Fiscal Policy Flashcards
Government spending (Major areas)
Social protection - Provide everyone with the basic minimum standard of living and reduces inequality in the distribution of income. Eg: state pension, child benefits
Health - Increase the welfare of the population
Education - Increase the welfare of the population
Direct tax
A tax on income or wealth
Government spending
The total amount of money of spent by the government in a given period time
Government revenue
The source of finance for government spending
Indirect tax
A tax on spending often defined as a tax on good and service
Direct tax (examples)
Income tax - collects the most revenue. Each person has a income tax allowance where no tax is paid. Once allowance passed, tax must be paid at the rate dependent upon the level income.
Nation insurance contributions - paid by employees and employers, tax on employing labour
Corporation tax - tax on profits of companies
Indirect tax (examples)
VAT - Value added tax - tax on a range of goods and services
Excise duties - tax on specific range of goods, demerit goods
Balanced government budget
Tax revenue is equal to government spending
Budget deficit
Government spending is greater than tax revenue
Budget surplus
Tax revenue is greater than government spending
Fiscal policy
A policy that uses government spending and taxation to affect the economy as a whole
Fiscal policy objectives
Economic Growth
Low Unemployment
Price Stability
A balance in the balance of payments
How can a budget deficit be used to achieve economic objectives?
Increase government spending or reduce taxes.
Use a budget deficit in a recession with high unemployment and a lack of economic growth.
Increase government spending
Causes
Extra spending provides income for others.
Eg : Government spend money on NHS, NHS employ more workers, more wages. As income rises, spending rises and firms produce extra output and employ more workers to meet demands.
A reduction in taxes
Causes
More disposable income. Able to spend more and total demand rises. Firms need to increase output to meet new demands so they employ more workers.
How can a budget surplus be used to achieve economic objectives?
Reducing government spending or increase tax
Use a budget surplus when there is too much inflation or a large balance of payments deficit
Decrease government spending
Causes
Reduce spending, reduces income in the economy. Consumers spend less, so less income for firms. Less income for firms means they will produce less and lay off workers. Total income decreases so demand falls so less pressure on prices and demands for imports fall.
A increase in tax
Causes
Increase tax, less disposable income. Less spending so total demand falls. Firms will produce less output and employ less workers so total income will fall. Total demand falls so less pressure on process and demands for imports falls
Costs and benefits of fiscal policy
Budget deficit increase disposable income, but doesn’t guarantee that consumers will spend all this extra money.
As disposable income rises, extra income may be spent on imported good and services leading to a larger balance of payments deficit
Budget deficit leads to a rise in total demand, supply rises to meet demand. If supply cannot meet demand, it will cause inflation to rise
Opportunity cost and fiscal policy
- Government spends on health and education to maintain a balanced budget. Opportunity cost of spending on health and education is spending less on other areas such as defence. So either the government has to give up spending on other areas, or consumer have to give up spending due to higher tax to fund those other areas.
- If government cut income tax rates, tax revenue falls while promising not to raise other taxes, this leads to a budget deficit or less government spending.
Income and wealth redistribution
Government actions using mainly taxation and benefits to reduce inequalities of income and wealth
Progressive tax
A tax which takes a greater percentage of tax the higher income
Inheritance tax
Tax on the assets of a person upon death.
Can be used for the redistribution of wealth
Reducing indirect tax
Redistribution
To redistribute income in favour of lower income groups. Lower indirect tax on goods to lower the price. However government may not be willing to do this for goods that are costly to society. UK government don’t place tax on necessities including food.
Government spending and redistribution
Spend on social protection which benefits lower income groups. More disposable income.
Consequences of redistribution measures
- People find ways they can live well enough on benefits provided by the government. Disincentive to work if post tax income from work is not much higher than benefits gained by not working.
- People make decision based upon the effect of direct taxes. Reluctant to apply for higher paid jobs
- High earners may move abroad to escape tax
- High direct tax may act as a disincentive for business to invest
- Saving decisions are also affected as people may not save if a lot of their income is taxed.
How fiscal policy can be used to achieve economic objectives?
(Economic Growth)
Budget deficit - Increase Government spending - Reduced tax - Increase spending, output and employment
How fiscal policy can be used to achieve economic objective?
Low unemployment
Budget deficit - Increased Government spending - Reduce tax - Increase spending, output and employment
How fiscal policy can be used to achieve economic objective?
Price stability
Budget surplus - Reduced Government spending - Increase tax - Reduced spending, so less pressure on price level
How fiscal policy can be used to achieve economic objective?
A healthier balance of payment
Budget surplus - Reduced Government spending - Increase tax - Reduce spending, including spending on imports
