Section Eleven-Macroeconomic Policy Instruments Flashcards
What is Fiscal policy or ( budgetary policy ) ?
-It involves government spending and taxation
(can be used to influence the economy as whole ,macroeconomic effects, or individual firms and people, microeconomic effects, )
Types of Fiscal policy ?
- Reflationary fiscal policy ( expansionary ) involves boosting aggregate demand by increasing government spending or lowering taxes, likely to involve government having a budget deficit.
- Deflationary Fiscal policy( contractionary) involves reducing aggregate demand by reducing government spending or increasing taxes, budget surplus .
When is a Reflationary Fiscal policy used ?
-During a recession or when there is a negative output gap
It will increase economics growth and reduce unemployment , but it will also increase inflation and worsen the current account of the balance of payments because as incomes increase , more is spent on imports .
When is Deflationary Fiscal policy used ?
-It used during a boom or when there is a positive output gap .
It will reduce economics growth and increase unemployment , but will also reduce price levels and improve the current the current account of the balance of payments, because as incomes fall people spend less on imports
What are the two important features of fiscal policy that you need to be aware of ?
- Automatic stabilisers- some of the government’s fiscal policy may automatically react to changes in the economic cycle. During a recession government spending will increase because the government will pay out more benefits. The government will also receive less tax revenue due to unemployment. These automatic stabilisers reduce the problems a recession causes. During a boom , the automatic stabilisers create a budget surplus as tax revenue increases and government spending on benefits falls
- Discretionary policy-This is where governments deliberately change their level of spending and tax. At any given point a government might choose to spend on improving the country’s infrastructure or services, and increase taxes to pay for it .On other occasions the government might take action because of the economic situation, e.g. during a recession the government might spend more and cut taxes to stimulate aggregate demand
What is a structural budget position ?
- Is a long term fiscal stance . This means their budget position over a whole period of economic cycle including booms /or recessions .
What is a cyclical budget position ?
-Is a government fiscal stance in the short term. This is affected by where the economy is in the economic cycle - automatic stabilisers are likely to create a surplus during a boom and a deficit during a recession.
NOTES
-A budget deficit caused by an expansionary cyclical budget position is known as a cyclical budget position .
This will be balanced out by a budget surplus during boom times( when the cyclical budget position is contractionary).
-A budget deficit caused by an expansionary structural budget position will add to national debt . This is called a structural budget deficit.
-Government spending can be split into current expenditure , repeated spending on things which are used up quickly ( e.g. wages ), and capital expenditure , spending on assets ( e.g. infrastructure ) which will last a long time .
Government may want taxes to achieve horizontal equity and vertical equity
What do these mean ?
- Horizontal equity will mean that people who have similar incomes and ability to pay taxes should pay the same amount of tax.
- Vertical equity will mean that people who have higher incomes and greater ability should pay more than those on lower incomes with less ability to pay taxes .
Governments may also want taxes that promote equality in an economy
-Might involve using taxes to reduce major difference’s in people’s disposable incomes, or to raise revenue to pay for benefits and state provision of services .
How do governments raise tax revenue
- Direct taxation
- Indirect taxation
What is progressive taxation ?
-Is where an individual’s taxes rise as their incomes rise, and it’s often used to redistribute income and reduce poverty.
A government can use the tax from those on high incomes and redistribute it to those on low incomes in the form of benefits or state provided merit goods(e.g. health care or education ), increasing equality.
Progressive taxation follows ‘the ability to pay ‘ principle ( the tax achieves vertical equity)
What is regressive taxation ?
-is where an individual’s taxes fall as their income rises, and used by government to encourage supply side growth.
By reducing the taxes from the rich the government will hope that the economy will benefit from the trickle down effect.
-A regressive tax system gives people more of an incentive to work harder and earn more income , but it may increase inequality.
- Supply-side economists argue that increasing direct taxes create a disincentive to work and will reduce a government’s tax revenue. This is shown on the laffer curve
- The laffer curve shows that as taxes increase, eventually this will lead to a decline in tax revenue and because people will have less incentive ot wor
Laffer curve
What is Proportional taxation ?
Also know as flat tax
-Is where everyone pays the same proportion of tax regardless of their income level .
This tax system can achieve horizontal equity , but setting a fair tax rate to apply to all members of society is difficult. For example , a 25% tax on income might be too high for those on lower incomes to afford , and it might not raise enough revenue form those on higher incomes for the government to be able to pay for all of the public goods and services it provides .
supporters of a flat tax argue that it can simplify the tax system , reduce the incentive to evade and avoid paying taxes , and increase the incentive to earn more .However flat tax systems may bring in less tax overall than variable rate tax systems
Flat rate tax systems also do not have vertical equity . but can be made progressive by having a tax free allowance ( where you do not have to pay any tax until you earn a certain amount .
