Fiscal Policy Flashcards
what is fiscal policy
making deliberate changes in government spending or taxation
how is G financed
taxation revenue
budget balance
the difference between govt spending and collected tax revenue
how are budget deficits financed
borrowing in the shortfall
govt issues bonds and people purchase them
bonds pay the holder a fixed rate of interest until repaid
direct tax
placed on incomes and often taken away by the employeri
indirect tax
paced on expenditure
part of the selling price which is not kept by the seller but collected by the govt
progressive tax
where those on higher incomes pay a higher proportion of their income in tax compared to those on lower incomes
why is it progressive
tax is paid only on additional income earned
regressive tax
taxes that increase in relative size4 on lower income earners
examples of a regressive taxx
VAT
proportional tax
‘flat’ taxes
one rate of taxes/ equal
3 main taxes
income tax
national insurance (varies with pension type)
VAT (20%)
advantages and disadvantages of income tax
a- fair, alleviate relative poverty
d- disincemntive to work, complex to administer, encourages tax avoidance
adv + disadv of VAT
a- hard to avoid
d-regressive, changes can be inflationary
why govt levy tax
raise revenue to finance expenditure (avg £800m a year)
change patterns of economic activity e.g lower taxes on renewable energy
discourage consumption of demerit goods - difficult if price inelastic
redistribute income (progressive)
horizontal equity
people with similar income pay similar income tax
vertical equity
tax is payed based on ability to pay
curent spending
day to day e.g salaries for public sector workers
capital spending
investment
expansionary fiscal policy
increases in govt spending and lower taxation
shifts AD rightward
contractionary fiscal policy
decrease in govt spending and tax rises shifts AD leftwards
fiscal policy changes which macroeconomic factors
level of real GDP
unemployment
price level
multiplier effects
effects of tax changes
changes disposable income of households which impacts C
taxes on business profits will impact I
tax cuts may lead to higher saving and not impact C
decrease or increase AD
effects of changes in indirect taxes
any increase in indirect tax e.g. VAT will shift SRAS leftward as higher indirect taxes cannot always be fully passed on to the consumer in he form of higher prices, so profit margins fall on output sold
this may reduce the incentive for firms to supply output at any price level
supply side fiscal policy
changes in fiscal policy to improve the LRAS of the economy
supply side fiscal policies include
govt spending on increasing production capacity and shifting LRAS right (e.g infrastructure spending)
tax incentives to encourage firms to employ workers and increase investment spending (reducing corp tax)
reducing direct tax to make work more attractive
micro impact of fiscal policy
govt spending on subsidies for merit goods with positive externalities
indirect taxes to discourage consumption of demerit goods
changing pattern of economic activity e.g declining industries and subsidising their costs
fiscal stance
the extent to which fiscal policy is likely to add or subtract from AD
what does expansionary policy effect the bdget
brings it closer to a deficit
what else impacts budget deficit
rate of economic growth
tax revenue collected
higher unemployment = higher govt welfare expenditure
cyclical budget deficit
the portion of a budget deficit that changes when the rate of economic growth changes
structural budget deficit
portion of the budget deficit that remains even if economic growth is at its normal long run rate
cyclical deficit e.g.
2009 recession
2010 govt attempted to reduce large budget deficit
also sectoral deficit where govt expenditure would have exceeded tax revenue regardless of rate of economic growth
how are cyclical vs structural deficits lifted
cyclical - eventually eliminated by economic growth returning to avg rate
structural - only if contractionary fiscal policy is implemented
impacts on economic growth of budget deficit/surpluses
budget deficit = policy is increasing AD
AD changes will affect short run economic growth
however the rate of EG if slow will require high welfare expenditure and less tax revenue collected
(low economic growth may have caused the deficit)
impact of budget on unemployment
govt can reduce unemployment through expansionary fiscal policy
higher govt spending and larger deficit = higher demand for workers
however in the long run unemployment will return to its natural rate and will be independent of budgetary policy
impact of budget on inflation
excessive AD= demand pull inflation which is the result of expansionary
rise in budget surplus (tax rises and govt cuts) will reduce demand pull
how does the govt finance the budget deficit
borrow in the shortfall
bonds are issued and eventually repaid but they form part of the national debt
debt interest payed in 2019-2020 uk
£40 billion
uk national debt in 2019
£1.8 trillion (almost 85% if GDP)
why is the national debt significant
a large national debt will require greater interest and govt must make a choice on how to repay
those who buy govt bonds will demand higher IR on the debt if there is the threat of an uncontrollable debt
the national debt as a % of GDP will fall if the rate at which it grows is less than the rate GDP grows
OBR functions
economic forecasting of govt finances
evaluating fiscal policy
analysis of the sustainability of public finances
analysis of tax and welfare costing