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 17.1 Government spending in the UK 0 10 20 30 40 50 % of GDP UK Government spending 1956 1976 1999  The scale of government spending has changed over the past four decades.  It is now running at just under 40%. 17.2 Government spending  EQUITY – a progressive tax and transfer system redistributes income from rich to poor  EFFICIENCY – correction of market failure may improve resource allocation We may justify government spending on two grounds: 17.3 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. 17.4 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. 17.5 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 17.6 Employers pay the green area, and workers the blue. A tax on wages Hours worked L W DD SS With no tax, the labour market is in equilibrium at wage W, hours L. L' SS' W' W'' With a tax, labour supply is effectively at SS', workers receive W'', but firms pay W', the difference being the tax. The red area is a welfare loss for society. 17.7 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. 17.8 A tax to offset an externality Quantity DD SS Given private demand DD and supply SS, free market equilibrium is at Q. Q A tax of E*F enables this optimum to be reached. F SS' DD' E* Q* But if there is a negative consumption externality (e.g. from smoking), the social optimum is at Q*. 17.9 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. t* 100% Tax rate [...]... Inventions and the patent system –  Research and Development (R&D) –  designed to provide a sufficient incentive for invention without suppressing competition for ever the social return on risky projects may exceed the private return Dynamic change – coping with sunset and sunrise industries 18.14 Consumer surplus A P C Consider the demand curve D and suppose price is at P with quantity demanded being... nations  Co-operation is needed to cope with transnational externalities 17.10 17.11 Chapter 18 Industrial policy and competition policy David Begg, Stanley Fischer and Rudiger Dornbusch, Economics, 6th Edition, McGraw-Hill, 2000 Power Point presentation by Peter Smith Industrial policy and Competition Policy  Competition policy –  aims to enhance economic efficiency by promoting or safeguarding competition... comparing perfect competition and monopoly For simplicity, suppose as industry with horizontal long-run average and marginal costs Pc Under perfect competition, long-run equilibrium would LAC = LMC be with industry output Qc selling at price Pc Consumer surplus is D the area of the big Qc Quantity green triangle 18.17 The social cost of monopoly: comparing perfect competition and monopoly If taken over... by a monopolist, profit maximization is at the lower output Qm and higher price Pm Consumer surplus is now the smaller green triangle Pm The monopoly receives LAC = LMC producer surplus (profit) of the blue rectangle Pc MR Qm Qc D and the red triangle shows the welfare loss – the Quantity social cost of monopoly 18.18 Perfect competition and monopoly under differing cost conditions Suppose that monopoly... (formerly the Monopolies and Mergers Commission) is the body responsible for administering competition policy in the UK A company can be referred to the Commission if it supplies more than 25% of the total market for a good –  or where there is collusion between firms The Commission is charged to investigate whether or not the monopoly acts against the public interest 18.21 Mergers and acquisitions  Firms... the gains from efficiency (the pink rectangle) 18.19 Counting the cost of monopoly  The size of the social cost of monopoly is difficult to evaluate – –  in part it depends upon the elasticity of demand which influences the size of the ‘red triangle’ of welfare loss Furthermore, firms may use up resources to defend their monopoly position – implying that costs are higher than under perfect competition... where there is collusion between firms The Commission is charged to investigate whether or not the monopoly acts against the public interest 18.21 Mergers and acquisitions  Firms can grow through merger and acquisition (M&A) activity – horizontal mergers  mergers between firms at the same stage of production in the same industry – vertical mergers  mergers between firms at different stages of production . 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 17.1 Government spending. regret. 17.5 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 . of GDP UK Government spending 1956 1976 1999  The scale of government spending has changed over the past four decades.  It is now running at just under 40%. 17.2 Government spending 