4.2.5.1: Fiscal Policy Flashcards
What does the fiscal policy include?
- anything that is changes to tax or gov spending
- affects the budget position.
—> aims to stimulate economic growth and stabilise the economy.
What is expansionary fiscal policy?
Aims to increase AD, by increasing gov spending or decreasing taxes. This would increase growth and decrease unemployment, and increase consumption if taxes decrease.
- could use this to increase inflation.
—> this all shifts AD right
What is deflationary/ contractionary fiscal policy?
Decrease in AD, by decreasing gov spending or increasing taxes. Use this to reduce inflation so therefore can improve the BofP current account. Prevent ‘over-heating’ of the economy. It will increase unemployment and reduce spending
—> so AD shifts left
How can fiscal policy be used to influence AS?
The gov could reduce income and corporation tax to encourage spending and investment and provide incentives to work
The gov could subsidise training or spend more on education. This lowers costs for firms, since they will have to train fewer workers. Spending more on healthcare helps improve the quality of the labour force, and contributes towards higher productivity.
Govs could spend more on infrastructure, such as improving roads and schools.
Why are demand side policies (e.g. fiscal and monetary) sometimes a problem?
There is always a trade off (e.g. increasing AD may achieve higher growth and lower unemployment, but suffer inflation and worse BoP position)
- demand side policies will never be able to achieve all 4 macroeconomic objective simultaneously
What are direct taxes?
- income tax
- corporation tax
- inheritance tax
- council tax
- national insurance
What are indirect taxes?
- VAT
- Stamp duties
- custom duties
- excise duties
Ad Valorem - taxes that are %s, such as VAT which adds 20% to the price
Specific taxes - a set tax per unit, e.g. the 58p per litre fuel duty on unleaded petrol
What is a regressive tax?
- does not relate to income, as the lower your income, the more you pay on indirect taxes (takes a bigger proportion of your income)
- e.g. the same amount of tax on cigarettes, yet affects the poor more heavily.
—> effects inequality (as the gap of rich and poor will widen)
What is a progressive tax?
Increase in the average rate of tax as income increases (e.g. income tax increases the more income you make)
- should create more equality
- also may create more incentives to work
What is a budget deficit?
When spending is more than tax revenue
- highly likely in a recession or downturn
- government budget deficit increases AD so can be done to deliberately create an expansionary policy
How can you reduce a budget deficit?
Reduce gov spending (e.g. cut down on welfare payments)
Or increase tax revenue (e.g. increasing income tax)
What is a budget surplus?
When tax revenue exceeds gov spending
What is national debt?
the accumulation of the government deficit over time. It is the total amount the government owes.
What would happen to national debt if the budget increases?
National debt would worse (if you have a deficit, you have to borrow more - bigger debt)
What wold happen to the national debt if the budget deficit decreased?
National debt would improve (reduce the rate it is increasing)
—> only if have a budget surplus will the national debt be gone
What is a cyclical deficit?
This is a temporary deficit, which is related to the business cycle. A deficit might
occur during recessions, when governments increase spending to stimulate the
economy.
What is a structural deficit?
This is a deficit which is due to an imbalance in the revenue and expenditure of the
government, so it exists at every point in the business cycle. It is a constant deficit and won’t really disappear or change, so long term
What are the principles of taxation?
1) The cost of collecting the tax must be low relative to the yield
2) The timing and quantity paid must be obvious to the tax payer
3) The timing and way of paying should be convenient for the tax payer
4) Taxes should be imposed depending on the ability to pay. Taxes should also be equitable.
5) The tax should not limit efficiency, and there should only be a minimum loss of efficiency.
6) Tax should be compatible with tax systems of other countries. For the UK, taxes should be compatible with the rest of Europe.
7) Taxes should adjust with inflation.
What is current gov expenditure?
spending which recurs. This is on goods and services which are consumed and last for a short period of time. For example, it could be on drugs for the health service.
What is capital gov expenditure?
spent on assets, which can be used multiple
times. For example, it could be government expenditure on roads or building a
school.
What is transfer payments?
welfare payments from the government. They aim to provide a minimum standard of living for those on low incomes. No goods or services are exchanged for transfer payments. (E.g. job seekers allowance, income support, child benefits, state pensions, etc.)
- Transfer payments are a means for the government to redistribute income from the rich to the poor.
What’s the budget mostly spent on in the UK?
In the UK, the government spends most of their budget on pensions and welfare benefits, followed by health and education. Income tax is the biggest source of tax revenue in the UK.
Education spending in the UK has remained relatively constant.
Defence spending in the UK is falling. This is the area the government spends least on.
What is crowding out?
Govs might have to fund its spending using taxes or running a budget deficit. This leaves fewer funds in the private sector for firms to use, since the gov is borrowing money, which crowds them out of the market.
When the gov borrows a lot of money, interest rates might increase. This discourages spending and investment among the private sector.
Why is productivity and growth needed to be a focus on gov spending?
Govs can spend money on supply-side policies to improve human capital and boost long run growth. Human capital is important for competitiveness. The gov could invest in youth apprentice schemes, for example, to make people more employable and productive from a young age.
Education and training can mean higher value products can be made and productivity can be improved
