- Higher unemployment means less people will be paying income tax
- Lower consumption levels mean lower VAT and excise duties.
- Lower company profits mean lower corporation tax
- Higher unemployment increases cost of social security payments - unemployment benefit, income support, housing benefit e.t.c
- Falling house and asset prices reduce stamp duties
Furthermore, in a recession, government often try to stimulate the economy using expansionary fiscal policy. This could involve:
- Cutting taxes so people (hopefully) spend more
- Increasing public sector spending to stimulate aggregate demand
National Debt in RecessionsIn a recession, not only will national debt increase, but as % of GDP, national debt will become higher. This is because the government borrow more, but GDP is decreasing. During economic growth of 3%, the government can borrow 1% of GDP, and National debt as a % of GDP falls
Should We Worry about Government Borrowing in a Recession?
- Apart from the most hardline neo-classical economist, most economists would say that a rise in government borrowing in a recession, is unwelcome but necessary.
- To balance the budget would cause a much deeper recession. If the government tried to balance the budget through higher taxes and cuts in public spending it would cause a bigger fall in GDP and lead to even lower tax receipts.
- However this is what the UK did in 1930, exacerbating the Great Depression (unemployment benefits were cut and taxes raised on the advice of 'treasury economists'
- Mrs Thatcher also did this in the 1981 recession, making the recession much deeper than necessary.
- By borrowing more the government is trying to increase aggregate demand and economic growth. The hope is by preventing a deep recession, they will get better tax revenues in the future.
- The key thing is that this cyclical deficit should prove temporary. This is different to a structural deficit (when the government is borrowing even with high growth)
- May cause crowding out. Government borrow from private sector so private sector have less to spend. Therefore, demand doesn't increase -
- If government cut taxes in a recession, then they need to raise them when the economy recovers and starts to grow. The problem is politicians forget to do this. Its easy to cut taxes, but, then they don't want to reverse the tax cuts or spending increases in times of a boom.
- If National debt becomes unmanageable, it may cause interest rates to rise, or if the Central bank starts printing money inflation could occur.
- Will require higher tax rates in the future.
Suffice to say, Government borrowing is not the biggest concern during a recession.