Fiscal policy Flashcards
what is the overall purpose of the government’s budget?
- a government’s budget is dictated by its fiscal policy
- the main aim of fiscal policy is to smooth out the business cycle and control aggregate demand
- the aim is also always to have debt decreasing as a percentage of its GDP
What is the structure of government’s spending budget
Public Sector Spending 2021-2022:
- Social protection - £302bn
- NHS - £230bn
- Education - £124bn
- industry, agriculture and employment - £70bn
- Defence - £60bn
- transport - 51bn
- Debt interest - £45bn
How does the government fund its expenditures
Public Sector Receipts 2021-22
- Income tax - £198bn
- VAT - £151bn
- National Insurance - £147bn
- non - tax revenue (income from nationalised companies) - £88bn
- Corporation Tax - £40bn
- Excise duties - £48bn
How does an increase in taxes affect aggregate demand?
- taxes are a withdrawal from the circular flow of income
- an increase in income tax, for instance, will decrease the proportion of disposable income left after the tax has been added.
- this will leaad to a decreased marginal propensity to spend
- C is a positive component of AD, therefore a reduction in spending on goods and services will result in an inward shift of the aggregate demand curve.
How does an increase in govt expenditure affect AD
- govt spending is an injection into the circular flow of income
- therefore govt spending contributes to the aggregate demand of the economy because it is a positive component of AD.
- it can also lead to a positive multiplier effect
Explain the logical chain of reasoning of the multiplier effect:
- an increase in govt spending will lead to a shift outwards in the AD curve of the economy, because govt spending is an injection into the circular flow of income of the economy, and a positive component of aggregate demand.
- it can lead to a multiplier effect, which is where the initial injection into the economy leads to a bigger final increase in the real national income.
- for instance, if spending on infrastructure creates new jobs, this will create extra injections into the circular flow of income, because these workers will spend money.
- one agent’s spending is another agent’s income
- each shift in AD will be less than the last, as less and less money gets respent each time
What is a hypothecation?
(this can be used to evaluate the positives of fiscal policy)
- a hypothecation is when money is raised for a specific purpose
- for instance, after the Covid-19 pandemic, the govt decided it was going to increase funding for the NHS in the long-term
- however, this necessitated raising the rate of National Insurance by 1.25 percentage points
- this means that total spending won’t change as a result, because the increase in govt spending will be cancelled out by a similar decrease in consumer spending
- but MULTIPLIER EFFECT…
What are the current tax key points to remember?
Taxes
- expected freeze in income tax rate thresholds until 2028 - this means that due to inflation, more people will find themselves in higher tax brackets, meaning they will pay higher taxes on additional income they get, despite not having any increase in their real-incomes. It brings low-income households into paying basic rate of tax (stealth tax - fiscal drag). Could generate up to £30 bn a year by 2026 due to inflation
- income tax threshold to be lowered from 150k to 125k, implemented April 2023.
- At 125k income, you will also not receive any personal allowance because 1£ is withdrawn for every £2 above £100k.
- Truss’ govt scrapped the increase in NIC, so gone back down 1.25% points
- windfall tax on oil and gas companies increasing from 25% to 35%.
What are the current spending key points to remember, announced in Hunt’s Autumn Statement?
Spending:
- help with cost of living - energy bills capped at 2500, increasing to 3000 in April
- state-pension payments to go up by 10.1% in line with inflation
what is the difference between current and capital govt expenditure?
Current expenditure - NHS, paying for education
Capital expenditure - HS2, new hospitals, investments
What is an expansionary fiscal policy?
G>T
- creates a govt deficit, leading to debt
- done in a recession to smooth out the business cycle and boost growth
What is a contractionary fiscal policy?
G<T
- govt surplus
- AD decreases due to net withdrawal from circular flow of income
- does this during periods of growth - when tax revenue is high and the govt doesn’t need to spend that much
what are automatic stabilisers?
- automatic stabilisers smooth out the economic cycle without the chancellor doing anything
- during a boom, tax receipts increase and govt spending on benefits will decrease
- during a recession, tax receipts will decrease and govt spending on u/e benefits will increase
- reduces the size of a positive or negative output gap, meaning that actual GDP is closer to trend GDP
What are the ways in which fiscal policy can be evaluated?
- fiscal crowding out
- laffer curve
- willingness and ability of govt to borrow
- evaluating the multiplier
- govt debt
what are the strengths of fiscal policy?
(summary)
Strengths:
- monetary policy disadvantages in deep recession - (time lag, liquidity trap, effective lower bound)
- monetary policy is one size fits all - fiscal policy can target specific regions and sectors of the economy
- ability to improve the supply side of the economy.
