CA Foundation · Business Economics · Business Cycles
During a prolonged downturn in an economy, which of the following is the most likely effect on the government's budget, assuming tax rates and spending programmes remain unchanged?
In a prolonged downturn, tax revenue falls because incomes and profits decline, while transfer payments like unemployment support rise. With revenue down and spending up, the government's budget deficit widens automatically, even without any change in tax rates or spending programmes.
- ATax revenue rises and transfer payments such as unemployment benefits fall, so the deficit narrows
- BTax revenue falls and transfer payments rise, so the deficit widensCorrect
- CBoth tax revenue and transfer payments fall, leaving the deficit unchanged
- DTax revenue rises and transfer payments rise, so the deficit is unchanged
Explanation
In a downturn incomes and profits fall, so tax collections fall. At the same time, support payments to the unemployed and poor rise. Lower revenue with higher spending widens the deficit. The option showing a narrower deficit describes a boom, not a downturn.
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