Government Impact on Business: Taxes, Spending & Interest Rates (Cambridge International IGCSE Business)
Exam board Cambridge International · IGCSEUpdated 2025-07-29
The impact of changes in taxes and government spending
Spec point — "• Impact of changes in taxes and government spending • Impact of changes in interest rates • How businesses might respond to these changes"
The impact of changes in taxes and government spending
Taxation
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Governments impose direct and indirect taxes on businesses and households
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Direct taxes are levied on income, e.g. income tax and corporation tax
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Indirect taxes are levied on spending, e.g value-added tax (VAT)
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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
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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
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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
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In recent years, the UK government has increasingly focused on reducing government spending
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Infrastructure projects have been scaled back or cancelled
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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
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Spending on key services such as health and education has been reduced as part of its austerity strategy
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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
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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
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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
| Privatisation of public sector organisations | Investment in training and education | Regulations to increase competition |
|---|---|---|
| - 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
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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
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
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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 |
|---|---|---|
| The 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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