chapter 9.2 - fiscal policy

fiscal policy

involves the use of taxation, public spending, and the government's budgetary position to achieve the government's policy objectives

budget deficit

occurs when government spending is greater than government revenue ( G > T ) - represents a net injection of demand into the CFI, + so is expansionary

budget surplus

occurs when government spending is less than government revenue ( G < T ) - represents a net withdrawal from the CFI, + so is contractionary

balanced budget

when government spending = government revenue ( G = T )

how can a budget deficit be eliminated

by cutting public spending or by raising taxation

how is a budget deficit financed if it persists

by public sector borrowing - whenever there is a budget deficit, there is a positive borrowing requirement

The UK governments fiscal year

runs for 12 months, starting on 1 April for companies, and 6 April for individuals

public sector borrowing

borrowing by the government and other parts of the public sector to finance a budget deficit - a budget surplus means the government can use tax revenues it isn't spending to repay previous borrowing, + so borrowing requirement is negative

demand-side fiscal policy

used to increase or decrease the level of aggregate demand through changes in government spending, taxation, and the budget balance - centres on the use of deficit financing

deficit financing

deliberately running a budget deficit and borrowing to finance the deficit - for each of the years the government runs a budget deficit, the shortfall of tax revenues has to be financed through a positive borrowing requirement

expansionary fiscal policy

uses fiscal policy to increase aggregate demand and to shift the AD curve right - the nearer the economy gets to its normal capacity level of output, the greater the inflationary effect and the smaller the reflationary effect

contractionary fiscal policy

uses fiscal policy to decrease aggregate demand and to shift the AD curve left

discretionary fiscal policy

involves making discrete changes to G, T and the budget deficit to manage the level of aggregate demand

crowding out

a situation in which an increase in government spending or public sector spending displaces private sector spending, with little or no increase in aggregate demand

sovereign debt

the part of the national debt owned by people or institutions outside the country that has sold the debt to them

the sovereign debt problem

stems from the difficulties governments face when trying to finance budget deficits by borrowing on international financial markets - e.g. the rest of the world wasn't prepared to lend to the UK to help finance its budget deficit, except at ever higher interest rates which the country couldn't afford

supply side fiscal policy

used to increase the economy's ability to produce and supply goods, through creating incentives to work, save, invest, and be entrepreneurial - increases aggregate supply via their effects on economic incentives

example an of interventionist supply side policies

financing of retraining schemes for unemployed workers

aim of supply side fiscal policy

to try and shift the economy's LRAS curve to the right, increasing the economy's potential and normal capacity level of output

The Office for Budget Responsibility (OBR)

advisory public body that provides independent economic forecasts and analysis of the public finances as background to the preparation of the UK budget

national debt

the stock of all past central government borrowing that has not been paid back

cyclical budget deficit

the part of the budget deficit which rises in the downswing of the economic cycle and falls in the upswing of the cycle

cyclical budget surplus

caused by a rise in economic activity leading to higher tax revenues and a fall in government spending on welfare - emerges in the upswing of an economic cycle

structural budget deficit

the part of the budget deficit which isn't affected by the economic cycle, but results from structural change in the economy affecting the government's finances, + from long term government policy decisions

2 of the main reasons for public spending an taxation within fiscal policy

allocation and distribution

how does public spending and taxation within fiscal policy result in allocation

taxes are used: to alter relative prices and patterns of consumption; to finance provision of public goods e.g. defence, roads; to reduce production + consumption of negative externalities e.g. pollution; to deter monopoly by taxing monopoly profit

how does public spending and taxation within fiscal policy result in distribution

taxation and transfers in its public sector programme can be used to modify distributions of income and wealth produced by free market forces, and reduce the alleged market failure resulting from inequity

progressive taxation

as income increases, a larger proportion of income is paid as tax

principle of taxation

a criterion used for judging whether a tax is good or bad, aka a canon of taxation

the 4 principles of taxation

taxation should be equitable, economical, convenient, and certain

convenience (as a principle of taxation)

requires a tax to be convenient for taxpayers to pay

economy (as a principle of taxation)

requires a tax to be cheap to collect in relation to the revenue it yields

certainty (as a principle of taxation)

requires tax payers to be reasonably certain of the amount of tax they will be expected to pay

equity (as a principle of taxation)

requires a tax to be fair

efficiency (as a principle of taxation)

requires a tax to achieve its desired objective(s) with minimum unintended consequences

flexibility (as a principle of taxation)

requires a tax to be easy to change to meet new circumstances

transfer payments

a redistribution of spending power from taxpayers in general to those receiving welfare benefits and to holders of the national debt

how income taxes and transfers reduce inequalities in the distribution of income

reduce the disposable incomes of those in work and increases the disposable income and spending power of those living on welfare benefit and to holders of the national debt

the debt to GDP ratio

the government's debt as a percentage of GDP - an indicator of the burden of the national debt on the economy

corporation tax

tax paid by companies on their profits

regressive taxation

when the proportion of income paid in tax falls as income increases

proportional taxation

when the proportion of income paid in tax stays the same as income increases

the basic tax threshold

the level of income above which people pay income tax - income below the tax threshold is untaxed

the marginal tax rate

the amount of tax paid on an additional pound of income

direct tax

a tax which cannot be shifted by the person legally liable to pay the tax onto someone else - levied on income and wealth

indirect tax

a tax which can be shifted by the person legally liable to pay the tax onto someone else, e.g. through raising the price of a good being sold by the taxpayer - levied on spending

examples of demerit goods and how they are taxed

taxed in order to discourage consumption e.g. alcohol, tobacco

examples of merit goods and how taxes affect them

subsidised and often publicly provided e.g. healthcare and education