Fiscal Policy Flashcards
Define Fiscal Policy
This refers to the way that the government attempts to control the economy by changing its taxes and spending. The main way it does this is through its annual budget, and that budget is presented by the chancellor of the exchequer. (currently Rishi Sunak)
What are the 10 main areas of government spending? (In order of cost)
1-Social security/welfare 2-Healthcare 3-Education 4-Defence 5-Law and order - prisons, policing, courts etc. 6-Infrastructure (roads and transport) 7-Housing 8-Culture and the arts 9-Interest on the national debt 10-Foreign aid
What are the two elements you can split government spending into?
1 - Current Spending
2 - Capital spending
It is possible to split up all government spending into these two types.
What is Current Spending?
What the government spends to provide services on a day-to-day basis, e.g. Education.
Current spending includes teachers wages, NHS (Nurse/doctor) Wages.
This spending tends to have the biggest impact on people NOW, and are noticed quickly by people if stopped.
What is capital spending?
Spending on major investments which will tend to affect the quality of public services in the future.
For example, Law and order - building new prisons, Health-service - building new hospitals/new equipment.
This spending affects the future of these services if neglected
When reducing government spending, which element is easiest to reduce?
Note: The government was reducing spending every year from 2010 to 2017
When reducing government spending, it’s usually much easier for the government to reduce capital spending rather than current spending, because (In the short tern), people don’t tend to notice it so much.
For example,
But, in the long term, its going to be worse for the economy for multiple reasons, including:
- Slow/no LRAS output growth
- Higher taxes = lower welfare
Taxation - what is it? what are the main taxes?
What can all taxes be split into?
Taxation is the governments main form of income. The main taxes people pay include:
- Income tax
- VAT
- Corporation tax
- National insurance
- Excise duties (Cigarettes, alcohol, fuel) - Much higher than VAT
All taxes can be split into two types - Direct and indirect.
What is are direct taxes?
Direct taxes are taxes people pay on their income and wealth. These tend to be fairly progressive in their effects, however this can create a negative incentive to work harder. (Higher income/wealth = < tax)
For example, Income tax, inheritance tax, corporation tax.
What are indirect taxes?
Indirect taxes are taxes on goods and services we buy. These can be regressive in their effects, however because they are not related to how much people earn it does not have a big effect on peoples incentives to work.
For example, VAT (20%).
Taxation:
Progressive?
Proportional?
Regressive?
Progressive - the more someone earns, the more tax % they pay
Proportional - Everyone pays the same proportion of tax on their wealth/income
Regressive - The more someone earns, the less % of that they pay in tax
Why does freezing tax thresholds increase tax revenue?
Because it means people drift into higher bands as incomes increase yearly, increasing revenue.
What are the uses of Fiscal policy? (4)
1) Keynesian economists believe fiscal policy should be used to try and control the level of spending in the economy
2) To influence the types of goods and services people buy
3) To influence the way incomes are shared out between different people
4) To try and make the economy more efficient thorough the use of supply and demand, e.g. reduce income tax rates
Keynesian economists believe fiscal policy should be used to try and control the level of spending and keep the economy as close to FE without causing inflation.
What graph shows this, and what criticisms does this face?
A LRAS Keynesian curve
Criticisms include:
1) Creates more government debt - which needs to be paid back in the long run = lower standards of living as taxes are raised
2) Crowding out argument - The more money the government borrows from banks, the less money there is for firms to borrow, reducing economic growth.
3) Monetarists believe in the LR, the economy naturally tends to full employment, so an increase in spending will increase inflation.
Fiscal policies can influence the types of goods and services people buy.
How?
To discourage consumers, they can increase taxes on these goods. This tends to be done on demerit goods that have negative externalities e.g. Alcohol, Cigarettes. If PEW is fairly inelastic, it may not be very effective in reducing the amount of goods people buy, however, it will generate higher revenue
To encourage consumers to buy certain goods, they can give subsidies to producers, reducing their costs so they can charge less, and in turn consumers will buy more. This tends to be done for merit goods, e.g. public transport (LRAS curve mores outwards). However, this has an opportunity cost.
Fiscal polices can influence the way incomes are shared out between different people.
How?
Problems?
How:
- Increase taxes on people on a higher income, making it more progressive. The gap, in terms of their disposable income, will close a little
- Increase benefits they give to the poor/disabled/child benefits
Problems:
This could have negative effects on peoples incentives, both the very rich and the poor:
-Rich - disincentive to work harder/take risks
-Poor - Discourages people to work - particularly if their low-skill
