in infrastructure: HK 3rd runway. Increase the commuting facilities. More passengers and freights Can be transported. Increase Productivity capacity. 2) Market-oriented Supply side policy a) Competition – Based: Privatization: Transfer The ownership from public sector to private sector. Private sectors firms aim At profit max. Higher incentive to increase efficiency and cut cost. Increase Productive capacity -> shifting LRAS to the right. Deregulation: Reduce the entry barriers of a market So that more firms can join the market, increase the competition. Open-skies policy - many airlines Join the market . More firms → more Labour is needed b) Labour market reform - make the wage more flexible to the interaction of D and S. Reduce unemployment benefit. Reduce minimum wage. Reduce Trade union power: Trade union Bargain higher wage, better working environment for workers. This increases cost for the firms. Difficult to cut wage even if the demand for labour is reduced (e.G. Recession in 2008 in US). Reduce trade union power → less barriers for Firms to hire labour. Increase in FOP increase productive capacity c) Incentive related. Reduce income Tax: (e.G. UK reduces income tax rate from 45% to 40%). Workers consider more income earned can be kept. Increase working incentive. High Income earners would move into the country. Increase labour supply. Increase productive capacity, shifting LRAS to the Right. Reduce corporation tax (business Tax)

Discuss the view that market-oriented Supply policy to increase economic growth. [15] Limitation (general) - Time lag: Takes time to privatize. Political process, go through The congress. It takes time between the implementation of the policy and the Effects to be seen. Limitation (Disadvantage of specific point): Privatisation - profit max - cut cost - cut labour, create unemployment. Reduce trade union Power - harm labour - mostly low income workers, being exploited. Reduce income Tax - income inequality increases. Limitation (towards the objective that the Government wants to achieve: During recession, economy is weak and situated at Y, any increase in LRAS would not increase in real GDP Alternative: monetary Policy, By reducing interest rate, lower cost of borrowing would increase the Incentive for households and firms to borrow to consume and invest, increasing The AD, increasee the real GDP from Y1 to Y2. (Diagram showing AD increase). (+) Interdepence of central bank allows central bank to adjust interest rate Promptly according to the macroecnomic situation, unlike the supply side Policy, that has to undergo legislation. (-) AD increases would increase the Inflationary pressure, supply side policy can achieve economic growth without Causing inflation

Supply policy to reduce inflation. [15] Increase Productivity, productive capacity. LRAS will shift to the right from LRAS1 to LRAS2. Price level would decrease from PL1 to PL2. Alternative: Contractionary Monetary policy can be used (interest rate reduce, reduce AD and PL) (+/- Above)

Discuss the view that interventionist / market-oriented supply policy to reduce unemployment. [15] (copy Above) define, explain, limitation, alternative: Expansionary Monetary policy Can be used(decrease interest rate, Increase AD, Increase real GDP, Increase Production of goods and services, firms would hire more labour, reducing Unemployment (+/-)

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