Chapter 30

Question 1

What is fiscal policy

Answer 1

It involves the government cahnging levels of taxation and government spending in order to influence aggregate demand and levels of economic activity

Question 2

What is a direct tax

Answer 2

a tax levied directly on income

Question 3

What is an indirect tax

Answer 3

a tax on expenditure on goods or services (such as VAT)

Question 4

What are the 3 types of taxation (direct)

Answer 4

Progressive, proportional and regressive

Question 5

What is progressive taxation

Answer 5

A tax in which the marginal tax rate rises with income, it bears heavily on those that are relatively well off

Question 6

What is proportional taxation

Answer 6

a tax that is proportional to income

Question 7

What is regressive taxation

Answer 7

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)

Question 8

What is current government expenditure

Answer 8

Spending that reoccurs, spent on goods and services which are for a short period of time

Question 9

What is capital government expenditure

Answer 9

expenditure on assets which can be used multiple times such as roads, schools etc

Question 10

What is the government budget

Answer 10

the balance between recipets and outlays

Question 11

What is a transfer payment

Answer 11

when the government provides benefits to poor households

Question 12

What are two types of indirect taxes

Answer 12

Ad valorem and specific taxes

Question 13

What is ad valorem tax

Answer 13

taxes as a percentage (VAT - 20%)

Question 14

What is specific tax

Answer 14

tax based per unit

Question 15

What is a cyclical budget position

Answer 15

related to the business cycle, budget deficit in recession due to increased spending on welfare etc

Question 16

What is a structural budget position

Answer 16

balance based on imbalances in revenue and expenditure

Question 17

How can budget deficits be financed

Answer 17

• Borrowing
  
  • Cutting government spending on other areas of the economy
  • Increasing taxes
  • Welfare benefits cap

Question 18

What are fiscal policy aims

Answer 18

to stabilise economic growth and avoid a boom and bust in the economic cycle, often used in conjunction with monetary policy.

Question 19

What is an expansionary fiscal policy

Answer 19

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

Question 20

What is a deflationary fiscal policy

Answer 20

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

Question 21

What is automatic fiscal stabilisers

Answer 21

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

Question 22

How can expansionary fiscal policy ‘crowd out’ the private sector

Answer 22

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

Question 23

Evaluation of fiscal policy

Answer 23

The success of fiscal policy will depend on several factors, such as

1. 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.
2. 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.
3. 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.
4. 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.

Question 24

Limitations of fiscal policy

Answer 24

• 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.

Question 25

What is the Laffer curve

Answer 25

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

Question 26

What is crowding in and out

Answer 26

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