Fiscal Policy Flashcards
Contractionary FP
Reducing aggregate demand by reducing govt. spending or tax increases.
Expansionary FP
Boosting aggregate demand by increasing govt. spending or lowering taxes.
Tools of Fiscal Policy
Manipulation of Govt. Spending
Taxation
Budget balance
Automatic Stabilisers
When policy automatically reacts to changes in the economic cycle
- During a recession - Govt. spending increases via increased welfare payments but tax rev decreases leading to a budget deficit
- During a boom - Govt. tax rev increases and govt. welfare payments fall - leading to a buddget surplus
Evaluation of Automatic Stabilisers (3)
Impact depends on whether a government allows the automatic stabilisers to operate fully - ie. austerity policy
Impact depends on the relative generosity of the welfare system such as base levels of payment for universal credit and unemployment support. Some governments have capped total welfare payments.
Impact depends on the marginal propensity to spend and save of those households whose income is boosted by welfare during a recession.
Discretionary Policy
Govt. deliberately change their level of spending + tax.
- At any given point, Govt. can choose to improve infrastructure etc. and increase tax to do so.
- Govt. may take action due to the economic cycle.
Structural Budget Position
The long-term fiscal stance - ie. during the whole economic cycle.
Cyclical Budget Position
The short-term fiscal stance - ie. affected by the economic cycle
Types of Govt. spending
- Current Expenditure - Immediate spending, eg. wages
- Capital Expenditure - Spending of Long term assets eg. infrastructure projects.
Cannons of Tax (4)
Canon of Equity - Taxation should be equitable or fair, meaning that those who are wealthier should contribute more and taxes shouldnt penalise the poorest in society.
Canon of Certainty - Those who pay tax should be able to predict how much they will pay to enable them to plan expenditure. Govt. should be confident in tax revenue forecasts.
Canon of Convenience / Simplicity - Tax should be convenient and easy to plan, meaning tax is paid at the same time each year/month and tax should be easy to calculate.
Canon of Economy - The cost of tax collection should be lower than the amount of tax collected or the very purpose of applying tax has been undermined.
Golden rule of Fiscal Policy
Only borrow to invest in capital over the course of an economic cycle, hence funding long-run growth by increasing capacity.
Do not borrow to finance current expenditure
Horizontal Equity
People who have similar income and abilities should pay the same amount tax.
Vertical Equity
People earning higher incomes and with greater abilities should pay more tax than those on lower income.
Progressive Taxation
Tax paid increases as an individual’s income increases (eg. Income tax) , a useful tool to redistribute income and reduce poverty
Achieves vertical equity
Regressive Taxation
Tax paid falls are income rises. By reducing the tax rate on the rich, the Govt. aims to promote supply-side growth (trickle-down economics) + incentive to work harder to reduce tax burden
Increases inequality
Proportional Taxation
Everyone pays the same proportion of tax regardless of income (eg. VAT).
Horizontal Equity
What affects the size of Govt. Spending ?
1) Size + Structure of the population
2) Political Objectives
3) Policy on inequality / poverty / redistribution
4) Fiscal Policy
Public Sector Net Cash Requirment (PSNCR)
When UK Govt. spends more than it receives in revenue then the Govt. must borrow this money.
aka a budget defict
Public Sector Debt Repayment (PSDR)
When UK Govt. receives more in revenue than it spends, the Govt. can repay this debt.
Causes of a budget deficit
Rising unemployment - falling tax rev
Low levels of demand / profts - falling tax rev
Excessice Govt. spending / borrowing
Population demographic - eg. aging population
Increasing welfare payments
Key consequence of a budget deficit
Excessive borrowing (PSNCR) - Growing national Debt
Positive Effect of Increasing National Debt
Merit goods such as education and training or healthcare
Public goods such as roads or defence
Welfare benefits/social provision
The redistribution of income/wealth
Infrastructure
Supply-side policies
Crowding in
Negative Effect of Increasing National Debt
Crowding out
Lower credit rating for UK
Possible inflationary pressure
Intergenerational inequality
Reduced FDI
The Office for Budget Responsibility (+ 3 key roles)
The office for budget responsibility is an independent body that was created in 2010 that helps to keep Govt. fiscal policy under control. Their role includes;
Publishing reports that analyse the UK Govt.’s use of taxation, spending and evaluates Govt. future spending predictions.
Assess Govt. fiscal performance against Govt. targets and objectives.
Uses long-term projections to analyse the sustainability of Govt. spending.
Microeconomic impact of FP
Government policy influences microeconomics by implementing incentives and inputs that shape individual decisions.
Relationship between budget and debt
When the Govt. spends, their budget deficit worsens and their long-term debt increases.
Cyclical Budget Deficit
The size of the budget deficit is determined by the state of the economy, eg. economic cycle position
Structural Budget Deficit
Budget deficits that persist during times of boom due to structural issues within the economy.
Crowding Out Effect
Where excessive Govt. investment into the private sector deters private investment.
Crowding In Effect
When govt. investment in the private sector promotes further private sector investment due to growing confidence
Crowding In vs Crowding Out
Crowding in is more likely to occur in a recession when the private sector has unused savings. Crowding in may prove to be a temporary effect.
Crowding out will occur when the economy is close to full capacity and limited spare savings.
