3.5 Fiscal Policy

Question 1

government spending

Answer 1

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

Question 2

purposes of government spending?

Answer 2

• social protection: aims to provide everyone with a basic minimum standard of living and reduce inequality in the distribution of incomes, e.g. state benefit and universal credit
• health: aims to increase the welfare of the population - ensures everyone has access to health services, regardless of income - NHS
• education: aims to increase welfare of population - ensures everyone has access to education regardless of income - increases equality of opportunity
• defense: spending on armed forces, e.g. army, air force, navy
• law + order: spending on police, courts + prison service
• debt interest: gov has borrowed money, amount outstanding = national debt, and interest has to be paid on this

Question 3

government revenue

Answer 3

source of finance for government spending

Question 4

direct tax

Answer 4

tax on income/wealth, e.g:
- income tax: collects most revenue, income tax allowance and once used up income tax is paid at a rate dependent upon income level
- national insurance contributions: paid by both employees and employers = tax on employing labour
- corporation tax: tax on profits of companies
- inheritance tax: tax on transfer of wealth at time of death
- capital gains tax: tax on profit when an asset is sold for more than it was bought

Question 5

indirect tax

Answer 5

tax on spending (goods and services), e.g:
- value-added tax (VAT) = tax on wide range of g+s (collects 2nd most revenue)
- excise duties = taxes on a specific range of goods
- insurance premium tax
- air passenger duty
- gambling duties

Question 6

balanced government budget

Answer 6

tax revenue = government spending

Question 7

budget surplus

Answer 7

tax revenue > government spending

Question 8

budget deficit

Answer 8

tax revenue < government spending

Question 9

fiscal policy

Answer 9

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

Question 10

how can a budget deficit and surplus be used to achieve economic objectives?

Answer 10

budget deficit - gov spending increases and taxation reduces. this leads to economic growth and low unemployment, by increasing spending, output and employment.

budget surplus - gov spending reduces and taxation increases. this leads to price stability and a healthier balance of payments, by reducing pressure on the price level and reducing spending on imports.

Question 11

how do direct taxes affect markets and the overall economy?

Answer 11

direct taxes can affect labour markets - workers may feel it is not worth their while to seek higher wage jobs if a large proportion of extra wages
can also affect firms and the market as if direct taxes, e.g. corporation tax is increased = less profits and disposable income = shrink and would decrease demand, employing less labour.

Question 12

how do indirect taxes affect markets and the overall economy?

Answer 12

= VAT and excise duties
affect markets of products on which taxes are levied - will raise price of product, so QD will fall - extent to which depends upon price elasticity of demand.
when level/rate of tax differs between commodities - will affect pattern of demand as they aim to buy g+s with the least tax - means those taxes are discriminating the producers whose products are taxed - leads to less output and employment in those industries, e.g. fuels like LPG and biogas have lower taxes than petrol and diesel.
VAT = 20%. On 3 types of products - tobacco, alcoholic drinks and vehicle fuel = very highly taxed + excise duties as they are ‘demerit’ goods = negative externalities - consumers are paying towards external costs they cause.
Some goods - ‘zero-rated’ goods have no indirect tax as ‘basic necessities’, e.g. children’s clothes and most foods.

Question 13

how does government spending affect markets and the overall economy?

Answer 13

Government spends a lot of money on public welfare services - health, education, defence - also a huge employer of labour so if decides to improve services will demand more labour market supply = more wages
Government policy/investment into capital projects increases the demand for the construction market
Many private sector firms supply goods and services to the public sector - so will benefit
Can also give subsidies - deliberately influencing specific industries and markets, e.g. in the renewable energy market to encourage firms to provide energy from renewable sources or to small businesses or deprived area businesses