Fiscal Policy Flashcards
Fiscal Policy
The use of taxation and government spending to influence and manipulate the economy
Progressive Tax
A tax which takes a higher proportion of income when have a higher income compared to the local income
Regressive Tax
A tax which takes a higher proportion of income from low income households than higher income households
Proportional tax
A tax which takes the same percentage of income from both low income households and high income households
Average Rate of Taxation
(total amount of tax)/(total income) x 100
Marginal Rate of Tax
(change in total amount of tax)/(change in total income) x 100
Fiscal drag
When inflation and earnings growth pushes tax payers into a higher tax bracket without actually increasing tax
- government collect more tax revenue
Current Expenditure
Spending on goods and services for immediate use that is going to benefit the economy now
Capital Expenditure
Spending that is investment for the future benefit of the economy that would expand the productive capacity of the economy
Budget Surplus
When tax revenue is greater than governemnt spending
Budget Deficit
When government spending is greater than tax revenue
Balanced Budget
Tax revenue is equal to government spending
Cyclical budget deficit
A budget deficit that occurs during the downturn of the business cycle but it disappears in an upturn
Structural budget deficit
A budget deficit that persists even when the economy is at full employment
Discretionary fiscal policy
A situation in which the government uses its discretion to intervene in the economy in an attempt to stabilise it
Automatic Stabilisers
Automatic changes to the governents expenditure and revenue budget as the economy moves through the stages of the economic cycle which helps to stabilise the economy
National Debt
Total amount of government debt based on accumulated previous deficits and surpluses
Debt to GDP ratio
Debt/GDP
Disdvantages of national debt
1. Crowding out
- as national debt increases, the gov will need to pay this debt off by borrowing money
- money demanded increases within the economy, but as money supply is fixed and demand continues to increase, interest rates increase
- cost of borrowing increases so firms are crowded out of the market as they are less incentivized to borrow money to fuel their investments
- a rise in IR further worsens national debt as firms investing less, consumers borrow less to consume, tax revenue decreases
2. Increase in hot money inflows
- interest rates in the UK will increase, there is an increase in people from aboard wanting to save into UK banks as the reward for saving increases
- this increases the demand for UK pounds causing the exchange rate to appreciate making the pound stronger
- this makes exports more expensive and makes UK less internationally competitive, net exports decrease and balance of payments worsens
- imports also increase as they are now cheaper
Advantages of national debt
1. Duing a recession not long lasting
- not long lasting and will allow government to maintain people standard of living as giving out benefits
2. Depends upon the cause of national debt
- if national debt is high because of buying a lot of capital or fop, isnt bad as it’s going to be short-lived and capital will be more productive in the long run leading to economic growth and more revenue
3. Depends how national debt is funded
- if it is funded domestically it is not risky to default on a repayment so it wouldn’t default their economy
- not beneficial if it is funded by the financial account as it relies on FDI which are not always good as can pull out at any time
Expansionary Fiscal Policy
An increase in government spending and decrease in taxes
1. +ve
- increasing gov spending increases AD as it is a component
- decreasing taxes means people have more RDY
- consumption inceases, profit increases, investments increase
- unemployment decreases
- economic growth increases
2. -ve
- inflation increases
Contractionary Fiscal Policy
A decrease in government spending and increase in taxes
1. +ve
- decreasing gov spending decreases AD as it is a component
- increasing taxes means people have less RDY
- consumption deceases, profit decreases, investments decrease
- inflation decreases
2. -ve
- unemployment increases
- economic growth decreases
Advantages of Fiscal Policy
1. Leads to the multiplier effect, prevents recession
- If the government spends more on benefits, RDY increases, consumption increases, AD shifts
- firms become more confident so investments increase, AD shifts
- gov spending also causes AD to shift
2. AD and LRAS shift simultanueously
- if the gov increases spending on improving infrastructure then AD increases as gov spending is a component of AD
- productive capacity of the economy also increases so LRAS shifts
- confidence increases so firms also invest
- non inflation growth
3. AD directly impacted
- Government spedning is a component of AD so AD shifts directly which has a direct effect unlike other policies and so quicker
4. Reduced income inequality
- government can place progressive tax system so more income taxed for higher income households than lower
- if increase spending on benefits, so low income households have more RDY
5. Automatic stabilisers
- provides stability for the government by making automatic changes to their expenditure and revenue
- smoothing the economic cycle, prevents from going into a deep recession or overheating
Disadvantages of Fiscal Policy
1. worsens income inequality
- if they a implement regressive tax system, a higher proportion of income taken from low income households
- inflation might increase
2. crowding out
- if national debt is high due to large amounts of sending, gov borrow more money to service the debts
- money supply is fixed but money demanded increases
- interest rates increase so firms less incentivised to borrow as more costly to take out loans
- AD and LRAS shifts to left
3. laffer curve
- as tax rates increases, tax revenue initially increases until a certain point and then eventually decreases
- people reluctant to work as believe it isnt worth it as most of their income will be taxed anyways
- voluntary unemployment increases and work less hours, may accept benefits instead if wage replacement ratio is high
- human capital flight, as occupationally mobile workers may leave the country to another country with more generous tax rates
- this can lead to the economy with only low skilled workers left so productive capacity decreases
- reduced trickle down effect
4. decreasing FDI
- if corporation tax high, unincentivised to start up as profits taken
- can pull out anytime
5. time lag
- long time for people to notice and change habits
6. lack of information
- may make wrong decision as not perfect info
- difficult to estimate size of the multiplier effect, if small not very beneficial
7. ceteris paribus may not hold
- other factors shifting AD
- depends on whats happening in other countries
- confidence
What does fiscal policy depend upon?
1. Level of confidence
- low levels of confidence, consumption doesnt increase
- save instead
2. MPC of conumers
- if mps high, the size of the multiplier is low
3. Level of spare capacity
- if in a boom, cant invest more when nearing ful capacity as will be purely inflationary
- SSP instead
4. Level of national debt
- if national debt is really high, borrowing to spend is detrimental
