2.3.1 fiscal policy

aqa a level macroeconomics, fiscal policy

fiscal policy

the use of taxation, government spending and government borrowing to influence the economy

demand-side fiscal policy

fiscal policies that aim to manipulate AD to achieve macroeconomic objectives

supply-side fiscal policies

fiscal policies that aim to improve supply side of the economy

direct tax

taxes paid directly by taxpayer to government, income, wealth, corporation tax

indirect tax

charged on producers and paid indirectly by consumers, VAT, excise duties (cigarette tax)

progressive tax

takes higher proportion of income from those on higher incomes, ability to pay principle

proportional tax

takes same proportion of income whatever the level of income

regressive tax

takes a lower proportion of income from those on higher incomes

the laffer curve

argues there is an optimal tax rate, tax revenues rise initially as tax rates rise, after Rmax diminishing returns then negative returns

indirect tax benefits and costs

difficult to avoid, can internalise externalities, can be passed on to consumers so doesn’t affect AS, BUT regressive, can cause cost push inflation, may be unreliable if AD is low

direct tax benefits and costs

progressive so redistribution of income, can be more reliable source of gov rev, can help reduce inflation during boom, BUT reduces worker incentives and can discourage workers from seeking higher paying jobs

fine tuning

the use of fiscal or monetary policies to gradually change level of AD

fiscal multiplier effect

further effects on AD due to a fiscal policy

expansionary fiscal policy

reflationary, boosting AD by increasing gov spending or lowering taxes, involves budget deficit, used in a recession or when there’s a negative output gap

expansionary fiscal policy benefits and costs

increases economic growth, reduces unemployment, BUT increases inflation, worsens current account and BOP

contractionary fiscal policy

deflationary, austerity, reducing AD by cutting gov spending or increasing taxes, involves budget surplus, used during a boom when or when there’s a positive output gap

contractionary fiscal policy benefits and costs

reduces price levels, improes current account and BOP, BUT reduces economic growth and increases unemployment

automatic stabilisers

changes in tax revenues and public spending that arise automatically as the economy moves through its cycle, helps to stabilise the economy

During a boom, automatic stabilisers create a budget surplus as tax revenue rises and gov spending on benefits falls

discretionary fiscal policy

governments deliberately alter G and T to impact AD

structural budget position

the government’s long term fiscal position, their budget position over a whole period of the economic cycle

cyclical budget position

government’s fiscal stance in short term, affected by position in economic cycle, automatic stabilisers

current expenditure

gov spending on costs of running public services

capital expenditure

gov investment into the economy’s infrastructure

transfer payments

from taxpayers to benefit claimants through social security system

budget deficit

G is greater than T, the annual amount the gov borrows to make up gap between income and spending

balanced budget

G equals T

national debt

the total accumulation of budget deficits to be repaid

PSNCR

public sector net cash requirement, amount of money gov has to borrow when G is too low, includes government bonds

budget deficit issues

increases money supply so may cause demand pull inflation which may increase interest rates reducing investment

increases national debt meaning FDI less attractive, foreign firms stop lending to gov, future taxpayers left with large payments

crowding out effect

crowding out effect

governments compete with everyone else in the economy who also wants to borrow the limited available savings, real interest rates rise and private investment decreases due to competition

budget surpluses issues

might mean taxes are too high or gov isn’t spending enough on economy which may limit economic growth

fiscal policy issues

recognition lag, imperfect information, response lags, takes time for policy to have impact or create a multiplier effect

principles of taxation

taxes should be easy to collect, easy to pay, shouldn’t create undesireable disincentives

office for budget responsibility, OBR

provides analysis of UK’s finances, produce 5 year forecasts for the economy, including impact G and T changes announced in budget, assess likelihood of gov meeting targets, assess sustainability of public sector finances in long run