Government Budget and the Economy

The government budget: public goods, the three functions, revenue and capital receipts and expenditure, revenue, fiscal and primary deficits, and the spending and tax multipliers.

Key ideas

• Public goods are non-rivalrous and non-excludable, so private firms cannot charge for them and the government provides them.
• The budget has three functions: allocation (public goods), redistribution (taxes and transfers) and stabilisation (steadying output and employment).
• Revenue receipts (taxes, interest, dividends, fees) create no liability; capital receipts (borrowing, loan recovery, sale of shares) create liabilities or reduce assets.
• Revenue expenditure (salaries, pensions, interest, subsidies) creates no asset; capital expenditure (roads, machinery, loans given) creates assets or reduces liabilities.
• Direct taxes fall on the person who pays them; indirect taxes are paid on goods and passed on to buyers.
• The fiscal deficit is what the government must borrow; the primary deficit leaves out interest on past debt.
• A rise in government purchases raises income by more than an equal tax cut does, and a balanced rise in both raises income by the same amount.

Remember

Watch out

• Counting borrowing as a revenue receipt (it is a capital receipt).
• Forgetting to subtract non-debt creating capital receipts in the fiscal deficit.
• Using 1 ÷ (1 − c) for a tax change: only the fraction c of a tax change affects spending.

Worked example