2.6.2 Demand-side policies Flashcards
2.6 Macroeconomic objectives and policies
What is fiscal policy?
Government led policies relating to any of these areas:
- government spending (e.g. subsides)
- taxation (revenue)
- budget balance (e.g. borrowing)
Types of fiscal policy (taxation)
Direct:
- income tax
- corporation tax: tax on company profits
- National Insurance contributions: for certain state benefits
- inheritance tax: tax on transfer of money/property
- council tax: tax on property (bands)
Indirect:
- VAT: tax on spending
- capital gains tax: tax on profit earned from the sale of assets (houses/shares/bonds)
- excise duties: unit tax on sale of luxury goods (alcohol/tobacco/fuel/betting)
- stamp duty: paid when you purchase a property (rate based on value)
Taxes can be progressive, proportional or regressive.
Progressive tax
When the percentage of income taken in tax rises as income rises (e.g. income tax)
Proportional tax
Flat rate of tax:
When the percentage of income paid in tax is the same for each household (e.g. NICs)
Regressive tax
Where the percentage of income taken in tax falls as income rises (e.g. VAT/duties)
Why do governments impose taxes?
- to raise money for government spending
- to discourage the consumption of demerit goods
- to redistribute income within the economy
- to influence competitiveness
- to influence the level of AD in an economy
Advantages of income tax
Advantages:
- more fair (progressive)
- can be used to improve the wealth gap
- easy to pay as it is dealt with by employers
Disadvantages of income tax
Disadvantages:
- can act as a disincentive for workers to work harder to to work at all
- the tax bands and progressive system make it more complex
Advantages of VAT
Advantages:
- hard for consumers to avoid
- consumers can still have a choice on what they spend their money on
Disadvantages of VAT
Disadvantages:
- usually regressive
- changes in VAT can cause inflation
- increased costs of production for firms can make them less internationally competitive
What does the Laffer curve show?
The optimal tax rate in an economy, represents the relationship between the tax rate and the amount of government revenue earned
Types of government spending
- capital spending: investments in infrastructure that improves future productive capacity (e.g. new roads)
- current spending: day-to-day running expenses of the public sector (e.g. public sector worker salaries)
- transfer payments (e.g. pensions)
Reasons for government spending
- to provide public and merit goods
- to inc. the productive capacity of the economy
- to influence the level of demand
- to incentivise the production of goods with social benefits
- to improve the wealth gap
Fiscal/budget deficit
When government expenditure exceeds tax revenue
Fiscal/budget surplus
When government tax revenue exceeds expenditure
What are National Insurance Contributions?
Contributions paid by all employers and employees towards the cost of certain state benefits
What is capital spending?
Investment on infrastructure that improves the future productive capacity/growth of an economy (e.g. new roads/buildings/weapons)
What is current spending?
Day-to-day expenses of the public sector (e.g. public sector worker salaries/health services)
What are transfer payments?
Money transferred from those who produced goods/services to those who do not/are not productive in the economic sense (e.g. pensions/Job Seeker’s Allowance)
What are public goods?
Goods that could not be provided effectively through private businesses due to problems such as the free-rider problem, non-rivalry and non-excludability, so the govt. has to provide them so everyone has equal access (e.g. street lighting/traffic signals/road markings)
What are merit goods?
Goods that would be under-consumed and under provided if left to private individuals/businesses to provide (e.g. healthcare/education)
What is social protection?
Government spending on pensions and benefits (income support/disability benefits)
Why does the government pay for social protection?
Due to the aging population/rising costs of production and underemployment/low-paid work
What is debt interest?
Interest paid to bond holders who lend the government money when govt. expenditure exceeds govt. tax revenue, which contributes to total national debt rising
How does capital spending benefit the economy?
- improves the productive capacity/potential (LRAS outwards)
- economic growth
- multiplier effects from large-scale infrastructure investments
How does current spending benefit the economy?
- employment and wages(salaries) for public sector workers: inc. in living standards
- provides more essential services (healthcare): healthier population
- inc. flow of money in CFI: inc. in disposable income leading to an inc. in C (AD outwards)
- more productive workforce
How do transfer payments benefit the economy?
- improved income/wealth equality
- inc. flow of money in the CFI: especially during recessions as many are out of work (AD outwards)
- reduces the impact of lost flows of money: from an aging population (large no. of retired people)
How do public goods benefit the economy?
- improved social welfare/equality: equal access
- improved safety
- improved efficiency/productivity: quicker travel times (SRAS outwards)
How do merit goods benefit the economy?
- healthier/skilled population
- combats the underconsumption of merit goods
- more productive workforce (LRAS outwards)
