3.6 Fiscal Policy

Fiscal Policy

Use of direct taxes and government expenditure to influence the level of AD

Direct Taxes

Government levy imposed the income, wealth or profit of individuals and firms.

Imposed directly on the stakeholder liable to pay the tax.

Limitations of Fiscal Policy (CITEG)

1. Existing Tax levelLevel

   • May already be very low, therefore yields no effect on consumer’s disposable income and hence AD

2. Consumer and Business Confidence

   • Usually to close recessionary gap, meaning unemployment is high

   • Therefore, income tax cuts yield no effect on disp income

   • Consumers and businesses post recession have low confidence and may choose to save

3. Time Lag

   • Greater time lag than monetary policy, as tax level needs to be adjusted

4. Government Expenditure

   • Requires gov expenditure, hence incurs opportunity cost

   • Depends on what gov spends $$ on

5. Income Inequality

   • If tax imposed by gov is regressive boohoo income inequality increases

Advantages of Fiscal Policy

1. Targets Specific Sectors

   • The government can choose to subsidize specific sectors (fiscal policy can have a greater impact on certain industries)

   • Can be used to increase income equality, support low income/retireees/elderly/disabled families

2. Direct Impact of Gov Expenditure

   • G is a major component of AD. Hence in a deep recession, the gov can run a budget deficit (inject money into CFI)