Fiscal and Supply side policies Flashcards
1
Q
What is the fiscal policy?
A
Fiscal policy involves the manipulation of government spending, taxation and the budget balance. It can have both macroeconomic and microeconomic functions.
2
Q
What is the budget balance?
A
The difference between planned government spending and planned government revenue.
3
Q
What is a Expansionary fiscal policy?
A
involves boosting AD by increasing Government spending and lowering taxes. This leads to a budget deficit. ( GS > Revenue)
4
Q
What is an deflationary fiscal policy?
A
involves reducing AD by reducing GS and increasing taxes. This is likely to cause a budget surplus. ( GS < Revenue)
5
Q
When is a deflationary fiscal policy likely to be used?
A
In a boom or positive output gap, reducing economic growth and increase unemployment, increasing the current account of the balance of payments.
6
Q
When is an Expansionary fiscal policy likely to be used?
A
This wil be used in a recession or negative output gap, increasing economic growth, increasing employment, and worsen the current account of the balance of payments.
7
Q
How can fiscal policy influence AS?
A
The government could reduce income and corporation tax to encourage spending and investment.
The government could subsidise training or spend more on education. This lowers costs for firms, since they will have to train fewer workers. Spending more on healthcare helps improve the quality of the labour force, and contributes towards higher productivity.
8
Q
What is an automatic stabiliser?
A
To help counter swings in the business cycle and maintain economic stability
9
Q
How would a Automatic stabiliser work in a recession?
A
Economic growth is negative but an automatic stabliser reduces this fall in growth. With lower incomes people pay less tax and GS on unemployment benefits increase. So the Automatic stabilisers will increase Gov borrowing but at this expense causes a deficit.
10
Q
How would a automatic stabiliser work in a boom?
A
In a boom there is high economic growth so the AS will reduce the growth rate and unsustainable boom. The automatic stabiliser will create budget surplus as tax revenues will increase and government spending on benefits falls.
11
Q
What are 3 things the strength of automatic stabilisers depend on?
A
- size of gov’t sector
- progressivity of the tax system
- how many welfare benefits are income related
12
Q
What is an important thing to remember about deflationary fiscal policy?
A
it reduces demand but doesn’t necessarily cause deflation.
13
Q
What are two types of tax?
A
Direct and indirect tax
14
Q
What is an indirect tax?
A
Taxes on expenditure.
15
Q
What are direct taxes?
A
Direct taxation is levied on income, wealth and profit.
16
Q
What are some examples of direct taxes?
A
income tax
- corporation tax
- NIC
- inheritance tax
17
Q
What are examples of Indirect taxes?
A
Excise duties
Fuel duties
Carbon tax
18
Q
What are two types of Indirect tax?
A
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.
19
Q
Why do governments levy tax? 5 reasons
A
- correct market failure
- raise money for government expenditure
- prevent imports (tariffs) to improve BoP
- redistribute income
- influence AD
20
Q
What is a progessive tax?
A
The higher the income you receive the higher proportion of your income will be taxed. e.g. income tax
21
Q
What is a regressive tax?
A
As income increases, the proportion of tax they pay will fall, this gives an incentive to work harder and earn more income, but may cause inequality.
22
Q
What is a proportional tax?
A
Fixed rate for all taxpayers, regardless of income e.g. NIC
23
Q
What would supporters of a flat tax say?
A
It reduces incentive for tax avoidance and invasion, it also increases incentive to earn more.
24
Q
What is an evaluation of Flat tax?
A
It brings in less tax revenue overall than progressive tax also dont have vertical equity?
25
What is the difference between Horizontal and Vertical equity?
Horizontal equity means that people who have similar incomes and ability to pay tax should pay the same amount of tax
Vertical equity means that people who have higher incomes and greater ability to pay taxes should pay morethan those on lower incomes with less ability to pay.
26
What are the 4 cannons of tax?
1) Economical - administration costs must be lower than revenue
2) Certainty - the tax payer must be able to calculate how much they owe
3) Convenient - the timing and way of paying should be convenient for the tax payer
4) Equitable - taxes should be imposed depending on the ability to pay
27
What is the effect of lower corporation tax on businesses?
Keep larger percentage of profits --- Rise in planned investment --- Can be domestic or overseas investment --- Increase in capital spending is an injection in the economy --- creates a multiplier effect on demand and output and employment.
28
What are 3 evaluations of the question of the effect of lower corportation tac on businesses?
1) Effect depends on the scale of the tax cut
2) Many factors affect capital investment e.g. pace of technological change and market competition
3) Some investment may lead to loss of jobs through capital-labour subsitiution effects.
29
What are three outside the box arguments for a low tax economy?
Lower tax rates might end up increasing total tax revenue ( suggested by laffer curve)
Encourage an inflow of FDI from businesses looking for a low tax country.
Encourages start ups
30
What is an argument for Higher taxes in the Uk?
Taxes are needed to fund high quality public services such as education, transport and health which beenfit millions in the long run?
31
What is the diagram for the laffer curve and explain it?
As tax rate increases the tax revenue increases to a certain point. At this certain point as tax rate increases the tax revenue falls.
32
Why might total tax revenues fall if the tax rate increases?
Increased rate of tax avoidance (as legal measures to use the tax regime to find ways to pay the lowest rate of tax, e.g putting savings in the name of your partner to take advantage of their lower tax band)
Tax evasion ( not decaring your income and wealth (illegal))
33
What is an evaluation of the laffer curve?
Many people are on fixed hours / zero hours contracts – so tax rates have little bearing on work incentives ( fixed hours will not work more to be charged higher so has little bearing)
For some people, tax cuts will cause them to take more leisure time instead of work – a backward bending labour supply curve effect – especially at higher wages/ earnings
34
What are the government's highest sources of government revenue?
Income tax
National insurance
VAT
35
Indirect taxes cause a waste of resources which were would at their use, what is evaluation of this?
The theory of second best.
36
What is the theory of second best?
Indirect imposed, leads to fall in quantity demanded and the unemployment of some resources. This leads to economic waste as these resources may have been particularly good at what they used to do. The best case scenario is that they find productive employment in their 2nd best use. ( e.g. less demand for printers, the second best is to work in a school, talk about indirect tax)
37
What are evaluations of the theory of second best?
- assumes resources are being used in their best way
- businesses will make the least productive resources redundant first so may not be a big deal.
38
What is Ricardian Equivalence?
If consumers receive a tax cut financed by gov't borrowing, they won't change their spending as they know taxes will rise in the future to pay for it
39
What is the evaluation for ricardian Equivalence?
Consumers are not rational. Many would not anticipate that tax cuts will lead to tax rises in the future. Many households do not project future budget deficits and predict future tax increases.
40
What are some limitations of the 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 spends too much, there could be difficulties paying back the debt, which could make it difficult to borrow in the future
41
What are the 3 types of public expenditure?
Current - day to day (providing public services)
Capital - long term projects (public infrastructure)
Transfer payments - welfare transfers (benefits, state pensions)
42
What are the different purposes on government spending?
- influence the distribution of income
- provision of merit goods
- supply side reforms
43
What factors may affect the distribution of government spending?
- The size of a country's population.
- spending less on benefits during boom than a recession
44
What is the cyclical fiscal deficit?
This is a temporary deficit, which is related to the business cycle. A deficit might occur during recessions, when governments increase spending to stimulate the economy.
45
What are structural fiscal deficits?
This is a deficit which is due to an imbalance in the revenue and expenditure of the government, so it exists at every point in the business cycle.
46
What is a budget deficit?
The difference between what the governement receives in revenue and what it spends ( its caused by an explansionary structural budget position)
47
How could a budget deficit affect the macroeconomic performance?
- A fiscal deficit could be inflationary if it increases AD.
- More government spending could lead to crowding out of the private sector.
48
What is national debt?
accumulation of the government deficit over time - the amount the government owes.
49
What are 3 causes of Budget deficit?
1) Recession causing unemployment
2) Use of fiscal stimulus by gov to boost AD
3) Increase in interest rates on debt leading to arise in debt service costs.
50
What is austerity ( a measure of to stop excess borrowing?
Cutting government spending.
51
Is austerity right to reduce deficit why yes and why no?
Yes : Reducing debt in the long run interests of the economy (helps keeps taxes lower as an increase in natioanal debt, will mean higher taxes in the future)
No : Austerity is seld-defeating e.g. if it leads to deflation
52
How does Gov borrowing lead to a rise in value of pound?
Increase in money supply which It can cause inflation, which could also read to a rise in interest rates discouraging investment by firms and make a country's currency rise in value.
53
What will national debt increase mean for FDI?
FDI becomes less attractive as foreign countrties will be uncertain how debtor nation economy will do in the future and whether it will be good to invest.
54
What is government spending?
It is spending by the public sector on goods and services such as education and healthcare.
55
What is the crowding out debate?
It goes against the government fiscal expansionary policy. It is the idea that government spending fails to increase overall aggregate demand because higher government spending causes an equivalent fall in private sector spending and investment.
56
How does the crowding out effect work.
When a governemnt is in a deficit it will have to sell debt ( bonds ) --- to get people to buy your bonds needs their to be a high interest rate to e.g. investment banks etc. If there is high interest rates then this will crowd out private firms due to this high interest rates.
Also to finance this deficit governments need to increase tax burden for people --- again crowding out private firms. ( less profit)
So therefore an expansionary fiscal policy is not useful to stimulate economy.
57
What is the diagram for crowding out effect?
If government spends more the demand will shift right. Firms have to increase interest rate to meet the Q of loanable funds. These interest rates discourage firms due to higher borrowing costs.
58
What is evaluation for the crowding out debate?
The theory suggests that the avaliable supply of loanable funds is limited to domestic sources, but their can be external finance avaliable from other countries. So this means demand is more elastic and on the diagram if this is true then interest rates will not rise by that much
59
What is another evaluation of the crowding out debate?
Crowding in debate (When an increase in government spending leads to an expansion of economic activity (real GDP) which in turn incentivises private sector firms to raise their own levels of capital investment and employment.
60
How does the Crowding in effect work?
If government uses spending to boost infrastructure instead of paying back debt they can boost AS. This will mean that businesses will be incentivised more firms to come into the UK market and thus increasing AS.
61
Is a budget surplus ideal?
No as it suggests that the government is taxing too much and they are not spending enough.
62
What are the OBR?
The OBR provides analysis of the UK's finances and judge the government's performance against its fiscal targets.
63
What are the 3 points for the question discuss whether the best way forthe government to raise revenue is through direct taxation?
1) Direct tax can have positive effects on the redistrubtion of income and wealth ( one of the objectives, through indirect taxation)
2) Indirect tax can be explicitily used to correct market failure ( internalise externality, environmental damage, make polluters pay.
3) Supply side policies ( Reducing unemployment benefits)
64
What is the evaluation and evaluation squared for the point It can have positive effects on the redistrubtion of income and wealth ( one of the objectives, through indirect taxation) for the question Discuss whether direct taxation is the best way to raise government revenue?
The extent to which the government can redistrubte income by using direct taxes depends on the tax rate set, if it is set above tax rate optimasation point it will not be maximised.
Eval 2 :Many people are on fixed hours / zero hours contracts – so tax rates have little bearing on work incentives ( fixed hours will not work more to be charged higher so has little bearing)
65
What is evaluation and evaluation squared for the point Indirect tax can be explicitily used to correct market failure ( internalise externality, environmental damage, make polluters pay. for the question discuss whether direct taxation is the best way for government to raise revenue?
Depends on the elasticity of the good PED inelastic etc
Evaluation the degree of elasticity depends on the amount of subsitutes avaliable and the quality of goods amongst over goods.
66
What is the evaluation and eval 2 for the point supply side policy (reducing unemplyoment benefit) for the question discuss whether the best way for the government to raise revenue is through direct taxation)
It depends how much you reduce unemployment benefits by.
Eval 2 : It depends on the type of unemployment if there structural unemployment (won't be able to work, making them worse off, also meaning you can't tax them and cannot make revenue)
67
What are supply side policies?
Policies intended to increase the quantity or quality of a country's factors of production
68
What is the diagram for a supply side policy?
69
What is the difference between supply-side policies and supply-side improvements?
Supply side policies - gov't
Supply side improvements - private sector
70
What are Free market supply side policies?
Aims to increase the efficiency by removing things which intervene with the free market.
71
What are Interventionist supply side policies?
Are usually aimed at correcting market failure
72
What are examples of free market policies?
tax cuts ( income and corportaion tax)
Deregulation
Privisation
Reducing the power of trade unions
Reducing umeployment benefits
Lower tarrif barriers
73
What is degrulation?
This inolves reducing barriers to entry in order to make the markt more competitive. E.G. Uber
74
What is Privisation and what is evaluation for it?
The selling of state owned assets to the private sector. They have a profit motive and reduce costs and develop better services
In sectors such as Healthcare this will lead to it being less efficient due to the profit incentive. Cut costs reducing quality of service.
75
What is reducing the power of trade unions and what are the benefits?
Legisation that reduces the ability of trade unions to go on strike.
- increased efficiency in firms as less time lost to strikes
- reduce real wage unemployment
76
What are negatives of reducing trade union power?
- fall in productivity
- could be unpopular
77
What is reducing unemployment benefits and what is an evaluation?
Lower benefits may encourage the unemployed to take work
If people are out of work due to frictional unemployment then they will lose out.
78
What is Lower tariff barriers?
This will increase trade and provide an incentive for export firms to invest.
79
What are examples of interventionist policies?
Increased education and training
subsidising spending on research and development
Build more affordable houses
80
What is education and training?
Better education can improve labour productivity and increase AS, so government would subside employment schemes?
81
Evaluate education and training as a supply side policy?
- depends on the level of youth unemployment
- depends on the quality of the training
- opportunity cost
82
What is evaluation of subsidising spending on research and development
It will cost government money, requiring taxes.
83
What is Build more affordable homes?
Build affordable homes in expensive areas can make it easier for workers to move and find jobs in expesnsive areas, reducing geographical immobility.
84
What is a way the gov'ts can cut the cost of employing workers?
-reductions in NIC
85
What are some of the benefits of supply side policies?
- lower inflation (by reducing cost push inflation)
- lower unemployment
- improved economic growth
- improved trade and Balance of payments` ( because of increased international competitiveness)
86
What are 2 drawbacks of Supply side policies?
Time lag e.g education takes a long time
There could be unitended consequences ( e.g. risk taking in financial markets could contribute towards recession
87
Why may supply side policies be necessary to reduce unemployment/why may demand side policies not work to reduce unemployment?
The UK could be approaching NRU/NAIRU/full capacity, the supply-side may
be vital in order to gain further improvements. So supply side policies are used together with demand side policies. ( demand stabilises economy in SR and Supply side creates long term growth)
88
What is an evaluation point for Supply side policies overall?
Depends how much spare capacity there is in the economy, if there is lots of spare capacity what is needed is a boost in AD not AS.
89
When is there likely to be a high mutiplier value?
When the economy has plenty of spare capacity (negative output gap)
90
When is there likely to be a low multiplier value?
Economy is close to its capacity limits ( positive output gap)
91
What determines the size of the fiscal multiplier?
The avaliablity of credit ( if fiscal policy is injecting fresh demand, the banking system still needs the banking system to supply credit to businesses who neeed to borrow to fund an increase in production)
92
Why are Bugdet deficit harmful?
They need to be financed in the long run ( they result in a high debt to GDP ratio)
93
What are 2 problems of demand side policies trying to reduce unemployment?
Lack of information on the size of the output gap ( means AD overshoots and leads to inflaton alos government might underspend leading to recession
Lack of information of size of multiplier, if multiplier is bigger than what gov expects, then increase in spending can lead to inflation
