Fiscal policy Flashcards
What does fiscal policy concern
Taxation and government spending
What is a budget deficit
A budget deficit means the government has borrowed money and its expenditure exceeded its national income
What is national debt
All the previous budget deficits added together
Give 3 examples of scenarios which worsened national debt
- Covid - Furlough payments
- 2008 banking crisis - the government ‘bailed’ banks out
- Cost of living crisis - winter fuel payments
Give 4 examples of taxes on incomes
Inheritance tax
Capital gains tax
National insurance
Corporation tax
Which curve shows whether income tax leads to greater tax revenue
The laffer curve
What is on the X and Y axis of the Laffer curve
X - Tax rate (0-100%)
Y - Tax revenue
Draw the laffer curve
What does the point t on the laffer curve represent
t = maximum tax revenue, beyond which, tax revenue begins to fall
Give 3 reasons why tax revenue may decrease with an increasing tax rate (after point t on the laffer curve)
- Tax avoidance
- Tax evasion
- Lack of incentive to work
What are two examples of tax avoidance
Leaving the country (brain drain)
Tax planning (using an accountant)
How does an increase in the tax rate decrease the incentive to work
Less incentive to seek promotions and less entrepreneurship due to less financial rewards
How does less entrepreneurship due to increased tax revenue affect the government (3 effects)
Less corporation tax
Less growth
Less employment
Less private sector investment
Less N.I tax (recent budget)
What is the free market argument for cutting taxes
Free market economists often argue income tax rates are above point t on the laffer curve, therefore cutting taxes would increase tax revenue
What is the multiplier effect
An increase in government spending leads to a greater increase in national income
What is the numerical multiplier
1/MPS OR 1/1-MPC
What does MPS and MPC stand for
Marginal propensity to consume/save
What is austerity
Cutting spending or increasing tax in order to reduce a budget deficit
What is a direct tax
A tax on any form of income
What is an indirect tax
A tax on spending
What is a progressive tax
A tax which taxes a higher proportion of income from higher income earners
What is a regressive tax
A tax which takes a greater proportion of income from lower income earners
What are 3 advantages of a regressive/indirect tax
- Doesn’t take away the incentive to work/ earn income
- Helps reduce consumption of demerit goods
- Higher income earner still pay more tax in absolute terms
Give two examples of how regressive/indirect taxes reduce the consumption of demerit goods
Sugar tax
Excise duties
Explain how regressive/indirect taxes still mean higher income earners pay more tax in absolute terms
-Higher income earners do more total spending
-Hence they pay more in VAT
- Especially since VAT is not on necessity goods such as basic food items and children’s clothes (which low income earners would buy more of)
What are two negatives of regressive/indirect taxes
- Higher income earners have a lower MPC, and therefore are likely to spend less income meaning less VAT paid
- Low income groups have a higher propensity to gamble/smoke/drink which leads to more regressive taxes paid
What are two arguments for progressive/direct taxes
- They can be justified by arguing there is a diminishing marginal utility of money
- Very high income earners may only save or buy luxury goods (do not need it)
What two categories can government spending be broken down into
Capital spending
Current spending
What is capital spending
Spending by the government that generates a return (investment spending)
Give 3 examples of capital spending
Roads (Infrastructure)
Hospitals (Healthcare)
Schools (education)
What is current spending
Day to day spending on expenses
Give two examples of current spending
Public sector wages (Bin men, NHS doctors)
Welfare spending (Benefits)
What is a common cap target for a governments budget deficit
Governments try to keep the budget deficit to no more than 3% of GDP. In the financial year 23/34, the UKs was 4.4%
What is the ‘golden rule’ to do with government spending
Governments will only borrow to fund capital spending, not to cover current spending
Why the ‘golden rule’ to do with government spending justified
As capital spending generates a return which can cover the interest which needs to be paid for borrowing
What is a cyclical budget deficit
Caused by fluctuations in the economic cycle. In a recession VAT is lower due to less AD in the economy, therefore tax revenue is lower, coupled with more spending on benefits
Why is a cyclical budget deficit not seen as too problematic
The economic cycle shows that as an economy moves back into the recovery phase, AD will increase again meaning more VAT and tax revenue. Rising growth in the recovery period also means an increase in employment levels, which may reduce welfare spending
What is a structural budget deficit
When a country is living beyond its means either due to too much government spending or taxes are too low
Who are the OBR
Office for Budget Responsibility
Independent reviewers of the government tax and spending plans
What are 4 objectives of fiscal policy
Reduce poverty
Promote strong, sustainable growth
Value for money for the tax payer
Ensure sustainable public finances
What is expansionary fiscal policy
Decreasing tax and increasing government spending
How does expansionary fiscal policy affect a budget deficit in the SR and LR
In the short run the budget deficit worsens due to increased gocernment spending and lower tax revenue, in the long run, it decreases due to more private sector investment
What is contractionary fiscal policy
Increasing tax and less government spending
What is Keynesian economics
Argues that demand drives supply and healthy economies spend/invest more than they save
