Fiscal Policy Flashcards
1
Q
define fiscal policy
A
involves the government changing the levels of taxation and government spending in order to influence aggregate demand
2
Q
What does UK spend most of spending on
A
- spending on education in the UK reached 115.5 billion £ in 2023/24
- healthcare= 2022/23 was £181.7 billion
3
Q
adv of expansionary FP
A
- lower income tax= incentivise inactive to enter labour force
= increase Q of labour= increase LRAS - lower corporation tax= increase retained profits for firms to re-investment
= more productivity= increase LRAS - more spending on education= more teachers etc
= learn more skills= earn higher incomes= less unemployment
= higher SOL - more spending on infrastructure e.g. HS2
= easier transport
= less geographical immobility of labour - increase welfare benefits and spending
= redistribute income= higher standard of living and social welfare
4
Q
describe expansionary FP
A
higher spending and lower taxes to increase AD
5
Q
adv contractionary FP
A
- less debt fuelled spending= less crowding out
= less detraction of private sector= no pressure of IRs
= can still borrow at relatively low IRs to fund projects
= less x inefficiency - more confidence in gov finances= lower national debt means better credit ratings on gov bonds
= gov seen as less risky borrower= gov can issue low coupon rates on gov bonds
= easier and cheaper for gov to borrow over time to fund public services
= improve LR benefits - less AD= less demand pull inflation
= decrease CA deficit
6
Q
disadvantage of contractionary FP
A
- risks demand side shock= low AD means low growth
= increase unemployment and decrease SOL - low gov spending means longer waiting times, less teachers, less transport etc
= increase unemployment or low income jobs
= decrease SOL - less incentive to work and join labour force
= incentivise ppl to live abroad
= less tax revenue in LR= less gov funding
7
Q
EVALUATION POINTS of CFP
A
- is it rly necessary
= need CFP if gov finances are bad and have high debt
= pros outweigh cons - depends on policy used= don’t need to use both at same time
= cld try to balance G and T to mitigate cons - depends on stage of economic cycle
= BOOM is best time to use CFP to cool down overheating economy to lower inflation and mend finances
8
Q
disadv of expansionary FP
A
- demand pull inflation cause increase incomes
= increase AD of imports
= widen CA deficit - worsen gov finances= high budget deficits
= increase national debt due to borrowing
= may need to cut spending in other sectors to repay debt
= harm ppl who are reliant on gov benefits etc
= opportunity cost of gov spending - time lags= infrastructure projects take months to years to be completeed
= AD shift will be delayed
9
Q
EVALUATION POINTS of EFP
A
- depends on size of output gap
= small gap= close to full employment
= less effective to increase growth
=deep recession= large gap= a lot of spare capacity
=high growth to decrease unemployment - depends on size of multiplier
= large= less need for EFP as multiplier does most of work - consumer and business confidence
= less confidence= won’t spend retained profits - current state of gov finances
= high national debt= EPF can’t be afforded
10
Q
define budget surplus
A
when tax revenue is greater than government spending
11
Q
define structural BS
A
the amount by which a government’s spending is less than it receives in taxes in a particular period, whether the economy is performing well or not
12
Q
define a cyclical BS
A
that occurs when a growing economy is the cause, rather than fiscal policies like increasing taxes or decreasing spending
= usually during an economic boom
13
Q
define national debt
A
the total debt outstanding for a nation
14
Q
adv of budget surplus
A
- improve confidence in state of gov finances
= low national debt= stable finances
= increase credit ratings on gov bonds= seen as less risky borrower= overtime gov can issue low coupon rates (IRs)
= easier and cheaper for gov to borrow and fund spending - allow flexibility with fiscal policy whoever needed in future
= space to spend when needed due to less debt= helpful for next recession or emergency like COVID-19 - less debt fuelled spending= less crowding out of private sector= less pressure on demand for loanable funds= relatively low IRs= private firms can borrow and invest at low IRs
- high tax= less disposable income= low AD for imports
= decrease CA deficit
15
Q
disadv of budget surplus
A
- micro impacts of low gov spending e.g. education
= big classes and less teachers= low quality of education
= low income jobs due to less skills= inward LRAS - high tax= low disposable income= low incentive to work
= decrease tax revenue and increase income inequality - risk demand side shock due to low AD
16
Q
EVALUATION of budget surplus
A
- is it necessary?= bad finances= needs BS
- stage of economic cycle?= recession= BS wld worsen
- GDP levels?= low GDP= low debt= if GDP decreases faster than debt, finances cld get worse
17
Q
define budget deficit
A
when government spending is greater than tax revenues
= increases national debt
18
Q
adv of budget deficit
A
- high AD= high growth and low unemployment
= close negative output gap - more education= better qual of learning= more skills= high income jobs= LR high tax revenue returns
- low regressive taxes= more disposable income
= redistribution of incomes= higher SOL - high spending= high AD= more output= more activity
= promote private sector firms to invest= crowding in
= grow businesses to increase profit= higher LRAS
19
Q
Disadv of budget deficit
A
- deterioration of gov finances= high national debt due to more borrowing
= decrease confidence in state of gov finances
= low credit ratings on gov bonds= reflects risk of lending to UK= gov must offer high IRs= more expensive to borrow money overtime= burdens future gens= debt must be paid back potentially by increase tax or cuts in G= OC - high AD= demand pull inflation= high prices= low SOL
20
Q
EVALUATION of budget deficit
A
- state of gov finances= high debt= cons outweigh pros
- state of economic cycle= needed in recession to increase AD
- consumer and business confidence
= weak= limit effectiveness= not willing to borrow or spend
= no safety net
21
Q
define progressive tax
A
where the average rate of tax (as a %) rises as income increases
22
Q
define proportional tax
A
the marginal rate of tax is constant leading to a constant average rate of tax
23
Q
define regressive tax
A
tax imposed by a government which takes a higher percentage of someone’s income from those on low incomes
24
Q
principles of taxation
A
- cost of tax must be relative to the yield
- timing and Q paid must be obvious to payers
- timing and way of paying shld be convenient for payer
- taxes shld depend on ability to pay= shld be equitable
25
adv of taxation
- increase gov revenue to fund investments
- direct tax cuts decrease AD to increase inflation
- low BD and nation debt
- can increase tariffs on imports= protectionism of market
= decrease foreign competition
26
describe multiplier effect
occurs when an initial injection into the economy causes a bigger final increase in national income
27
define fiscal austerity
a policy approach that involves reducing government spending and/or increasing taxes in order to reduce budget deficits and debt
= goal of fiscal austerity is to improve financial health of a gov by reducing its reliance on borrowing and stabilizing its debt-to-GDP ratio
28
principles of tax
- costs of tax must be relative to yield
- timing and Q paid must be obvious to tax payers
- timing and way of paying must be convenient to tax payer
- taxes imposed should depend on ability to pay and should be equitable
29
reasons to use tax
- increase gov revenue to fund public services
- direct tax cuts increase AD and increase inflation
- decrease budget deficits and national debt
= sustainable gov finances
- progressive tax increases gov finances to increase benefits and disposable income of low income households= redistribute incomes
- increase tariffs on imports
= protectionism of domestic market to decrease foreign competition
30
how to reduce budget deficit and EVAL
- cut gov spending but it depends on the type of government spending you cut
= if u cut pension spending it will force people to work longer= increase economy's productive capacity but cuts in investment of education etc, will damage AD and worsen economic growth
- increase tax
= depends on timing of tax imposition, during recession it would cause drop in spending but during growth, wouldn't lead to damaging decrease in consumption
= depends on type of tax imposed, France increased taxes on the rich to over 70% however some have complained its too high and creates disincentives to work in France
= if high marginal tax rates do reduce incentives to work, the tax revenue raised may be less than planned
- if country already in recession, it's much more difficult to reduce the deficit because fiscal consolidation tends to worsen the economic situation leading to lower tax revenues. In some cases, austerity can even be self-defeating
- best way to reduce the budget deficit is to aim for positive economic growth, but in the long-term evaluate government spending commitments and reduce spending to sustainable levels
