Chapter 26: Fiscal Policy

Question 1

Fiscal policy

Answer 1

Use of government spending and taxation to influence aggregate demand

Question 2

Government budget

Answer 2

Relationship between government revenue and government spending

Question 3

Budget deficit

Answer 3

Government spending > government revenue

Must be funed by government borriwng (bonds)

Question 4

Balanced budget

Answer 4

Government spending = government revenue

Question 5

Budget surplus

Answer 5

Government revenue > government spending

Question 6

Reasons for government spending

Answer 6

• Promote equity (fair distribution of income)
• Providing benefits/welfare to vulnerable
• Boosting economic activity
  - Tackle deflation or low growth
• Pay back/’service’ government borrowing
• Address market failure

Question 7

Reasons for levying tax

Answer 7

• Promote equity (progressive taxation
• Address market failure
• Raise government revenue
• Discourage imports/support domestic industries (tariffs)
• Reduce demand/economic activity
  - Tackle inflation

Question 8

Direct taxes

Answer 8

Taxes on income and wealth

Question 9

Indirect taxes

Answer 9

Income on expenditure

Question 10

Direct tax

Windfall tax

Answer 10

One - off tax on high profits. Eg. Lottery

Question 11

Direct tax

Corporate tax

Answer 11

Tax on profits

Question 12

Direct tax

Income tax

Answer 12

Tax on income

Question 13

Direct tax

Inheritance tax

Answer 13

Tax on wealth which is passed on to other people, when a person dies

Question 14

Direct tax

Capital gains tax

Answer 14

Tax on earnings made by selling an asset which has gone up in value

Question 15

Indirect taxes

Sales tax

Answer 15

Tax imposed when products are sold. Eg. VAT and GST

Question 16

Indirect taxes

Excise taxes

Answer 16

Taxes charged on certain domestically produced goods, most commonly on alcoholic drinks, petrol and tobacco.

Charged in addition to VAT.

Question 17

Indirect taxes

Custom duties/Tariffs

Answer 17

Taxes on imports

Question 18

Progressive tax

Answer 18

Where upper-income families pay a larger share of their incomes in tax than do those with lower incomes

Question 19

Rregressive tax

Answer 19

The poor and middle income pay a larger share of their incomes in taxes than the rich

Question 20

Proportional tax

Answer 20

Takes the same percentage of income from everyone

Question 21

Advantages of direct taxation

Answer 21

• High tax rates may encourage some to work harder (Especially for people who have fixed financial commitments)
• Number of workers cannot alter the hours they work for as
  they are contracted for a fixed number of hours per week.
• Encourage target savers
• Redistribution of income
• Can act as automatic stabilisers

Question 22

Disadvantages of direct taxation

Answer 22

• If set too high, it can discourage effort, enterprise, and saving
• Stop some from working overtime
• Stop some from taking promotions
• Prevent some from entering labour force
• May discourage entrepreneurs from expanding their firms and investing in new markets.
• Brain drain

Question 23

Advantages of indirect taxation

Answer 23

• Easy and cheap to collect
• Less of a disincentive to effort and enterprise
• Can alter consumption patterns (reduce market failure)
• Harder to evade
• Easier to adjust
• People have more choice
• Useful source of income (especially in countries with big informal economies)

Question 24

Disadvantages of indirect tax

Answer 24

• Are regressive and falls more heavily on the poor
• ## Increasing indirect taxes will lead to higher prices/inflation (workers may press for higher wage)

Question 25

Fiscal policy as a demand side tool

Expansionary fiscal policy

Answer 25

In a recession (negative growth, high unemployment):
- Government wants to increase total spending
- Reduce tax
- Running a budget deficit (financed by government borrowing)
- Results in an increase in disposable income and boost spending
- Results in an increase in profiy and boost spending

Question 26

Fiscal policy as a demand side tool

Contractionary fiscal policy

Answer 26

In a boom (inflation high):

• Government wants to decrease total spending
• Increase tax
• Running a budget surplus
• Reduce demand-pull inflation
• Results in a decrease in disposable income and lower spending
• Results in an decrease in profiy and lower spending