Fiscal Policy

Question 1

Fiscal policy definition

Answer 1

Use of gov finances (spending, taxation, borrowing) to manipulate AD (and LRAS) to achieve macroeconomic objectives

Question 2

Bond yield

Answer 2

The rate of interest paid on government debt

Question 3

Budget deficit

Answer 3

The budget deficit is the difference between what the government receives in revenue and what it spends

Question 4

Direct taxation

Answer 4

Taxes on income, profits and wealth, paid directly by the bearer to the tax authorities.

Question 5

Cyclical fiscal deficit

Answer 5

The size of the deficit is influenced by state of the economy: in a boom, tax receipts are relatively high and spending on unemployment benefit is low

Question 6

Indirect taxation

Answer 6

Taxes on expenditure (e.g. VAT). They are paid to the tax authorities, not by the consumer, but indirectly by the suppliers of the goods or services.

Question 7

National debt

Answer 7

Debt is the total amount owed by the government that has accumulated over the years.

Question 8

Structural fiscal deficit

Answer 8

The structural deficit is that part of the deficit which is not related to the state of the economy. This part of the deficit will not disappear when the economy recovers.

Question 9

6 key roles for fiscal policy

Answer 9

1. Financing gov spending 2. Changing wealth and final income 3. Providing a welfare state safety-net 4. Managing economic cycle 5. Improving LR competitiveness 6. Tackle market failure

Question 10

Cut in personal income tax rates –> (exp)

Answer 10

Boost to disposible income –> adds to consumer demand

Question 11

Cut in indirect taxes –> (exp)

Answer 11

Lower prices- leads to higher real GDP –> adds to consumer demand

Question 12

Cut in corporation tax –> (exp)

Answer 12

Higher profits post tax –> adds to capital spending

Question 13

Cut in tax from interest from saving –> (exp)

Answer 13

Boost to disponible income of people with net savings –> adds to consumer demand

Question 14

What would contractionary fiscal policy involve (at least 1 of)

Answer 14

• A cut in government expenditure either in real terms or as a share of GDP
• An increase in direct and/or indirect taxes
• An attempt to reduce the size of the budget deficit

Question 15

Spending by the public sector can be broken into 3 parts

Answer 15

1. Transfer payments (welfare payments)
2. Current government spending (on state provided G&S)
3. Capital spending (includes infrastructure)

Question 16

Total UK government spending in 2015

Answer 16

£745 billion (43.1% of GDP–> 7% on capital & 22% on public services)

Question 17

What are the justifications for G?

Answer 17

1. Socially efficient level of public & merit goods & overcome market failure
2. Safety net system of welfare benefits- part of redistribution of wealth
3. Provide necessary infrastructure
4. Manage level of growth of AD
5. Promoting equity
6. Economic efficiency e.g. infrastructure projects

Question 18

What is direct taxation levied on?

Answer 18

Income, wealth and profit

Question 19

What happens to tax revenue when the economy expands?

Answer 19

Tax revenue increases which takes money out of the circular flow model

Question 20

What happens to welfare sending when the economy expands?

Answer 20

Less welfare spending on e.g. income support & unemployed benefits

Question 21

What happens to the budget balance and the circular flow in a growing economy?

Answer 21

Net outflow of money when the economy is fast growing and in a recession budget deficit is larger

Question 22

6 key roles of fiscal policy with AS

Answer 22

1. Work incentives/active labour supply
2. Inward migration of key workers
3. Capital investment e.g. FDI projects
4. Enterprise/entrepreneurship
5. Taxation and incentives to study
6. Tariffs fact import costs

Question 23

Labour market incentives

Answer 23

a) changes in income tax encourage people to actively seek work
b) lower taxes may have a positive effect on work effort and labour productivity
c) cuts to national insurance contributions may help expand the active labour supply

Question 24

Capital spending

Answer 24

a) spending on infrastructure helps provide capacity needed for other businesses to flourish
b) lower corporation tax attracts foreign investment

Question 25

Entrepreneurship and investment

Answer 25

a) gov spending can be used to fund expansion in small start-ups

Question 26

R&D&Innovation

Answer 26

a) Government spending, tax credits & other tax allowances to encourage R&D to improve competitiveness & contribute to a faster pace of innovation & invention
b) aim is to use tax incentives to incentivise investment in low carbon tech to promote green growth

Question 27

Human capital of workforce

Answer 27

a) spending on education & more investment in health and transport lead to supply effects in LR
b) G on apprenticeships to better human capital, employability & productivity

Question 28

Case for lower tax burdens (5)

Answer 28

• Stimulates work incentives & productivity
• Helps create more jobs as businesses have less tax to pay
• Encourages inflow of FDI from businesses looking for low tax country
• Incentivizes enterprise & start-ups – source of long term wealth & jobs
• Lower tax rates may end up increasing total tax revenues

Question 29

Counter arguments to the low tax economy (4)

Answer 29

Taxation is key for changing final distribution of income & wealth. It’s equitable for those with greatest resources to pay more
• Tax cuts don’t necessarily lead to increase in total tax revenues for the gov
• Consider relative economic success of countries like Denmark, Norway & Sweden who all have higher tax burdens & progressive tax & welfare systems
• Taxes needed to fund high quality public services like education & health which benefit millions in LR

Question 30

Budget balance

Answer 30

the annual difference between tax revenues and government spending

Question 31

Government borrowing can benefit growth

Answer 31

a. A budget deficit can have positive macroeconomic effects if used to finance capital spending that leads to increase in the stock of national assets
b. E.g. spending on transport infrastructure improves the supply-side capacity & productivity of economy
c. Improved provision of public goods can create positive externalities (social benefits)

Question 32

The budget deficit as a tool of demand management

Answer 32

a. Keynesian economists support borrowing as a way of managing AD
b. An increase in borrowing can be a useful stimulus to demand when other sectors of the economy are suffering from weal or falling spending
c. A change in the government budget deficit may lead to a more than proportional change in AD – (positive) fiscal multiplier effect.