1.8.1 Fiscal policy Flashcards
What is fiscal policy?
- Use of government spending, direct and indirect taxation and government borrowing to affect AD, output and jobs
- Changes pattern of spending on goods and services
- Redistributes income and wealth
- Corrects market failures
- Affects both AS and AD
Expansionary fiscal policy encourages an increase in G or reduces tax to shift AD right and increase disposable incomes
Contractionary fiscal policy - higher taxes lower G - reduced AD used to pay off debt
Why should governments spend money?
- Socially efficient level of public goods and merit goods - tend to be underprovided
- Access to healthcare, education, housing and services
- Safety net of welfare benefits to incomes of the poorest in society
- Provide necessary infrastructure via capital spending
- Manage growth levels and AD to meet macroeconomic policy objectives
- Promotes equality
- Catalyst for efficiency and competitiveness
How can government spending affect inequality?
- Welfare state transfers
- Benefits
- Pensions
- Education
- Health care
- Social housing
- Employment training
What are the types of tax?
Direct tax - levied on incomes, wealth ad profit - income tax, inheritance tax, national insurance contributions, capital gains tax and corporation tax - burden not passed don
Indirect tax - taxes on spending - duties on fuel, cigarettes and alcohol and VAT - may be able to be passed on depending on price elasticity of demand and supply
What are the key tax rates in the UK?
Income tax:
- 20% up to £37,500
- 40% between £37,501 and £150,000
- 45% over £150,000
No taxed up to £12,500
VAT:
- 20%
- 5% to domestic fuel and power, women’s sanitary products, contraceptives
Zero VAT on: food, construction of new houses, transport, books, prescriptions
Exempt from VAT: Rent, private education, health service, postal services
How do taxes influence AD?
- Effect on disposable incomes
- Change in corporation tax effects post tax profit available for businesses to invest
- Changes in national insurance affect cost of employing workers
- Change in VAT changes retail prices and affects real incomes of consumer
- AD shifts outwards during expansionary fiscal policy, moving closer to full employment - reinforced by multiplier and keeps moving out as technically an injection
- If economy at YFE causes inflation
- Can smooth out the business cycle making troughs and peaks smaller having more stable growth
How do taxes/government spending influence LRAS?
- Affect business costs
- Influence work incentives
- Affect level of FDI and migration into a country
- Affect incentive to setup or spend money on R&D
Crowding out may occur as if the spending is financed from borrowing there may be pressure on interest rates causing private sector spending to decline, limiting growth
What are the causes of a budget deficit?
- Recession rises unemployment, less tax paid
- Decreased consumer spending and profits - less tax revenue
- Increase inactivity - rise in welfare benefit spending
- Fiscal stimulus lifts AD
- Increased interest rates
- Demographic factors
What are automatic stabilisers?
-Changes in tax revenues and government spending that come about automatically as an economy moves through the business cycle.
Tax revenues: tax revenues increase in growth taking money out of the circular flow - decrease in recession, reinforced by progressive tax - may be funded by borrowing
Welfare spending: growing economy means country spends less of benefits and universal credit
Budget balance: during slowdown or recession government usually runs larger budget deficit
What factors may limit the effectiveness of Fiscal policy?
- Crowding out occurs as if spending financed from borrowing causes pressure on interest rate and causes decline in public sector spending, limiting the amount that the AD curve can shift outwards
- Political parties balance taxation and spending to create balance between public and private sectors
- Effect on balance of payments as may be spent on imports as there is no immediate change in exports, deficit may rise
- Leads to government budget deficit - increases AD but not sustainable.
What is fiscal policy used for?
- Stimulate economic growth and creating jobs/tax revenues
- Determine relative size of public and private sector using how much GDP comes from them
- Addressing market failure
- Redistribution of wealth and income
- Adjust balance between direct and indirect taxation
What is the PSNCR, PSNB and PSND
Public Sector Net Cash Requirement - difference between government income and cash required to run public bodies
Public sector net borrowing: how much borrowed in a time period. Calculated by PSNCR - amount government funds through other methods than borrowing
Public sector net debt - how much government is in debt in total
What are the 3 types of tax used in fiscal policy?
- Progressive
- Proportional - remains constant as incomes rise
- Regressive: proportion paid falls as incomes rise
How can fiscal deficit be reduced?
- Cut in government spending - controlling public sector pay
- Limiting welfare entitlement
- Higher indirect taxes
- Cut tax allowances
- Bring in new taxes
- Supply side policies - stronger growth + tax revenue
- Growth cuts deficit as % of GDP
Summarise fiscal policy
Changes to Tax and G - less tax/higher G increases disposable incomes so C and I rise so AD rises
E.g. income tax, VAT, duty, corporation tax, spending programmes, public sector wages, influence imports
Taxes may be used for demerit goods - final effect depends on multiplier
Evaluation:
- Inflationary pressure
- Environmental damage
- Widens fiscal deficit
- Contraction risk recession
- Inequality and poverty
- Indirect tax regressive on poorer households
