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Tax Revenues and Economic Shocks
Total government revenue fell during the 2020 Covid-19 Pandemic. To understand why, let’s explore what happens to tax revenues during economic shocks.
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By ordering firms to close and households to stay at home, the lockdown caused spending on goods and services to decrease.
- Decreased sales of goods and services mean that firms earn less.
- This means less VAT receipts sent to the government.
- Decreased profits mean firms send less corporation tax to the government.
- Without government support during lockdown in the form of the Job Retention Scheme, the government would receive less income tax as a result of growing unemployment.
The Job Retention Scheme (JRS): During the lockdowns imposed due to the Covid-19 pandemic, the UK government implemented the JRS and paid 80% of wages. This ensured that the country avoided significant unemployment, and ensured that the government would still receive a similar level of income tax, and tax revenue would not decrease substantially.
As the economy expands, tax revenues tend to rise. As the economy contracts, tax revenues tend to fall. This is because automatic fiscal stabilisers mean that when the economy is under pressure, tax revenue falls and spending increases, avoiding significant reductions in demand.
The majority of tax revenues are cyclical! Tax revenue rise when the economy is in a positive state, while tax revenues decrease when the economy is in a negative state or a recession.