Fiscal and Supply Side Policies Flashcards
What does fiscal policy involve
the manipulation of government spending, taxation and the budget
balance. It can have both macroeconomic and microeconomic functions.
what are the instruments of fiscal policy
Government spending and taxation
-they can change the amount of spending and taxation to stimulate the economy (increase or decrease AD)
the government can influence the supply of the circular flow by changing the government budget, and spending and taxes can be targeted in areas which need stimulating
what does fiscal policy aim to do
Fiscal policy aims to stimulate economic growth and stabilise the economy.
what does expansionary fiscal policy aim to do
aims to increase AD
done by increasing government spending or reduce taxes
costs of using expansionary fiscal policy
leads to a worsening of the government budget deficit -> may mean governments have to borrow more to finance this
what does contractional fiscal policy aim to do
aims to decrease AD. Government cuts spending or raise taxes, which reduce consumer spending, leading to an improvement on the government’s budget deficit
how fiscal policy can be used to influence AS
the government could reduce income and corporation tax to encourage spending and investment
the government could subsidise training or spend more on education -> lowers costs for firms (they will have to train fewer workers) -> spending more on healthcare helps improve the quality of the labour force -> contributes towards higher productivity
governments could spend more on infrastructure -> such as improving roads and schools
when does government have a budget deficit
when expenditure exceeds tax receipts in a
financial year
when does a government have a budget surplus
when tax receipts exceed expenditure
what is debt
The debt is the accumulation of the government deficit over time
the deficit/surplus is
the difference between expenditure and
revenue at any one point
what are direct taxes
Direct taxes are imposed on income and are paid directly to the government from
the tax payer.
e.g. income tax, corporation tax, inheritance tax
what are indirect taxes
Indirect taxes are imposed on expenditure on goods and services, and they increase
production costs for producers.
This increases market price and demand contracts.
what are the two types of indirect taxes
Ad valorem taxes are percentages, such as VAT, which adds 20% of the unit
price. This is the main indirect tax in the UK.
Specific taxes are a set tax per unit, such as the 58p per litre fuel duty on
unleaded petrol.
what are proportional taxes
A proportional tax has a fixed rate for all tax payers, regardless of income. It is also
called a flat tax.
For example, all tax payers might have to pay 20% income tax rate.
what is a progressive tax
an increase in the average rate of tax as income increases. As
income increases, the proportion of income taxed increases.
what is a regressive tax
A regressive tax does not relate to income, but means those on lowest incomes have
a higher average rate of tax.
In other words, the proportion of income paid as tax is
higher for those on lower incomes than those on higher incomes.
what are the limitations of fiscal policy
Governments might have imperfect information about the economy. It could
lead to inefficient spending.
There is a significant time lag involved with employing fiscal policy. It could
take months or years to have an effect.
If the government borrows from the private sector, there are fewer funds
available for the private sector, which could lead to crowding out.
The bigger the size of the multiplier, the bigger the effect on AD and the
more effective the policy.
If interest rates are high, fiscal policy might not be effective for increasing
demand.
If the government spends too much, there could be difficulties paying back
the debt, which could make it difficult to borrow in the future
what is crowding out
Governments might have to fund its spending using taxes or running a budget
deficit. This leaves fewer funds in the private sector for firms to use, since the
government is borrowing money, which crowds them out of the market.
When the government borrows a lot of money, interest rates might increase.
This discourages spending and investment among the private sector.
Productivity and growth
Level of taxation
Equality and living standards
The consequences of budget deficits and surpluses for macroeconomic
performance.
A fiscal deficit could be inflationary if it increases AD.
More government spending could lead to crowding out of the private sector. This
leaves fewer funds in the private sector for firms to use, since the government is
borrowing money, which crowds them out of the market.
It could lead to increased interest rates. This is because the government has to offer
investors an attractive rate in order to encourage them to buy the debt.
The significance of the size of the national debt
The cost of borrowing could increase, since by borrowing money, the government is
increasing demand for credit in the economy.
If confidence is lost in the government’s ability to repay the debt, governments
might have to raise interest rates to encourage investors to buy bonds, so that they
can finance the debt.
It could lead to higher taxes and austerity measures, especially if the debt becomes
uncontrollable.