3.5 Fiscal policy Flashcards
Define government spending
The total amount of money spent by the government in a given time period
Define government revenue
THe amount of money the government recieves
Define direct tax
A tax on income and wealth
Define indirect tax
A tax on spending which is imposed on the producer but may then be passed onto consumers through an increase in price
What is the purpose of government spending?
- to supply goods and services that the private sector would fail to do (e.g. defence)
- to supply goods or services that would be too costly for many people (e.g. healthcare)
- to reduce poverty through welfare and benefit payments (e.g. unemployment benefit)
What are the sources of government spending?
- Direct tax (e.g. income tax, inheritance tax etc)
- Indirect tax (e.g. value-added tax/VAT)
- Local tax (e.g. council tax)
Define balanced budget
When revenue is equal to government spending
Define budget surplus
When revenue is greater than government spending
Define budget deficit
When revenue is less than government spending
Define fiscal policy
A policy that uses taxation and government spending to affect the economy as a whole
What are the economic objectives?
- Economic growth
- Lower unemployment
- Price stability
- Fair distribution of income
- Improved balance of payments
How could fiscal policy be used to create economic growth?
- Reduced tax
- Increase spending
- Will lead to a budget deficit
- Outcome: greater output and employment, potential increased exports
How could fiscal policy be used to lower unemployment?
- Reduced tax
- Increase spending
- Will lead to a budget deficit
- Outcome: More employment and output, potential increased imports
How can fiscal policy be used to create price stability?
- Increase tax
- Reduce spending
- Will lead to a budget surplus
- Outcome: Prices are stable/rise more slowly, balance of payments improves, but growth may decrease
How can fiscal policy be used to improve balance of payments?
- Increase tax
- Reduce spending
- Will lead to a budget surplus
- Outcome: imports decrease, economic growth may increase as exports exceed imports
How can fiscal policy be used to create fair distribution of income?
- Increase tax
- Increase spending
- Will lead to a budget deficit
- Outcome: the rich lose income while the poor become better off, both financially and in terms of more services
What are the costs of fiscal policy?
- Consumers may save rather than spend their extra income so the economy does not grow as much as expected
- Firms and consumers might spend the extra money on imports, making the balance of payments worse.
- Inflation may rise if supply cannot keep up with demand in either the factor or product market
What are the benefits of fiscal policy?
- Reduced unemployment: the government can cut taxes/increase spending. There is more demand for labour. Consumers can spend more, so again more labour is demanded.
- Economic growth: cutting taxes and increasing spending both lead to greater output as consumers purchase more and firms increase investment
- Faster acting: compared with monetary policy and supply-side policy, changes in fiscal policy act more directly and faster on the economy
What are the opportunity costs with fiscal policy?
- If the government spends more on one area (e.g. education), then it will spend less on another area (e.g. healthcare)
- If the government spends more, it could pay for it by increasing taxes. This means consumers have less income so they spend less.
- If a government cuts taxes, then it must either spend less or accept a higher budget deficit
Define progressive taxes
Taxes that take a greater percentage of tax, the higher the income
What is the result of measures to redistribute income and wealth (e.g. progressive taxes)
- Reduces inequality of income: poorer people are better off and those with higher incomes receive less money
- Lower savings: if the interest on savings is heavily taxed, people may prefer to spend rather than save
- Tax avoidance/evasion: people may seek ways to avoid paying tax (legal) or try to evade taxes (illegal)
If there was an increased VAT on TVs, how would this affect markets?
- Fall in demand for TVs
- Consumers switch to buying goods with lower VAT
If there was an increased VAT on TVs, how would this affect the economy?
- If produced in the UK, then employment in the industry will fall. If produced abroad, imports may fall.
How would increased government spending affect the economy?
Increased government spending is likely to:
- increase economic growth
- increase employment
- increase inflation
- may worsen the balance of payments (if there are more imports)
