Unit 4, Area of Study 1 - Budgetary Policy

Question 1

Budgetary Policy

Answer 1

The manipulation of the level and composition of Federal Government receipts/revenues and outlays/expenses in order to assist in the achievement of its economic and social goals for Australia.

Question 2

Progressive Tax

Answer 2

A tax that collects proportionally more from higher income earners compared to lower income earners. It involves the rate of tax increasing as income increases.

E.g., Personal Income Tax

Question 3

Proportional tax

Answer 3

A tax that collects proportionally identical amounts from all income earners. It involves the rate of tax remaining the same.

E.g., Medicare Levy

Question 4

Regressive tax

Answer 4

A tax that collects proportionally more from lower income earners, compared to higher income earners.

E.g., GST or Excise taxes on cigarettes and alcohol

Question 5

Direct Tax

Answer 5

Are taxes that are paid directly to the government and usually applied on income, whether that be personal income (households) or business/corporate incomes (usually profits)

Question 6

Indirect tax

Answer 6

Usually taxes on expenditure or consumption, not paid to the government by the consumer but by another party, usually a supplier.
e.g., GST, Excise taxes

Question 7

G = Government Spending

(AD = C + I + G + (X - M))

Answer 7

1. Government consumption spending (G1) - this is current expenditure,therefore no on-going benefit created, e.g., supplies for schools, wages of public servants
2. Capital/Investment spending designed to increase the productive capacity of the economy (G2) – this is capital expenditure, therefore an on-going benefit is created. e.g., spending on infrastruture such as roads, hospital and school buildings, ports, railways.
3. Transfer payments (e.g. Newstart – now JOBSEEKER or Unemployment benefits):•Are not regarded as government spending (G) because it is the recipient of transfer payments/benefits who actually spends the money (C) & (I).

Question 8

Budget Outcomes

Answer 8

Headline cash balance: total cash received by the federal government less the total cash paid.

Underlying cash balance (most commonly referred to as the Budget Outcome): seeks to exclude cash flows that are included in Headline cash balance, but do not have a direct or immediate impact on the economy) headline cash outcome excluding future fund earnings and net asset purchases.

-Future Fund earnings are mandated to be reinvested in the Future Fund and not to be used for general government expenditure.-Net proceeds from asset sales or purchases are ‘one-off’, non-recurring, transactions that will not feature as cash flows in future Budgets.

Fiscal outcome: relates to revenue that has been earned over the relevant period compared to expenses that have been incurred over the period (accrual accounting), and also excludes net capital investment (e.g. purchase of capital items).

Question 9

Budget Outcomes (Deficit or Surplus)

Answer 9

Budget deficit = revenues (receipts) < expenditures (outlays)

(A deficit has an expansionary impact on economic activity.)

Budget surplus = revenues (receipts) > expenditures (outlays)

(A surplus has a contractionary impact on economic activity).

The forecast budget deficit for 2022-23 is $78 billion

Question 10

Budgetary policy stance

Answer 10

Contractionary stance

Expansionary stance

Each of these describe the impact that the budget is expected to have on the economy. For example, when the government takes an expansionary stance, it is expected that the budget will “expand” or encourage the economy to grow by entering the expansionary phase of the business cycle.

Remember: the government will use the budget to have a counter-cyclical impact on the business cycle.

Question 11

How can the government fund a budget deficit?

Answer 11

A: Selling bonds to the RBA

B: Selling bonds to overseas investors (lenders)

C: Selling bonds to Australian Investors (lenders)

All these add to public** or **government debt

What is a government bond?

A government bond is a bond issued by the federal government, generally with a promise to pay periodic interest payments and to repay the face value or principle on the maturity date.

Question 12

A: Selling bonds to the RBA

What is this and what issues does it create?

Answer 12

• Selling government bonds to the RBA via secondary money markets
• The most expansionary (and most inflationary) policy as the RBA uses money that is not in circulation in the economy (i.e. not in the money supply), but rather is in the RBA’s vault or does not exist yet and the RBA prints it.
• Rare option since the late 80’s, because the RBA does not want to be seen to be funding the government and for there to be a clear separation between Budgetary and Monetary policy.

Question 13

B: Selling bonds to overseas investors (lenders)

What is this and what issues does it create?

Answer 13

• Used to finance a large expansionary budget deficits during and following the GFC.
• However:-this adds to the NFD and grows the size of the CAD, as interest payments flow as debits to the Net Primary Income subaccount.
• Results in capital inflow that exerts upward pressure on the value of the AUD due to increase in demand for AUD = negative impact on net exports and AD = which can counteract the expansionary stance of the budget.

Question 14

C: Selling bonds to Australian Investors (lenders)

What is this and what issues does it create?

Answer 14

• Selling government bonds to Australian investors via domestic money markets.
• Least expansionary because domestic bond sales place upward pressure on interest rates as demand for money in financial markets increases resulting in an increase in the price of money (interest rates).
• Higher interest rates (C&I) : does not stimulate AD
• Will lead to crowding out of the private sector as consumers and businesses reduce Consumption (C) and Investment (I) because of the higher interest rates (i.e., it crowds private borrowers out from borrowing to fund expenditure).

Question 15

Problems with an expansionary budgetary policy (deficit)

Answer 15

• Cost of financing budget deficits
• Crowding out effect and impact on C, I and AD
• Building up of government debt that needs to be serviced and will attract interest that also needs to be paid.
• Potential problems:
  
  1. Impact on credit rating (AAA credit rating downgrade)
  2. Leads to higher borrowing costs and even bigger deficit
  3. Therefore will need higher tax and lower government spending
  4. Meaning negative consequences on growth and employment

Question 16

Benefits / Reasons for pursuing a surplus

Answer 16

1. Help to buffer Australia against future economic decline with Budget Surpluses being re-invested into the Future Fund.
2. Generate international investor confidence and assists in maintaining Australia’s AAA rating credit rating.
3. Allows monetary policy (RBA) to better manage the economy, particularly, avoiding the chances of “crowding out” occurring.

Question 17

2021/22 Budget initiatives / policies

Answer 17

1. Instant Asset Write-off
2. Increase in the Child Care Subsidy Scheme giving families greater access to subsidized childcare allowing both partners to re-enter the workforce. An extra $1.7 billion five-year spend for childcare.
3. Building Australia 10-year $110 billion infrastructure investment pipeline – There is currently a $110 Infrastructure pipeline, and the government has committed an additional $15.2 billion on many projects around Australia, particularly in the area of highways/roads.

Question 18

2022/23 Budget initiatives / policies

Answer 18

1. An increase in the low- and middle-income tax offset (LMITO) providing an additional $420 for low- and middle-income earners, in addition to the maximum $1080 already set in the 2018-19 Budget.
2. A $250 cash payment for eligible pensioners and welfare recipients.
3. A 50% reduction in the excise on fuel from $0.44 per litre to $0.22 per litre for 6 months only.

Question 19

Budgetary Policy to address structural unemployment

Answer 19

2022-23 budget

• The JobTrainer Fund has been further extended as part of the 2022-23 Budget, with the Australian Government announcing an additional investment of $48.5 million over two years.

Background:

• 2020-21 Federal Budget established a $1 billion JobTrainer fund to support around 300,000 enrolments in free or low fee training places for job seekers and young people (including school leavers) to upskill or reskill in areas of identified skills need.
• 2021-22 Budget, the Australian Government announced it would commit an additional $500 million to extend the program until 31 December 2022

Question 20

Budgetary Policy to address Hardcore / Long term unemployment

Answer 20

2021-22 budget

Mental health services – The Government is providing an additional $2.3 billion over four years for mental health and suicide prevention. This investment will deliver landmark reform of the system to ensure that we act early to safeguard the wellbeing of all Australians, and deliver effective, compassionate, high-quality care to all Australians when and where they need it.

Question 21

Budgetary policy to address youth unemployment

Answer 21

2022-23 budget

• The JobTrainer Fund has been further extended as part of the 2022-23 Budget, with the Australian Government announcing an additional investment of $48.5 million over two years.

Background:

• 2020-21 Federal Budget established a $1 billion JobTrainer fund to support around 300,000 enrolments in free or low fee training places for job seekers and young people (including school leavers) to upskill or reskill in areas of identified skills need.
• 2021-22 Budget, the Australian Government announced it would commit an additional $500 million to extend the program until 31 December 2022

Question 22

Strengths of budgetary policy in stabilising aggregate demand and achieving the macro-economic goals

Answer 22

Remember, the common error is that student fail to explain / discuss how the strength enhances the ability of the goal in question to be achieved.

1. Government can use discretionary stabilisers to target particular sectors (unlike monetary policy)
2. Budget will swing into action automatically via the operation of automatic / cyclical built-in stabilisers = short time lag for their recognition and impact, and therefore a short impact lag.
3. Impact lag is relatively short due to Governments direct control over taxation and government spending (discretionary stabilisers) and ability to make required adjustments to stabilise aggregate demand and economic activity.
4. Effective in stimulating AD directly – for example, in the event of a downturn in economic activity, introduce policies aimed directly at C, I and incorporating G, examples include the $250 cash payment to pensioners and welfare recipients
5. Many checks and balances, to ensure poorly designed policies are not implemented as these will not pass through the legislative process.
6. Public scrutiny makes policy makers more accountable and transparent - which makes them less likely that bad policy decisions will be made.

Question 23

Weakness of budgetary policy in stabilising aggregate demand and achieving the macro-economic goals

Answer 23

Remember, the common error is that student fail to explain / discuss how the weakness limits the ability of the goal in question to be achieved.

1. Financial restrictions – e.g. current government’s medium term fiscal strategy is to stabilise and reduce debt, increase in taxes unpopular so have to reduce outlays/expenditure.
2. Can undermine monetary policy via “crowding out / in” issues.
3. Discretionary stabilisers could prove to be pro-cyclical due to long time lags – e.g. infrastructure.
4. Lack of flexibility compared to monetary policy as budget delivered once a year, whereas Monetary Policy is adjusted on a monthly basis.
5. Implementation lag (as opposed to impact lag) – bill must pass both houses of parliament and in some cases requires co-operation from State governments
6. Budgetary policy is less effective at restricting AD during a boom in economic activity (compared to monetary policy) as government is less able to immediately restrict the disposable income of consumers.
7. Political hurdles – e.g. bills can be blocked in the Senate.
8. Political bias – pandering to voters / lobby groups can influence decisions

Question 24

Automatic stabilisers

Answer 24

Changes to the budget that occur automatically in line with changes in the level of economic activity, they are built-in to the budget and occur without deliberate government intervention (also referred to as cyclical stabilisers or cyclical component of the budget).

For example, welfare payments in the form of JobSeeker or Personal Income Tax.

You need to be able to describe how each of these (e.g. Job Seeker and Personal Income Tax) influence AD and stabilise the business cycle.

Question 25

Discretionary stabilisers

Answer 25

Deliberate policy decisions designed to change receipts or outlays in the effort to influence economic activity (also referred to as the structural component of the budget outcome)

Question 26

What is the relationship between the budget outcome and the level of government (public) debt?

Answer 26

A budget deficit needs to be funded, therefore there will be an increase in government (public debt) → refer to 3 flash cards on how the government raises funds by selling bonds to domestic and internatioanl investors and the RBA.

A budget surplus means receipts > outlays and the excess funds can be used to pay down government (public) debt.

Question 27

the role of automatic stabilisers (cyclical component of the budget) in influencing aggregate demand and stabilising the business cycle

Answer 27

During a contraction:

• ⤒ in welfare payments in the form of Job Seeker (unemployment benefits) provides individuals who become unemployment with an income substitute that can be used for purchasing essentials such as food, as a result placing upward pressure on private consumption expenditure and stabilising levels of aggregate demand → stabilising the business cycle by placing upward pressure on economic activity.

During an expansion:

• ⤓ in welfare payments in the form of Job Seeker (unemployment benefit) along with the ⤒ in the personal income tax from workers as they move up into higher tax brackets (i.e., bracket creep) will slowing growth in private consumption expenditure → stabilising the business cycle by restraining the growth in levels of of economic activity.

Question 28

The role of discretionary stabilisers (structural component of the budget) in influencing aggregate demand and stabilising the business cycle

Answer 28

Deliberate policy decisions designed to stimulate or restrain levels of expenditure (consumer and investment) in the economy in order to place upward or downward pressure on AD and stabilise levels of economic activity / hte business cycle.

Review flash cards that refer specific budgetary policy initiatives over the last two years.

Question 29

The effect of automatic changes in the budget on the budget outcome and government (public) debt

Answer 29

Automatic stabilisers

• ⤒ in Job Seeker / Welfare Payments due to higher unemployment → ⤒ in outlays in the budget and ⤓ in personal income tax receipts due to higher unemployment → ⤓ in receipts in the budget = ⤒ in budget deficit and this means ⤒ in the amount the government must borrow → refer to 3 flash cards on how the government raises funds by selling bonds to domestic and internatioanl investors and the RBA.
• The opposite occurs when there is a fall in unemployment and rise in economic activity.

Question 30

The effect of discretionary changes in the budget on the budget outcome and government (public) debt

Answer 30

Discretionary stabilisers.

• Ask yourself what does the deliberate policy involve and what will it do to Budget Payments/Outlays or Budget Receipts
• ⤒ payments/outlays from the budget - for example, the $250 payment to pensioners and elligible welfare recipients → ⤒ in budget deficit → govt sells bonds → ⤒ in govt (public) debt
• ⤓ receipts from the budget - for example, the LMITO means the government will receive less in personal income tax receipts from workers → ⤒ in budget deficit → govt sells bonds → ⤒ in govt (public) debt
• And it would be the opposite for a ⤓ in payments/outlays or an ⤒ in receipts.