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Fiscal Policy - Government Borrowing

  • Levels: AS, A Level
  • Exam boards: AQA, Edexcel, OCR, IB, Other

When a government's tax revenues are insufficient to pay for a given level of state spending then a nation must borrow to make up the difference, this is a budget deficit. Governments often find that they have to borrow to finance their spending

UK government spending and taxation

Causes of a rising budget (fiscal Deficit)

  • Recession causing rising employment
  • Decrease in consumer spending, falling profits leading to less tax revenue
  • Increase in economic inactivity leading to rise in welfare benefit spending
  • Deliberate use of fiscal stimulus by a government to boost aggregate demand
  • Increase in interest rates on debt leading to a rise in debt service costs
  • Demographioc factors causing state pensions to rise
  • Deliberate attempts to increase spending on public service
  • The UK fiscal deficit

    Not all countries and groups of countries run budget deficits, there are many both from the richer advanced groupings and fast-growing developing nations who have been running budget surpluses in recent years.

    Fiscal balances for selected groupings of countries
    (-) Indicates a budget deficit, a +ve value shows a budget surplus
    Country Group Name 2008 2009 2010 2011 2012
    Major advanced economies (G7) -4.5 -10.0 -8.7 -7.7 -6.8
    Euro area -2.1 -6.4 -6.3 -4.1 -3.2
    Developing Asia -1.7 -4.2 -3.5 -2.6 -2.6
    Latin America and the Caribbean -0.9 -3.9 -3.0 -2.6 -2.3
    Emerging and developing economies 1.0 -4.0 -2.8 -1.1 -1.0
    Sub-Saharan Africa 2.0 -5.3 -3.8 -1.4 -0.7
    Commonwealth of Independent States 4.2 -5.1 -2.6 2.0 0.9
    Newly industrialized Asian economies 1.0 -1.1 1.1 1.6 1.0
    Middle East and North Africa 13.4 -0.6 2.0 6.1 6.9
    Source: IMF World Economic Outlook, April 2012
    • Most of the member nations of the Group of 7 have seen a significant rise in government borrowing and higher levels of debt.
    • A number of newly industrialized Asian countries run budget surpluses as do the oil and gas rich nations of the Middle East
    UK National (Government) Debt

    Fiscal austerity under the 2010-2015 Coalition Government

    The UK coalition government has a deficit-reduction policy with the emphasis on cutting government spending in some areas in real terms and a series of direct and indirect tax increases:

    Key policies for deficit reduction:

    • Rise in VAT to 20%
    • Rise in employee national insurance contributions
    • Deep cuts in real government spending e.g. for local authorities
    • Welfare caps including £26k pa cap on welfare for each family

    Some taxes have been cut

    • A series of cuts to corporation tax - down to 20% in 2015
    • Freezing of fuel duties (meaning a cut in real terms)
    • Increases in the real value of the income tax free allowance
    • Freezing of council tax (so that council tax falls in real terms)

    The UK government also helped by lower interest rates on newly issued debt. 10 year bond yields fell to a record low of 1.4% in January 2015.

    Government spending and taxation in the UK economy

    New fiscal rule (July 2015 Budget)

    The government’s fiscal rules are to be revised to include a target for a budget surplus by 2019/20 and for all subsequent years when in ‘normal times’. The economy will be viewed as being in ‘normal times’ if real annual growth is above 1%.

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