MACRO - fiscal policy ✅ Flashcards
1
Q
what is fiscal policy
A
the manipulation of government spending, taxation and borrowing with both micro/macro functions to influence patterns of economic activity (spending on scare resources), AD, output and jobs
2
Q
what is a bond yield
A
rate of interest paid on government debt that has yet to be repaid
3
Q
budget (fiscal) deficit definiton
A
occurs when gov spending exceeds tax revenue
4
Q
what is a budget (fiscal) surplus
A
occurs when gov spending is less than tax revenue
5
Q
what is cyclical fiscal deficit
A
size of deficit influenced by state of economy
in boom = high tax receipts and spending on unemployment benefits are low
6
Q
what is direct taxation
A
taxes on income, profits and wealth paid directly by bearer to tax authorities eg income/corporation tax
7
Q
what is indirect taxation
A
taxes on expenditure (eg vat) paid to tax authorities not by consumer but indirectly by supplier of goods/services
8
Q
what are uses of fiscal policy (3)
A
- can redistribute wealth by changing tax rates on different levels of wealth/income
- can aid as a microeconomic gov intervention to correct market failure
- changes in fiscal policy affect AS/AD
9
Q
what does gov spending do (6)
A
- provides welfare state safety net - supplement low incomes, part of redistribution of wealth, controlling poverty
- can promote equity
- tackle important market failures
- providing necessary infrastructure (capital spending) on transport, education, health (LRAS)
- improving long run competitiveness - well targeted public spending = efficiency improved
- managing economic cycle
10
Q
difference between current and capital spending
A
CAPITAL = spending on assets lasting a number of years (building/vehicle eg motorways, bridges, nhs equipment)
CURRENT = spending on things used up (salaries of civil servants, teachers, healthcare drugs)
11
Q
what is crowding out
A
rapid growth of gov spending = transfer of scarce productive resources from private to public sector
12
Q
fiscal effects of crowding out (increased gov spending) (2)
A
- can create higher taxes/interest rates = profits squeezed, investment and employment in the private sector
- if gov borrowing increases= higher demand for loanable funds = rise in market interest rates eg on bonds, can increase borrowing costs in priv sector
13
Q
evaluation of crowding out (3)
A
- probability of 100% crowding out is small if economy operating below capacity and lots of supply available
- Keynesian economists opposed to fiscal austerity and argue fiscal deficits crowd in private sector demand/investment
- external finance available from other countries
14
Q
what is crowding in
A
- increase in gov spending/investment = expansion of economic activity (real GDP) and incentivises private sector to raise own capital investment and employment
- supported by Keynesian economists
15
Q
what is fiscal austerity
A
- when the government uses contractionary fiscal policy to decrease their budget deficit
- The primary aim is not to decrease AD but to slow the rate of growth of the national debt by bringing government borrowing down to lower levels.
16
Q
micro impacts of cuts in gov spending (3)
A
- effects on real income and relative poverty of households
- change in demand patterns
- cuts in pension spending = delayed retirement
17
Q
macro impacts of cuts in gov spending (4)
A
- multiplier effect of cuts in public sector spending and employment
- lower fiscal deficit = help investor confidence
- risks of deflationary pressures if cutting creates excess capacity (negative output gap)
- bank of england more likely to keep interest rates low
18
Q
what is progressive tax
A
- marginal rate of tax (MRT) rises as income rises
- people earn more = rate of tax increases on each pound increasing average rate of tax
- income tax = progressive (basic, higher, additional rate)
19
Q
what is regressive tax
A
- rate of tax paid falls as income rise eg average rate of tax is lower for people on higher incomes (tobacco, alcohol)
- tax regressive when low income earners pay higher proportion/percentage of their income in tax than high income earners
20
Q
what is the laffer curve
A
- supposed relationship between economic activity and rate of taxation suggesting there is optimum tax rate which maximises total tax revenue
21
Q
why do tax revenues fall if tax rates increase (4)
A
- increased rates of tax avoidance - greater incentive to seek out tax relief and make use of tax allowances
- greater incentive to tax evade (non-declaration of income/wealth)
- possible disincentive effects in labour market depending on which taxes increased
- ‘brain drain’ effects - loss of high skilled/high income taxpayers
22
Q
evaluation of laffer curve
A
- lower top rate taxes = income inequality increased
- little evidence that higher top rates of income tax is barrier to inward migration of skilled labour
- many people on fixed/zero hour contracts so tax rates may have small effects on work incentives
- sometimes tax cuts = more leisure time instead of work = backward bending labour supply curve effect
- keynesian explanation for some - cuts in indirect/direct taxes increase real disposable income = higher consumer spending and AD
23
Q
how does taxation influence AD
(NI, VAT, corporation tax)
A
- tax rate changes have indirect/direct effects on level/growth of AD
- changes in income tax/NI = direct effect on peoples disposable incomes
- corporation tax changes affects post-tax profit available for businesses to invest
- changes in NI affects cost of employing extra workers in labour market
- changes in VAT = change in retail prices and affects real income of consumers
24
Q
how does taxation influence AS
(VAT, direct tax, business taxes)
A
- changes in vat affects business costs eg vat applied when buying component parts/supplies
- changes in direct tax influences work incentives
- changes in business taxes influencing level of FDI
- taxes also influencing incentive to start a business/spend money on R&D
25
what is the effect of corporation tax cuts
(chain of reasoning)
c. tax cut = businesses keeping larger profits = increase in post-tax profitability may rise planned investment = investment done by both domestic and overseas businesses
= increased capital spending is injection into circular flow model = positive multiplier effect on demand, output and employment
26
evaluation of a corporation tax cut (3)
- impact depends on scale of tax cut, whether its long lasting/temporary measure
- many factors affecting capital investment eg technological change and strength of market competition
- some extra investment = loss of jobs through capital-labour substitution effects
27
impacts of a rise in VAT on economic objectives (+spare capacity and fiscal balance)
INFLATION - higher in short run business passes on tax
ECONOMIC GROWTH - slower if real incomes and demand falls
UNEMPLOYMENT - higher if AD weakens
BALANCE OF TRADES - improved - falling incomes = demand for imports drops
SPARE CAPACITY - decline if businesses hit by lower profits and weaker consumer spending
GOVERNMENT (FISCAL) BALANCE - short run improvement from higher taxes but risk of falling revenues in medium term
28
what is discretionary fiscal policy
deliberate changes in direct/indirect taxation and gov spending
eg extra capital spending on roads/more resources in NHS
29
what are automatic stabilisers
changes in tax revenues and government spending coming about automatically as economy moves through business cycle
30
explanation for automatic stabilisers
1. tax revenues - expanding economy = tax revenue increase, takes money out of circular flow of income and spending
2. welfare spending - growing economy = gov doesn’t spend as much on benefits
3. budget flow and circular flow - growing economy = net outflow of money from circular flow. recession = larger budget deficit, lower revenue as less income earned = less profits made = fewer goods bought and at same time gov expenditure on transfer payments
31
fiscal deficit vs national debt
- gov borrowing is amount borrowed each year to finance spending and public sector debt is a measure of the accumulated national debt owned by gov sector
- gov runs fiscal budget deficit when total gov spending > tax revenue in a year
32
difference between structural/fiscal deficits
size influenced by current economy state:
- boom = real GDP expands, economy about potential (positive output gap) = high tax reveue = spending on benefits low and opposite happens in recession
structural fiscal deficit isnt related to economy’s state , doesnt disappear when economy recovers from recession, better indicator of underlying level of deficit
33
cyclical factors influencing size of fiscal deficits - tax
- unemployment rate, higher = reduction in tax revenues
- consumer spending - strong = increase VAT revenue
- business profits - rising = increase revenue from corporation tax
- automatic stabilisers - in economic downturn, fiscal deficit rises as g increases and taxes fall
34
long run factors influencing size of fiscal deficit (5)
- size of welfare state
- relative level of welfare benefits eg vs income
- demographic factors eg ageing population, net inward migration of labour impact
- size of tax base and tax rates(economy moving towards lower/higher tax burden)
- efficiency of public sector - productivity of workers in nhs/education
35
factors influencing size of national debts (3)
- scale of gov spending (current spending, investment spending, social welfare spending)
- level of tax revenues (size of tax base, efficiency of tax collection)
- cost of servicing debt and state bailouts (yield on existing/new bonds, willingness of lends to give gov new credit, gov rescue of businesses can add to public sector debt)
36
what is a result of high levels of gov borrowing
‘a high level of gov borrowing results in money being spent to repay debt. this can lead to both reduction in investment and requirement for future generations to continue paying debts, may cause a negative impact on national wellbeing.’
37
what are the arguments that rising national debt creates economic problems (4)
1. high fiscal deficits = rising debt interest payments
2. this interest burden has opportunity cost for less interest on debt could free up extra spending on healthcare
3. national debt increase = higher taxes in future = disposable income of taxpayers cut = reduction in priv sector growth
4. can be unfair if rising tax burden falls more heavily on future generations of taxpayers rather than people who benefit from gov spending now
38
counter-argument for government borrowing (4)
1. rise in borrowing to fund extra gov spending = effects on AD, output, employment when economy operating below full capacity output
2. automatic rise in budget deficit to cushion AD fall caused by external economic shock, higher fiscal deficit needed to lift AD back towards pre-recession levels to support recovery
3. if fiscal stimulus works = improved budget deficit because of higher tax revenues and reductions in welfare spending, growing economy helps shrink debt as a % of gdp
4. useful to borrow with low interest, deficit used for investment to improve infrastructure helping competitiveness. borrowing to invest improves public services = LRAS increase, supports long run growth
39
what is involved with bond yields
fixed annual interest (coupon paid in £,$, euros)
yield varies inversely with market price of bond
- when bond prices rise = falling yield
- when bond prices fall = yield rises
40
what is fiscal austerity
- policies designed to reduce size of fiscal deficit and control/lower size of national debt
41
what are the policies to reduce fiscal deficit (3)
- cuts in gov spending (control of public sector pay, limiting welfare entitlement)
- higher taxes (higher indirect taxes eg VAT to 20%
- supply side policies to encourage growth (growing economy = more effective way of cutting deficit/debt, stronger gdp = increased tax revenues because higher income/profits earned as tax bands widen, in progressive tax system = expanding incomes = higher prices = faster growth of tax receipt, growth cuts a deficit as a % of GDP because its increased)
42
arguments in favour of fiscal austerity (5)
1. in long run interests of economy (helps keep taxes lower, avoid crowding out of investment and growth in priv sector)
2. shrinking state encourages priv sector long run growth
3. high opp. cost, over 50bn spent each year on debt
4. cutting fiscal deficit improves consumer confidence attracts more FDI
5. upturn of economic cycle = time for gov to borrow less, makes sense to run stronger budget finances before cyclical slowdown
43
arguments against fiscal austerity
1. austerity is self defeating, can lead to delfation, high unemployment, depresses investment vital to sustain tax revenue
2. gov bond yields are low, low yield so best time to invest more because will increase both AD and LRAS
3. wrong to cut state spending when economy in liquidity trap (unresponsive to low interest rates)
4. economic growth needed to pay debt back and fiscal austerity makes harder to achieve
5. risks increase of income inequality = more food banks used, borrowing at high interest rates from loan sharks
6. pay freezes in public sector = harmed recruitment = growing shortages of key workers = longer waiting times, threatens delivery of merit goods
44
Keynesian view of fiscal policy
- favour active use as use can manage demand, economic activity
- argues fiscal multiplier effects of increased gov spending can be high, policy is key in stabilising confidence, demand, output, jobs especially after severe external economic shocks
45
what is the role of the office for budget responsibility
gives independent and authoritative analysis of the UK's public finances
