5.1 Fiscal Policy Flashcards
Fiscal policy definition
Deliberate changes to government spending and/or taxation in order to influence aggregate demand
What is expansionary fiscal policy?
Increase in AD
What is contractionary fiscal policy?
Reduction in AD
Why may governments use expansionary fiscal policy?
- increase economic growth
- reduce unemployment
- increase inflation
- redistribute income
Why may a government use contractionary fiscal policy?
- reduce inflation
- reduce budget deficit
- redistribute income
- reduce current account deficit
Direct tax definition
A tax that is levied on incomes or profits and is taken away before the individual ever receive it
Indirect tax definition
A tax placed on expenditure and can be passed onto another individual
Progressive tax definition
A progressive tax has an increase in the average rate of tax as income increases. As income increases the proportion of income taxes increases.
Example of progressive tax
Income tax
Proportional tax definition
A proportional tax has a fixed rate for all tax payers regardless of income
Regressive tax definition
A tax that increases in relative size on lower income earners
Ad valorem tax definition
A tax based on a percentage of added value on top of the original price
Unit tax definition
A tax where a fixed amount is placed on the item sold
Advantages of income tax
- seen as fair as based on earnings and progressive
- progressive nature can be used to alleviate relative poverty
Disadvantages of income tax
- acts as a disincentive to work
- progressive system makes it more complex
Advantages of VAT
- does not affect work incentive
- hard to avoid
Disadvantages of VAT
- regressive in many cases
- changes in VAT rate can be inflationary
What are excise duties?
These are additional indirect taxes placed on alcohol, tobacco and fuel. They are unit taxes
Advantages of Exercise duties
- can change patterns of expenditure (e.g different rate taxes used for petroleum and diesel, say you to buy the less bad item)
- can be used to discourage consumption of demerit goods
Disadvantages of Exercise duties
- may lead to unemployment in those industries
- regressive in some cases
- can lead to ‘black markets’ where consumers get the product through alternative means to avoid the tax
What is council tax?
Council tax is administered by the local government and is based on the value of property
Advantages of council tax
- seen as fair as based on wealth of household
- raises money for local services
Disadvantages of council tax
- ‘bands’ are very out of date
- may be difficult to pay for those who are ‘asset rich and cash poor’
- lower revenues for poorer areas
Advantages of corporation tax
- based on success of companies, does not hit less successful companies
Disadvantages of corporation tax
- may deter foreign direct investment
- encourages tax avoidance
- may discourage business investment
The reasons why governments levy taxes
- to raise revenue to finance gov spending
- to change patterns of economic activity
- to discourage consumption and production of certain products
- to redistribute income
Hypothecated tax definition
A tax levied to raise money for a specific purpose
Horizontal equity definition
Where people with similar income levels pay similar amounts of tax
Vertical equity definition
Where the tax paid is based on the ability to pay
What are the principles of taxation
- economical
- equitable
- efficient
- convenient
- certain
- flexible
Describe economical in the principles of taxation
Relative to the revenue the tax generates, the tax should be inexpensive to collect
Describe equitable in the principles of taxation
The tax should be fair and should be based on people’s ability to pay
- equity can be measured in terms of horizontal and vertical equity
Describe efficient in the principles of taxation
The tax should have few side effects or unexpected consequences
Describe convenient in the principles of taxation
The tax should be easy and convenient to pay
Describe certain in the principles of taxation
A taxpayer should be able to work out broadly the amount of tax that they will pay
What are the types of public expenditure
- current government expenditure
- capital government expenditure
- transfer payments
What is the current government expenditure and give an example
Current government expenditure is spending which recurs. This is on goods and services which are consumed and last for a short period of time.
- for example = drugs for the health service
What is the capital government expenditure and give an example
Capital government expenditure is spent on assets, which can be used multiple times
- for example = roads or building a school
What are transfer payments and give an example
- they are 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
- for example = job seekers allowance and child benefits
How does fiscal policy affect aggregate supply?
- indirect taxes lead to higher cost of production = reduces the incentive for firms to supply output at any given price level
- supply-side fiscal polices
Supply-side fiscal policies definition
Policies that involve changes in fiscal policy that are designed to improve the LRAS of the economy
What are the common supply-side fiscal policies?
- government spending on improvements to the economy = infrastructure, education, health
- tax incentives or cuts = increase investment into the economy from MNCs
- reducing direct taxation = incentives to work more
How does the fiscal policy link to microeconomics?
- government spending on subsidies can encourage consumption of merit goods
- indirect tax can be used to discourage consumption and production of certain goods
- increase in regressive taxes or cutting benefits gov spending affects income and poverty
Fiscal stance definition
The extent to which fiscal policy is likely to add to or subtract from aggregate demand
Cyclical budget deficit definition
The portion of any budget deficit that changes when the rate of economic growth changes
Structural budget deficit definition
The portion of a budget deficit that remains even if the economic growth is at its normal long-run rate
National debt definition
The stock of all outstanding government debt that has yet to be repaid
How does government spending exceed government taxation?
The government issues bonds to finance spending
Relationship between budget balance and national debt
- a budget deficit means the government has to borrow to make up the extra = increase in national debt as gov bonds are issued
What is the office for budget responsibility
Set but by the government in 2010 to provide independent analysis of fiscal policy
What is the reason why the OBR was set up?
To make it harder for the government to implement changes in fiscal policy which might be politically rather than economically motivated
What are the main functions of the OBR?
- economic forecasting
- evaluating fiscal policy
- analysis of the sustainability of public finances
- evaluation of fiscal risks
- analysis of tax and welfare costing
