THE GOVERNMENT BUDGET

Sources of government revenue

• Explain that the government earns
revenue primarily from taxes (direct
and indirect), as well as from the sale of
goods and services and the sale of
state-owned (government-owned)
enterprises.
 Sources of government revenue
• Taxes of all types, both direct and indirect Taxes are
the most important source of government
revenues.
• From the sale of goods and services such as but in
general may include such services as transportation,
electricity, water, and many more. The revenues
from these sales usually go toward covering the
government’s costs of providing them.
*the sale of government-owned (state owned)
enterprises, or property.
 Government expenditure

Governments have three types of expenditures:

Current expenditures include the government’s
spending on day-to-day items that are recurring (i.e.
repeat themselves) and items that are used up or
‘consumed’ as a good or service is provided. They
include wages and salaries (for all government
employees); spending for supplies and equipment for
the day-to-day operation of government activities,
including for example, school supplies and medical
supplies for public schools and public health care
services; provision of subsidies; and interest
payments on government loans.
 Government expenditure-cont.
• Capital expenditures include public
investments , or the production of physical
capital, such as building roads, airports,
harbours, school buildings, hospitals, etc.
• Transfer payments include payments by
the government to vulnerable groups for
the purposes of income redistribution (for
example, unemployment benefits, child
allowances, etc.
 The budget outcome
• A government budget is a type of plan of a country’s tax
revenues and expenditures over a period of time (usually a
year). If tax revenues are equal to government expenditures
over that period, the government is said to have a balanced
budget. However, in practice, the government’s budget is
rarely if ever balanced.
• If expenditures are larger than tax revenues, there is a
budget deficit; if expenditures are smaller than tax
revenues, there is a budget surplus. When there is a budget
deficit, the government finances (pays for) the excess of
expenditures over revenues by borrowing. This is similar to
personal finance: if you spend more than you earn, it is likely
that you borrow to pay for your extra spending over your
income.
 GOVERNMENT(PUBLIC )DEBT
• Over time, the government’s
accumulation of deficits minus surpluses
is referred to as public debt, or
government debt. In any particular year,
if the government runs a budget deficit,
its debt will become larger; if it runs a
budget surplus, its debt will become
smaller.
Fiscal stance and Budget outcome
• Expansionary fiscal policy is that which adds to the
level of aggregate demand. This is also referred
to as an ‘easing’ off policy, or a ‘loose’ policy.
• Contractionary fiscal policy (also called a ‘tight’
fiscal policy) would be where changes in fiscal
policy reduce the level of aggregate demand.
Clearly, the fiscal stance will affect the budgetary
balance— with an expansionary fiscal policy moving
the budgetary balance closer to, or further into, a
budget deficit, and a contractionary fiscal policy
moving it towards a budget surplus.
 ECONOMIC GROWTH RATE AND
BUDGET OUTCOME
• The rate of economic growth will affect the
budgetary balance. A downturn or recession
reduces tax revenue collected by a government.
It is also likely that higher unemployment will
require higher levels of government welfare
expenditure. Therefore, a downturn or
recession is likely to increase a budget deficit.
The opposite would also be true: as the economy
moves towards a boom, the budgetary balance is
likely to move closer to (or further into) a
budget surplus.
 Cyclical and structural budget
deficits
• Given that a budget deficit could be the
result of either a expansionary fiscal
stance or a fall in the rate of economic
growth (or both), economists can
analyse a budget deficit into two
components: the cyclical budget deficit
and the structural budget deficit.
 The cyclical budget deficit
• . The cyclical budget deficit is the
portion of any budget deficit that
changes when the rate of economic
growth changes. Over time, the cyclical
deficit will be eliminated as the economic
growth rate recovers towards its long-
run average rate (and would move into a
cyclical budget surplus if the economy
were growing at an above-average rate).
The structural budget deficit
• The structural budget deficit is the portion of a
budget deficit that remains even if the economic
growth is at its normal long-run rate. This means
any structural deficit will not necessarily be
eliminated after a prolonged period of growth.
Recently, the UK government has attempted to
reduce a very large budget deficit caused partly by
the deep recession of 2008–09, which significantly
boosted the cyclical deficit, but also partly by a
structural deficit where government expenditure
would have exceeded tax revenue regardless of the
rate of economic growth.
 Eliminating cyclical and structural
budget deficit
• A cyclical budget deficit will eventually
be eliminated by economic growth
returning to its average rate. A
structural budget deficit will be
eliminated only if contractionary fiscal
policy is implemented.
 Consequences of budget deficits and
budget surpluses
• The budgetary balance will have a
number of effects on macroeconomic
performance. We must be careful in our
analysis here as we must distinguish
between whether economic performance
is causing a change in the budgetary
balance or whether a change in the
budgetary balance is causing a change in
economic performance.
 Impact of budget deficits and budget
surpluses on Economic growth
• A budget deficit implies that fiscal policy is adding to
aggregate demand. This implies that tax rate is
decreasing or government expenditure is increasing or a
combination of both.
• A surplus would mean that fiscal policy is subtracting
from aggregate demand. Meaning that government is
spending less or charging high rate of tax.
• Clearly, these changes to aggregate demand will affect
short-run economic growth. However, the rate of
economic growth will, in turn, affect the budgetary
position in that slower growth will require higher welfare
expenditure and will mean lower tax revenue collected.
 Impact of budget deficits and
budget surpluses on Unemployment
• A government can reduce unemployment
levels through expansionary fiscal policy.
Higher government spending and a larger
budget deficit may mean there is a
greater demand for workers as a result.
• However, in the long run, some economists
would argue that unemployment will
return to its natural rate and will be
independent of the budgetary policy.
 Impact of budget deficits and budget
surpluses on Unemployment and Inflation
• Demand-pull inflation is the result of
excessive aggregate demand, which may
be the result of expansionary fiscal
policy(reduced tax rate and increased
government spending)-budget deficit.
• A rise in the budget surplus (through a
combination of tax rises and cuts in
government spending) will help to
reduce demand-pull inflation.