Y12 Booklet 3: Government Macroeconomic Policy Flashcards
How can (demand-side) government policy be divided?
Fiscal Policy
Monetary Policy
What is Fiscal Policy? Who controls it?
controlling taxes & govt. spending to manage the economy
government
What is Monetary Policy? Who controls it?
controlling interest rates, exchange rates and quantitative easing to manage the economy
Bank of England
Which is the easier/faster to manage an economy? (Fiscal or Monetary policy)
Fiscal
What is “fine-tuning”?
intentionally maintaining AD levels by frequently managing government policy
What funds government expenditure? What are the problems with these?
taxes (unpopular) & borrowing (incurs debts)
What does government expenditure usually fund? Why?
public and merit goods
under allocated for in free market
What is the most common/effective way governments manage macroeconomic policy?
interest rates
How can policies be divided by their intended impact?
Expansionary/Loosening Policies
Contractionary/Tightening Policies
What effect do Expansionary policies have?
increase Aggregate Demand
What effect do Contractionary policies have?
reduce Aggregate Demand
How can policies be further divided by how the fit the current economic cycle?
Pro-cyclical Policies
Counter-cyclical Policies
How does a pro-cyclical policy suit the economy?
works with cyclical tendencies (makes booms & slumps bigger)
e.g. prolonging an economic boom
How does a counter-cyclical policy suit the economy?
works against cyclical tendencies (makes booms & slumps smaller)
e.g. reducing impact of recession
Where is a positive and negative output gap on an economic cycle?
What are the 2 examples of pro-cyclical policy?
expansionary during growth
contractionary during recession
What are the 2 examples of counter-cyclical policy?
contractionary during growth
expansionary during recession
Why might a government use counter-cyclical policies during a time of economic growth?
reduced size of boom = reduced size of inevitable slump
What are the reasons for taxation?
- correct market failure (Pigouvian tax)
- macroeconomic policy tool
- redistribute income
What are Adam Smith’s 4 “Canons of Taxation”?
the essentials features of a “good tax”: ACCE
Ability - amount of tax should vary according to ability to pay
Certainty - payers should know how much, when & how to pay
Convenience - method should be convenient to payer
Economy - cost of collection should be low relative to yield
What are modern economists 4 additional “Canons of Taxation”?
CDEF
Compatibility - tax systems should be internationally compatible
Diversity - govt. revenue should be from a variety of sources
Efficiency - causes min. loss of allocative/economic efficiency
Flexibility - should automatically adjust to changes in price level
How can a tax be categorised by its effects on different people?
progressive
proportionate
regressive
What is a progressive tax?
takes a higher proportion of higher incomes
What is a proportional tax?
takes a equal proportion of everyone’s incomes
What is a regressive tax?
takes a higher proportion of lower incomes
How can progressive/regressive taxes be used in an essay? What must be referred to? Which canon of tax does this mirror?
to evaluate taxes
“relative to proportion of income”
Ability
What is a direct tax? Example?
a tax paid directly by an individual or organisation, for which the burden can’t be passed on
e.g. income tax
What is an indirect tax? Example?
a tax paid on goods and services, for which the burden may be passed on to the consumer
e.g. VAT
What is the “incidence” of a tax?
who pays the burden
When a good’s demand is price inelastic, who bears the incidence of a tax? Why? How is this shown on a diagram? Why is this especially bad?
consumers
consumption will not be affected much, as price increases
proportionally hurts lower-income earners more, regressive
When a good’s demand is price elastic, who bears the incidence of a tax? Why? How is this shown on a diagram?
producers
consumption will be significantly affected, as price increases
What is an excise duty? How can it be described?
an indirect tax placed on goods with negative externalities or demerit properties to reduce consumption
“sin tax”
Pros & cons of using indirect taxes
+ raises government revenue for govt. spending
+ can reduce market failure
+ can be easily changed (with little political resistance, unlike direct taxes)
– inflationary
– regressive
– risk of black market
Pros & cons of using direct taxes
+ raises government revenue for govt. spending
+ more progressive (than indirect taxes)
– disincentivises work
– often faces political resistance & consequences
What % of government revenue does income tax account for?
> 25%
expected 2025-26
How is income tax collected?
usually as a % of wages or salary
(also can be on interest on savings, profits from unincorporated firms, rents & pensions)
collected by employers
What is the structure of income tax brackets?
[£0 - £12,570] x 0% (personal allowance)
[£12,571 - £50,270] x 20% (basic rate)
[£50,271 - £125,140] x 40% (higher rate)
[£125,141+ ] x 45% (additional rate)
also, personal allowance reduces for incomes >£100,000
e.g. >£125,140 gets no personal allowance
How is national insurance (NI) collected? What is the structure of brackets?
usually as % of wages or salary, deducted at source rather than collected later
[£12,570 - £50,270] = 8% [£50,270+ ] = 2%
collected by employers who also contribute (up to 15% on pay >£5k)
What do income tax and national insurance (NI) impact on a diagram?
AD - disposable income, affects consumption
LRAS - willingness to work, affects size of labour force
What is the idea behind the Laffer Curve?
suggests that there is an optimum tax rate
- too high, reduces incentive to work, reduces tax revenue
- too low, reduces size of cut of tax, reduces tax revenue
What does the Laffer Curve look like?
What is the Laffer Curve used to evaluate? Why?
the risks of changes in tax rates
unpopular, has political consequences for party making changes
How is corporation tax collected? What is the structure of brackets?
as a % of profits
[ - £50,000] = 19%
[£50,000 - £250,000] = marginal tax relief
[£250,000 + ] = 25%
What does corporation tax impact? What does it NOT impact?
AD - affects ability & incentive to invest in capital
LRAS - affects investment in capital, a factor of productive capacity
SRAS - NOT A COST OF PRODUCTION, HAS NO EFFECT
How is VAT collected? What does it impact?
standard rate (20%) applied to most goods & services
Supply curve - affects costs of prod (despite often being passed onto consumers)
Why might VAT not be charged at 20% on some goods? Examples?
exempt - e.g. stamps, gambling
zero-rated - e.g. children’s clothes, books
reduced rate - e.g. gas, electricity
How is council tax collected? What does it fund? What are some exceptions?
domestic properties (i.e. houses, flats) given a valuation and placed into a band, which pay different rates of council tax
local services; e.g. fire service, libraries, bin men
households with only one resident entitled to 25% discount
How are business rates collected? Who collects/controls it? Why? What problems could this cause?
commercial properties (i.e. shops, factories) given a rental valuation and category (> or < £51k), which decides the business rate
local authorities (i.e. councils)
gives councils power to change rates to attract firms to depressed areas
risk of “race to the bottom” brings tax harmonisation into question
How can different government spending affect the economy differently? Examples?
Pensions - increase AD (C&G), especially since elderly have higher MPC, causes multiplier effect
Education - increase AD (G) and LRAS (Lab), increase quality of labour & capital, productive cap grows
What is government/national debt?
the accumulation of budget deficit over time (a stock variable)
What is budget deficit?
the value by which govt. spending exceeds taxation revenue, so must be funded through borrowing (a flow variable)
During a recession, how is government policy affected?
1) tax revenue falls (e.g. unemployment = lower avg incomes, so income tax receipts falls, and less consumption, so VAT revenue falls etc.)
2) govt spending increases (e.g. JSA for unemployed, investments to grow AD etc.)
so, governments must cover budget deficit by BORROWING money
Pros/cons of a budget deficit?
+ spending promotes AD
+ pays for public & merit goods (underallocated)
+ investments increase prod. cap (LRAS)
– opportunity cost of paying back interest via taxes, would be better spent on social security etc.
– intergenerational inequity (unfair bearing of costs on future generations)
What is a budget surplus?
What is a balanced budget?
the value by which taxation revenue exceeds govt. spending
when taxation revenue = govt. spending
What is intergenerational inequity?
when a future generation is forced to pay back debts (+ interest) incurred and enjoyed by a previous generation, unfairly
What is an “automatic stabiliser”? Example? What does it evaluate?
a factor which changes in a way to automatically stabilise AD and the economic cycle (GDP)
JSA, progressive tax structuring etc. (often counter-cyclical tendencies)
need for government policy to manage the economy
What is a “discretionary fiscal policy”?
when the government makes a conscious decision to change taxes or spending (as oppose to an existing automatically managed system, i.e. automatic stabilisers)
