Chapter 26 Fiscal Policy

Question 1

Define fiscal policy

Answer 1

The use of government spending and taxation to influence aggregate demand/total spending in an economy

Question 2

Define budget defecit

Answer 2

When government spending is higher then government revenue.

(funded through govt borrowing)

Question 3

Define balanced budget

Answer 3

When government spending is equal to the government revenue

Question 4

Define budget surplus

Answer 4

When government revenue is higher than the government spending

Question 5

reasons for govt spending (4)

Answer 5

influence economic activity
- increase spending —> increase aggregate demand —-> tackle deflation + economic growth

Reduce market failure
- Spending on public goods + merit goods

promote equity
- provide benefits to vulnerable/unemployed

Pay interest on national debt

Question 6

Reasons for levying tax (4)

Answer 6

promote equity
- Redistrute income through progressive taxation

address market failure
- tax demerit goods

Discourage imports + support domestic industries
- Impose Tariffs —> people buy less foreign and more domestic goods

influence economic activity
- cut tax —-> Increase consumption + investment

Question 7

Define direct taxes

Answer 7

Taxes on income and wealth (paid by both households and firms)

Question 8

Define indirect taxes

Answer 8

taxes on expenditure, paid by firms but can be passed onto consumers through higher prices

Question 9

Define progressive tax

Answer 9

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

managed through different tax brackets

Question 10

Define proportional tax

Answer 10

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

Question 11

Define regressive tax

Answer 11

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

Question 12

Understand the graph for indirect taxes!!

Answer 12

Alr bro

Question 13

What are the main types of direct taxes (4)

Answer 13

Income tax - tax on income that people receive from employment/investment

Corporation tax - tax on firms’ profits

Capital gains tax - taxes on earnings made by selling and asset which has gone up in value

Inherience tax - tax on wealth which is passed onto other people

Question 14

What are common types of indirect taxes (2)

Answer 14

Sales tax - tax imposed when products are sold

Import tariffs - taxes on imports

Question 15

Advantages of Direct Taxation (3)

Answer 15

May encourage workers to work harder
- Workers have to work harder to compensate through the loss in higher income tax

Redistribute income and wealth from rich to poor

Can act as automatic stabilisers

Question 16

Define automatic stabilisers

Answer 16

form of fiscal policy that reduce fluctuations in economic activity without any change in government policy

Question 17

Explain automatic stabilisers during an economic boom

Answer 17

Boom —> More taxable activity —-> tax revenue increases even though tax rates don’t increase

Question 18

Disadvantages of direct taxation

Answer 18

May discourage effort
- Reward from working doesn’t justify the effort

May discourage enterprise
- Higher corporation tax will discourage entrepreneurs from expanding

May discourage saving
-Reduce return from saving

May cause a “brain drain”
- rich people are ocupationally/geographically mobile

Question 19

Advantages of indirect taxation (3)

Answer 19

More choice
- People can choose what/how much they buy

Alter consumption
- reduce market failure (high tax for demerit goods)

Easier for government to administer
- harder to evade indirect than direct

Question 20

Disadvantages of indirect taxes (2)

Answer 20

Greater chance of inflation
- Increased direct tax —> Increased price —-> Worker demand higher wage —-> trend of rising price (cost - push)

Regressive
- Poor people spend higher proportion of income than the rich

Question 21

What are the principles of tax (6)

Answer 21

Equity - Fairness in the amount of tax people pay is based on their ability to pay

Certainty - Tax should be easy to calculate and understand

Convenience - Should be easy to pay

Flexibility - Should be possible to change the tax if economic activity changes or government aims changes (“counter cyclical”)

Economy - Cost of collecting tax should be lower than tax revenue

Efficiency - tax should improve the performance of markets

Question 22

How does tax that promote equity impact efficiency

Answer 22

Tax which promote equity damages efficiency

tax tat promote equity = progressive —> lead to brain drain, reducing efficiency

Question 23

Define counter-cyclical

Answer 23

works to even out fluctuations in the economy

Question 24

If demand is relatively inelastic, whose burn will be higher in a indirect tax diagram (2)

Answer 24

Consumer incidence > producer incidence

Firms know that consumers will not react to a change in price, so firms are able to force their costs onto consumers

Question 25

If demand is relatively elastic, whose burden is greater in a indirect tax diagram (2)

Answer 25

Produce incidence > consumer incidence

Consumers are price sensitive, firms don’t raise price by much and take in more burden of the tax

Question 26

Define expansionary fiscal policy

Answer 26

rises in government expenditure/cuts in taxation designed to increase aggregate demand

Question 27

Define contractionary fiscal policy

Answer 27

cuts in government expenditure/ rise in taxation designed to reduce aggregate demand

Question 28

What components is GDP made of

Answer 28

GDP = Consumer spending + Investment spending + Government spending +Net exports

GDP = C + I + G + (X-M)

Question 29

In a recession which fiscal policy would a government use?

Answer 29

Expansionary (govt wants to stimulate total spending in an economy)

Question 30

In a boom, when inflation is too high, which fiscal policy would a government use?

Answer 30

Contractionary (reduce total spending in an economy)