Fiscal policy Flashcards
Why was the OBR needed
Before the OBR came along, the Treasury produced its own economic forecasts under supervision of the chancellor. But these were often too optimistic about UK growth and the impact of new policies. The result was lower tax receipts than expected, higher borrowing and, ultimately, damaged fiscal credibility.
Spring Budget Wednesday 6 March 2024.
Hunt: a “budget for long term growth”.
2024 Spring Budget National insurance
- National insurance contribution rate will be cut from 10% to 8% of pay
- This comes on top of a 2p cut in the November autumn statement, which reduced the rate from 12% to 10%.
- It is estimated that the 2p cut to national insurance would be worth about £450 a year for someone on a £35,000 full-time salary.
2024 Spring Budget Growth
- Hunt says the economy is expected to grow by 0.8% this year and 1.9% in 2025. That is slightly stronger than the 0.7% and 1.4% growth rate expected by the Office for Budget Responsibility at the time of the autumn statement in November.
- Growth is then forecast to be 2% in 2026 before dipping to 1.8% and 1.7% in 2027 and 2028.
2024 Spring Budget Government Borrowing
- Hunt says underlying debt, which excludes Bank of England debt, will be 91.7% of GDP in 2024-25 according to the OBR, then 92.8%, 93.2%, 93.2% before falling to 92.9% in 2028-29. “We continue to have the second lowest level of government debt in the G7, lower than Japan, France or the US,” he adds.
- Hunt says borrowing falls from 4.2% of GDP in 2023-24, to 3.1%, 2.7%, 2.3%, 1.6% and 1.2% in 2028-29. “By the end of the forecast, borrowing is at its lowest level of GDP since 2001,” he adds.
2024 Spring Budget Public Services
- The chancellor has kept a 1% increase in day-to-day public spending above inflation, despite speculation it would be cut to just 0.75%.
- Military spending will rise to 2.5% of GDP “as soon as economic conditions allow”, Hunt says. It is now at 2% of GDP.
2024 Spring Budget Property tax
- Hunt says the government will reduce the higher rate of property capital gains tax from 28% to 24%.
- He also announces the abolition of stamp duty relief for those buying more than one dwelling.
2024 Spring Budget vaping tax
- Hunt confirms widely expected plans for a “vaping products levy” to be paid on imports by manufacturers, specifically on the liquid in vapes. It will be introduced in October 2026.
- The move is an attempt to discourage children from buying the products. It is expected to raise £500m by 2028/29. A one-off increase in tobacco duty is also announced.
- Tobacco duty will go up £2.00 per 100 cigarettes at same time, to ensure vaping remains cheaper
2024 Spring Budget Alcohol and fuel duty
- Alcohol duty was due to rise by 3% from August but Hunt said it will be frozen until February 2025, benefiting 38,000 pubs across the UK. The government is “backing the great British pub”, Hunt says.
- Hunt said he would freeze fuel duty at its current level for another year, as expected. The levy should rise in line with inflation but this has not happened since 2011.
- A 5p cut to fuel duty, which was introduced in 2022 and is due to run out this month, has been extended.
2024 Spring Budget Savings
- Hunt announces a new “British Isa”, giving investors a £5,000 extra tax-free allowance to “encourage more people to invest in UK assets”.
- Hunt says a new British Savings Bond will launched in April, delivered by the state-owned National Savings and Investments. It will offer a guaranteed rate, fixed for three years.
2024 Spring Budget child beneift
extended eligibility for child benefits for around 170,000 families, with people earning up to £60,000 getting benefits in full and the threshold for them to be withdrawn entirely raised to £80,000.
2024 Spring Budget Investment
£3.4bn to modernise NHS IT systems
Definition of fiscal policy
The use of government spending, taxation and budgetary position to achieve their macro policy objectives.
General objectives of fiscal policy
- managing AD
- Influencing AS
- achieving micro-econ goals (supporting particular indsutries, influencing demand for merit/demerit goods)
- redistributing wealth
Why does the government spend
- Subsidies to encourage consumption of merit goods
- Provide public goods
- Provide a safety net of welfare benefits to supplement the incomes of the poorest in society
- Provide neccessary infrastructure via capital spending
- Stiimulate economic growth (multiplier effect)
- Expensive supply-side projects (new runway at heathrow)
catagories of gov spending
- Transfer payments: welfare payments (redistribution)
- Current government spending: spending on state-provided goods & services that are provided on a recurrent basis (e.g. public sector salaries)
- Capital spending: includes infrastructure spending such as new motorways and roads, hospitals, schools and prisons. This investment spending adds to the economy’s capital stock
Types of tax
Income tax – a percentage of income.
Corporation tax – a percentage of a firm’s profit.
Sales tax/VAT – an indirect tax on the sale of goods.
Excise duties – taxes on alcohol, tobacco, petrol.
Production taxes – taxes on particular goods/services, e.g. gambling tax, airlines, insurance.
Environmental taxes – taxes on carbon, airports e.t.c.
Stamp duty – tax on buying a house or shares.
Tariff – this is a charge levied on the import of particular goods.
Inheritance tax – a tax levied on the estate of a deceased person.
Wealth tax – a tax levied on wealth, rather than income.
Capital gains tax – a tax levied on an increase in the value of assets/wealth.
Poll Tax – a tax on individuals. Introduced in UK as the “Community Charge”
Windfall taxes – These are a type of corporation tax levied on companies making ‘excess’ profit. The UK introduced windfall tax on privatised industries. Also levelled on particular industries like north sea oil
Council taxes – taxes collected by local government, could be a tax on property or local sales/income tax
Direct and indirect taxes
- Direct tax is a tax that a person or company pays directly (income tax)
- Indirect tax is paid by a third party. (VAT charge the consumer does not pay, but the firm who sells the good is responsible for paying the tax to the government on your behalf.)
Progressive, proportional and regressive taxes
- A progressive tax takes a higher percentage of tax from people with higher incomes.
- A proportional tax means different income levels pay the same % of income in tax.
- A regressive tax takes a higher percentage of tax from people with low income.
Ad valorem vs specific tax
- certain percentage of the price of the good. VAT is levied at 20% so the more expensive the good is the more VAT that is paid.
- A specific tax is a fixed levy whatever the price of the good. For example, a £20 passenger levy on long-haul flights. This
Public sector current receipts
In 2022/23, UK government raised around £1,027 billion in receipts
- In 2022/23, UK government raised around £1,027 billion in receipts (highest since early 80s)
- Income tax, NICs, & VAT together raised around £591 billion in 2022/23.
Expansionary
- fiscal policy used to grow AD
- stimulate real output and employment and perhaps reduce the risk of a persistent deflationary recession
Contractionary fiscal policy
- aims to shrink the economy
Fiscal Multiplier Effect
- An initial change in AD can have a greater final impact on the level of equilibrium national income.
- Positive: occurs when an inital injection into the economy causes a bigger final increase in national income
- Final change in real GDP / Initial change in AD
- 1 / (1 - MPC )
Crowding out
- Higher taxes leads to lower consumer spending, offsetting rise in G
- When Gov borrows from private sector (bonds), firms spend less money in investment, offsetting rise
- When Gov increases its spending it will increase the demand for goods and services, which can lead to higher interest rates and inflation. This, in turn, can make borrowing more expensive for private investors, reducing their ability to invest
- Private investment may decrease or “crowd out” as the government spending increases.
Fiscal Policy and Long Run Aggregate Supply
- Changes in marginal and average income tax rates can have a significant effect on work incentives in the labour market
- State funding of R&D can have important effects on process innovation and the pace of dynamic efficiency in markets
- Higher government spending on education & training can increase human capital & labour productivity to lift the long-term trend rate of growth
- Changes in corporation tax and import tariffs can influence the size and direction of FDI
- Government spending on new infrastructure is crucial to lift LRAS – it often makes private sector firms more efficient and profitable too
Fiscal Policy and Short Run Aggregate Supply
Changes in VAT affect the supply costs of businesses – a fall in VAT reduces costs and – ceteris paribus – will cause SRAS to shift outwards
Changes in environmental taxes – a rise in a carbon tax will increase the costs especially of energy-intensive firms. SRAS will shift inwards
Changes in import tariffs – lower tariffs as a result of trade liberalisation will lead – ceteris paribus – to lower costs, SRAS shifts outwards
Changes in government subsidies – input subsidies paid to producers (such as farmers) lower their costs and cause an outward shift of supply
What does the OBR forecast do
The OBR forecast tells the government whether it is on track to meet its fiscal targets and, if so, how much headroom it has against them (i.e. how much more it can increase spending / reduce taxes and still achieve its targets for borrowing and debt). This information is critical for sound economic and fiscal policy making.
- provides information to the UK government’s creditors (i.e. financial markets) on the sustainability of public finances
What did George Osborne say about the OBR
According to George Osborne the OBR was introduced to “remove [from politicians] the temptation to fiddle the figures”.
Arguably one of the best legacies of the Cameron–Osborne government
What did John Kenneth Galbraith say about economic forecasting
“the only function of economic forecasting is to make astrology look respectable”
Is the OBR using long term economic forecasting
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What does Liz truss say about the OBR
- They didn’t produce a report for Rishi Sunak furlough scheme during COVID so why would they for her
- the core purpose of the OBR is to produce twice-yearly forecasts of whether the Government is on track to meet its fiscal targets. We weren’t due to set our spending plans until November so it would have been neither appropriate nor feasible for a report to have been produced in September.
Insurance Premium Tax (IPT)
- a type of indirect tax levied on general insurance premiums
- reinsurance and life insurance are exempt
A spending review
also called: a comprehensive spending review
- A governmental process carried out by HM Treasury to set firm expenditure limits and, through public service agreements, define the key improvements that the public can expect from these resources.
- Spending reviews typically focus upon one or several aspects of public spending while comprehensive spending reviews focus upon each government department’s spending requirements from a zero base (i.e. without reference to past plans or, initially, current expenditure).
2010 Sending review
- Driven by a desire to reduce government spending in order to cut the budget deficit.
- George Osborne announced the details of the spending review on 20 October 2010
- The review led to an £81 billion cut in public spending in the following 4 years of the parliament, with average departmental cuts of 19%. In addition;
- £7 billion of extra welfare cuts,
- changes to incapacity benefit, housing benefit and tax credits
- rise in the state pension age to 66
- Public sector employees would face a £3.5 billion increase in public pension contributions.
Additional cuts from 2010 spending review
The Home Office faced cuts of 25%,[10] local councils would face a yearly 7% cut in funding from central government each year until 2014.[10] The Ministry of Defence faced cuts of around 8%. DEFRA withdrew funding support from seven waste management PFI projects, the BBC had its licence fee frozen for 6 years and took on the funding of the BBC World Service. The OBR predicted that the spending review led to a loss of about 490,000 public sector jobs by 2015
Marginal propensity to save
- The portion of additional disposable income that is saved by a consumer
- MPS = Change in Saving ÷ Change in Income
- typically higher at higher incomes.
- ## MPS helps determine the Keynesian multiplier
Factors that influence MPS: Income levels
At low-income levels, consumers will be buying all the necessities of life. An increase in income, will probably all be spent. At higher income levels, with all necessities bought, saving becomes an affordable extra.
Factors that influence MPS: The diminishing marginal utility of income
As income levels rise, extra income has a diminishing utility and so consumers may not know what to spend the money on and therefore spend an increasing percentage.
The Keynesian consumption function shows that the marginal propensity to consume falls at higher incomes – meaning the marginal propensity to save rises.
Factors that influence MPS: Life-cycle hypothesis
Theories of life-cycle spending assume individuals wish to smooth out their consumption over a period of time. During a period of studying, marginal propensity to save will be zero (student probably will borrow. As they get a better-paid job and pay off their debts, they will be in a position to increase savings. During their mid-working life, individuals will tend to have a higher propensity to save – as they put money aside for retirement.
Factors that influence MPS: Individual preferences
Not all individuals are rational. Approx 25% of individuals do not follow the life-cycle hypothesis models and may fail to save, when rational utility maximisation may suggest they should. Some individuals are more prone to present-income bias. This means individuals place a higher weighting on consumption in present moment, than saving for future.
Factors that influence MPS: Individual preferences
Not all individuals are rational. Approx 25% of individuals do not follow the life-cycle hypothesis models and may fail to save, when rational utility maximisation may suggest they should. Some individuals are more prone to present-income bias. This means individuals place a higher weighting on consumption in present moment, than saving for future.
