6. Fiscal Policy Flashcards
What is fiscal policy
changes in gov’t spending,taxation and the level of gov’t borrowing to help achieve some of the micro and macro objectives of the gov’t
State sector spending
Gov’t spending
spending on public services, infrastructure, welfare benefits,
Taxation
indirect taxes (VAT), income tax, corporation tax
Fiscal balance
Budget defecit (G >T), Budget surplus (T>G), Budget balance when G=T
Current gov’t spending
on providing public services e.g.NHS salaries
Capital gov’t spending
new public infrastructure e.g. new motorway
UK spending 2023-24
Social protection £341 billion - transfer payments
Health £245 billio
Education £131 billion
Significance of gov’t spending for the UK?
- is a key componenet of AD
- helps to stabalise demand in a recession
- has a regional economic impact
- important in providing public & merit goods
- Driver of long-run growth
- Can help achieve greater equality in society
Sources of UK tax revenue in 2023-24
Income tax - £268 billion
VAT £187 billion
National insurance contribution - £172 billion
Main reasons for taxation
revenue generation
redistribution of income and wealth
economic stabalisation
regulation & incentives
Public goods
ADAM smiths Canons of Taxation
Fairness - benefit pay principle
Certaintiy and Convenience
Efficiency - hard to avoidE
Equity
taxes should be fair and equitable, meaning individuals and businesses in similar scenarios pay the same tax
Efficiency
it should minimises economic distortions and losses
Economic neutrality
Taxes should not distort economic decision making
Horizontal equity
Similar tax payers in similar circumstances should be treated equally
Vertical equity
Ability to pay principle - those with more wealth should pay more
Direct taxation
is levied on income,wealth and profit - no choice
Indirect taxes
taxes on spending
Tax base
the people who pay tax and for what items
Tax burden (micro & macro)
micro - if a busienss is taxed it will pass this onto consumers
macro - total amount of taxes collected compared to GDP
Income tax
personal allowance of £12,570. Progressive tax rates
National insurance
a direct tax helped to fund, pensions and sick pay
Vat
indirect tax on many G&S. 20%
Corporation tax
Paid by business 25%
Proportional tax
everybody pays the same level of tax
What is the budget balance
Fiscal balance - total tax revenue - total expenditure
Surplus - when the fiscal balance is positive
Deficit - when the fiscal balance is negative
Budget deficit and implications
when the gov’t spend more than it collects
the gov’t will need to borrow money by issuing bonds which can increase their overall debt.
Budget surplus
occurs when a gov’t collects more money than it spends. Allows them to save and pay off any debt, invest in infrastructure, reduce taxes.
National debt
the gov’ts stock of outstanding debt. in billions of pounds
accumulated over time as countrys borrow.
How is a budget deficit financed
issues bonds - to raise funds. They are sold to investors.
International borrowing - gov’ts can also borrow from IMF or world bank
Central bank financing
Bond yields
represent the return an investor can expect to earn by investing in a gov’t bond
Coupon yield
fixed annual interest rate paid by the gov’t
Normal yield curve
it is upwards sloping which means long term bonds have higher yields that short term bonds
Budget deficit impact on AD
increase in gov’t spending - spends more than it earns
lower taxes - a budget defecit may be a result of this which can increase their disposable income
Multiplier effect
Negative effects of Budget defecit on AD
increase borrowing
Higher interest rates - reduces private sector borrowing doing the crowding effect leaving more capital to borrow for the gov’t
Expectations of higher taxes
Automatic stabaliser
automatic fiscal changes as an economy moves through different stages of the business cycle e.g. an increase in state welfare benefits when the unemployment rate is rising.
Expansionary fiscal policy
involves the gov’t aiming to increase AD - through deliberately increasing real government spending and/or lowering taxes.
Fiscal multilier
estimates the final change in real national income (GDP) that results from an initial change in environmental spending and/or revenue plans.
Lafer curve
is a relationship between economic activity and the rate of taxation which suggest there might be an optimum tax rate which maximises total revenue.
Fiscal policy and short run AS
changes in VAT affect the supply costs of businesses - a fall in VAT reduces costs and will cause SRAS to shift outwards.
Changes in environmental taxes
changes in import tariffs
CHanges in gov’t subsidies
Fiscal Policy and LRAS
changes in marginal & average income tax costs can have significance effect on work incentives in the labour market
state funding of R&D
Change in corporation Tax and import tariffs
Gov’t spending on new infrastructure
