Chapter 10

Question 1

Define budgetary

Answer 1

the manipulation of the level and composition of Federal government receipts and outlays in order to assist in the achievement of it’s economic and social goals for Australia

Budgetary policy refers to the gov’ts use of it’s budget to achieve specified outcomes in the country, where the ‘budget’ is the major fiscal document released annually each may

Question 2

What is the objectives of the budgetary policy

Answer 2

The longer term goals of the budgetary policy
As with all policies – the primary goal of the budgetary policy is to improve the welfare or living standards of all Australian’s, or to achieve the most efficient allocation of the nation’s resources. In economic terms, budgetary policy is used to assist in the achievement of all of the government’s goals:
Strong and sustainable growth
Low inflation
Full employment
External stability
Greater equity in the distribution of income

The achievement of these goals will clearly help to boost “economic prosperity” and “welfare” for all Australians – which is the overriding goal underpinning all government policies reinforced in the government legislation:

“The government’s fiscal policy is to be directed at maintaining the ongoing economic prosperity and welfare for the people of Australia and is therefore to be set in a sustainable medium-term framework”

Question 3

Define the fiscal strategy

Answer 3

In relation to the budgetary policy, the government laying out a strategy for how it intends to meet it’s objectives or goals

e.g. strategy of 2009-10 budget was to ensure that the govt could meet it’s current and future spending commitments

Question 4

Explain the composition of revenue

Answer 4

Gov’t collects approx. $386B from various sources annually
The largest form of federal revenue comes through personal tax income (levied on wages + salaries of Australian’s through the progressive tax system) – 48% of total revenue
Second largest is company tax (30% flat tax levied on all company profits) – 19% of all revenue

Question 5

3 main types of gov’t revenue

Answer 5

Taxes – direct tax - e.g income tax, company tax, CGT, FBT (main form of gov’t revenue

Taxes – indirect taxes – e.g. exercise tax, Gst, tariffs

Non tax revenue – e.g. HECS, profits + dividends from GBE’s (government business enterprise’s

Question 6

Define direct taxes

Answer 6

a tax paid directly by economic agents, normally based on the income they earn such as income taxes

Question 7

Define indirect taxes

Answer 7

a tax paid by economic agents via their purchases of goods and services (e.g. GST)

Question 8

Define government expenditure

Answer 8

expenditure by all areas of government (federal, state + local) and commonly broken up into G1 and G2

Question 9

3 common budget expenses

Answer 9

Wages – public teachers, nurses, military personal (public sector employees)

Infrastructure – roads, ports, schools + hospitals

Welfare – disability payments, transfer incomes

The govt’s budget amounts to approx. 25% of the GDP – this means that the manipulation of government revenue and expenses will tend to have a powerful influence on the level of economic activity or living standards in Australia

e.g – decision to remove carbon tax decreased business costs in the short term, but have negative implications of living standards in the long term.
A properly functioning government will only change budget settings if it feels that national welfare or living standards will improve as a result

Question 10

3 possible budget outcomes

Answer 10

Budget balanced = income (receipts) = expenditure (outlays)

Budget deficit = income (receipts) expenditure (outlays

Question 11

Define budget outcome

Answer 11

the outcome of the budget, either balanced, surplus or deficit

Question 12

Define budget balanced

Answer 12

when gov’t revenue or receipts equals expenses (or expenditure)

Question 13

Define budget deficit

Answer 13

when gov’t revenue or receipts is less than gov’t expenses or expenditure

Question 14

Define budget surplus

Answer 14

when gov’t revenue is greater than gov’t expenses or expenditure

Question 15

The commonwealth government will report the outcome of the budget in 3 different ways

Answer 15

Headline cash outcome
Underlying cash outcome
Fiscal outcome

Question 16

Define + explain the headline cash outcome

Answer 16

In relation to the government’s budget, it is the total cash received by the federal government minus total cash paid

However this outcome can provide a misleading picture about the stance or impact of budgetary policy because it includes cash flows that do no directly impact the economy

Question 17

Define + explain the underlying cash outcome

Answer 17

In relation to the gov’t budget, the headline cash outcome, but excluding future fund earnings and net cash flows from investments in financial assets for policy purposes

Seeks to exclude cash flows that are included in the headline cash outcome but that do not directly affect the economy – therefore the ‘underlying cash outcome’ is most commonly reffered to as the budget outcome

It provides the best indicator of the budgetary policy stance (or postion) of the federal government and the impact it is likely to have on the economy over the short term
The underlying cash outcome is simply the headline cash outcome excluding the following transactions:
Future fund earnings – the interest and the dividends earned by the government owned ‘future fund’
Net cash flows from investments in financial assets – this excludes any proceeds from the sale of a GBE such as medibank, any purchases of shares by the government or the granting or repayment of state government aid
These items are excluded because they have no direct or immediate effect on the economy and their inclusion in the headline outcome only servers to distort the true cash flow position of the government

Question 18

Explain the underlying cash outcome

Answer 18

The underlying cash outcome is simply the headline cash outcome excluding the following transactions:
Future fund earnings – the interest and the dividends earned by the government owned ‘future fund’
Net cash flows from investments in financial assets – this excludes any proceeds from the sale of a GBE such as medibank, any purchases of shares by the government or the granting or repayment of state government aid
These items are excluded because they have no direct or immediate effect on the economy and their inclusion in the headline outcome only servers to distort the true cash flow position of the government

Question 19

Define + explain the fiscal outcome

Answer 19

In relation to the governments budget, revenue that has been earned over the relevant period minus expenses that have been incurred over the relative period

It provides the most accurate picture of the governments financial performance – this is because items are included as revenue regardless of whether they have been received, and expenses regardless of whether they have actually been paid.

Question 20

Explain discretionary stabilisers

Answer 20

Any tme the government decides to change the way it collects money, makes payments or adjusts the level of receipts it will typically impact on the size of the budget outcome.
E.g. changes such as reducing company tax rates – are deliberate policy decisions to change way the budget is used to influence the allocation of resources or assist with the achievement with it’s economic + social goals
These represent the structural component of the budget + changes of this nature are often referred to as ‘discretionary stabilizers

Discretionary stabilisers will never account for the entire changes in the budget outcome. This is because budget receipts + outlays will change automatically in response to changing levels of economic activity

Question 21

Explain automatic stabilisers

Answer 21

Lower levels of economic activity should negatively impact the budget outcome as receipts on taxation are likely to fall (tax revenue) and the payments (expenditure) on government services or transfer payments is likely to increase – this happens with no deliberate interaction via the gov’t
This represents the ‘cyclical component of the budget’ commonly referred to as ‘automatic stabilizer’s

Question 22

Importance / explain automatic stabilisers

Answer 22

It is important to recognize the gov’t relies on automatic stabilisers to swig in to action in a counter-cyclical manner, helping to stimulate the economy – when the economy experiences a downturn and restraining the economy it expands

A slowdown in eco activity will result in greater welfare assistance (proportionally more unemployed require transfer incomes), which therefore helps to maintain spending levels (consumption) that would otherwise not occur with government support.
Similarly, lower income levels across the economy tend to push income earners into lower tax brackets , thereby resulting in lower average tax rates paid, helping to slow the decline in disposable income (opposite occurs during eco expansion)

Question 23

Define discretionary stabilisers

Answer 23

are deliberate policy decisions designed to change receipts or outlays in an effort to influence economic activity

Question 24

Define automatic stabilisers

Answer 24

Are changes to the budget that occur automatically with changes in the level of economic activity

Question 25

2 examples of both automatic + discretionary stabilisers

Answer 25

Automatic = welfare, progressive income tax

Discretionary = increase infrastructure funding, decreasing small business taxing, increase tax bracket from 85k to 86k

Question 26

Define fiscal drag // bracket creep

Answer 26

the process of inflation increasing nominal wages (as workers seeks to protect real wages) and pushing some workers into higher marginal tax brackets. This increases the ‘average’ rate of tax paid by taxpayers and boosts the real value of Federal gov’t revenue

Question 27

2 major affects of fiscal drag

Answer 27

Increases total personal income tax received by the government – thereby increasing the surplus or reducing the defecit as the gov’t has greater revenue. It is another cyclical component, but it does not rely on the growth rate in the GDP to change the budget outcome automatically. Instead it relies on the rate of inflation to change the budget outcome, with higher inflation rates working to increase the size of the surplus (reduce the defecit) (tax revenue ^ deficit down)

Some taxpayers will experience a decline in their ‘real disposable income’ because they will be paying a higher average rate of tax on their ‘nominal wage’, which reduces the purchasing power of their ‘after tax and their after inflation wage’ This has the effect of slowing the rate of spending (consumption) and reduced the incentive to work
(Disposable down > consumption down).

Question 28

Difference between actual and estimated budget outcomes

Answer 28

e.g. assume we have a budget deficit of $20B for year 2 we prepare the budget for year 3, where a budget deficit of only $3B is estimated – this $3B is clearly dependent on the ‘discretionary’ changes the government expects to make to the budget as well as any anticipated changed to the ‘cyclical’ component of the budget. For simplicity reasons let’s assume the government decided to make no discretionary changes. Then it must be the case the government expects the deficit to decrease by $17B purely because it expects the economy to grow relatively strongly (e.g 4% per year). However, what would happen to the ‘actual’ budget outcome if economic growth were much lower, for example 1%?

The actual deficit will be higher because the government overestimated tax receipts and underestimated outlays (expenditure). This failure to correctly forecast economic activity has resulted in budgetary policy becoming less effective. If it had correctly anticipated a low growth rate it would have implemented the much-needed additional discretionary measures to stimulate activity – the failure to forecast accurately caused a delayed policy response that might be detrimental to the economic recovery

Thus there is typically a difference between the ‘estimated budget outcome (released at the end of the budget speech in may) and the actual budget outcome fir any given year, because the estimated outcome depends heavily on the forecasts for economic growth – that are never guaranteed

Question 29

Explain the difference between contractionary and expansionary outcome

Answer 29

If the government had a balanced budget outcome, then it is injecting back into the economy exactly the same amount of money than it is taking out. In simple terms a balanced budget will neither expand or contract the economy thus it is neither expansionary or contractionary in it’s affect on the economy

However if the government delivered a budget deficit of $10B, it means that the federal government will be injecting more into the economy than it is taking out. This will tend to expand economic activity, particularly in the shorter term

On the other hand if the government experienced a budget surplus of $10B, it will be taking more from the economy than it is injecting. This will tend to contract economic activity, particularly in the shorter term.
In simpler terms if the government delivers a bigger surplus than the year before, then it is likely to be considered a more contractionary budgetary policy stance and a smaller surplus is likely to be considered a less contractionary stance. In contrast, a bigger deficit is likely to be more expansionary and a smaller deficit, less expansionary

To determine the stance or impact of any budget outcome from one year to the next, we need to determine how much of the change to the budget outcome occurred automatically and how much of the change was deliberate – this means we need to separate the cyclical from the structural components

Question 30

When a budget is in deficit it means that the government needs to raise funds to finance the difference between receipts and outlays. The department of treasurey determines the amount of money required and issues treasurey bonds to raise money for the government – the purchasers of the bonds effectively become lenders to the federal government and, in return they receive interest rates on the bonds. - how does a government finance a deficit

Answer 30

Borrowing from the RBA:
Selling bonds to the RBA is the most expansionary and most inflationary, as money that was previously not money in the money supply (not yet printed) then relased into circulation
Using savings accumulated from budget surpluses

Domestic borrowing – selling bonds to Australian investors:
Selling bonds to Australian investors is the least expansionary because domestic bond sales place upward pressure on interest rates as the demand for ‘money’ in financial markets increases, resulting in an increase in the price of money (the interest rate)
These higher interest rates result in a “crowding out” of the private sector’ as consumers + businesses reduce consumption and investment. In addition, the higher interest rates may cause some local borrowers to borrow from the relatively cheaper overseas lenders, resulting in capital inflow and a higher exchange rate
This contributes to ‘crowding out of the extrernal sector’ where Australian exporters and import competing businesses lose market share, the effect of ‘crowding out’ reduces growth in AD over time and somewhat negates the expansionary impact of any budget defecit – selling bonds to Australian investors has been common form of budget financing over the years

Overseas borrowing – selling bonds to overseas:
Selling bonds to overseas is simply another way of saying that the Aus’t gov’t is borrowing from overseas to finance it’s budget deficit – this will result in capital inflow exerting upward pressure on the AUD, which in turn has a negative impact on net exports and aggregate demand- further reducing the expansionary impact of the budget deficit

Question 31

Problems with an expansionary (large) deficit?

Answer 31

In addition to the costs of financing the budget deficits and the crowding out problem, budget deficits can lead to a build up of government debt overtime – this creates potential problems fir governments in terms of the impact on government credit ratings which if downgraded (currently AAA) lead to higher borrowing costs and even higher budget deficits
Further deficits may eventually be reined in overtime, which may involve future restraint in the form of higher taxes and lower government spending which then have negative consequences for employment and economic growth
Accordingly to avoid future pain the government needs to achieve the right balance by delivering deficits that do just enough to achieve it’s short – medium term goals (e.g. fill the void in economy during downturn) without imposing too big a burden on taxpayers and the economy in the future

Question 32

Define crowding out

Answer 32

describes the process of budget deficits resulting in higher interest rates and or exchange rates which then reduce AS (via consumption, investment + net exports) and eco growth

Question 33

Explain how the gov’t deals with a surplus *

Answer 33

surplus means the government can either unvest the money in financial markets (an account held by RBA), repay existing government debt or place money into funds it established for specific purposes (such as building Australia fund or education investment fund)
While a deficit tends to lead to crowding out contrastingly a surplus contributes to ‘crowding in’ of the private sector (and/or external) sector.
A surplus means the gov’t becomes a net lender for that year (rather than a borrower) and this leads to less pressure for funds in financial markets. This should lead to a reduction in interest rates (and/or exchange rate) which causes an increase in consumption, investment and net exports – this will tend to exert upward pressure on AD and real GDP over the longer term

Question 34

Define crowding in

Answer 34

the opposite to crowding out. Describes the process f budget surpluses resulting in lower interest rates and/or exchange rates which then stimulates AD (via consumption, investment and net exports) + eco growth

Question 35

Define fiscal consolidation

Answer 35

is the government seeking to reduce the budget deficit and return the budget to surplus, consistent with its medium term fiscal strategy

Question 36

Explain fiscal consolidation

Answer 36

The potential for s surplus has expansionary effects such as; the downward pressure a surplus places on interest rates and stimulates (crowding in) this gives to investment, net exports and AD over the long term
In addition if a surplus is consistent with a smaller government sector in the economy, then it also has the power to ‘free up’ resources and make conditions more conducive for private sector investment – this is one of the underpinning arguments supporting the governments ‘medium term fiscal strategy’ to achieve a budget surplus on average over the course of the economic cycle
The government notes that the ‘medium term fiscal strategy’ is important for:
“maintain strong fiscal discipline to reduce the government’s share of the economy over time in order to free up resources for private investment to drive jobs and economic growth

Question 37

In addition the economic rationale for fiscal consolidation and/or budget surpluses include the following points:

Answer 37

It can help buffer Australia against future economic decline as surplus funds can be saved and then spent when the economy requires fiscal stimulus
It helps to generate greater international investor confidence in Australian government finances and thereby preserving Australia’s excellent AAA credit rating reducing the costs of future debt issues
Allows for the cyclical component of the budget to do it’s job of automatically reducing the deficit as the economy recovers.
It allows the monetary policy to better manage the economy (particularly the rate of inflation) as the RBA can loosen policy with less fear about it’s inflationary effects

Question 38

How can the budget affect the goal of inflation

Answer 38

The gov’t needs to know whether inflation is demand or supply when implementing initiatives
Demand = reduce government expenditure or raise taxes would decrease inflation and assist in the goal of low inflation
E.g. Gov’t expenditure (Down) > AD (down) > demand inflation (down)
Example of similar initiatives in budget; reducing ‘higher education reform’ $2B

E.g. of taxing* = Tax^ > C (down) + I (down) > AD (down) > demand inflation (down)
Example of similar initiatives in budget; multinational taxing, taxing higher superannuation earners
To increase demand inflation – opposite increase gov’t expenditure (increase defense spending, etc infrastructure spending) or decrease taxing (increase tax bracket from 80,000 to 87,000 more disposable income, cutting company taxes *careful not supply

Question 39

How can the got affect strong and sustainable growth via ad

Answer 39

The gov’t uses expansionary policies in order to stimulate economic activity when AD is not sufficient to utilize the economy’s productive capacity
*Any policies that increase AD^ and GDP^
Increase military spending
increase tax bracket from 80,000 – 87,000

Question 40

How can the gov’t affect employment via ad

Answer 40

AD^ > GDP^ > to facilitate the greater ‘derived demand for labour’ employment ^
Proportionally more people employed in the labour force will see proportionally less on transfer incomes and more on factor incomes enabling them a basic income to obtain essential G+S’s to live a dignified standard of living, prevent absolute poverty + reduce the gap of obscene inequalities
Initiatives = reduce company tax, increase military spending

Question 41

How can the gov’t affect external NOT VIA Ad

Answer 41

Effected not via AD – but via paying our way, CAD or NFD
Contractionary budgets may be used to slow AD and therefore slow the CAD less M BOMT^ CAD (down) –
Another contractionary budget example = taxes^ > 20% rule + C (down) > M (down) > Bomt^ > CAD (down)
But budget deficits may increase NFD^ (more need to finance the deficits) which will increase the CAD^ through NPI

Increase national savings:
Medium term fiscal stratergy is to improve gov’t net financial worth – fiscal consolidation helps to reduce savings/investment gap

Increasing share of world income:
Assist Australian exporters
Access to foreign markets
Increase their competiveness (Australia to grow relative to other countries therefore more exports required)
e.g. Aus-trade

Question 42

Explain the company tax initiative

Answer 42

“Ten year enterprise plan” designed to promote growth and employment applicable to companies with less than $2M turnover will be lowered from 28.5% to 27.5%

Question 43

Explain tobacco tax

Answer 43

Increasing the tobacco exercise duty rate - to improve health outcomes
Regressive tax - does not promote equity in the distribution of income

Question 44

Explain multinational tax

Answer 44

Strengthen intregrety of tax system especially for multi national cope rations preventing offshore profit shifting - conducted through updating Australia’s transfer pricing rules

Question 45

Explain superannuation tax

Answer 45

Will now be capped at $1.6M in super and those will incomes greater than $250,000 will pay 30% on their concessionary contributions - instead of 15%

Question 46

Explain child care initiative

Answer 46

“Jobs for families child care package” provides 40B into child care support
Subsidy relative to the income of parents e.g. Income earners less than 65,000 receive a 85% subsidy

Question 47

Explain the infrastructure initiative

Answer 47

Investing a record $50 billion into infrastructure - currently about 100 projects under construction and 80 more in pre-construction phase e.g. Such as Melb rail project accounting for $10.9 Billion

Question 48

Explain the defence initiative

Answer 48

“Defence white paper” providing additional $29.9 billion for defence as well as
$154 b for domestic security
$195 b for cyber security