Government Aims and Fiscal Policy: Question 9
Syllabus 4.1, 4.2
In one financial year, the government of Astwick collected the following tax revenue: $18 billion in income tax, $9 billion in sales tax, and $5 billion in corporation tax. Over the same year, it spent $11 billion on healthcare, $9 billion on education, $4 billion on infrastructure, and $3 billion on interest payments on existing government debt.
(a) Calculate Astwick's total government revenue and total government spending for the year, and state whether this represents a budget deficit or a budget surplus, giving its size. [3]
(b) Explain one way in which Astwick's government could use this outcome. [2]
(c) Explain how running this budget outcome, rather than a budget deficit, could make it harder for Astwick's government to achieve its aim of economic growth. [3]
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Worked solution
Part (a): Total revenue, total spending, and the budget outcome
Total government revenue:
Total government spending:
Since total revenue ($32 billion) is greater than total spending ($27 billion), Astwick has a budget surplus, not a deficit. Its size:
Astwick’s budget surplus for the year is $5 billion.
Part (b): Using the surplus
A government running a budget surplus is collecting more in tax revenue than it is spending, so it does not need to borrow that year and can instead use the extra $5 billion productively. One clear use is to pay down part of Astwick’s existing national debt: reducing the outstanding debt lowers the interest the government has to pay on it in future years, freeing up money for other priorities later on.
Part (c): The surplus and the aim of economic growth
A budget surplus means Astwick’s government is taking more purchasing power out of the economy through taxation than it is putting back in through its own spending. This net withdrawal reduces total (aggregate) demand compared with a balanced budget, and reduces it even further compared with running a deficit.
If firms across Astwick see weaker demand for their goods and services as a result, they are likely to produce less and cut back on investment, since there is less incentive to expand capacity when demand is subdued. Slower growth in output directly works against the government’s aim of achieving strong economic growth, even though the same surplus may be helping the government make progress on a different goal, such as reducing its national debt.
Final answers
- (a) Total revenue = $32 billion; total spending = $27 billion; this is a budget surplus of $5 billion.
- (b) The surplus could be used to pay down part of the national debt, cutting future interest payments.
- (c) The surplus withdraws more from the economy than it injects, reducing total demand; if firms produce and invest less as a result, this can slow the growth in output the government is aiming for.