section 5 Flashcards
what is fiscal policy
the manipulation of…
government spending
taxation
budget balance
… to achieve macro objectives
who implements fiscal policy in the uk
the government, in particular the treasury and the chancellor of the exchequer
what is ‘the budget’
when the chancellor announces changes in government tax, spending, and borrowing plans
what does government expenditure mean
the spending by the government in the economy
how much does the government spend in the uk economy
between 2023-2024 it was rougly £1200 billion
pattern of government spending in uk from ww2-2008-now
in real terms spending has increased most years since ww2 period
but did fall slightly after the 2008 crisis before recovering
spending increased more than proportionally to deal with the covid 19 crisis
why is government spending measured as a % of gdp
tells us how much is being spent relative to a countries overall economic activity
and make it easier to compare with other countries
main areas of government spending
social protection
education
health
debt interest repayments
social protection
includes ares like pensions, housing benefit, supporting people who are risk of exclusion from society (e.g. low income)
dominated by pensions, set to be even more dominating due to aging population`
current spendings
day to day spending on providing public services
e.g. public sector wages
capital spending
spending on new public infrastructure; increases the amoint of capital stock
transfer payments
money provided to provide a welfare safety net with no increase in output
tax
compulsory contributions to state revenue, levied by the government
main types of taxes in the uk
income tax (tax on income)
national insurance (additional tax on income)
vat (tax on spending)
corporation tax (tax on business profits)
other tax examples
excise duties (tax on spending for specific products like alcohol or tobacco)
council tax (tax on property)
inheritance tax (tax on inheritance)
what taxes generate the most government revenue
income tax, national insurance and vat
what is taxed more; income or wealth
income taxed > wealth taxed
what makes a good tax according to adam smith
economical (simple and cheap to collect)
equitable (fair and based upon ability to pay)
convinient (payment and timing)
certain (understood and difficult to evade)
efficient (minimum disincentives)
flexible (responsive to economic conditions)
direct taxes
tax levied on income
the tax must be paid by the person it is levied on, cannot be passed on
mostly affects ad
e..g income tax, corporation tax, council tax
indirect tax
tax levied on spending
the firm has to pay the tax to the government, but the firm will try to pass on the tax to the consumer in forms of higher prices
mostly affects sras
e.g. vat, excise duties, customs duties
what income bracket pays 20%
12,571 - 50,0270
what income tax bracket pays 40%
50,271 - 125,140
what income tax bracket pays 45%
125,141 and over
average tax rate
refers to proportion of total income paid in tax
average tax rate formula
average tax rate = (total tax paid / total income)
marginal tax rate
the tax rate (%) paid on one additional unit of income
marginal tax rate formula
marginal tax rate = (change in tax / change in income)
progressive tax
as income rises, a greater proportion of income is paid in tax, the average and marginal tax rates rise
proportional/flat tax
as income increases, the proportion of tax paid stays the same; the average and marginal rates of tax are constant
regressive tax
as income rises, a smaller proportion of income is paid in tax (higher earners still pay a higher amount of tax, but a smaller proportion of their income); the average and marginal tax rates fall
national insurance
additional tax on income
both employers and employees pay NICs
NICs are calculated weekly, but the brackets are roughly the same for employees (8 or 2% depending on weekly pay)
vat
value added tax; a tax on spending
any firm with sales over £85,000 has to charge vat
vat is regressive, those with lower income spend a higher proportion of their income so are disproportionally affected
corporation tax
tax on firms profits
uk has pretty low corporation tax compared to other countries
council tax
tax paid to local authorities based on the value of a property- the higher the value of the property, the higher the amount payable
valuations are based on 1991 data
regressive tax
what taxes are progressive verus regressive in the uk
regressive - national insurance, indirect taxes, council tax
progressive tax - income tax
fiscal drag
when the tax bracket sare frozen, so more taxpayers are dragged into higher tax brackets as their wages increase hence more tax is paid
how could. the goverment make tax system more progressive
lower the basic rate of tax
increase the personal allowance threshold
raise the higher and additional rates of income tax
lower the thresholds for higher and additional rates
reduce vat
tax wealth equally/more than income
fiscal budget balance
the difference between tax revenue and government spending in one year
fiscal deficit
spending > tax
has to be financed through borrowing
the uk nearly always runs a fiscal deficit
how many fiscal surpluses has the uk had since 1945
12 =
how does the uk finance a deficit
borrowing through issuing bond
bonds
tradable, interest paying IOUs or debt which have to be repaid on a set date
the buyers recieve an annual rate of interest (called a coupon rate)
mostly bought by non bank financial institutions like pension funds or insurance companies
national debt
the total amount the government owes
every year the fiscal deficit gets added to national debt
uk owes £2.5trillion, nearly 1000% of gdp
how much does the uk spend annually to finance the debt
borrowing has to be repaid with interest
£120billion every year, 4.5% of gdp and 10% of all government spending
how is fiscal policy used to influence the level of AD
expansionary (increase spending reduce tax)
contractionary (lower spending increase tax)
neutral (increase tax and spending or reverse)
multiplier
a change in aggregate demand leads to a larger proportional change in income
how can the multiplier be used to justify expansionary fiscal policy or to discredit austerity measures
the mutiplier effect means that an increase in net government spenidng will cause real output to increase by more than increase in net government spending- useful in a recession
tax influence on supply side of the economy
reducing income tax, incentivieses labour market particpation and improves quality of labour
reducing corporation tax incentivises investment and increase productive capacity
how does government spending influence the supply side of the economy
reducing welfare payments incentivises labour market participation
capital spending can increase productive capacity (e.g. physical capital through infrastructure or human capital through improved quality of labour)
how do fiscal policies influence the microeconomy
taxes - indirect taxes can be used to reduce spending on demerit goods
subsidies - can be used to increase spending on merit goods
state provision - the provision of a good where there would be. a missing market, i.e. defence (public goods)
examples of how fiscal policy can be used to influece pattern of spending
spending; spending on electric charging infrastructure to encourage the buying of electric cars
taxes; higher taxes on fuel so people want electric cars over petrol
how has direct and indirect tax changed in the uk in recent decade
move towards indirect tax over direct tax
pros of direct taxation
equitable ; based on ability to pay
certainty ; people know how much they will be taxes
economical ; easy to collect
cons of direct taxation
disincentive effects on running a business / getting a job over £12500
may cause a brain drain as people relocate to avoid taxes on higher paid jobs
easier to avoid ; higher income earners can use tax advisors to minimise tax
pros of indirect taxation
can be used to address market failure / the pattern of demand (e..g merit goods)
choice ; people have a choice about whether or not to buy certain products
harder to avoid ; the tax is automatically added to the price of products
cons of indirect taxation
distributional effects ; regressive so increase inequality
inflationary effects ; can contribute to cost push inflation
unintended consequences ; black markets may develop in response (e.g. (imported) cigarettes)
cyclical fiscal deficit
a deficit caused by a downturn in the economic cycle
structural fiscal deficit
the part of the budget defiict not caused the economic cycle
a structural deficit is present even when the economy is booming
