Question

in your opinion, should the government cut its spending levels, and if so, what specific area should be cut first? Explain your reasoning. What could be the possible unintended consequences of such a cut?

Attachments

Skills

• Describe government spending at federal, state, and local levels.
• Describe how federal deficits and the national debt relate to the economy.
• Describe how automatic stabilizers respond to economic events.

Answer 1

Government in order to reduce its deficit have generally two options. First one is to increase taxes and other one being to reduce spending. But point is to find which one is better, Blanchard and Dlazen explains this very well. Stabilization that eliminates uncertainty about higher fiscal costs in the future stimulates demand today—especially from investors, who are more sensitive to uncertainty given the long-term nature of their plans. However, it is quite likely that the benefits of removing uncertainty are more likely to occur with spending-based, rather than tax-based, austerity plans. So, government should go for decrease in spending.

Lawmakers need to change important policies to increase the revenues of large remuneration programs in the long run, to support the federal budget below current plans or to combine them all to increase revenues more than current legislation.

There are several ways by which spending can be reduced first one being, eliminate crop insurance program which was started to protect farmers but this now subsidizes insurance premium on Agriculture on coverage which thay can afford thereby distorting the insurance sector. Spending on defense can also help as reducing deficit. These include overspending on night goggles, etc which is generally higher than their base spending. Replacing some military personnel with civilian employees would also help because these employees cost less as compared to military personnel. One most important cut in spending would be to stop reviving non performing government organisations by providing them aids and subsidies.

Possible consequences of these cut can be that if those government organisations are not provided with aid they will not be able to work and therefore that sector may be overtaken by the private organisations, which operate for profit maximisation not the social welfare. Reducing spending on defense may affect civilians will to enter the defense personnel and may reduce competence of the defense sector. Reducing subsidies may adversely affect small farmers which constitute around 50-70% of the agriculture sector, especially in developing countries.

Governments have traditionally been responsible for the provision of public goods and services (education and health) and the redistribution of income (for example, social security and subsidies). The need to improve the quality and efficiency of public spending has confirmed that local governments play an important role in the implementation of public policy. In fact, the central government can come up with more sub-central governments to provide information on local needs and better adapt to the provision of public services. Federal spending consist of mandatory spending like Medicare and Social Security, discretionary spending for defense and interest payment and debt. This till now consist of one half of the total spending, rest being covered in local and state spending. While revenue generated by state is more than by local, but spending of local like townships, cities, etc are high. Generally all state and local government spending falls into one of six categories: elementary and secondary education, public welfare (which includes Medicaid), higher education, health and hospitals, police and corrections, and highways and roads.

A budget deficit occurs when expenditures exceed revenues in the same year. If expenses exceed revenues, this is called deficit spending. National debt is the annual accumulation of deficit. If your income exceeds your expenses, you will get a budget surplus. Surplus reduces debt. All government deficit needs to be financed which is generally done by sale of government securities which leads to a fall in potential capital stock in the economy. But if this totally monetised than there will inflation rather than fall in stock. National debt has negative consequences in the long run. If under normal taxation interest payments on debts always fail, the government has three options: cut costs and sell assets, print money to cover defects or credit failure. An overly aggressive money supply can cause high inflation and effectively limit the use of a second strategy. Delayed social security, rising interest rates, difficulties in investing, burdened taxpayers and the economic downturn in many countries are the five ways in which government debt can affect the economy.

Automatic stabilization is a function of the tax and remittance system, which, if the economy gets too hot, suppresses the economy and stimulates the economy if the economy collapses without direct intervention. Automatic stabilizers compensate for periodic fluctuations without direct political intervention. During phases of high economic growth, automatic stabilizers will help to reduce the growth rate and avoid the risks of an unsustainable boom and accelerating inflation. Economic growth is negative during an economic downturn, but auto-stabilizers will help limit the fall in growth. The lower the income, the less people will be taxed, and government spending on unemployment will increase. As a result, government borrowing automatically increased as the public sector periodically introduced additional requests.