Government Impact on Business: Taxes, Spending & Interest Rates (CIE IGCSE Business)

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Author

Lisa Eades

The Impact of Changes in Taxes & Government Spending

Taxation

Governments impose direct and indirect taxes on businesses and households
- Direct taxes are levied on income, e.g. income tax and corporation tax
- Indirect taxes are levied on spending, e.g value-added tax (VAT)
- Governments may impose customs duties on imports to increase the costs associated with purchasing goods from abroad
  - This can increase demand for the products of domestic businesses and raise government revenue

The Impact on Businesses of an Increase in Taxation

Area of Impact

Explanation

Sales revenue

Revenue may fall for many businesses
- Increased income tax reduces customers' disposable income leading to lower demand
- Increased VAT makes selected products more expensive and customers may switch to alternatives

Costs

Operating costs will rise as a result of increased taxes such as VAT and National Insurance contributions
- Higher costs may be offset by charging higher prices
- Higher prices may lead to lower sales and profit may fall
Import costs are increased when customs duties are raised

Business decisions

Business spending and investment may be lower as a result of increases in corporation tax as less profit is retained to fund business expansion
Operational decisions may be affected by increases in business rates and taxes related to employing workers
- Businesses may choose to forego business improvement or relocation, or employ fewer workers as a result of increased costs
In some cases, businesses may take steps to try to avoid paying specific taxes or pay lower rates of taxation
- Move the business to a low-tax location
- Change production methods to reduce the use of highly-taxed components

Government spending

Increased government spending is usually funded by increases in taxes or increases in public sector borrowing
- Increased investment spending (e.g. on roads or hospitals) can encourage businesses to invest and lead to economic growth
- Increased public sector spending can be focused on raising specific skills in an economy, which can improve productivity and lower business costs
In recent years, the UK government has increasingly focused on reducing government spending
- Infrastructure projects have been scaled back or cancelled
  - E.g. The scale of the planned HS2 (High Speed 2) rail line intended to connect London with cities in the North has been reduced
    - Businesses in cities such as Leeds and Manchester are now unlikely to benefit from more efficient transport links, affecting access to markets and workers
- Spending on key services such as health and education has been reduced as part of its austerity strategy
- Public sector wage rises have been limited
  - Businesses have been affected by ongoing strike action across the public sector, which have increased employee absence levels and increased business costs

In contrast, the Portuguese government's economic plan in the same period has involved spending on infrastructure and prioritising R&D to grow its economy
- Spending on public services has risen whilst labour costs have fallen. Exports have risen and increased foreign direct investment is taking place in the growing economy
Supply-side policies are adopted by many governments to make their economies more efficient
- The aim is to increase the competitiveness of domestic industries compared to those from other countries
- Supply-side policies are so named because they are focused on improving the supply of goods and services

Recent Examples of Supply-side Policies

Policy

Privatisation of Public Sector Organisations

Investment in Training & Education

Regulations to Increase Competition

Example

In Serbia, state-owned businesses were privatised in 2016, including Galenika, a pharmaceutical company, and Železara Smederevo, a steel producer

The government of Chile has significantly increased spending on schools to equip young people with IT skills required by its growing technology sector

In 2022, China enacted its Anti-Monopoly Law, which changed rules related to competition and business mergers

The Impact of Changes in Interest Rates

The interest rate is the cost of borrowing money and the reward for saving
- Lenders charge interest on borrowing at a rate higher than that of the Central Banks base rate and award a lower rate on savings and investments

The Implications of Rising Interest Rates

Implication

Explanation

Higher repayments

Businesses will have to pay more on new loans. If their existing loan is a variable-rate loan, they will have to pay a higher amount back each month

Fall in exports

Exporting businesses may see demand for their products overseas fall as higher interest rates usually strengthen the value of the domestic currency, making their products more expensive abroad

Credit sales fall

Customers are less likely to purchase goods on credit when interest rates are high, leading to a fall in sales

Savings become more attractive than investment

Businesses may be less willing to make capital investments when their retained profit may be more profitably invested into a savings scheme

The Response of Businesses to Changes in Economic Policy

Businesses need to respond appropriately to changes in government policy
- The long- and short-term consequences of decisions needs to be balanced
- The responses of different stakeholder groups should be carefully considered
- Individual business circumstances may mean that even the closest of competitors respond in different ways

Responses of Businesses to Changes in Economic Policy

Policy Change

Possible Responses

Possible Implications

Central Bank reduces the base rate of interest

The business may increase investment as borrowing should be cheaper and retained profits attract low levels of interest
New products targeting wealthier/credit customers are developed

Assets are available for future expansion and improve the businesses balance sheet
Product portfolios are broadened, attracting new market segments

The government increases spending on education

Spending on internal training may be reduced as higher-quality staff are available
Specialist education and training businesses may start up or expand to meet increasing demand for their services

Spending priorities can change when governments change so reducing spending on internal training could be short-sighted
Businesses may seek long-term government supply contracts to ensure future revenues

Import taxes are reduced on household appliances

Domestic manufacturers may lower their prices to allow them to compete with cheaper imports
Retailers of household appliances may choose to stock imported goods over domestic brands

Lower prices could lead to lower profit margins unless products can be made more cheaply - this could affect quality
Retailers may increase profit on sales but need to implement controls to ensure products continue to meet customer expectations

Corporation tax is reduced

Businesses use higher retained profits to reward shareholders with increased dividends
Businesses no longer take steps to avoid paying taxes

Shareholders are more likely to invest, increasing capital available for business expansion
Government tax revenue barely changes, allowing for continued investment in public services

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