Chapter 26: Fiscal policy

Question 1

Reasons for government spending

Answer 1

• Influence economic activity
• Reduce market failure
• Promote equity
• Pay interest on national debt
• Multiplier effect

Question 2

Reasons for levying taxation

Answer 2

• Redistribute income
• Discourage 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

Question 3

Principles of taxation

Answer 3

• Equity
• Certainty
• Convenience
• Economy
• Flexibility
• Efficiency

Question 4

Advnatages of direct taxes

Answer 4

• High tax rates may encourage some to work ahrder especially for workers who have fixed financial commitments such as mortgages
• Number of workers cannot alter the hours they work for as they are contracted
• May cause people to save less but encourage target savers to save more
• Can redistribute income and wealth, act as automatic stabilisers and as good source of tax revenue

Question 5

Disadvantages of direct taxes

Answer 5

• RIsk that if set too high, may discourage effort, enterprise, and saving
• High rates of income tax may stop some people working overtime and taking promotion and prevnet some from entering the labour force
• High corporation tax amy discourage entrepreneurs from expanding their firms and investing in new markets

Question 6

Disadvantages of indirect taxes

Answer 6

• Indirect taxes are regressive and fall more heavily on the poor
• Increasing indirect taxes will raise prices
• Increase in price may stimulate workers to press for wage increases and set off a trend of rising prices

Question 7

Advantages of indirect taxes

Answer 7

• Relatively easy and cheap to collect as firms do some of the work
• Act as less of a disincentive to effor and enterprise
• Can be used to selectively achieve particular aims such as reducing demerit goods
• Harder to evade than direct taxes and easier to adjust
• People have more choice with indirect taxes
• Useful source of income, especially in countries where it is difficult to raise income tax because significant number of workers work in the informal economy

Question 8

Fiscal policy

Answer 8

Decisions on government spending and taxation taken to influence total aggregate demand in the economy

Question 9

Expansionary fiscal policy

Answer 9

• Increase expenditure and cut in taxation
• Raises disposable income
• Government expenditure increases aggregate demand
• Higher consumption likley to raise investment
• Higher demand causes economic growth
• More goods and services produced, employment likley to rise

Question 10

Contractionary fiscal policy

Answer 10

• Cut in government expenditure and rise in tax rates
• Cut in government spending reduces aggregate demand
• Lower the rise in the general price level
• May reduce an excess of import spending over export revenue
• Domestic firms may also put more effort into exporting