Definitions of government budget

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Government and the Macro‑economy – Fiscal Policy (Cambridge 0455)

1. Government’s Macro‑economic Aims (Syllabus 4.1)

  • Economic growth – increase in real GDP per‑capita (target ≈ 3 % p.a.).
  • Full‑employment – unemployment at the natural rate (≈ 5 % of the labour force).
  • Low inflation – price rises below 3 % per year.
  • Balance‑of‑payments stability – current‑account deficit not larger than 5 % of GDP.
  • Redistribution of income and wealth – reduce inequality and poverty.
  • Environmental sustainability – promote green growth and limit pollution.

Policy Trade‑offs

Aim that may be prioritised Possible conflict with Typical fiscal response
Higher growth Higher inflation (if demand‑driven) Increase spending or cut taxes; monitor price pressures.
Low inflation Higher unemployment (if demand is restrained) Raise taxes or cut spending; consider supply‑side measures.
Redistribution Reduced incentives to work or invest Progressive taxes + targeted transfers; balance with growth goals.

2. Core Definitions (Syllabus 4.2 – AO1)

  • Government budget – a statement of the government’s planned revenue and planned expenditure for a fiscal year.
  • Government budget deficit – the amount by which total planned expenditure exceeds total planned revenue in a given fiscal year.
  • Government budget surplus – the amount by which total planned revenue exceeds total planned expenditure in a given fiscal year.
  • Fiscal policy – changes in government taxation and/or government spending designed to influence aggregate demand (AD) and achieve the macro‑economic aims listed above.

3. Why Governments Spend (Syllabus 4.2)

  • Stabilisation – counteract recessionary or inflationary gaps (e.g., stimulus spending during a downturn or austerity during an overheating economy).
  • Redistribution – reduce income and wealth inequality (e.g., welfare benefits, progressive income tax).
  • Provision of public goods – goods/services that markets under‑provide (e.g., defence, street lighting, policing).
  • Infrastructure development – long‑term growth‑enhancing assets (e.g., roads, rail, hospitals, broadband).

4. Government Revenue

Tax / Revenue type Classification Typical purpose Likely macro‑economic impact
Income tax (progressive) Direct, progressive Raise revenue & redistribute income ↓ disposable income of high earners → ↓ consumption; ↑ equity.
Corporate tax (proportional) Direct, proportional Raise revenue from firms High rates can ↓ investment; moderate rates have limited AD effect.
Value‑added tax (VAT) (regressive) Indirect, regressive Broad‑base revenue ↑ price of most goods → ↓ consumption, especially for low‑income households.
Excise duties (fuel, tobacco, alcohol) Indirect, often regressive Raise revenue & discourage undesirable consumption Targeted price rise; small overall AD effect.
Customs duties Indirect Protect domestic industry & raise revenue ↑ import prices → ↓ imports, may boost domestic output.
Non‑tax revenue (fees, licences, dividends, borrowing) Mixed Supplementary income Borrowing raises current‑year spending but creates future interest obligations.

5. Government Expenditure

  • Current (recurrent) expenditure – day‑to‑day spending such as civil‑servant salaries, welfare benefits, interest on debt.
  • Capital (investment) expenditure – spending on long‑term assets like roads, schools, hospitals, defence equipment.

6. Budget‑related Concepts (AO1)

  • Budget balance = Revenue – Expenditure
    • Surplus when the result is positive.
    • Deficit when the result is negative.
  • Primary balance – budget balance before interest payments: $$\text{Primary Balance}= \text{Revenue} - (\text{Expenditure} - \text{Interest Payments})$$
  • Structural (underlying) deficit – the part of the deficit that would remain even if the economy were operating at its potential output.
  • Cyclical (economic‑cycle) deficit – the part of the deficit caused by the business cycle (larger in recessions, smaller in booms).
  • Cyclically Adjusted Balance (CAB) – actual balance after removing the cyclical component: $$\text{CAB}= \text{Actual Balance} - \text{Cyclical Deficit}$$

7. Fiscal Tools – Changes in Taxes & Spending

Tool Direction of change Effect on Aggregate Demand (AD) Typical impact on macro‑economic aims
Increase government spending ↑ AD shifts right ↑ growth, ↓ unemployment, ↑ inflation (if near full capacity), may worsen BoP.
Decrease government spending ↓ AD shifts left ↓ growth, ↑ unemployment, ↓ inflation, may improve BoP.
Increase taxes (especially progressive) ↑ AD shifts left ↓ consumption/investment → lower growth, lower inflation, ↑ unemployment, ↑ equity.
Decrease taxes (especially regressive) ↓ AD shifts right ↑ consumption/investment → higher growth, lower unemployment, ↑ inflation, ↓ equity.

8. Impact Matrix – Fiscal Tools vs. Macro‑economic Aims

Fiscal Tool Growth Unemployment Inflation Balance‑of‑Payments Redistribution
Increase spending ↑ ↓ ↑ (if economy near capacity) ↓ (higher import demand) Neutral – depends on sector funded
Decrease spending ↓ ↑ ↓ ↑ (lower import demand) Neutral
Increase taxes (progressive) ↓ ↑ ↓ ↑ (reduced import demand) ↑ (greater equity)
Decrease taxes (regressive) ↑ ↓ ↑ ↓ (higher import demand) ↓ (wider inequality)

9. Summary Table of Budget Components

Component Definition (AO1) Typical Examples
Revenue All income received by the government in a fiscal year. Income tax, VAT, corporation tax, customs duties, fees, borrowing.
Current (recurrent) Expenditure Day‑to‑day spending on services and interest. Salaries of civil servants, welfare benefits, interest on debt.
Capital Expenditure Spending on long‑term assets that increase future productive capacity. Roads, schools, hospitals, defence equipment.
Budget Deficit Expenditure exceeds revenue. Deficit = Expenditure – Revenue (positive value).
Budget Surplus Revenue exceeds expenditure. Surplus = Revenue – Expenditure (positive value).
Primary Balance Balance before interest payments are taken into account. Primary Balance = Revenue – (Expenditure – Interest).
Structural Deficit Deficit that would remain at full‑employment output. Reflects the underlying fiscal stance, independent of the cycle.
Cyclical Deficit Deficit caused by the economy operating below potential. Large in recessions, small or negative in booms.
Cyclically Adjusted Balance (CAB) Actual balance after removing the cyclical component. Used by the IMF and OECD to assess fiscal sustainability.

10. Quick‑scan Checklist – Alignment with Syllabus 4 (Government & the Macro‑economy)

Syllabus sub‑topic (4.x) Covered in the notes? What is missing / thin Suggested fix (actionable)
4.1 Macro‑economic aims Yes Numeric targets not always explicit. Add target ranges (e.g., growth ≈ 3 %, inflation < 3 %).
4.2 Government budget – definitions Yes Distinction between “budget balance” and “primary balance” could be clearer. Separate definitions and give a short worked example.
4.2 Why governments spend Yes Examples are brief. Insert concrete real‑world examples (e.g., UK 2023‑24 stimulus, US infrastructure bill).
4.2 Taxation & fiscal tools Yes Impact on balance‑of‑payments only in the matrix. Add a short note on how taxes affect the current account.
4.2 Budget‑related concepts (structural vs cyclical) Yes No formula for cyclical component. Provide a simple illustration:
Actual Deficit = Structural + Cyclical.
4.3 Evaluation of fiscal policy Partly Lacks explicit AO3 prompts. Include a bullet list of evaluation points (sustainability, timing, multiplier uncertainty, crowding‑out, distributional effects).

11. Evaluation – Why Distinguish These Concepts? (AO3)

  • Fiscal sustainability – structural deficits indicate long‑run problems; cyclical deficits may be temporary.
  • Policy effectiveness – knowing the primary balance helps assess whether a deficit is driven by interest‑payment burdens or by current‑year spending/tax choices.
  • Trade‑offs – expansionary fiscal policy can boost growth but may raise inflation, increase the current‑account deficit, or worsen debt sustainability.
  • Timing and multipliers – the impact of a tax cut versus a spending increase depends on the fiscal multiplier, which varies with the state of the economy.
  • Distributional consequences – progressive taxes improve equity but can dampen incentives; regressive taxes may be politically easier but increase inequality.
  • Real‑world application – students can apply the concepts to case studies such as the UK 2023‑24 budget, the US 2021 American Rescue Plan, or Euro‑area austerity programmes.
Suggested diagram: Flowchart showing the relationships among Revenue, Expenditure, Budget Balance, Primary Balance, Interest Payments, and the adjustments for Cyclical and Structural components (leading to the Cyclically Adjusted Balance).

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