Chapter 26- Fiscal Policy

Question 1

Budget

Answer 1

the relationship between government revenue and government spending

Question 2

Budget Deficit

Answer 2

Government spending is higher than government revenue

Question 3

Budget Surplus

Answer 3

government revenue is higher than government spending

Question 4

National Debt

Answer 4

the total amount the government has borrowed over time

Question 5

Reasons for Government Spending

Answer 5

To influence Economic Activity- Eg: Increase spending to increase aggregate demand in hope to stimulate output and lead to economic growth

To reduce market failure- Spending on public and merit goods and spending to regulate markets where there is abuse of power and difference between public and private cost and benefit

To promote equity- benefits and products to vulnerable groups

To pay interest on national debt

Question 6

Multiplier Effect

Answer 6

Government spending has multiplier effect which means that any increase in initial spending would result in a greater increase in aggregate demand. Eg: If there is an initial spending increase of 20 million, those who benefitted from this would also spend 16m and those who benefitted from this spending would spend 13m and so on. This would lead to a much larger total spending and income and output would also rise.

Question 7

Reasons or Levying Taxation

Answer 7

Redistribute Income from the rich to the poor

Discourage the consumption of demerit goods

Raise the costs of firms that impose costs on others

Discourage the consumption of imports and hence protect domestic industries

Influence economic activity- if economy is experiencing rising unemployment, government may cut taxes to stimulate consumption and investment

Raise revenue for government expenditure

Question 8

Direct taxes

Answer 8

taxes on income and wealth

Question 9

Indirect taxes

Answer 9

Taxes on expenditure. It is possible to pass on atleast some of the burden to another party. Eg: most of the tax that governments impose on petrol companies is passed on to customers in the form of higher prices

Question 10

Progressive Tax

Answer 10

one which takes a larger percentage of the income or wealth of the rich

Question 11

Regressive Tax

Answer 11

one which takes a larger percentage of the income or wealth of the poor

Question 12

Proportional Tax

Answer 12

one which takes the same percentage of income or wealth from all taxpayers

Question 13

Main Types of direct taxes

Answer 13

Income tax- people are given a tax allowance, which is the amount of money they can earn free of tax. Income above this amount is referred to as taxable income

Corporation Tax- tax on profits of firms

Capital gains tax- on profit made on assets when they are sold for a higher price than they are bought

Inheritance Tax- only on wealth above a certain amount that is passed on to people when someone dies

Question 14

Common types of indirect Taxes

Answer 14

Sales tax- tax imposed when products are sold. eg: GST and VAT

Excise duties- taxes charged on certain domestically produced goods (alcohol, petrol, tobacco) in addition to VAT

Customs duties- taxes on imports

Licenses- needed in order to use a range of products such as a car

Question 15

Local Taxes

Answer 15

used to pay for local services such as education, fire services, libraries, roads and refuse collection. There are 2 types, one is based on property of local firms and other is based on value of household property.

Question 16

Principles of Taxation

Answer 16

Equity- fairness that people should pay taxes based on their ability to pay
Certainty- easy to understand and calculate
Convenience
Economy- cost of collection should be less that revenue generated
Flexibility- possibility to change tax if economic activity or government aims change
Efficiency- tax should improve performance of markets or at the very least not significantly reduce efficiency

Question 17

tax base and tax return

Answer 17

tax base is source of tax revenue. Wide tax base usually means lower tax rate. In the case where there is high tax rate, the tax base is relatively small as firms are driven out of the market.
tax burden is the amount of tax paid by people and firms and is expressed as a % of a country’s GDP. Higher the burden, the more percentage of income taken as tax.

Question 18

Impact of Taxation

Answer 18

Incidence of taxation is the distribution of the burden of indirect taxes. When a product is inelastic, producers know they can pass on more tax to consumers as they know that their demand will not reduce significantly. When a product is elastic, producers bear most of the taxes as they know if they pass it on in the form of higher prices, the demand for their product will fall significantly.

Question 19

Impact of Direct taxes

Answer 19

If set too high, it may discourage effort, enterprise and saving. it may also stop people from working overtime and taking promotions and prevent ppl from entering the labor force. high corporation tax can discourage entrepreneurs from expanding their firms and investing in new markets. Workers who have fixed financial goals may be encouraged to work harder in piece rate systems. Target saving would increase but overall savers would decrease. They are able to redistribute income and are automatic stabilizers.

Question 20

automatic stablisers

Answer 20

forms of government expenditure and taxation that reduce fluctuations in economic activity, without any change in government policy.

Question 21

Inflation

Answer 21

the rise in price level of goods and services over time

Question 22

Informal Economy

Answer 22

the part of the economy that is not regulated, protected or taxed by the government

Question 23

flat taxes

Answer 23

taxes with a single rate

Question 24

Impact of Indirect Taxes

Answer 24

they are regressive and raise prices and hence may push workers to push for wage raises and might set off inflation. They are cheaper to collect as firms do some of the work and can be used to achieve specific goals such as the disincentivizing of the consumption of demerit goods. They are easier to adjust and harder to evade than direct taxes and people have a certain amount of choice with them.

Question 25

Changes in Taxes

Answer 25

recently more countries have become more reliant on indirect taxes and some have begun adopting flat taxes. flat taxes are simple to administer for governments and firms. There is less incentive to evade them and more incentive for workers and entrepreneurs to produce more. They are more regressive in nature but all present applications have set the rate above a tax-free level of income.

Question 26

Fiscal POlicy

Answer 26

decisions on government spending and taxation designed to influence aggregate demand

Question 27

Fiscal policy and the budget

Answer 27

fiscal policy ahs a direct influence on the budget balance. Budget balance is revenue-spending. if they are equal and government increases spending or cuts taxes there will be a budget deficit in the short run. IN the long run the effects may differ as increased spending on education would lead to more skilled workers and hence more output and higher amount of taxes paid.

Question 28

Expansionary Fiscal policy

Answer 28

rises in government expenditure and or cuts in taxation designed to increase aggregate demand

Question 29

Contractionary fiscal policy

Answer 29

cuts in government expenditure and or rises in taxation designed to reduce aggregate demand. it is implemented to reduce inflationary pressure.