Question

2.3. In the article by Julie Doyle, it was revealed that the government would withdraw funding to the higher education sector. As a result, university fees are expected to increase, and the income threshold to repay HECs debt has been lowered. The article states that these changes are expected to "save [the government] $2.8 billion over four years." The key reason for this was to reduce the government budget deficits that accumulated as a result of the Global Financial Crisis. In answering the following questions, use the equation BD = G - T and T = tY where BD = budget deficit, G = government expenditure, T = tax revenue, Y = income and t = tax rate. The effect on the budget deficit is as follows: A. It will definitely worsen B. It will definitely improve C. It is unclear whether it will worsen or improve

My main question is whether because tax rates fall, it might hence be ambiguous because of the multiplier effect or is it because tax rates wont fall by 20 billion the deficit will decrease

Answer 1

The government budget deficit is given as

BD=G-tY

Now decrease in G decreases BD, on the other hand the decrease in Y increases BD.

In this case, the decrease in government expenditure Wil have multiplier effect. This will decrease output Y of the economy more than the decrease in G.

Thus the effect of fall in G will decrease decrease BD and decrease in Y will increase the same. Therefore, there will be two opposite force acting to change BD. The effect of these two forces on BD is ambiguous and can either increase or decrease BD.

Therefore the correct answer is

• C. It is unclear whether it will worsen or improve