Question

If the interest income is taxed and the interest payments are deductible, then the ef- fect of a tax raise on a saver’s saving is positive (namely, more saving) while the effect of a tax raise on a borrower’s savings is negative (namely, less saving). Therefore, the government should reduce tax rates to increase private savings in a society with more savers. Nevertheless, the national savings are determined by private savings and government savings, so whether the equilibrium interest is higher or lower is also influenced by government savings.

Answer 1

There is an unresolved debate on the effect of tax-based savings incentives on government revenue. The conventional wisdom on tax-assisted saving plans (TASPs) holds that they reduce public savings, but may raise national savings by stimulating private savings. Feldstein (1995) has challenged the view that TASPs reduce government revenue. According to Feldstein, 'some of the increase in personal saving raises the corporate capital stock, and the return on this additional capital raises corporate tax payments'. When the additional corporate income tax revenue is taken into account, 'the revenue loss associated with IRAs [Individual Retirement Accounts] either is much smaller than has generally been estimated or is actually a revenue gain'. This paper extends Feldstein's analysis to incorporate international considerations, differences in tax structures and alternative values for key parameters. We show that the result presented by Feldstein represents a special case that does not lead to broad generalisations. We also show that, under most conditions, the tenets of conventional wisdom that TASPs reduce government revenue are likely to hold, but that the magnitude of the effect may not be large. Finally, we suggest that the focus of research on the savings effects of TASPs is justifiable in a closed economy, where domestic savings affect domestic investment, but is not useful for policy development in small open economies.

In economics, a country's national saving is the sum of private and public saving. It equals a nation's income minus consumption and the government's taxes levied.

When governments change their spending or levels of taxation, it effects the demand for the economy's output of goods and services and alters national savings, investment and the equilibrium interest rate. ... The immediate impact is to increase the demand for goods and services

Impact of government spending on the economy

However, it is possible that increased spending and rise in tax could lead to an increase in GDP. In a recession, consumers may reduce spending leading to an increase in private sector saving. Therefore a rise in taxes may not reduce spending as much as usual.

In response to the financial slowdown and its impact on the economy, the government plays a key role by increasing its spending in order to boost economic growth. With so much spending going in this area, it becomes important for the policy-makers to review whether the spends made by the government is actually promoting economic growth or not.

Before we discuss the topic in-depth, you need to be familiar with the terms like fiscal deficit, government spends, economic growth to create understanding of Macroeconomics required for financial markets.

The Government has a huge role to play in the economy. Some of its key roles are as follows:

• Provides a well functioning legal and political system:-
  Any economy facing political or economic turmoil is not conducive to economic growth since it has very little trust in the economy. Moreover, there is uncertainty in the economy and people are also unwilling to invest. The government needs to make sure that there is a stable political environment. It’s very important on the part of the government to provide good legal and political framework.
  • Plays regulatory role to provide a competitive market:-
    There should be certain regulations to ensure that the economy does not drift to the monopolistic situation.The government needs to think about trade policies with foreign countries, regulation on natural resources available in our country etc.

• • • Stimulate the economy by increasing the government spending:-
      This was one of the philosophies given by one of the renowned economist John Maynard Keynes. He was of the view that government’s role is very important when the economy is in recession or depression like situation and the government should increase spending to have a pickup in the economic activity.
  • Keep economic inequality in check:-
    Great disparity amongst masses may lead to a certain amount of unrest in the economy. This disparity causes a certain amount of imbalances in goods and capital market. Hence, the government needs to provide schemes and policies via taxes or social spending to keep inequality in check.Before understanding how does spending affect the economy, let’s first understand how government earns and spent its money.

The main sources of income for the government are Tax and Non-Tax revenue. Taxes include Income tax, Corporation tax, and Indirect taxes while the Non-Tax revenue comes from Public Sector units like income from Railways or Public sector Banks etc.

The government spends can be classified as Revenue and Capital Expenditure. Revenue expenditure includes payment of salaries to government employees, payment to ministers etc. Capital expenditure leads to the formation of assets in the economy like the building of roads, bridges, schools etc.

Now since we are aware of the source of income and expenditure of the government, let’s understand about the deficit.

A Budget Deficit is an indicator of financial health in which expenditures exceed revenue. It is the sum of Revenue Account Deficit and Capital Account Deficit.

The government tries to fulfill this gap through borrowing which it does so by issuing bonds or borrowing from the foreign government.

India recorded a Government Budget deficit equal to 3.50 percent of the country’s Gross Domestic Product for the financial year ended on March 2018.