3.5 Fiscal policy

Question 1

What is meant by government spending?

Answer 1

The total amount of money spent by the government in a given period of time

Question 2

What are the 4 reasons why a gov spends money?

Answer 2

• to supply goods and services that the private sector would fail to do e.g. defence
• to supply goods and services that would be too costly for many people e.g. healthcare
• to reduce poverty through welfare payments and benefits
• to support the economy when there is insufficient private sector investment/spending.

Question 3

What are the 5 different types of government spending?

Answer 3

social protection, education, healthcare, defence law and order, and debt interest

Question 4

What is the purpose of spending on social protection?

Answer 4

social protection includes state pension, chid benefit, jobseeker’s allowance, and others. The purpose of social protection is first: to provide everyone with a basic minimum standard of living and second: to reduce inequality of distribution of incomes

Question 5

What is the purpose of spending on healthcare?

Answer 5

the purpose of spending on healthcare is to increase the welfare of the population e.g. health spending helps to stop the spreading of diseases through vaccination and treatment of individuals with the disease. The purpose of spending on health care is also to ensure that everyone has access to health care regardless of their income

Question 6

What is the purpose of spending on education?

Answer 6

to increase the welfare of the population, to ensure everyone is equipped with the basic skills, and to ensure that everyone has access to education regardless of income, which helps increase equality of opportunity.

Question 7

What is the purpose of spending on defence, law and order?

Answer 7

to provide essential services the private sector could not

Question 8

What is the purpose of spending on debt interest?

Answer 8

the gov has borrowed money in the past. the amount outstanding (which is still owes) is called the national debt, and interest has to be paid on this. so the purpose is to repay the money the gov has borrowed

Question 9

What is meant by government revenue?

Answer 9

the amount of money the government receives from taxes and other sources such as privatisation and is used to finance government spending

Question 10

What are the 2 sources of government revenue?

Answer 10

direct taxes and indirect taxes

Question 11

What is a direct tax?

Answer 11

A tax on income and wealth

Question 12

What are the 5 main direct taxes?

Answer 12

income tax, national insurance contributions (NIC), capital gains tax, inheritance tax, and corporation tax

Question 13

What is income tax?

Answer 13

The tax paid on all incomes including wages, pensions, dividends etc. Each person gets an income tax allowance before tax is paid.

Question 14

What is meant by an income tax allowance?

Answer 14

The amount of income on which no tax is paid.

Question 15

What is National insurance contributions?

Answer 15

NIC is paid by both employers and employees

Question 16

What is capital gains tax?

Answer 16

A tax on profits when an asset is sold for more than when it was bought

Question 17

What is inheritance tax?

Answer 17

a tax paid on the transfer of wealth to relatives when someone dies

Question 18

What is corporation tax?

Answer 18

A tax paid by firms on the profits they have made

Question 19

What is meant by indirect taxes?

Answer 19

A tax on spending. sometimes this tax is imposed on producers, but they can pass it on to consumers through an increase in price.

Question 20

What are the 3 main types of indirect taxes?

Answer 20

value-added tax (VAT), excise duties, and customs duties

Question 21

What is value-added tax?

Answer 21

A tax on a wide range of different goods and services. It is paid at 3 different rates:

• 20% standard rate applied to the majority of goods and services
• 5% reduced rate on some items, e.g. children’s car seats and fuel in the home.
• 0% rates on most food and children’s cloths

Question 22

What is excise duties?

Answer 22

Taxes on specific goods such as alcohol, petrol and tobacco

Question 23

What are customs duties?

Answer 23

taxes on imports of goods into the country

Question 24

Is climate change tax a direct or indirect tax?

Answer 24

indirect tax

Question 25

Who do local taxes provide revenue for

Answer 25

For local authorities

Question 26

What are the 2 types of local taxes?

Answer 26

• council tax: a tax on the value of a persons home. As the value of the property rises so does the tax
• business rates: a tax on the value of the property of a business

Question 27

What is meant by a balanced government budget?

Answer 27

Is when tax revenue is equal to government spending

Question 28

What is meant by a budget surplus?

Answer 28

is when tax revenue is greater than government spending

Question 29

What is meant by budget deficit?

Answer 29

When tax revenue is lower than government spending

Question 30

What is meant by fiscal policy?

Answer 30

A policy that uses government spending and taxation to affect the economy as a whole

Question 31

What are some of the things fiscal policy can be used to achieve?

Answer 31

• low unemployment
• economic growth
• price stability
• a balance in the balance of payments

Question 32

How can a budget deficit be achieved? When may a gov use it? and how can it be used to achieve economic objectives?

Answer 32

If there is a balanced budget initially, the a budget deficit can result from either increasing gov spending or decreasing taxes or both. A gov may use a budget deficit when the economy is in a recession, with high unemployment and a lack of economic growth. The budget deficit will increase economic activity, thus achieving more employment and economic growth

Question 33

How does a budget deficit from increasing gov spending achieve economic objectives?

Answer 33

If government spending rises, it could spend more on for example health and education. This extra spending provides incomes for others - if more is spent on the NHS there may be more nurses and other staffs receiving wages. As incomes rise, people are able spend more, and this spending becomes income for the firms that are producing the extra output which people are buying. The firms may need to expand and employ more workers to meet the extra demands, resulting in less unemployment and more incomes.

Question 34

How does a budget deficit from reducing taxes help achieve economic objectives?

Answer 34

If the government chose to reduce taxes, it will increase the disposable income of taxpayers. With greater disposable income, consumers are able to spend more, so total demand rises. This spending becomes income for the firms producing the output and they may need to higher more workers in order to meet the extra demand. This results in more people with incomes they can spend. Therefore this process continues with incomes, spending, output and employment all rising

Question 35

How can a budget surplus be achieved? When does a gov use it?

Answer 35

If there’s a balanced budget initially, then a budget surplus can be achieved by either decreasing gov spending, increasing taxes, or both. The gov will use a budget surplus when there is too much inflation or a large balance of payments deficit

Question 36

How does a budget surplus from decreasing gov spending help achieve economic objectives?

Answer 36

the gov could spend less on roads and transport, or cut benefits. This will reduce incomes in the economy one way or another. As incomes falls, consumers spend less so there is less incomes for firms in the economy. These firms will react by producing less output and employing fewer workers. This means total demand falls.

Question 37

How does a budget surplus from an increase of taxes achieve economic objectives?

Answer 37

If taxes are increased, disposable incomes are reduced, therefore consumers have less money to spend so total demand falls. The firms will react by reducing their output and employing fewer workers and total incomes will fall further. As demand falls there is less pressure on prices and the demand for imports falls

Question 38

What may happen if the gov has a large budget deficit when there is already low unemployment and high economic growth?

Answer 38

It could lead to a higher rate of inflation if supply doesn’t meat to the demand, and it can also lead to a large balance of payments deficit

Question 39

How can direct taxes such as income tax or national insurance contribution affect markets?

Answer 39

Direct taxes such as income tax and national insurance contributions can affect labour markets. For example workers may not think its worth their while to seek jobs that pay a higher wage if a large proportion of the extra wage goes into paying taxes.

Question 40

How can direct taxes such as corporation tax affect markets?

Answer 40

If the rate of corporation tax is reduced, firms will have more disposable income, which they may use to expand. They may invest in new capital goods such as machinery which could raise demand in those markets. Furthermore, they may employ more labour, thus influencing those labour markets. However, if corporation tax is increased, firms may decide that some investment is not worth the risk, as the post tax rewards are now lower.

Question 41

How can indirect taxes affect markets?

Answer 41

they will obviously affect the markets of the product on which the taxes are levied. These taxes will raise the price of the product, so the quantity demanded will fall. the extent to which the quantity demanded falls by will depend on the price elasticity of demand of the product

Question 42

How does government spending affect the labour market?

Answer 42

The gov is a major employer so any change change in spending will have a major affect on civil servants, nurses, etc. For example if the gov decided to spend more on heath, then there will be more demand for nurses, and their wages may also increase

Question 43

How does go spending affect the construction market?

Answer 43

Gov’s are directly responsible for roads, hospitals and schools. So if for example the gov decided to spend more on education by building more schools, then those firms that supply school desks and furniture will benefit from the rise in demand for their products. Governments can also encourage housebuilding by cutting interest rates.

Question 44

How does gov spending affect the private sector?

Answer 44

By building new schools there is more demand for goods such as computers, so the profits of firms producing these goods rise. The same will be true in the navy orders a new ship etc.

Question 45

How does gov spending affect specific markets?

Answer 45

The gov sometimes gives of subsidies, which deliberately have an influence on specific markets and industries.

• The gov gives subsidies to firms in the renewable energy market. This is because the gov wishes to encourage firms to provide energy from renewable sources and reduce the amount of energy coming from fossil fuels and thus decrease negative externalities
• the gov offers grants for small businesses to encourage enterprise in many product markets by helping people start up their own business.
• the gov also has subsidies that are targeted at encouraging businesses to set up in deprived areas where unemployment is very high.

Question 46

What are the costs of fiscal policy?

Answer 46

• If the gov budgets for a deficit by reducing taxes, then the disposable income increases, but there is no guarantee that they will spend this extra money. they may save it, especially if interest rates are very high. Therefore the economy doesn’t grow us much as expected.
• as disposable incomes rises, much of consumers and firms extra spending may be on imported goods and services, which may lead to a larger balance of payments deficit
• As the budget deficit leads to a rise in total demand, there may be a rise in inflation if supply does not rise enough to keep up with the demand.

Question 47

What are the opportunity costs of fiscal policy?

Answer 47

• If the gov promises to spend more on education and healthcare but maintain a balanced budget, then the opportunity cost of the extra spending on health and education will either be less spending in other areas, such as defence or transport, or higher taxes, which means consumers will have less to spend. In other words, either the government has give up some spending on other areas, or consumers have to give up some of their spending
• If the government reduces income tax rates and doesn’t increase any other taxes, then the opportunity cost is either a rise in the budget deficit or a fall in the government spending. In other words, either the gov will have to give up some spending, or it has to accept a larger budget deficit

Question 48

What is the policy of income and wealth redistribution/

Answer 48

refers to the gov action, using mainly taxation and benefits to reduce the inequalities on income and wealth

Question 49

What is a progressive tax?

Answer 49

A tax that has a higher rate of tax on higher incomes

Question 50

What are the 4 methods the government uses in order to redistribute income and wealth?

Answer 50

• progressive taxes
• inheritance tax
• Reducing indirect taxes
• Gov spending and redistribution

Question 51

How can inheritance tax be used to redistribute income and wealth?

Answer 51

As it is a tax on the assets of a person upon death. A proportion of the wealth of the deceased person is paid in tax, so wealth is redistributed from the family

Question 52

How can reducing indirect taxes help to redistribute income and wealth?

Answer 52

If the gov wishes to redistribute income in favour of lower income groups, then one way is by reducing indirect taxes. However, it may not wish to do this because certain goods with a high tax burden such as tobacco and alcohol have negative impacts on society. Therefore the gov is likely to carry on to tax them heavily even though they discriminate against those with lower incomes. On the other hand, the UK gov does not impose taxes on goods that are necessities such as most foods, children’s clothes, books, medicines and public transport.

Question 53

How can gov spending and redistribution help redistribute income and wealth?

Answer 53

The gov can increase its spending on measures that will help it to reduce inequalities. One way is by providing social protection benefits to lower income groups, which directly increases the disposable incomes of those households. These benefits are also known as transfer payments, since they transfer money from higher income groups through taxation to lower income groups. Some gov spending increases equality of opportunity, so people from poorer households may be able to have higher incomes in the future

Question 54

What are the consequences of redistribution measures?

Answer 54

• people may find that they can live well enough on the benefits they receive from the government, so they may not be bothered to seek work. This is particularly true if the post-tax income from work is not much higher than the benefits provided by the government from not working at all.
• People may be more reluctant to apply to higher paying jobs because the difference in post-tax income may not make it worthwhile.
• Some high earners may move abroad in order to escape the tax, leading to the UK gov losing all the tax revenue. If talented workers move abroad, the UK economy loses their contribution to the economy.
• High indirect taxes can also act as a disincentive for businesses to invest, The rate of corporation tax is also a consideration for businesses deciding which country to locate in.
• Saving decision are also affected by direct taxes on interest. People may be reluctant to save if a lot of their interest is taxed