I have been a teacher for 26 years, a Headteacher for 11 years and, at the age of 50 this much I know about revising on 8 May 2015. Stick with this... Comment on whether a cut in tax rates will always result in a budget deficit. This is the OCR AS Economics question my students asked me to revise yesterday, 8 May 2015. Here’s the answer, beginning, for the first three marks, with some Analysis... Always begin with your definitions. A budget deficit is the difference between the Government’s income in terms of revenue from taxation and Government spending on things like the NHS, the Police, the Army, Welfare for the poor & disadvantaged and Education. If the Government’s income revenue from taxation is more than the Government’s spending then there is a budget surplus. If the Government’s revenue from taxation is less than the Government’s spending there will be a budget deficit. If the rate of tax is cut, it is likely that, if everything else in the economy remains the same (ceteris paribus) there will be a budget deficit, because there will be a reduction in the Government’s income in terms of revenue from taxation but no change in its spending. The pie chart below shows the current budget deficit in red. Commentary follows Analysis in a six marker. The last three marks are awarded for commentary on the basic analysis, or, in other words, the analysis is correct but it all depends… The first thing I point out to the students is that the question is asking about a reduction in the tax rate, not tax revenue. The income tax rate may fall, for instance, but if more people are working then the tax revenue might actually increase and we would have a budget surplus, rather than a budget deficit. But, if there has been an 8% reduction in wage levels, or a huge increase in workers with zero hour contracts, then even if more people are employed it might not mean that income tax revenues increase. Then there is the other half of the pie chart, Government spending, which could be cut. If spending on the NHS, the Police, the Army, Welfare for the poor & disadvantaged and Education is cut by more than the reduction in tax revenue, then there will be a budget surplus, even if there is a cut in the tax rate. The government could choose, for instance, to privatise more elements of the NHS, or allow profit-making companies to run schools so that Government spending on Health and Education would be reduced. Furthermore, if the manufacturing and construction industries are shrinking, there will be less income from corporation tax and so, in order for there to be a budget surplus the cuts in Government spending on things like the NHS, the Police, the Army, Welfare for the poor & disadvantaged and Education will have to be greater. I could have explained to the students the implications of a housing price boom which will surely implode, flat-lining business investment, negative inflation and slow economic growth of 0.3% in the first quarter, but by this point we had done enough to be awarded all the six marks available. Explaining this on 8 May 2015 made me wonder if basic Economics should be a mandatory element of our national curriculum.
