2.5.1 Fiscal policy Flashcards
fiscal policy defintion
use of taxation, government spending and government borrowing to influence the economy.
demand side fiscal policy definition
fiscal policies that aim to manipulate aggregate demand (AD) to achieve the macroeconomic objectives
supply side fiscal policy
fiscal policies that aim to improve the supply-side of the economy
direct tax
a tax on income/wealth
e.g. income tax, corporation tax, capital gains tax
indirect tax
a tax on spending
e.g. VAT, excise duties
Fiscal policy to influence microeconomics
intended to change the pattern of econ activity.
e.g. subsidies to encourage C, indirect tax to discourage C of CERTAIN products
fiscal policy + AD
expansionary fiscal policy
either increases in gov spending or reductions in tax - shift AD to the right.
fiscal policy + AD
contractionary fiscal policy
tax rises/ public spending cuts - shifts AD left
fiscal policy + AD
what directly effects AD (to do with fiscal policy)
government spending - its a component of it.
What economic indicators do changes in AD effect?
- level of real GDP
- level of unemployment
- price level
changes in gov spending = cause mutliplier
fiscal policy + AS
effects of changes in indirect tax
- increases = shift SRAS left
- reductions = shift SRAS right
because higher indirect taxes cannot always be fully passed onto the consumer in forms of higher prices, so profit margins fall.
∴ reduces incentive to supply output at any given price level
supply-side foscal policy defintion
fiscal policies designed to imrpove the LRAS of economy.
examples of supply side fiscal policy:
- targetted gov spending on increasing econs production capacity.
- tax incentives to firms to encourage employment of workers.
- reducing direct tax - work more attractive
fiscal stance definition
extent to which fiscal policy is likely to add or subtract from AD
fiscal stance affects:
affects budget balance -
expansionary = closer to deficit
contractionary = closer to surplus
public expenditure
resource (CURRENT) spending defintion
spending on day to day items e.g. salaries for employees of public sector.
capital spending defintion
spending on investment e.g. new hospitals, schools, roads
public expenditure
what does dividing into capital and current expenditure to?
allows us to see which spending will boost LRAS
public expenditure
what is the amount spent refered to as?
total managed expenditure (TME)
public expenditure
what is Total Managed Expenditure (TME) divided into?
- gov departments given amount they can spend Departmental Expenditure Limits (DEL)
- spending not controlled by such e.g. welfare, pensions Annual Managed Expenditure (AME)
public expenditure
major areas of public expenditure?
- public goods provision e.g. roads, defence
- merit goods provison e.g. health, education
- welfare expenditure e.g. prevent poverty
- debt interest
principles of taxation: (6)
- economical - inexpensive to collect
- equitable - fair
- efficient - few harmful side effects
- convinient - easy to pay
- certain - shoudl be able to work out how much
- flexible - changeable to different circumstances
reasons why govs levy taxes (4)
- raise revenue to finace gov expenditure
- change patterns of econ activity - cause shift away from one product to another
- discourage consumption + production of certain goods
- distribute income - gap between rich and poor narrowed
hypothecated tax
= tax levied to raise money for specific purpose
* on negative externalities could deal w/ problems caused by them to society
* restricts govs ability to use revenue as it chooses, limits flexability towards financing spending
progressive tax
= higher incomes - higher tax
* achieved through tax bands, tax only paided on additional income earned.
regressive tax
= taxes that increase in relative size on lower income earners
e.g. community charge - every person paid same amount, reguardless of income, contraversial and changed, hits poor harder
proportional tax
= taxes that are paid in equal proportions by everyone
one rate of tax and no tax-free thresholds
income tax advantages
- fair - based on earnings
- progressive nature - alleviate relative poverty
- administered by employers for most workers
income tax disadvantages
- disincentive to work
- progressive system - complex and expensive t administer
- encourages tax avoidence
VAT advantages
- Does not affect work incentives
- Hard to avoid
VAT disadvantages
- Regressive in many cases
- Changes in VAT rate can be inflationary
Excise duties advantages
- Can change patterns of expenditure (e.g. different rates used for petrol and diesel)
- discourage consumption of demerit goods
Excise duties disadvantages
- May lead to unemployment in those industries
- Regressive in some cases
- Can lead to ‘black markets where consumers get the product through alternative means to avoid the tax
council tax advantages
- Seen as fair as based on wealth of household
- Raises money for local services
council tax disadvantages
- Poverty values used to set ‘bands’ are very out of date
- Those who are ‘asset rich and cash poor’ may find it difficult to pay
corporation tax advantages
Based on success of companies - I.e. does not hit less successful companies as hard
corporation tax disadvantages
- May deter foreign direct investment
- Encourages tax avoidance
- May discourage business investment
cyclical budget deficit
- portion of a budget deficit that changes when rate of economic growth changes.
- Over time, cyclical deficit = eliminated as economic growth rate recovers towards its long-run average rate (and would move into a cyclical budget surplus if the economy were growing at an above-average rate).
structrual budget deficit
portion of budget deficit that remains even if econ growth is at normal long-run rat - means any structural deficit won’t be eliminated after a period of time.
- only eliminated if contractionary fiscal is implimented.
concequences of budget deficits and surpluses
economic growth
- Budget deficit: Fiscal policy adds to AD
- Budget surplus: Fiscal policy subtracts from AD
- Impact on growth: Changes in AD affect SR economic growth
- Economic growth rate affects budgetary position
- Slower growth leads to higher welfare expenditure and lower tax revenue.
- Low economic growth might lead to a budget deficit
concequences of budget deficits and surpluses
unemployment
- Higher government spending and larger budget deficit may increase demand for workers.
- ST effect: Greater demand for workers due to increased government spending
- LT perspective: Some economists argue unemployment returns to natural rate independent of budgetary policy
concequences of budget deficits and surpluses
inflation
- Demand-pull inflation: Result of excessive AD
- Expansionary fiscal policy may contribute to excessive demand
- Budget surplus effect: Rise in budget surplus (via tax increases and government spending cuts) reduces demand-pull inflation
fiscal policy and national debt
What does the government do when it runs a budget deficit?
- gov borrows to cover deficits, forming part of the national debt.
- Bonds issued to finance the deficit eventually need repayment, but deficits occur more frequently than surpluses, leading to continuous accumulation of debt.
fiscal policy and national debt
How does the size of the national debt affect interest payments?
The size of the national debt, expressed as a percentage of national income, influences the amount spent on interest payments.
fiscal policy and national debt
why do govs tend to run deficits + political impications?
- govs run deficits due to popular support for government spending among voters, reluctance of politicians to promise tax increases, and less immediate concerns about future debt repayment for politicians seeking election.
significance of national debt
What does large debt require?
- greater interest to be paids on the debt
- requires gov to make choces as to how to finace the payments
Office for Budget Responsibility (OBR)
set up 201- to provide independent analysis of fiscal policy
Main functions of OBR
- Economic forecasting - especially focusing on forecasts of the government’s finances.
- Evaluating fiscal policy (against the government’s own previously set targets).
- Analysis of the sustainability of public finances.
- Evaluation of fiscal risks.
- Analysis of tax and welfare costing.
