3.2.5.1 Fiscal policy

Fiscal Policy

The use of taxation, public spending and the governments position to achieve the government’s policy objectives

Public sector borrowing

Borrowing by the government and other parts of the public sector to finance a budget deficit

Deficit financing

When the government runs a budget deficit, usually for several years, deliberately setting public spending at a higher level than tax revenues and other government revenues

Demand-side fiscal policy (Keynesian fiscal policy)

Increasing or decreasing the level of AD through changes in government spending, taxation and the budget balance

Expansionary fiscal policy

The use of taxation and government spending to reflate, or kick start economic growth in the economy and shift the AD curve to the right

Contractionary fiscal policy

The use of taxation and government spending to deflate the level of economic growth in the economy and shift AD to the left

Supply-side fiscal policy

Fiscal policy that act on the supply-side of the economy to increase the economy’s ability to produce and supply products

How fiscal policy can be used to influence AS

1. Government can reduce corporate and income tax to encourage spending and investment

2. Government can subsidise training or increase spending on education

3. Increase government spending on infrastructure

4. Spending on healthcare, improving the quality of labour

Reasons for taxation and government spending

1. Allows the government to reuse the revenue to finance spending

2. Taxes and subsidies can be used to alter the prices to change consumption patterns

3. To pay for public and merit goods that would be under-provided in the free market

4. To provide a basic system of welfare support

5. To redistribute income in society

6. To control AD as part of macroeconomic policy

Main categories of tax

1. Tax on income

2. Tax on spending/expenditure

3. Tax on capital and wealth

Fiscal stance

The government’s overall position in applying fiscal policy

Main objectives of the UK tax systems

1. Funding government spending

2. Managing the economy as a whole

3. Redistribution of income

4. Correcting market failure

Tax base

The number of tax-paying agents in the economy and the amount of income, wealth and spending on which taxes are applied

Discretionary fiscal policy

Changes in spending and taxation independent of the state of the economic cycle

Fiscal policy and the supply side

1. The productive capacity of the economy

2. The ability of the economy to produce a higher level of real GDP each year

Three systems of tax

1. Progressive taxes

2. Regressive taxes

3. Proportional taxes

Progressive taxes

The marginal rate of tax rises as income rises

Proportional taxes (Flat tax)

The marginal rate of tax is constant, regardless of income

Regressive taxes

The rate of taxes falls as income rises

6 principles of taxation

1. Economical

2. Equitable

3. Convenient for the tax payer

4. Certain

5. Efficient

6. Flexible

Hypothecation

When taxes are raised for a specific use

Two aims and objectives of public spending and taxation

1. Allocation

2. Distribution

Tax avoidance

When financial affairs are arranged to minimise tax liability within the law

Tax evasion

An illegal practice where a person, organisation or corporation intentionally avoids paying their true tax liabilyu

Excise duty

Inland taxes on the sale, production for sale, of specific goods within a country. These are different from custom duties

The Office for Budget Responsibility

An advisory public body providing independent economic assessment for government fiscal policy

Crowding out

An economic theory describing how increased government spending can lead to a decrease in private sector spending

The national debt

The total stock of central government debt at a particular point in time

Cyclical deficit

The part of the overall budget deficit that rises and falls with the upswings and downswings of the economic cycle

Structural deficit (Cyclically adjusted deficit)

The part of a county’s deficit that is not caused by changes in the economic cycle, it is due to an imbalance in the business cycles

Two fiscal rules

1. The deficit rule

2. The debt rule