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Ricardo A Level Economics (AQA) > 4.13.1 - Fiscal Policy > Flashcards

4.13.1 - Fiscal Policy Flashcards

1
Q

What is fiscal policy?

A

The use by the government of government spending and taxation to try to achieve the government’s policy objectives.

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2
Q

What is fiscal policy often associated with?

A

Keynesian macroeconomic theory and policy.

Associated with the 1950s to 1970s.

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3
Q

What affect does fiscal policy have on microeconomics?

A

Government uses taxation and subsidies to influence consumer behaviour.

Uses income taax and the welfare system to create incentives in the labour market.

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4
Q

What is a balanced budget?

A

When gov. spending = gov. taxation.

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5
Q

What is a budget deficit?

A

When gov. spending > gov. taxation.

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6
Q

What is a budget surplus?

A

When gov. spending < gov. taxation.

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7
Q

What did fiscal policy attempt to do?

A

Manage the level of AD in the economy.

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8
Q

What is demand-side fiscal policy?

A

Used to increase or decrease the level of AD through changes in gov. spending, gov. taxation and the budget balance.

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9
Q

What is deficit financing?

A

Deliberately running a budget deficit and borrowing to finance the debt.

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10
Q

What was the central assumption to Keynesian fiscal policy?

And what is the main issue with this assumption?

A

The assumption that the government spending multiplier is high. i.e. increasing gov. spending by £10 billion would increase AD and national income by £30 billion.

It is now generally assumed that government multiplier effects are not this high. Many being closer to a multiplier of 1 (i.e. no multiplier).

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11
Q

What Keynesian views led to fiscal policy being implemented?

A
  • An unregulated market economy results in unnecessarily low econ. growth and high unemployment.
  • A lack of AD (the private sector saves too much and spends too little) can lead the economy to settle into an under-full employment equilibrium.
  • Deficit financing can allow the gvoernment to achieve full employment.
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12
Q

What is sound finance?

aka fiscal orthodoxy

A

The belief that governments had a moral duty to balance the budget.

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13
Q

When was fiscal orthodoxy overturned?

A

When Keynesian economics legitimised deficit financing.

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14
Q

What is expansionary fiscal policy?

A

Uses fiscal policy to increase AD and shift the AD curve to the right.

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15
Q

Draw a graph of the effects of expansionary fiscal policy.

A
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16
Q

Why does expansionary fiscal policy work (according to Keynesians)?

A

The equation for AD is:
AD = C + I + G + (X - M).

Increasing government spending will increase AD as there is an injection into the circular flow of income.

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17
Q

How do Keynesians look to remove cyclical unemployment?

A

Increasing the budget deficit by raising levels of government spending and/or cutting taxes.

This expansionary fiscal policy shifts the AD curve rightwards, and a higher equilibrium national income is achieved.

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18
Q

What is the free-market argument against Keynesian methods to remove cyclical unemployment?

A
  • The price level will increase, possibly leading to demand-pull inflation.
  • Improvements to equilibrium national income are highly dependent on the shape of the SRAS curve.
  • The nearer the economy gets to it’s “normal output”, the greater the inflationary effect and the smaller the reflationary effect.
  • Once the “normal output” is reached, the effects are purely inflationary.
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19
Q

What is contractionary fiscal policy?

A

Uses fiscal policy to decrease AD and shift AD to the left.

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20
Q

Draw a graph demonstrating contractionary fiscal policy.

A
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21
Q

What is discretionary fiscal policy?

A

Involves making intentional goverment policies to change G, T and the budget deficit to manage levels of AD.

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22
Q

Why was discretionary fiscal policy used?

A

To ‘fine-tune’ the level of AD in the economy.

Gov. taxation, gov. spending and/or the budget deficit were changed to stabilise fluctuations in the economic cycle.

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23
Q

Why is a larger government spending multiplier/tax multiplier desirable?

A

The smaller the increase in public spending needed to bring about a desired increase in national income.

In a similar vein, the larger the tax mulitplier, the smaller the required tax cut to bring about a desired increase in national income.

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24
Q

What is crowding out?

A

A situation in which an increase in government or public-sector spending displaces private-sector spending, with little or no increase in AD.

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25
Q

Why does crowding out lead to a small government spending multiplier?

A

Assuming an economy is producing on it’s PPF, increasing public-sector spending will reduce private-sector spending with little to no improvement in AD.

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26
Q

What is the argument against crowding out?

A

It is almost safe to assume an economy is never producing on it’s PPF as that needs such high levels of productivity.

As a result, crowding out will not occur and the government spending multiplier will be large enough to make an improvement.

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27
Q

What is supply-side fiscal policy?

A

Policies to increase the economy’s ability to produce and supply goods.

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28
Q

What are supply-side policies?

A

Government economic policies which aim to make markets more competitive and efficient.

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29
Q

When did demand-side fiscal policy become unfavoured?

A

Mostly following 1979.

(Revived briefly in 2008 to 2010 to ‘spend the economy out of recession’.)

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30
Q

What are the effects of income tax cuts according to demand-side fiscal policy?

A

Shift the AD curve to the right as there is more money available for people to spend.

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31
Q

What are the effects of income tax cuts according to supply-side fiscal policy?

A

AS is increased as economic incentives are changed.

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32
Q

What are the effects of supply-side fiscal policy from an AD AS perspective?

A

The LRAS will shift rightwards meaning the normal capacity level of output has risen.

Alongside this, supply-side fiscal policy can also cause the SRAS to shift rightwards.

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33
Q

What are the main types of public expenditure?

A
  • Investment (i.e. new schools, hospital renovations etc.)
  • Annual running costs (teacher salaries, electricity in hospitals etc.)
  • Transfers (state pension, unemployment benefits)
  • Interest payments on national debt.
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34
Q

What is total managed expenditure?

A

The total amount that the government spends.

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35
Q

Why will the costs of social protection continuously increase?

A

The number of pensioners is increasing steadily, and the ‘triple lock’ protects pensioners.

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36
Q

Why may social protection spending fall or increase?

A

In economic booms, there are less unemployed so less spending on unemployment related benefits.

In economic recessions, there are more unemployed so more spending on unemployment related benefits.

37
Q

What are transfer payments?

A

Taxation of one group to redistribute to another.

38
Q

What makes up the majority of social protection?

A

Transfer payments.

39
Q

What are interest payments directly affected by?

A

Interest rates set by the BoE.

40
Q

Where does the UK government generate the majority of it’s revenue from?

A

Income tax, closely followed by VAT and NI contributions.

41
Q

What is income tax?

A

The UK’s most direct tax, paid on earnings, pensions, benefits, savings and investment income and rents.

42
Q

What is national insurance?

A

Was started as a rainy-day fund that people could claim from.

It’s now used to finance the NHS and welfare benefits.

43
Q

What type of tax is NI?

A

A regressive tax.

44
Q

What is a corporation tax?

A

A tax levied on company profits.

45
Q

What is the rate of corporation tax?

A

25%.

46
Q

What are the rates of income tax?

A

20% (~£12.5k to ~£50k)
40% (~£50k to ~£125k)
45% (>~£125k)

47
Q

What are excise duties?

A

Indirect taxes on the sale and consumption of goods such as alcohol, tobacco and energy.

48
Q

What is stamp duty?

A

A tax paid on the purchase of a property.

49
Q

What is inheritance tax?

A

A tax on the wealth of someone who dies at 40%.

50
Q

What is capital gains tax?

A

A tax levied on the profit a person makes when selling possessions or investments.

51
Q

What is council tax?

A

A tax charged by local authorities on the value of houses and flats to the people who live in the properties.

52
Q

What is a direct tax?

A

A tax that cannot be shifted by the person legally liable to pay the tax onto someone else.

53
Q

What is an indirect tax?

A

A tax that can be shifted by the person legally liable to pay the tax onto someone else.

54
Q

Why was progressive taxation employed?

A

Mostly under the guise of reducing income inequalities.

55
Q

What is regressive taxation?

A

When the proportion of income paid in tax falls as income increases.

56
Q

What is proportional taxation?

A

When the proportion of income paid in tax stays the same as income increases.

57
Q

How, mathematically, can you tell if a tax is regressive, progressive or proportional?

A

You can examine the relationship between the average rate at which the tax is levied and the marginal rate.

58
Q

What makes a progressive tax, progressive?

A

The marginal tax rate is higher than the average tax rate.

(i.e. the average rate rises as income increases)

59
Q

What makes a regressive tax, regressive?

A

The marginal rate of tax is less than the average rate.

(i.e. the average rate falls as income increases)

60
Q

Which of the average tax rate or marginal tax rate have a bigger impact on economic choices?

A

The marginal tax rate.

61
Q

What are the canons of taxation?

A
  • Economy (a tax should be cheap to collect in relation to revenue gained)
  • Convenience and certainty (it should be easy to pay, and taxpayers should roughly know how much they are going to pay)
  • Equity (tax system should be fair)
  • Efficiency (a tax must have its desired objective(s) with minimal undesired side-effects)
  • Flexibility (the tax should be easy to change to meet new circumstances)
62
Q

How is income tax relatively easy to pay (for most?)

A

Most people are on PAYE taxation.

Employers bear most of the costs as a result.

63
Q

What is an ad valorem tax?

A

A tax levied on the value of an item.

64
Q

What is the main advantage of taxes on spending?

A

It can be used to encourage people to change behaviours by making prices higher.

65
Q

Why can indirect taxes become less useful to influence consumer spending?

A

If more and more goods are taxed at the same rate, people will not have the same incentive to change behaviours as everything is taxed at the same rate.

66
Q

Which of the two canons of taxation prove to conflict?

A

Efficiency and equity.

67
Q

Why are the canons of efficiency and equity difficult to meet at the same time?

A

To have an efficient tax system, it must provide greater incentives to work in order to increase the UK’s growth rate.

If you use the taxation system to make the UK more equitable, there is less incentive to work hard and take risks by being entrepreneurial. (aka dependency culture)

68
Q

What do supply-side economists think about income tax and benefit rates?

A

Generally think they should be cut.
Income tax cuts and benefit cuts would alter the work/leisure choice in favour of supplying labour.

This view thinks increased inequality is a necessary evil to create incentives to facilitate economic growth. i.e. trickle down.
The poor will end up better in absolute terms, but worse in relative terms to the rich.

69
Q

What is the national debt?

A

The stock of all past government borrowing that has not been paid back.

70
Q

What is the difference between deficit and debt?

A

Deficits are economic flows.
Debts are economic stocks.

i.e. the deficit can fall, but the debt will continue to grow.

71
Q

What is the cyclical budget deficit?

A

The part of the budget deficit which rises in the downswing of the economic cycle and falls in the upswing.

72
Q

What is the structural budget deficit?

A

The part of the budget deficit that is not affected by the economic cycle but results from structural change in the economy.

73
Q

What is counter-cyclical demand management policy?

A

Contractionary fiscal and/or monetary policy deflated AD in the boom phase of the economic cycle.

Expansionary fiscal and/or monetary policy reflated AD in the recessionary phase of the economic cycle.

This will smooth out the economic cycle had discretionary demand management not been used.

74
Q

What are automatic stabilisers?

A

Fiscal policy instruments that automatically stimulate AD in an economic upswing and depress AD in an economic downswing. Thereby ‘smoothing’ the economic cycle.

75
Q

What are some examples of automatic stabilisers?

A

Progressive taxes
Income-related welfare benefits

76
Q

What is the main benefit of automatic stabilisers? (and how does this happen)

A

It reduces the volatility of the economic cycle.

The multiplier effects within the economy are dampened. If AD falls, national income will also fall. The progressive tax system will take less money from people and the demand-led income-related welfare benefits will spend more. Increased public spending on transfers and declining tax revenues inject more money back into the economy which stabilises and dampens the deflationary impact of the initial fall in AD.

77
Q

What proof is there that automatic stabilisers contributed to milder economic cycles?

A

In the UK, economic cycles became more mild between 1945 and 1973, where discretionary fiscal policy to manage AD was applied. This also happened in Germany where discretionary fiscal policy to manage AD was not applied.

The main thing in common both countries had were automatic stabilisers.

78
Q

Why do free-market economists argue against Keynesian counter-cyclical demand mangement policies?

A
  • Governments may get it wrong accidentally. (reflating when they should be deflating and vice-versa).
  • Governments may also get it wrong deliberately. (in the run up to a GE to win votes)
  • If governments get it wrong, the long-run trend rate of growth is likely to fall.
  • Leads to a growth in ‘big government’ leading to ‘crowding out’ which stifles the private sector as the public sector grows too big.
79
Q

What is resource crowding out?

A

When resources used by the government cannot simultaeneously be employed in the private sector.

80
Q

What is financial crowding out?

A

Public spending has to be financed by either taxation or borrowing.

If the government finances by selling gilts, the annual interest rates on new gilt issues must rise, but the resulting increase in interest rates makes it more expensive to borrow. Private sector investment then falls, and financial crowding out occurs.

In a more simplistic way, by taking money from the private sector in taxation will lead to less private sector investment.

81
Q

Why do free-market economists argue against Keynesian intervention?

A

They focus on cyclical deficits, which are not all that important. These deficits can be solved by government intervention.

Structural deficits are more important, but also more difficult to solve and free-market economics strives to solve this.

82
Q

Why do some argue that a large national debt is a burden on the economy?

A

You must differentiate between reproductive national debt and deadweight national debt.

Future generations of taxpayers will have to end up paying interest to pay for borrowing of prior governments.

Long-term borrowing to finance current spending is certainly a burden, as there is no benefit to future generations, and the liability is not offset by any real asset and is therefore a deadweight national debt.

83
Q

Why do some argue that a large national debt is not a burden on the economy?

A

You must differentiate between reproductive national debt and deadweight national debt.

If a government borrows to finance a project, the liability should be matched by a wealth producing asset (i.e. a motorway, hospital etc.). This reproductive borrowing is not a burden on future generations as interest payments on the debt are basically ‘paid for’ by the motorway’s contribution to national output.

84
Q

How does inflation tie to debt?

A

If the rate of inflation is greater than the rate at which the budget deficit and borrowing requirement adds to the national debt, then the value of debt as a proportion of nominal GDP falls.

85
Q

What is ‘rolling over’ the national debt?

A

When a national debt matures, the government must sell new debt in order to raise funds with which to repay the maturing debt.

If there is a budget surplus, they don’t have to sell new debt though.

86
Q

How can rolling over the national debt lead to financial crowding out?

A

When the government rolls over the national debt, the government may be forced to pay higher nominal interest rates to provide lenders a real return on their savings.

This general rise in interest rates makes it more expensive for firms to borrow. This leads private sector investment to fall, and financial crowding out has taken place.

87
Q
A
88
Q

What sector is the biggest portion of total government expenditure?

A

Social protection, followed by health.

89
Q

Draw the effects of supply-side fiscal policy on LRAS.

A

Ricardo A Level Economics (AQA) (81 decks)

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