macro- FISCAL POLICY Flashcards
what does gov do if there is a negative output gap
gov. may use reflationary policies
what does gov do if there is a positive output gap
gov. may use deflationary policies
describe fiscal policy
involves changes in levels of taxation &/or gov. spending to influence the economy and level of AD
fiscal policy equation
Taxation - Spending = budget balance
(surplus or deficit*)
why is fiscal policy used
- Correct market failures (microeconomic) like over consumption of tobacco or alcohol
- Achieve macroeconomic objectives like keeping inflation low, reducing demand deficient (cyclical) unemployment, boosting growth (GDP) or achieving stability of the balance of payments
list types of taxation
- direct (taken directly from earnings e.g. income tax)
- indirect (charged with items are bought e.g. VAT)
- progressive (when ppl w higher income pay higher proportion of income in tax)
- proportional (average rate of tax stays same regardless of income)
- regressive (those on lower incomes pay higher proportion of their income in tax compared with those on higher incomes)
list the principles of taxation
Equity (tax should be based on individual’s ability to pay)
Certainty (taxpayers should know how much they owe & when the tax is due)
Convenience (the tax should be easy to pay)
Economy (the cost of collecting tax should be less than the revenue collected)
define hypothecated tax
tax collected for a specific purpose & funds raised through this tax are earmarked for a specific purpose
For example, a tax on petrol & diesel might be used to fund road and highway construction, while a tax on cigarettes might be used to fund healthcare programmes
Reasons for the government to levy taxes
To raise revenue to finance expenditure
To shift away consumption or production from one product to another (e.g. from fossil fuels to renewable energy)
To discourage consumption or production of certain products (e.g. tobacco or alcohol)
To redistribute income from rich to the poor people
impact of taxes
Incentive or disincentive to work
Incentive or disincentive to invest in capital & innovation (potential impact on AD)
Increase or decrease the price level (increase in VAT can increase costs & ultimately prices)
Tariffs on imports can affect costs & prices
Taxes can affect the likelihood of foreign businesses wanting to locate in the UK & the flow of FDI
list the canons of taxation
The canons of taxation (Adam Smith) stipulate that the tax system should be fair, transparent, efficient & easy to comply with
Reasons for government spending
Provision of welfare: to provide a basic income
Provision of public goods: roads, defence, infrastructure
Provision of merit goods: health, education or pensions
Debt interest (interest on national debt)
Macroeconomic policies to impact AD
Supply-side improvements/investments
Forms of government spending
Current spending: spending on day-to-day costs in providing public services (e.g. NHS staff salaries & goods & services)
Transfer payments: welfare payments to provide a basic income
Capital spending: spending/investment on capital (long-term projects) (e.g. infrastructure or building new schools)
Expansionary fiscal policy define
when tax is reduced &/or spending is increased
= rightward shift of AD
Contractionary fiscal policy define
when tax is increased &/or spending is decreased
= leftward shift of AD
Automatic stabilisers define
like built-in shock absorbers for the economy. These are changes that kick in automatically at certain points of the eco. cycle (recession or boom) without requiring explicit action from gov
define national debt
the stock of outstanding gov. debt
describe the fiscal golden rule
gov should try to borrow only for investment purposes, to fund long-run growth, not for day-to-day expenses.
The gov. (Treasury) should set a deadline for repayment of the deficit
The gov. (Treasury) should have a transparent plan for spending & borrowing
describe the OBR
provides independent & authoritative analysis of the public finances of the UK
Produce economic forecasts
Assess performance against targets set by the gov
Assess the long-term sustainability of the public finances
Assess the fiscal risks of the forecasts
types of fiscal policy
expansionary= boost AD and growth
= decrease tax or increase gov spending
= used in recessions
contractionary= decrease AD and inflation
= decrease gov spending and increase tax
= used in a boom to decrease inflation
limits to the effects of increased interest rates on businesses investments (EVALUATE)
- depends on choice of commercial bank interest rates
- businesses may be able to use own resources that interest rates don’t affect like retained profit
- growth of tech is at fast pace= market may decrease price of capital due to competitive market
describe budget deficit
when gov spending is higher than tax revenue or income
= gov injecting money into economy
= expansionary fiscal policy
facts on real life fiscal policy
- £155bn made on income tax
- £108bn borrowed
- £27bn business tax
- £220bn spent on social protection
- £137bn healthcare
- £97bn education
examples of supply-side policies
- education
- HS2 railway
- Crossrail
effect of lower corporation tax
- increase profits retained by businesses= used to fund new projects
= increase investments eg capital
= AD increases
(AD= C+I+G+(X-M)= I increased
effect and evaluate contractionary policy on inflation
- reduces AD
= lower demand in economy means producers charge less for goods and services
= decrease in general price level
HOWEVER - may not be effective if cause of inflation is increased cost of production
= may also reduce employment and GDP
effect and evaluate contractionary policies on balance of payments
- help reduce imports by lowering household’s disposable income
= because consumer imports tend to be more income elastic normal goods
= lowering total expenditure on imports will help decrease current account deficit
HOWEVER - may not be effective if country’s imports are on raw materials that are necessities
= become income inelastic goods= a change in income will only effect quantities purchased minutely
effectiveness depends on marginal propensity of import of citizens
= gov can use expansionary policy on targeted domestic industries to produce needed goods instead and replace imports
example of a discretionary policy
if a gov chooses to target a budget surplus
disadvantage of expansionary fiscal policy
- more growth= higher incomes= more spending on imports= widen trade deficit= cause tradeoff
- for funding of policies= must cut spending of other areas like welfare, education etc= worsen SOL
- cause crowding out effect
adv of contractionary policies
- improve confidence of gov finances= by reducing budget deficits and national debt= improve credit ratings in gov bonds= as gov seen as less risky borrower= means over time gov can lower Its on borrowing= fund welfare
- allow flexibility with fiscal policy when needed= less national debt= less spending on debt interest= free up higher gov spending to prevent next recession, emergency spending etc
- less crowding out of private sector= less demand for loanable funds= keep low IRs= allow private sector firms to borrow at lower costs to fund growth
- lowers AD= lowers demand-pull inflation= improve current account deficit= lower spending on imports
disadvantage of contractionary policies
- if policies are used simultaneously and strongly= can shock economy into demand side recession= reduce AD= low growth and high unemployment
- cuts in gov spend eg education, infrastructure= macro cons
- cuts in gov spend on individual= eg long wait times to see doctor or emergency surgery= low qual of healthcare
- increase in direct tax can strain LR productivity
- will cause a lower incentive for economically inactive ppl to work and join labour force= greater incentive for ppl to leave country
- risk of income inequality= benefits can be cut, regressive tax increase= not socially desirable
evaluate contractionary policies
- can question whether its necessary= pros can outweigh cons if gov has unstable and unsustainable finance
- could policies lead to worse debt or GDP
- depends on policy used= don’t have to use both at same time
- depends on stage of economic cycle= eg when economy is booming it best time to cool down economy and reduce inflation= mend economic finance
define negative output gap
actual output is greater than potential output
(economic boom)
define positive output gap
occurs when actual output is more than full-capacity output. This happens when demand is very high and, to meet that demand, factories and workers operate far above their most efficient capacity
