4.2.5 - Fiscal Policy And Supply-side Policies Flashcards
Define Fiscal policy
Involves making deliberate changes in either government spending or taxation in order to influence aggregate demand or supply and the level of economic activity
Define the fiscal budget
Is financed by government spending from the collection of tax revenue
Define a budget deficit
Is the annual shortfall between government spending and taxation, the annual amount the government needs to borrow
Explain the effects of a budget deficit (4)
Rise in national debt - will have to borrow from the public sector
Higher debt interest repayments - have to be paid from borrowing
Increased aggregate demand- due to increased government spending
Possible increase in public sector investment- investment in infrastructure to help increase long run productive capacity
Define a budget surplus
When is it appropriate
Occurs when tax revenue is greater than government spending, can allow the government to pay off public sector debt.
Is appropriate when the economy is in the growth phase of the economic cycle
Define demand management
Occurs where fiscal policy is used to manipulate the level of aggregate demand
Draw and explain expansionary fiscal policy
Involves increasing aggregate demand leading to an increase in government spending and reduced taxes in order to increase consumption. Will worsen the budget deficit
Draw and explain deflationary fiscal policy
Involves decreasing aggregate demand, leading to a cutting government spending an increase in taxes in order to reduce consumer spending. Improves the budget deficit
Define automatic stabilisers
Are expenditures, government spending, which automatically increase when the economy is going into a recession
Define a direct tax
Is a tax that cannot be passed on to another person and is usyally levied on incomes
Define a indirect tax
Is a tax on spending, sellers usually pass on the burden to the buyer
Define a progressive tax
Occurs where those on higher incomes pay a higher proportion of their income in tax compared to those on lower incomes
Define a regressive tax
Is a tax that increases in relative size and proportion on those on lower income
Define a proportional tax
Is one that is paid in equal proportion by everyone
Define income tax
Benefits and drawbacks
Is the main direct tax in the UK, paid on earnings from employment.
B
Progressive and seen as fair
Can be used to alleviate relative poverty
D
Is a disincentive to work
Is a complex system
Define national insurance contributions
Raises finance for health and welfare expenditure, charged on income
Define corporation tax
Benefits and drawbacks
Is a tax based on the profits earned by companies , 19% in the UK.
B
Based on the success of companies meaning smaller less successful firms will not be hit as hard
D
May deter foreign direct investment
Encourages tax avoidance
May discourage business investment
Define inheritance tax
Is based on the value of a persons wealth when they die and it’s 40% of their net value. Peoples estate worth less than £325,000 are not subject to this tax.
Define capital gains tax
Based on the profit earned from the sale of physical assets like homes and financial assets like shares and bonds
Define Value added tax (VAT)
Benefits and drawbacks
Is the UK’s main indirect tax, 20% on spending on most goods and services
B
Does not affect incentive to work
Hard to avoid
D
Regressive in many cases
Define Excise duty
Benefits and drawbacks
Is a unit tax paid on mainly demerit goods like alcohol, tobacco and fuel, leading to an increased price.
B
Can change patterns of expenditure
Can be used to discourage the consumption of demerit goods
D
May lead to unemployment in those industries
Can lead to black markets being created (removing possible tax)
Define council tax
Benefits and drawbacks
Is based on the value of property, the higher the value the higher the charge
B
Fair as it is based on wealth and household
Raises money for local services
D
May be difficult to pay for those who are asset rich but cash poor
Define Stamp duty
Is based on a percentage of the purchase price of property, paid by the purchaser and rises in bands with the value.
Why do governments levy (impose) taxes (4)
Raise revenue to finance government expenditure
To change patterns of economic activity- tax can be implemented on one product to cause a shift in demand to another product
To discourage consumption and production of certain products- demerit goods
To redistribute income - progressive taxes will narrow the gap between high and low income households.
State the principles of taxation (6)
Economical- should be inexpensive to collect
Equitable- should be fair and based on ability to pay
Efficient- should have few consequences
Convenient - should be easy to pay
Certain- should be able to be worked out how much each person owes
Flexible- should be able to be modified if circumstances change
Define a hypothecated tax
What would there use be on demerit goods
Is a tax levied to raise money for a particular purpose
Could be used on demerit goods and activities generating negative externalities to raise money to deal with the problems that their consumption and production impose on society
Define current spending
Impact on society?
Is government spending on the day to day running of it’s services, paying salaries to public sector workers.
Is likely to be more popular with voters but is likely to be inflationary
Define capital spending
Impact on society
Is government spending on investment projects, such as new infrastructure
Will impact the supply side of the economy
Should capital or current spending be used in a recession period
It makes sense to invest heavily in capital spending during a recession as interest rates are low and there are spare productive capacity so things can be funded for cheaper
Define austerity
Austerity involves policies to reduce government spending or higher taxes in order to try and reduce government budget deficits
Explain the arguments for and against austerity
For
The expansionary fiscal contraction (EFC) - Reducing government spending will mean lower tax rates in the future which gives confidence to businesses and consumers leading to an increase in investment and consumption
Budget deficits are too high and need to be reduced
Against
Liquidity trap- keynesians suggest in a liquidity trap we should increase government spending to offset the fall in private sector spending.
Aggregate demand - Government spending cuts would lead to an even bigger fall in aggregate demand
Hit’s lower income groups harder- rely more on public services and jobseekers allowance, will worsen inequality and widen the poverty gap in society.
Explain the cyclical budget position
What occurs in a recession and boom
Is the part of the fiscal deficit/surplus which is caused by changes in government spending and taxation through the trade cycle.
In a recession government spending increases and taxation is lowered
In a boom government spending decreases and taxation increases
Explain the structural budget position
What will occur if the structural deficit is large
Is the part of the fiscal deficit which occurs even when the economy is in a boom, will not disappear when an economy recovers.
If the structural deficit is large, 10-15% of GDP, it will cause national debt to rise very quickly. The interest rate of borrowing will add to the debt. The government will be unable to pay their debts so will either turn to organisations like the IMF to borrow money or refuse to pay it’s debts and therefore be locked out of world financial markets
Explain the debt to GDP ratio
Is the metric comparing a country’s public debt, what it owes, to it’s Gross domestic product, what it produces. The ratio indicates a country’s ability to pay back it’s debts. Countries with a high ratio experience unsustainable debt and slow economic growth
Explain the global financial crisis of 2008:
- How it happened
- effects
- fiscal policy solutions
Originated in the US where many relatively poor people were encouraged to take out a mortgage for property.
Many borrowers were unable to repay the loan, meaning houses were repossessed and the value of loans exceeded the value of the property, many institutions were now holding depreciating assets.
Confidence collapsed in UK banks, many of the loans it bad made were not repaid.
Financial instability and a fall in lending led to a fall in consumption and investment, GDP fell and unemployment rose.
There was a fall in taxation and increase in government spending. Welfare benefits were paid, banks that would have collapsed and led to a significant fall in AD were nationalised and quantitative easing was implemented to stimulate the economy and increase AD.
Governments were forced to turn to the IMF and in return for money were forced to cut spending, raise taxes and introduce supply side policies to stimulate the economy.
Labour tried to spend it’s way out of the recession, which created unsustainable debt and the Conservatives promised to introduce Austerity and cut government spending
Explain fiscal policy’s impact on microeconomics
Fiscal policy can have a microeconomic effect where it involves intervention in individual markets.
Government spending on subsidies encourage consumption and investment of desirable products.
Indirect taxes can be used to discourage consumption and production of certain goods
These fiscal policy interventions are intended to change the pattern of economic activity
Explain the Keynesian approach to a recession
Keynes said governments should intervene and use expansionary fiscal policy during a recession, increasing government spending and reducing taxation.
Is a politically popular move as people support spending on public services and benefiting from reduced taxes.
Explain the Laffer curve
States that if tax rates increase above a certain level, the tax revenue will fall. This is because their would be a reduced incentive to work, if income tax was lowered, due to the possibility of post tax income being low and close to the unemployment trap. If corporation tax was increased there would be reduced investment, the UK’s competitiveness in attracting FDI would be reduced and shareholders would receive less dividends potentially reducing consumption.
Explain the office for budget responsibility (OBR)
Was set up by the government to provide independent analysis of fiscal policy, in the hope it would make it harder for government’s to implement politically motivated fiscal policy
Define Average tax rates
Is a measure of a household’s tax burden, how taxes affect the households ability to consume today or in the future (saving)
Define marginal tax rates
How would a higher marginal rate affect the economy
Measures the degree to which taxes affect household or business economic incentives such as whether to work more, save more or change what they buy.
A higher marginal rate reduces incentives to engage in a particular activity (work) or to consume a particular item (cost of sales tax)
Define a supply side policy
Are government attempts to increase productivity and increase efficiency in the economy. If successful they will cause a increase in aggregate supply and higher levels of economic growth
Explain free market supply side policies
Involve policies to increase competitiveness and free market efficiency.
Explain Interventionist supply side policies
Involve government intervention to overcome market failure
Explain the benefits of supply side polcies (4)
Improved economic growth- will increase the sustainable rate of economic growth as increasing the productive potential of the economy will lead to a higher RGDP.
Lower unemployment- will increase incentives to work and policies to invest in infrastructure will provide employment opportunities
Lower Inflation- increased AS will lead to a lower price level. Making an economy efficient will reduce cost push inflation.
Improved trade and balance of payments- making firms more productive and competitive will increase exports
Explain privatisation as a free market supply side policy
Involves selling state owned assets to the private sector, leading to increased efficiency and increased economic growth due to the increased competition.
Explain deregulation as a free market supply side policy
Involves reducing barriers to entry to allow new firms to enter the market, allowing the market to become more competitive and leading to lower prices and higher quality. However some industries are not affected by competition, in a monopoly market structure.
Explain reducing income tax as a free market supply side policy
Increases the incentives for people to work harder, leading to increased productivity and AS. The substitution effect occurs where workers are willing to take away from their leisure time in order to work, increasing efficiency. However lower taxes may lead to the income effect where workers are willing to add to their leisure time as they are satisfied with their wages.
Explain reforming the labour market as a free market supply side policies
Involves policies that increases the economy’s flexibility, through zero hour contracts and making it easier to recruit and dismiss workers. This would create more employment opportunities, increasing efficiency and AS. However flexible markets can cause uncertainty and exploitation
Explain reducing the power of trade unions as a free market supply side policy
Involves legislation to reduce the power of trade unions as a monopolist, a sole seller of labour. This would increase the efficiency in the economy, as less time is lost due to strikes and there is reduced real wage unemployment.
Explain reducing welfare benefits as a free market supply side policy
Will reduce the unemployment trap, the gap between those on unemployment benefits and those on low wages, and encourage the unemployed to take jobs. This will increase efficiency and reduce the waste of labour.
Explain encouraging immigration as a free market supply side policy
Allows the economy to fill skill shortages in skilled jobs, engineering and construction, and low skilled jobs, fruit picking. Will make labour markets more flexible and in economic booms will help firms keep up with growing demand. Can prevent wage inflation and help the economy to increase it’s productive potential.
Explain increased education and training as a interventionist supply side policy
Will improve labour productivity and increase AS. The government may subsidise suitable education and training schemes to increase the quality and quantity of labour, increasing productivity. However this will cost and require higher taxes, will also take time to have an effect and the wrong industries may be subsidised.
Explain improving transport and infrastructure as a interventionist supply side policy
Will help reduce congestion and pollution, encouraging FDI. Seen in the UK, the HS2 Cross rail linking London to other parts of the UK. Will reduce geographical immobility. However in a country, like the UK, it can be difficult to increase transport capacity.
Explain building more affordable homes as a interventionist supply side policy
Reduces geographical immobility, by making it easier for workers to move and find jobs, reducing unemployment.
Explain improved healthcare as a interventionist supply side policy
Improves the quality of a workforce, increasing productivity and the ability of a worker to work for longer.
Explain the limitations of supply side policies (6)
Productivity growth largely depends on private enterprise- there is a limit to which the government can accelerate the growth of technological change and improvements in working practices.
Supply side policies can be counter productive- flexible labour markets will reduce costs for businesses costs for businesses but cause job insecurity and therefore a lack of productivity and motivation.
Not effective in a recession- supply side policies cannot tackle the problem of a lack of aggregate demand
Time- supply side policies take a long time to have an effect
Expensive- requires high levels of spending, leading to increased borrowing
Increased income inequality- cutting welfare benefits, abolishing minimum wage and reducing trade union power, will lead to a growing gap between high and low income earners
