Economics Unit 2 and Unit 4 Essey Questions?

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olEvaluate the case for cutting public expenditure rather than raising taxes as a means of reducing fiscal deficits. (30) A fiscal deficit is when the government spends more than it receives in tax revenue. There are many benefits of cutting expenditure rather than increasing taxes. Firstly this will avoid any tax evasion and avoidance. This is because when taxes are increased a smaller amount of income is retained giving people the incentive to declare lower incomes to the HMRC so that they fall into a lower tax bracket. Moreover people may take incomes as a share option. This is because capital gains tax is at a flat rate of 18% therefore much lower that income tax allowing people to retain more of their incomes and enjoy better living standards. This will result in a reduction in the government’s tax revenue as people are paying less tax, which will lead to further increases in the deficits. Secondly high taxes create disincentives to work and this can be analysed through income and substitution effects. The substitute for work is leisure time and when taxes increase the opportunity cost for leisure time decreases, also people will have to work longer hours to earn the same post tax income causing disincentives as it reduces living standards as people must work longer and harder for the same incomes. This will create disincentives to work and so lead to a reduction in the labour force meaning less people in jobs and so less people paying income tax. Also as people earn less this way consumption in the economy falls therefore reducing the governments VAT recipts and corporate tax revenues and businesses make lower profits. This will lead to increases in the fiscal deficits as the government earns less and may be spending more in forms of social protection i.e. unemployment benefits. These factors can be shown using the laffer curve, as tax rates increase tax
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