2.6.2(c) - fiscal policy

define fiscal policy

using government borrowing, tax and spending to influence AD

what does gov spending include and not include

INCLUDES: direct expenditure

EXCLUDES: transfer payments (but they are still part of fiscal policy)

2 examples of how the gov could decrease inflation using fiscal policy

increase VAT = less disposable income = less consumption = less AD = less inflation

reduce public sector pay = less consumer confidence = less consumption = less AD = less inflation

2 examples of how the gov could increase inflation

decrease corporation tax = more profit = more investment = more AD = more inflation

increase benefits = more income = more consumption = more AD = more inflation

fiscal (budget) deficit/surplus

BALANCED: revenue = expenditure

SURPLUS: revenue > expenditure

DEFICIT: revenue < expenditure

how can you finance a budget (fiscal) deficit

public sector borrowing

main source of gov revenue

taxation

types of tax (not direct + indirect)

progressive - proportion of income paid in tax rises with income
eg. income tax

regressive - proportion of income paid in tax falls as income rises
eg. VAT

examples of DIRECT taxes

taxes on income/profits:

• income tax

• corporation tax

• capital gains tax

• NI contributions

• inheritance tax

examples of INDIRECT taxes:

tax on expenditure:

• VAT

• excise duties

what are automatic stabilisers

features of fiscal policy that automatically reduce the volatility of the economic cycle without new government action

examples:
recession = less tax paid + more benefits = more disposable income = more consumption = grow economy (automatically comes back to trend GDP)

boom = more tax paid = less benefits = less disposable income = less consumption = slow economy (automatically comes back to trend GDP)

what is financial crowding out

budget deficit = gov borrowing = higher interest rates (high demand for loanable funds) = discourage priv sector investment

what are the cannons of taxation

ADAM SMITH’S ops on how tax should be:

equity (fairness) - pay according to ability to pay

certainty - know when/what you are gonna pay

convenience - easy to pay

economy (efficiency) - low cost of collection