However, they are not aware about how these freebies cost them a lot more in the long run. For instance, consider the fact that most Americans are very happy with the latest tax reforms announced by Donald Trump. They can see a visible difference in the salary that they receive every month. Also, if the state tries to borrow large amounts of money, it will end up increasing the interest rates.
It is, therefore, no surprise that the Federal Reserve has to raise interest rates. On the one hand, Donald Trump is expressing his displeasure at the fact that the interest rates are being raised. However, on the other hand, he is the person who has set into motion the forces which cause interest rates to hike. Governments all over the world are trying to create some form of economic magic.
They want to give money to the poor so that their votes can be obtained. However, they want to pretend that this money has not been taken from anybody. The bottom line is that once the government has spent money, it will have to take it from the private sector. Hence, to solve the problem governments have to be prevented from spending excess money.
The fact of the matter is that the economy can only grow if government spending is reined in vis-a-vis tax revenues. Hence, people will be free to choose how they want to spend their money instead of letting the government decide it for them. View All Articles. Government Taxation Government Spending vs. Government Taxation. Similar Articles Under - Globalization. To Know more, click on About Us. The use of this material is free for learning and education purpose.
Please reference authorship of content used, including link s to ManagementStudyGuide. What is Globalization? Counter-cyclical Fiscal Policies : Keynesian economists advocate counter-cyclical fiscal policies. This means increased spending and lower taxes during recessions and lower spending and higher taxes during economic boom times.
According to Keynesian economics, if the economy is producing less than potential output, government spending can be used to employ idle resources and boost output. Increased government spending will result in increased aggregate demand, which then increases the real GDP, resulting in an rise in prices.
This is known as expansionary fiscal policy. Conversely, in times of economic expansion, the government can adopt a contractionary policy, decreasing spending, which decreases aggregate demand and the real GDP, resulting in a decrease in prices.
Highway Construction : The government can implement expansionary fiscal policy through increased spending, such as paying for the construction of new highways. In instances of recession, government spending does not have to make up for the entire output gap.
There is a multiplier effect that boosts the impact of government spending. The government could stimulate a great deal of new production with a modest expenditure increase if the people who receive this money consume most of it. This extra spending allows businesses to hire more people and pay them, which in turn allows a further increase in spending, and so on in a virtuous circle. In addition to changes in spending, the government can also close recessionary gaps by decreasing income taxes, which increases aggregate demand and real GDP, which in turn increases prices.
Conversely, to close an expansionary gap, the government would increase income taxes, which decreases aggregate demand, the real GDP, and then prices. The effects of fiscal policy can be limited by crowding out. Crowding out occurs when government spending simply replaces private sector output instead of adding additional output to the economy. Crowding out also occurs when government spending raises interest rates, which limits investment.
Spending and taxation are the two levers available to the government for setting fiscal policy. In expansionary fiscal policy, the government increases its spending, cuts taxes, or a combination of both.
The increase in spending and tax cuts will increase aggregate demand, but the extent of the increase depends on the spending and tax multipliers. The government spending multiplier is a number that indicates how much change in aggregate demand would result from a given change in spending.
The government spending multiplier effect is evident when an incremental increase in spending leads to an rise in income and consumption. The tax multiplier is the magnification effect of a change in taxes on aggregate demand. The decrease in taxes has a similar effect on income and consumption as an increase in government spending. However, the tax multiplier is smaller than the spending multiplier. This is because when the government spends money, it directly purchases something, causing the full amount of the change in expenditure to be applied to the aggregate demand.
When the government cuts taxes instead, there is an increase in disposable income. Part of the disposable income will be spent, but part of it will be saved. The money that is saved does not contribute to the multiplier effect.
Spending and Saving : The tax multiplier is smaller than the government expenditure multiplier because some of the increase in disposable income that results from lower taxes is not just consumed, but saved. The government spending multiplier is always positive.
In contrast, the tax multiplier is always negative. This is because there is an inverse relationship between taxes and aggregate demand. When taxes decrease, aggregate demand increases. The multiplier effect of a tax cut can be affected by the size of the tax cut, the marginal propensity to consume, as well as the crowding out effect.
The crowding out effect occurs when higher income leads to an increased demand for money, causing interest rates to rise. This leads to a reduction in investment spending, one of the four components of aggregate demand, which mitigates the increase in aggregate demand otherwise caused by lower taxes.
Expansionary fiscal policy can impact the gross domestic product GDP through the fiscal multiplier. The fiscal multiplier which is not to be confused with the monetary multiplier is the ratio of a change in national income to the change in government spending that causes it. When this multiplier exceeds one, the enhanced effect on national income is called the multiplier effect.
The multiplier effect arises when an initial incremental amount of government spending leads to increased income and consumption, increasing income further, and hence further increasing consumption, and so on, resulting in an overall increase in national income that is greater than the initial incremental amount of spending.
In other words, an initial change in aggregate demand may cause a change in aggregate output and hence the aggregate income that it generates that is a multiple of the initial change. The multiplier effect has been used as an argument for the efficacy of government spending or taxation relief to stimulate aggregate demand.
The money does not disappear, but rather becomes wages to builders, revenue to suppliers, etc. The builders then will have more disposable income, and consumption may rise, so that aggregate demand will also rise. Suppose further that recipients of the new spending by the builder in turn spend their new income, raising demand and possibly consumption further, and so on. Therefore, the objective of this study was to examine the causal relationship between government expenditure and revenue in Kenya.
The study tested whether there is unidirectional causality or bidirectional causality between government spending and government taxation. The results show that there is bidirectional causality from government revenue to government expenditure. Therefore, the results support the fiscal synchronization hypothesis. The results indicated that deviation from the long-term growth rate in government expenditure revenue is corrected by approximately 73 percent in the following year.
The policy implication of the results shows that there is a relation between government expenditure and revenue. The government makes its expenditures and revenues decision simultaneously.
Therefore, the Treasury should increase revenues and decrease expenditures simultaneously in order to manage the budget deficits. Increasing government expenditure stimulates economic activities, which in turn increase government revenues.
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