Cambridge O Level Economics: Government budget, spending and taxation (2281) – Revision Notes

These notes cover the Cambridge O Level Economics 2281 syllabus for examination in 2026 (statements 4.3.1 to 4.3.6) in short form. For full explanations, use the study guide. Test yourself with the practice questions, then check progress with the free 10-minute diagnostics. Course links: the Cambridge O Level Economics hub and the printable checklist. All numbers below are invented and illustrative.

Definitions

Term	Meaning
Government budget	The government’s plan of expected spending and revenue for a set period, usually a year
Balanced budget	Planned revenue equals planned spending
Budget deficit	Planned spending is more than planned revenue
Budget surplus	Planned revenue is more than planned spending
Tax	A compulsory payment to the government with no direct service in return
Direct tax	Collected from the person or firm that earns the income or owns the wealth
Indirect tax	Added to spending; the seller collects it and hands it over
Progressive tax	Takes a bigger share of income from richer people
Regressive tax	Takes a smaller share of income from richer people
Proportional tax	Takes the same share from everyone
Average tax rate	Tax paid ÷ income × 100

4.3.2 Government spending in one table

Area	Why the government spends	Possible effect
Health	Merit good, external benefits	Healthier workforce, rising costs
Education	Merit good, raises skills	Better skills, benefit comes later
Defence, law and order	Public goods	Security, resources used
Infrastructure	High cost, many users	Lower business costs
Social protection	Redistribute income, support the vulnerable	Less poverty, high cost
Subsidies	Lower prices, protect industries	More output, cost to taxpayers

Key idea: all spending has an opportunity cost. It is paid for by taxation or borrowing.

Method: share of spending

1. Share = area ÷ total spending × 100.
2. If you move an amount between areas, the total stays the same. Recalculate both shares.

Reminder: in a budget of 250, an area of 55 is 55 ÷ 250 × 100 = 22%.

4.3.3 Why tax?

• Funding: the main source of revenue for public spending.
• Fairness: narrows gaps between incomes.
• Demerit goods: higher price, lower use.
• Home industry: import duties.
• Behaviour: reward or discourage chosen actions.

Other sources of revenue: charges, profits of state-owned firms and borrowing. Borrowing creates debt, so it is not the same as tax.

4.3.4 Classifying taxes

Direct	Indirect
Income tax	Sales tax
Corporation tax	Excise duties
Inheritance tax	Import duties

Two classifications, not one. A tax is direct or indirect, and separately it is progressive, regressive or proportional. For example, income tax is direct and usually progressive. A fixed licence fee is regressive.

Method: test for progressive, regressive or proportional

1. Work out tax at each income. For a banded tax, apply each rate only to the slice of income in that band.
2. Divide each tax by its income to get the average rate.
3. Compare: rising means progressive, falling means regressive, equal means proportional.

Reminder: bands are 0% to 8,000, 10% from 8,000 to 25,000 and 20% above. On 40,000: (25,000 − 8,000) × 10% = 1,700 and (40,000 − 25,000) × 20% = 3,000. Tax = 4,700. Average rate = 4,700 ÷ 40,000 × 100 = 11.75%. On 16,000: 8,000 × 10% = 800, so the average rate is 5%. The rate rises, so it is progressive.

Reminder: a flat fee of 90 paid by an earner on 1,800 is 5%, and by an earner on 9,000 is 1%. It is regressive.

4.3.5 Qualities of a good tax

Quality	In one line
Equity	Burden fits ability to pay
Certainty	Taxpayer knows what, when and how much
Convenience	Easy to pay
Economy	Low cost of collection compared with revenue
Efficiency or flexibility	Raises the revenue wanted with little damage, and can be adjusted

No tax has every quality. Say which quality matters most for the tax in the question, then judge the tax against it.

4.3.6 Impact of taxation

Group	Effects
Consumers	Less disposable income. Higher prices from indirect tax. Less of the taxed good bought. May switch to substitutes
Producers	Higher costs. Lower sales and profit. Corporation tax cuts profit after tax and may reduce investment
Government	Gains revenue. Revenue depends on how responsive demand is to the price rise
Economy	Redistribution, work incentives, price level, trade, tax evasion

Method: who bears an indirect tax

1. Find the equilibrium price without the tax.
2. For a tax t, subtract t from P wherever P appears in the supply equation.
3. Find the new equilibrium price and quantity.
4. Consumer burden per unit = new price − old price.
5. Producer burden per unit = t − consumer burden.
6. Multiply each burden by the new quantity. The two add up to total revenue t × new quantity.

Reminder: Qd = 600 − 20P and Qs = −100 + 30P. Equilibrium: 700 = 50P, so P = 14 and Q = 320. Tax of 5: Qs = −100 + 30(P − 5) = −250 + 30P. Then 850 = 50P, P = 17, Q = 260. Consumers pay 3 more and producers lose 2. Revenue = 5 × 260 = 1,300. Consumers bear 3 × 260 = 780 and producers bear 2 × 260 = 520. The total is 1,300.

Rule: who bears more. Whichever side reacts less to a price change carries more of the burden. Inelastic demand means consumers carry more.

Tax and revenue. The same per-unit tax raises more revenue where demand is inelastic, because quantity falls less.

Evaluating a tax: a short chain

1. Say what the tax is: direct or indirect, then progressive, regressive or proportional, with average rates if figures are given.
2. Pick two qualities that matter for its purpose, for example equity and economy.
3. State the effect on each group: consumers, producers, government, economy.
4. Weigh the gain against the cost, using figures where possible.
5. Finish with a verdict, and name what it turns on, such as the elasticity of demand or how the revenue is used.

Reminder: a sales tax on basic food is cheap to collect and certain, so it scores well on economy and certainty. Poorer households spend a larger share of income on food, so it scores badly on equity. A fair judgement says the tax raises reliable revenue but is regressive, so the answer depends on whether revenue is used to support low-income households.

Must-know distinctions

• Progressive is about the rate, not the amount. A tax can take more money from a richer person and still be regressive.
• Direct and indirect describes how the tax is collected. It does not tell you whether the tax is fair.
• Tax paid by a firm to the government is not always borne by the firm. Check incidence.
• Government budget is a plan. Government spending is one side of it.

Quick self-test

1. Define the government budget.
2. Name two main areas of government spending.
3. Give one reason for taxing cigarettes.
4. State one direct tax and one indirect tax.
5. A person earning 20,000 pays 3,000 in tax and a person earning 50,000 pays 12,500. Is the tax progressive, regressive or proportional?
6. A tax charges 10% on every income. State the name of this type of tax.
7. State two qualities of a good tax.
8. A budget of 500 includes 90 for health. What share is health?
9. Per-unit tax of 4 moves price from 20 to 23. How much of the tax per unit do consumers pay?
10. Why does a tax on a good with inelastic demand raise more revenue than the same tax on a good with elastic demand?

Answers

1. The government’s plan of its expected spending and revenue, usually for one year.
2. Any two of health, education, defence, infrastructure, social protection, subsidies.
3. To discourage a demerit good, or to raise revenue.
4. Direct: income tax (or corporation tax). Indirect: sales tax (or excise duty).
5. Average rates are 3,000 ÷ 20,000 = 15% and 12,500 ÷ 50,000 = 25%. The rate rises, so the tax is progressive.
6. Proportional.
7. Any two of equity, certainty, convenience, economy, efficiency or flexibility.
8. 90 ÷ 500 × 100 = 18%.
9. Consumers pay 23 − 20 = 3, so producers bear 4 − 3 = 1.
10. Quantity falls by a smaller percentage, leaving more units to collect tax on.

Where marks are usually lost

• Naming the type of tax with no average rates to back it up.
• Charging the top rate on all income rather than on the slice in the top band.
• Mixing up the two classifications, such as writing “indirect and progressive” for sales tax without reasons.
• Listing qualities with no link to the tax in the question.
• Giving only the benefits of spending and forgetting the opportunity cost.
• Saying that indirect tax always falls entirely on consumers.
• Writing about aggregate demand and supply in place of effects on incomes, prices and output.
• Writing a one-sided answer to an impact question with no judgement.

Official syllabus

Aligned to the Cambridge O Level Economics 2281 syllabus for examination in 2026, published by Cambridge University Press and Assessment (Cambridge International), subject content statements 4.3.1 to 4.3.6.