Government spending and taxation: the main categories

Overview

Difference between current and capital government spending, transfer payments and main sources of government tax revenue.

What you need to know

Answer each one before you reveal it.

Questions from this subtopic

Each one with the model answer underneath.

1. 1

   What is the difference between current and capital government spending? Give two examples of each.

   Model answer

   Current spending is on the day-to-day running of public services and is consumed within the year, for example the salaries of teachers and nurses or the purchase of medicines and stationery. Capital spending is investment in assets that last and add to the nation's stock of capital, for example building a new hospital or upgrading a rail line. Capital spending is the part that adds most to future productive capacity.

2. 2

   What are transfer payments, and which parts of public spending do they cover?

   Model answer

   Transfer payments are payments made by the state to individuals for which no good or service is supplied in return. They include the state pension, unemployment and disability benefits, child-related payments and income-related support. They are a large share of public spending and their purpose is to support incomes and reduce poverty rather than to buy output.

3. 3

   Which are the largest areas of government spending in a typical advanced economy, and what does each cover?

   Model answer

   Social protection is usually the largest and covers pensions and working-age benefits. Health care is next, covering hospitals, primary care and public health, followed by education from early years through to universities. Defence, transport, public order and justice, and housing and environment make up most of the remainder.

4. 4

   Why does capital spending by government have effects on both aggregate demand and aggregate supply?

   Model answer

   When a road or a hospital is being built, the government is buying construction services, materials and labour, so government expenditure rises and aggregate demand shifts to the right straight away. Once the asset is complete it lowers the costs and raises the efficiency of firms and workers who use it, for example by cutting journey times or improving the health of the workforce, so productive capacity rises and long-run aggregate supply shifts to the right. The demand effect is immediate and temporary; the supply effect is delayed and lasting.

5. 5

   Why is an ageing population likely to push up several categories of public spending?

   Model answer

   A larger share of the population beyond working age raises the number of state pensions in payment, and pensions are already the biggest single item of social protection. Older people use health and social care far more intensively than the young, so health and care budgets rise as well. At the same time the working-age population that pays income tax and national insurance grows more slowly, so the pressure comes from both sides of the account.

6. 6

   What are the main sources of government tax revenue?

   Model answer

   The largest sources are usually income tax on earnings, national insurance or social security contributions paid by employees and employers, and value added tax on spending. Corporation tax on company profits, excise duties on fuel, alcohol and tobacco, and property-based taxes such as council tax and business rates supply most of the rest. Smaller amounts come from capital gains tax, inheritance tax, stamp duties and various licence fees.

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