Chapter 30 Flashcards
What is fiscal policy
It involves the government cahnging levels of taxation and government spending in order to influence aggregate demand and levels of economic activity
What is a direct tax
a tax levied directly on income
What is an indirect tax
a tax on expenditure on goods or services (such as VAT)
What are the 3 types of taxation (direct)
Progressive, proportional and regressive
What is progressive taxation
A tax in which the marginal tax rate rises with income, it bears heavily on those that are relatively well off
What is proportional taxation
a tax that is proportional to income
What is regressive taxation
a tax bearing more heavily on the poorer members of society. Isn’t related to income but just takes up a higher proportion of income (necessities)
What is current government expenditure
Spending that reoccurs, spent on goods and services which are for a short period of time
What is capital government expenditure
expenditure on assets which can be used multiple times such as roads, schools etc
What is the government budget
the balance between recipets and outlays
What is a transfer payment
when the government provides benefits to poor households
What are two types of indirect taxes
Ad valorem and specific taxes
What is ad valorem tax
taxes as a percentage (VAT - 20%)
What is specific tax
tax based per unit
What is a cyclical budget position
related to the business cycle, budget deficit in recession due to increased spending on welfare etc
What is a structural budget position
balance based on imbalances in revenue and expenditure
How can budget deficits be financed
- Borrowing
- Cutting government spending on other areas of the economy
- Increasing taxes
- Welfare benefits cap
What are fiscal policy aims
to stabilise economic growth and avoid a boom and bust in the economic cycle, often used in conjunction with monetary policy.
What is an expansionary fiscal policy
it involves increasing AD, by increasing government spending and cutting taxes. Lower taxes will increase consumers spending as they have higher disposable incomes. However, this will worsen the government budget as they are spending less and earning less from tax revenue. This means the government will have to borrow
What is a deflationary fiscal policy
this involves decreasing aggregate demand. This can be done by increasing taxes and cutting government spending. This will improve a budget deficit and potentially into a surplus. Tend to be one-off policy changes
What is automatic fiscal stabilisers
Automatic fiscal stabilisers – If the economy is growing, people will automatically pay more taxes ( VAT and Income tax) and the Government will spend less on unemployment benefits. The increased T and lower G will act as a check on AD. But, in a recession, the opposite will occur with tax revenue falling but increased government spending on benefits, this will help increase AD
How can expansionary fiscal policy ‘crowd out’ the private sector
Crowding out. Some economists argue that expansionary fiscal policy (higher government spending) will not increase AD because the higher government spending will crowd out the private sector. This is because the government have to borrow from the private sector who will then have lower funds for private investment
Evaluation of fiscal policy
The success of fiscal policy will depend on several factors, such as
- It depends on the size of the multiplier. If the multiplier effect is large, then changes in government spending will have a bigger effect on overall demand.
- It depends on the state of the economy. Fiscal policy is most effective in a deep recession where monetary policy is insufficient to boost demand. In a deep recession (liquidity trap). Higher government spending will not cause crowding out because the private sector saving has increased substantially. See: Liquidity trap and fiscal policy – why fiscal policy is more important during a liquidity trap.
- It depends on other factors in the economy. For example, if the government pursue expansionary fiscal policy, but interest rates rise, and the global economy is in a recession, it may be insufficient to boost demand.
- Bond yields. If there is concern over the state of government finances, the government may not be able to borrow to finance fiscal policy. Countries in the Eurozone experienced this problem in the 2008-13 recession.
Limitations of fiscal policy
- Government might have imperfect information about the economy and this could lead to inefficient spending
- Significant time lag involved with employing fiscal policy and could take months/ years to feel the effect.
- It the government borrows from the private sector there are fewer funds available for the private sector (crowding out)
- How effective depends on the mutiplier
- If interest rates are high its harder to increase demand
- If the governent spends or borrows to much it will be hard to pay it back.
What is the Laffer curve
Shows how much tax revenue will be received at each level of tax. n shape, at turning point T is the optimum rate of tax. He argued if tax rates are too high people are not incentivised to work. to encourage people to work harder tax rates needs to be lowered
What is crowding in and out
Government fund its spending by taxes or running a budget deficit, which leaves fewer funds in the private sector which crowds them out the market
This might increase interest rates which discourages spending and investment in the private sector, this is known as crowding out the private sector
Can lead to government providing good instead of private sector
