The Government Budget (Cambridge (CIE) O Level Economics)

Definition of the Government Budget

• The Government Budget (Fiscal policy) is presented each year as a balanced budget, a budget deficit, or a budget surplus

  • A balanced budget means that government revenue = government expenditure

  • A budget deficit means that government revenue < government expenditure

  • A budget surplus means that government revenue > government expenditure

• A budget deficit has to be financed through public sector borrowing

  • This borrowing gets added to the public debt

Reasons for Government Spending

• Public expenditure (government spending) represents a significant portion of the total (aggregate) demand in many economies. The expenditure can be broken down into three categories

1. Current Expenditures: These include the daily payments required to run the government and public sector. E.g. The wages and salaries of public employees such as teachers, police, members of parliament, military personnel, judges, dentists etc. It also includes payments for goods/services such as medicines for government hospitals

2. Capital Expenditures: These are investments in infrastructure and capital equipment. E.g. High speed rail projects; new hospitals and schools; new aircraft carriers

3. Transfer payments: Payments made by the government for which no goods/services are exchanged. E.g. Unemployment benefits, disability payments, subsidies to producers and consumers etc. This type of government spending does not contribute to GDP as income is only transferred from one group of people to another

Reasons for Taxation

• Nearly every economy in the world is a mixed economy and has varying degrees of government intervention

• One of the main forms of government intervention is taxation and there are many reasons why it is necessary

• Correct market failure: in many markets there is a less than optimal allocation of resources from society's point of view

  • The government aims to subsidise merit goods and tax demerit goods to address this market failure 

• Earn government revenue: governments need money to provide essential services, public and merit goods

  • Revenue to fund this is raised through taxation

• Promote equity: the wealthy are taxed to provide funds that can be utilised in reducing the opportunity gap between the rich and poor 

• Support firms: in a global economy, governments choose to support key industries so as to help them remain competitive and taxation provides the funds to do this 

• Support poorer households: poverty has multiple impacts on both the individual and the economy 

  • Intervention seeks to redistribute income (tax the rich and give to the poor) so as to reduce the impact of poverty