4.2.5.1: Fiscal Policy

Question 1

What does the fiscal policy include?

Answer 1

• anything that is changes to tax or gov spending
• affects the budget position.
  —> aims to stimulate economic growth and stabilise the economy.

Question 2

What is expansionary fiscal policy?

Answer 2

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

Question 3

What is deflationary/ contractionary fiscal policy?

Answer 3

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

Question 4

How can fiscal policy be used to influence AS?

Answer 4

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.

Question 5

Why are demand side policies (e.g. fiscal and monetary) sometimes a problem?

Answer 5

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

Question 6

What are direct taxes?

Answer 6

• income tax
• corporation tax
• inheritance tax
• council tax
• national insurance

Question 7

What are indirect taxes?

Answer 7

• 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

Question 8

What is a regressive tax?

Answer 8

• 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)

Question 9

What is a progressive tax?

Answer 9

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

Question 10

What is a budget deficit?

Answer 10

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

Question 11

How can you reduce a budget deficit?

Answer 11

Reduce gov spending (e.g. cut down on welfare payments)
Or increase tax revenue (e.g. increasing income tax)

Question 12

What is a budget surplus?

Answer 12

When tax revenue exceeds gov spending

Question 13

What is national debt?

Answer 13

the accumulation of the government deficit over time. It is the total amount the government owes.

Question 14

What would happen to national debt if the budget increases?

Answer 14

National debt would worse (if you have a deficit, you have to borrow more - bigger debt)

Question 15

What wold happen to the national debt if the budget deficit decreased?

Answer 15

National debt would improve (reduce the rate it is increasing)
—> only if have a budget surplus will the national debt be gone

Question 16

What is a cyclical deficit?

Answer 16

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.

Question 17

What is a structural deficit?

Answer 17

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

Question 18

What are the principles of taxation?

Answer 18

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.

Question 19

What is current gov expenditure?

Answer 19

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.

Question 20

What is capital gov expenditure?

Answer 20

spent on assets, which can be used multiple
times. For example, it could be government expenditure on roads or building a
school.

Question 21

What is transfer payments?

Answer 21

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.

Question 22

What’s the budget mostly spent on in the UK?

Answer 22

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.

Question 23

What is crowding out?

Answer 23

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.

Question 24

Why is productivity and growth needed to be a focus on gov spending?

Answer 24

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

Question 25

Why does the level of taxation sometimes differ?

Answer 25

The tax rate might increase if government debts get too high. If confidence is
lost in the government’s ability to repay the debt, governments might have to raise interest rates to encourage investors to buy bonds, so that they can finance the debt. It could lead to higher taxes and austerity measures,
especially if the debt becomes uncontrollable.

Question 26

Why is equity and living standards an important factor for gov spending?

Answer 26

Progressive taxes to reduce inequality. Redistributive policies and welfare payments, such as Income Support, could be used to help those on the lowest incomes.
Also, gov spending on housing and the provision of public services, such as education and healthcare, helps provide equal opportunities for people from all income backgrounds.

Question 27

What are some limitations of fiscal policy?

Answer 27

• Govs might have imperfect information about the economy. It could lead to inefficient spending.
• There is a significant time lag involved with employing fiscal policy. It could take months or years to have an effect.
• If the gov borrows from the private sector, there are fewer funds available for the private sector, which could lead to crowding out.
• The bigger the size of the multiplier, the bigger the effect on AD and the more effective the policy.
• If interest rates are high, fiscal policy might not be effective for increasing demand.
• If the gov spends too much, there could be difficulties paying back the debt, which could make it difficult to borrow in the future

Question 28

What are some of the consequences fo budget deficits and surpluses for macroeconomic performance?

Answer 28

• A fiscal deficit could be inflationary if it increases AD.
• More gov spending could lead to crowding out of the private sector. 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.
• It could lead to increased interest rates. This is because the gov has to offer investors an attractive rate in order to encourage them to buy the debt.

Question 29

Why can the size of the national debt be significant?

Answer 29

The cost of borrowing could increase, since by borrowing money, the gov is increasing demand for credit in the economy.
- If confidence is lost in the govs ability to repay the debt, govs might have to raise interest rates to encourage investors to buy bonds, so that they can finance the debt.
- It could lead to higher taxes and austerity measures, especially if the debt becomes
uncontrollable.

Question 30

What is the role of the Office for Budget Responsibility (OBB)?

Answer 30

• The OBR provides analysis of the UK’s finances.
• produce 5-year forecasts for the economy, including the impact of tax and spending changes announced in the Budget.
• judge the govs performance against its fiscal targets. These are to balance the budget 5 years ahead
• assess the likelihood of the gov meeting the targets.
• scrutinise tax and welfare spending measures
• assess how sustainable public sector finances are in the long run.

Question 31

What are proportional taxes?

Answer 31

has a fixed rate for all tax payers, regardless of income. It is also called a flat tax. For example, all tax payers might have to pay 20% income tax rate. The incidence of taxes is equal, regardless of the ability of the taxpayer to pay. It could encourage people to earn higher incomes, because the rate of tax paid does not increase.