Macroeconomics: Fiscal policy Flashcards
What is fiscal policy?
Changes in government spending, taxation and the level of government borrowing.
What are the key roles of fiscal policy?
Correcting for market failures e.g. sugar drinks levy subsidies to help people afford social housing.
Changing the final distribution of income and wealth e.g. progressive direct taxes (marginal tax rates, new wealth tax).
Stabilising and stimulating AD and GDP growth e.g. changes in income tax, state welfare.
Improving the economy’s supply-side potential (LRAS) e.g. increased state spending in education and healthcare.
Responding to crises caused by external shocks e.g. fiscal activism during the pandemic including job retention scheme.
What is government spending?
Money that a government allocates to fund various state-provided programmes and public services. These expenditures are typically financed through taxes and government borrowing (such as issuing bonds).
What is the significance of government spending for the UK?
Helps to stabilise demand in a recession
Has a regional economic impact
Important in providing public and merit goods
Driver of long run growth
Can help achieve greater equity in society
What is taxation?
When governments collect revenue from individuals, businesses, and other entities to finance public services, infrastructure, and various government functions.
What are the main reasons for taxation?
Revenue generation- used to fund government programmes and services.
Redistribution of income and wealth- progressive taxation, where higher income individuals pay a higher % of their income in taxes.
Economic stabilisation- governments may implement countercyclical fiscal policies, such as reducing taxes during economic downturns to stimulate spending or increasing taxes during economic booms to cool down inflation.
Regulation and incentives- e.g. increased taxes on tobacco and alcohol can discourage consumption, while tax incentives for R+D can encourage innovation.
Public goods- taxes are essential for financing pure public goods and services that are non-excludable and non-rivalrous.
What is the importance of equity and efficiency with taxes?
Equity- taxation should be fair and equitable, meaning that individuals and businesses with similar financial capacities should pay similar amounts of tax. Equity can be achieved through progressive, proportional, or regressive taxation systems.
Efficiency- taxation should minimise economic distortions and deadweight losses. An efficient tax system should not discourage productive activities or create unnecessary administrative burdens.
Economic neutrality- taxes should not distort economic decision making.
What is horizontal equity?
Similar taxpayers in similar circumstances should be treated equally in terms of their tax liabilities.
What is vertical equity?
Tax burdens should be distributed in a way that is fair and reflects differences in the ability to pay.
What is the ability-to-pay principle?
Individuals or entities with a greater ability to pay taxes should contribute a larger share of their income/wealth to the government in the form of taxes.
What is direct taxation?
Levied on income, wealth and profit.
e.g. income tax, inheritance tax, national insurance contributions, capital gains tax, and corporation tax.
What is indirect taxation?
Taxes on spending e.g. excise duties on fuel, cigarettes and alcohol.
What is income tax like in the UK?
Taxable income- income tax is levied on various types of income, including employment, rental income, interest, dividends and pension income.
Personal allowance- amount of income they can earn before they start paying income tax.
Progressive
What is national insurance?
Paid by employees, employers and the self-employed, and are used to help fund the state pension and welfare benefits such as Jobseekers’ Allowance and sick pay.
What is corporation tax?
Raised from the taxable profits of limited companies and other organisations, after considering various deductions and allowances.
What are the different tax systems?
Proportional Taxes: Require all taxpayers to pay the same fraction of their income, regardless of how much money they earn.
Regressive Taxes: Require high-income taxpayers to pay a smaller fraction of their income than low-income taxpayers.
Progressive Taxes: Tax rates increase as income increases
What is fiscal balance?
Total tax revenue - Total expenditure
What is a fiscal surplus?
When the fiscal balance is positive (Total revenue > Total expenditure)
It allows a government to save or pay down debt, invest in infrastructure, and reduce taxes.
What is a fiscal deficit?
When the fiscal balance is negative (Total revenue < Total expenditure)
This indicates the government is spending more than it is in collecting revenue.
How can a government cover its fiscal deficit?
Borrow money by issuing bonds
What is national debt?
The government’s stock of outstanding debt.
It is the result of a country constantly running budget deficits. When this happens, the government borrows money to cover the deficit leading to an increase in the debt.
What is a national debt used for?
Finance critical infrastructure projects, public services, and economic tool during recessions to stimulate economic growth.
What is the impact of AD as a result of budget deficits?
Direct increase in government spending- when a government runs a budget deficit, it is spending more than collecting in revenue. This often involves increasing government expenditures.
Lower taxes- reduction in direct/indirect taxes which then causes a rise in household disposable incomes and in theory a higher level of AD.
Multiplier effect- as government spending rises, it can increase income for individuals and businesses, leading to higher consumption and investment, further boosting AD.
What are the negative impacts on AD as a result of budget deficits?
Increased borrowing- To finance a budget deficit, the government often needs to borrow money by issuing bonds or other debt instruments. When the government competes with private borrowers for funds in the financial market, it can lead to higher interest rates.
Higher interest rates can lead to reduced private-sector investment and borrowing.
Expectations of higher taxes- a growing fiscal deficit might lead some households and businesses to expect higher taxes in the future causing them to cut back on spending and save more. This lowers AD.
