fiscal policy Flashcards
3 types of government spending
- current spending (stuff consumed today like wages)
- capital (investment, infrastructure)
- transfer payments (will get no return from - benefits)
roles of government spending
- regulation of AD to achieve objectives
- providing public goods and services
- reducing inequality and redistributing income
- preventing market failure and pushing positive externalities
difference between merit goods and positive externalities
positive externality: positive spillover effect on a third party
merit good: a goof that will bring benefit to consumer in the future
government failure
when government intervening makes a problem worse
why is G in the UK rising
- aging population - more pensions
- banks need bailout
- pandemic spending
- defense spending more in recent years
- energy subsidies in an energy crisis and cost of living crisis
- net zero goals - spending on transport and renewable energy solutions
GDP and G correlation
- not a distinct correlation - G is more so used as a response to market failure
- depends how effective spending is
Taxation definition
a compulsory levy by a government to individuals or firms
tax evasion
illegal - not paying taxes
tax avoidance
legal - finding loopholes to paying tax
aims of taxation
- raise government revenue
- reducing market failure
- reducing income inequality
- macroeconomic objectives being met
types of taxes (EVALS)
- direct or indirect
- expenditure, income or capital
- progressive, proportional or regressive
direct vs indirect taxes
direct - liability lies on consumer or firm
indirect - liability shifted to a third party
examples of direct and indirect taxes
direct: income tax, NICs, corporation tax
indirect: VAT
categories for ‘what is being taxed?’
- income - MOST UK TAXES
- expenditure - TAX BASE BROADENED IN UK TO MORE OF THIS
- capital
nature of tax: difference between progressive, proportional or regressive
ART = T/Y
MRT = ΔT/ΔY
progressive: art < mrt
proportional: art = mrt
regressive: art > mrt
average rate of tax formula
tax / income (T/Y)
marginal rate of tax formula
change in tax / change in income (ΔT/ΔY)
difference between art and mrt
A taxpayer’s average tax rate (or effective tax rate) is the share of income that they pay in taxes. By contrast, a taxpayer’s marginal tax rate is the tax rate imposed on their last dollar of income.
4 principles of taxation
- equitable - people’s ability to pay
- convenient - cheap and easy to collect
- certain - difficult to evade the tax
- (!!) efficient - does the tax change behaviours?
recent tax changes in the UK
- 40% income tax bracket narrowed to £25000
- tax allowances frozen - personal allowance of £12,500 and next bracket of £50,000 - CAUSES FISCAL DRAG WHEN THERE IS INFLATION
- significant rise in corp tax - 19% - 25% (Apr 2023)
- 2% fall in NICs in Spring Budget 2024 - 10% to 8%
Demand-side economic effects of a tax cut
↑dispo Y, ↑consumption:
- ↑AD, ↑rGDP
- ↑Tax (VAT) or down
- ↑ PL (demand pull inflation)
- ↑budget deficit (lower tax rev)
- ↑investment, ↑profits, ↑employment (labour is derived demand)
evals for demand side effects of tax cut
-effects on the price level depend on the output gap - close to full employment will have a larger impact on the PL and lower effect on rGDP
-depends if the tax is seen to be permanent or temp - if people anticipate a raise soon after, will likely not change their behaviour (time lag)
depends where the tax cut was placed
supply side effects of a tax cut
opportunity cost of work = leisure
income effect: as wages increase, less incentive to work - afford to work less
substitution effect: more wage, more incentive to work
as there are 2 simultaneous effects, the NET EFFECT IS UNCERTAIN
laffer curve
shows TR peaks at midpoint of mrt
