4.3 - Fiscal Policy Flashcards
Government budget
A financial statement showing the forecasted government revenue and expenditure in the coming fiscal year
Characteristics of government budget (3)
- lays out the amount the government expects to receive as revenue in taxes and other incomes
- how and where it will use this revenue to finance its various spending endeavours
- aimed to be balanced
Balanced budget
government revenue = government expenditure
Budget deficit
government revenue < government expenditure
Budget surplus
government revenue > government expenditure
Public debt
The cumulation total of past government borrowing which has to be repaid (including interest)
Aggregate demand
A measurement of the total amount of demand for all finished goods and services produced in an economy (same formula as GDP)
Public expenditure
Spending made by the government of a country on collective or individual needs and wants of public goods and public services
Three reasons for public spending
- Current expenditures
- Capital expenditures
- Transfer payments
Current expenditures
Include daily payments required to run the government and the public sector (wages, salaries of public employees like teachers, military etc.) and **includes payments for public goods/services **(such as medicines for government run hospitals)
Capital expenditures
Investments in infrastructure and capital equipment (e.g. new hospitals and schools, railways etc.)
Transfer payments
Payments made by the government for which no goods or services are exchanges (e.g. unemployment benefits etc.)
- does not contribute to GDP as income is only transferred from one group to another
Five reasons for taxation
- Correct market failure
- Earn government revenue
- Promote equity
- Support firms
- Support poorer households
How does taxation help correct market failure?
The government aims to subsidise merit goods & tax demerit goods to address market failure
How does taxation help earn government revenue?
Revenue to fund the provision of essential services, public and merit goods is collected through taxation
How does taxation help promote equity?
The wealthy are taxed to provide funds that can be utilised in reducing the opportunity gap between the rich & poor
How does taxation help support firms?
In a global economy, governments choose to support key industries so as to help them remain competitive & taxation provides the funds to do this
How does taxation help support poorer households?
Intervention seeks to redistribute income (tax the rich and give to the poor) so as to reduce the impact of poverty
Direct taxes
Imposed on income and profits and are directly paid to the government by the individual or firm
Examples of direct taxes (name 3)
- income tax
- corporation tax
- capital gains tax
- national insurance contributions
- inheritance tax
Indirect tax
Imposed on spending: the less a consumer spends the less indirect tay they pay
Examples of indirect taxes (name 2)
- VAT
- taxes on demerit goods
- excise duties on fuel
Tax revenues to the government (name 3)
- Income tax
- Corporation tax
- Inheritance tax
- Sales tax
- Import tax
Non-tax revenues to the government (name 3)
- Fines, tolls, fees etc.
- Forein aid (goods lent by another country)
- Loans from banks
- Donations
- Interest payments on loans
- Revenue from state-owned enterpises
- Rents
- Sale of assets (such as governmetn owned industries)
Income tax
A tax levied directly on personal income
Corporation tax
A tax levied on corporations’ profits
Inheritance tax
A tax levied on property and money acquired by gift or inheritance
Sales tax
A tax on sales or on the receipts from sales (such as VAT)
Import taxes
A tax collected on imports and some exports by a country’s custom authorities
Excise duties
Indirect inland tax imposed on certain unhealthy goods and services (e.g. alcohol, tobacco, gambking etc.)
Customs duties
Indirect cross-border taxes on foreign imports
Capital gains tax
A direct tax on earnings made from investments such as shares and private property
Stamp duty
A progressive tax paid on the sale of commercial or residential property
Carbon tax
A tax imposed on vehicle manufacturers or firms that produce excessive carbon emissions
Windfall tax
Charged on indiciduals or firms that gain an unexpected one-off amount of money (e.g. lottery, company takeover)
Progressive tax system
As income rises, a larger percentage of income is paid in tax
Regressive taxation
As income rises, a smaller percentage of income is paid in tax
- all indirect taxes are regressive
Proportional taxation
As income rises, the same percentage of income is paid in tax
Marginal tax rates
The amount of additional tax paid for every additional dollar earned as income
The six principles of taxation
- Simple: should know what, when, where and how to pay tax
- Fair (equity): should reflect taxpayer’s ability to pay
- Convenient: system to collect should be easy and provide choice
- Efficient: management by government should not be expensive or wasteful
- Fit for purpose: no unintended side effect
- Flexible: easy to adjust as required by changes in economy
The seven impacts of taxation
- Incentive to work
- Government tax revenues
- Income distribution
- Economics growth
- Trade balance (exports - imports)
- Business location
Fiscal policy
Fiscal policy is the use of taxation and government expenditure strategies to influence the level of economic activity and achieve macroeconomic aims
Expansionary fiscal policy
includes reducing taxes or increasing government spending
* used in order to generate further economic growth
Contractionary fiscal policy
includes increasing taxes or decreasing government spending
* in order to slow down economic growth or reduce inflation
Discretionary income
Income that remains after taxes and necessity purchases are accounted for
Strengths of fiscal policy (name 4)
- Spending can be trageted on specific industries
- Short time lag (quick effect)
- Redistribution of income through taxation
- Reduces negative externalities
- Increased consumption of merit/public goods
- Short term government spending can lead to an increase in the total supply of an economy
Weaknesses of fiscal policy
- Policies can fluctuate significantly when new governments are elected
- Increased government spending can create budget deficits
* Repaying this debt may lead to austerity on future generations - Conflicts between objectives
* E.g. Cutting taxes to increase economic growth may cause inflation
