Essay 2
In March 2011, the UK Office for Budget Responsibility (OBR) forecast that the budget deficit would fall from 7.9% of GDP in the financial year 2011-12 to 1.5% in 2015-16.
Question 9. Explain the term ‘living standards’ and analyse how cuts in government spending to lower the budget deficit might affect living standards in the UK.
Living standards are measured by GDP per capita, and include income levels and incorporate a range of other indications such as healthcare and education.
Government spending is a form of AD, and so reduced spending will reduce AD and so reduce the level of output. Since O=E=Y, this would also reduce income levels since unemployment would increase, as labour is derived demand.
If income levels fall in an economy, GDP per capita would also fall, creating a decrease in living standards. Government spending also includes spending on public and merit goods such as education and healthcare. Under-provision of these would occur if spending was reduced, which would contribute to further decreases in living standards.
*One more point*
Question 10. Discuss whether the UK Government should either raise taxes or cut government spending to achieve its 2015-16 fiscal objective.
A budget deficit occurs when total government expenditure exceeds government revenue from taxes: the deficit is financed through borrowing. The UK’s budget deficit for 2014 is approximately £91bn, but recent revisions have placed it at -£120bn. The main reasons the government wishes to reduce the budget deficit, is to prevent our AAA credit rating being lost and also to prevent future rises in interest rates and taxes, which risk crowding out.
Raising taxes would not be beneficial to the economy. If direct taxes (levied on income, wealth and profit) were to increase, consumers would see a fall in their disposable incomes and so would spend less, causing consumption to decrease. Firms too would see a fall in post-tax profits, and so would reduce investment levels, especially given the depressed domestic demand in the economy. Since both consumption and investment are components of AD, it would ultimately AD would decrease. As the UK economy is already fragile in its economic recovery, decreased levels of AD would harm the economy significantly.
Increase in government spending also poses a risk of crowding out. In order to finance out a deficit, a government issues bonds, which firms and individuals buy. However, they could have spent this money instead, thus it can be argued that government spending results in little net movement of AD, in terms of the risks of crowding out spending. As a result, cutting spending would reduce crowding out, whereas increased taxes would amplify it since firms/individuals would have less money to spend. High levels of spending could help to keep interest rates low, thus complementing the current expansionary monetary policy.
The another reason which supports government spending cuts, as opposed to tax increases, is because cuts in spending can actually lead to
