Fiscal Policy

Question 1

Fiscal policy aim

Answer 1

• to stimulate growth in the economy
• (by changing the spending or taxation)

Question 2

How it influences AD

Answer 2

• Expansionary fiscal
• Deflationary fiscal

Question 3

Expansionary Fiscal

Answer 3

• aims to increase AD
• Increase spending or reduce tax
• Leads to worsening of the budget deficit.
• (gov. may have to borrow finance)

Question 4

Deflationary Fiscal

Answer 4

• aims to decrease AD
• cut spending or raise tax
• leads to improvement of the budget deficit

Question 5

How it influences AS

Answer 5

• Gov. reduce income/corporate tax to encourage spending and Investment
• Subsidise training/ education. Lowers the cost for firms.
• Spend on healthcare - improves quality of labour and higher productivity.
• Gov. spend on infrastructure (roads and schools)

Question 6

Budget deficit

Answer 6

Expenditure exceeds tax receipts

Question 7

Budget surplus

Answer 7

tax receipts exceed expenditure

Question 8

Direct taxes

Answer 8

• Imposed on income
• paid directly to the gov.
• Income, corporation, NIC’s, inheritance

Question 9

Indirect taxes

Answer 9

• imposed on expenditure on G&S
• they increase production costs
• increases market price and demand contracts

Question 10

2 types of indirect tax

Answer 10

• Ad valoren - taxes as percentage (VAT 20%)
• Specific tax - set tax per unit

Question 11

Proportional tax

Answer 11

• fixed rate for all tax payers
• ‘Flat rate’
• incidence of tax is equal
  (could encourage higher income)

Question 12

Progressive tax

Answer 12

• has an increase in average rate as income increases
• (UK system)

Question 13

Regressive tax

Answer 13

• Does not relate to income
• those on lower income have a higher average rate
• leads to a less equitable distribution of income.

Question 14

Limitations of fiscal policy

Answer 14

• Gov have imperfect info
• Time lag
• Borrowing from private sector (crowding out)
• Bigger the multiplier - more effect on AD - more effective
• High IR, fiscal won’t effectively increase demand
• If gov. spends too much, difficulties paying debt. (difficult borrowing in the future. )

Question 15

Structural deficit

Answer 15

• One that remains even when the economy is operating at full capacity.
  Can be due to:
• Low tax revenues (tax evasion/avoidance, low productivity)
• High levels of gov. spending. (wars,NHS, etc.)

Question 16

Cyclical deficit

Answer 16

• One that arises due to an economic downturn.
• During low growth or recession
• Low employment, incomes, expenditure and profits reduce tax.
• High unemployment increase gov. spending on social security.

Question 17

Discretionary fiscal policy

Answer 17

• to manipulate AD
• cutting VAT/income tax/corporation tax/business rates
• Increase gov. expenditure.