2.5 Fiscal policy and supply side policies Flashcards
Fiscal policy
the use of taxation and government spending to achieve policy objectives
direct tax
a tax which cannot be shifted by the person legally liable to pay the tax onto someone else. They are normally levied on income and wealth.
Income tax
a direct tax levied on personal income
Income tax threshold
the level of income above which people pay income tax
Indirect tax
a tax which can be shifted by the person legally liable to pat the tax onto someone else, for example through raising the price of a good being sold by the taxpayer. They are normally levied on spending
Progressive tax
a tax when, as income rises, a greater proportion of income is paid in taxation
proportional tax
a tax when, as income rises, an equal proportion of income is paid in taxation
regressive tax
a tax when, as income rises, a smaller proportion of income is paid in taxation
wage elasticity of supply of labour
proportionate change in supply of labour following a change in the wage rate
laffer curve
- a curve which shows the levels of tax revenue relative to the income tax rate
- if tax cuts cause incomes to rise (due to incentives) proportionally more than the tax rate has fallen, tax revenues will increase
- if tax increases cause income to fall proportionally more than the tax rate has risen, then tax revenues will decrease
Describe the shape of an individual workers labour supply curve
- workers face an opportunity cost - labour vs. leisure
- an individual has a backward bending supply curve
- at a certain point hourly wage rate will be large enough to cause people to want more leisure hours, since leisure time is a normal good
Why collect taxes? (4)
- to pay for government expenditure
- to correct market failures such as externalities
- to manage the level of spending in the economy
- to redistribute income
policy instrument
a tool or set of tools used to try and achieve a policy objective
Balanced budget
occurs when government spending equals government revenue (G=T)
budget deficit
occurs when government spending exceeds government revenue (G>T)
budget surplus
occurs when government revenue exceeds government spending (G<T)
public sector borrowing
borrowing by the government and other parts of the public sector to finance a budget deficit
national debt
the amount of accumulated debt, resulting from past government borrowing, that is owed by the UK government
multiplier
the relationship between an initial change in aggregate demand and the resulting usually larger change in national income
cyclical unemployment
those unemployed because there is a lack of economic activity in the economy and their labour is not demanded due to the existence of sticky wages (e.g. during a recession)
contractionary policies
policies aimed at reducing aggregate demand
expansionary policies
policies aimed at increasing aggregate demand
Describe expansionary fiscal policy
- budget deficit (G>T)
- lower taxes increases disposable incomes, C↑, AD↑
- increased government spending on services in the economy creates new jobs
How can fiscal policy be used to influence AS?
- The government could reduce income and corporation tax to encourage spending and investment.
- The government could subsidise training or spend more on education. This lowers costs for firms, since they will have to train fewer workers. Spending more on healthcare helps improve the quality of the labour force, and contributes towards higher productivity.
- Governments could spend more on infrastructure, such as improving roads and schools.
supply-side economics
a branch of free-market economics which argues that government policy should be used to improve the competitiveness and efficiency of markets with an aim to increase the productive potential of an economy
supply side policies
the use of policy instruments to create more competitive and efficient markets with an aim to increase the productive potential of an economy
interventionist supply-side policies
the regulation or replacement of free markets with an aim to promote competition and efficiency aiming to increase the productive potential of an economy
non-interventionist supply-side policies
the freeing-up of markets, promotion of competition, promotion of efficiency, and a reduction in the economic role of the government with an aim to increase the productive potential of an economy
privatisation
the transfer of publicly owned assets to the private sector
marketisation
the provision of goods and services shifting from the non-market sector to the market sector
deregulation
the removal of rules which restrict economic action
contractualisation
services that are provided by the government being contracted to private sector bidders
supply-side improvement
reforms undertaken by the private sector to reduce costs to enable firms to become more productively efficient and competitive
aims of supply side policies (5)
- increase incentives
- promote competition
- reform the labour market
- improve skills and quality of the labour force
- improve infrastructure
Strengths of supply-side policies (1)
- Supply-side policies are the only policies which can deal with structural unemployment, because the labour market can be directly improved with education and training.
Weaknesses of supply side policies (3)
- Demand-side policies are better at dealing with cyclical unemployment, since they can reduce the size of a negative output gap and shift the AD curve to the right.
- There are significant time lags associated with supply-side policies.
- Market-based supply-side policies, such as reducing the rate of tax, could lead to a more unequal distribution of wealth.
Office for budget responsibility
an advisory public body that provides independent economic forecasts and analysis of the public finances as background to perpetration of the UK budget
Duties of the Office of Budget Responsibility (4)
- forecasts of the economy and public finances
- evaluation of the government’s performances against its fiscal targets
- scrutiny of the government’s policy costings
- assess the long-term sustainability of the public finances
Canons (or principles) of taxation
criteria used for judging if a tax is good or not
What are the six canons of taxation?
- economy - a tax must be cheap relative to the revenue it yields
- convenience - a tax must be convenient for taxpayers to pay
- certainty - taxpayers must be reasonably certain of the amount they will be expected to pay
- equity - a tax must be fair
- efficiency - a tax must achieve its desired objectives with minimum intended consequences
- flexibility - a tax must be easy to change to meet new circumstances
Economic cycle
regular fluctuations in the level of economic activity around the productive potential of the economy. In the cycle the economy moves from troughs, when it is operating below its productive capacity, to booms when it is operating above its productive capacity
Automatic stabilisers
features of modern government budgets, particularly income taxes and welfare spending, that act to dampen fluctuations in real GDP and reduce the size of output gaps
Cyclical budget deficit
the part of the budget deficit which rises in the downswing of the economic cycle and falls in the upswing of the cycle
Structural budget deficit
the part of the budget deficit which is not affected by the economic cycle but results from structural change affecting the government’s finances
Examples of microeconomic supply-side policies - industrial policy measures (5)
- privatisation
- marketisation
- deregulation
- internal markets
- subsidising spending on research and development
Examples of microeconomic supply-side policies - labour market measures (6)
- lower rates of income tax
- reducing state welfare benefits relative to average earnings
- changing employment law to reduce the power of trade unions
- repealing legislation which limits employers’ freedom to employ
- more flexible pension agreements
- improving the training of labour
Examples of microeconomic supply-side policies - financial and capital market measures (4)
- deregulating financial markets
- encouraging saving
- promoting entrepreneurship
- reducing public spending and public-sector borrowing
Financial crowding out
when governments borrow money to finance a deficit, and in doing so increase the interest rate for consumers and firms, reducing their availability of credit
Current government expenditure
Current spending is short term and has to be renewed. For example, it could be on drugs for the health service
Capital government expenditure
spending on physical assets like roads, bridges, hospital buildings and equipment. Capital spending is long term as it does not have to be renewed.
