fiscal policy

UK Economy

Cut in tax on Boost to disposable Adds to consumer interest from income of people with demand saving net savings Impact of a rise in indirect taxes on the ________ All other things being equal, an increase in indirect taxes by the government is most likely to ….

AD2

 An increase in taxes on households and ________ firms, or  A decrease in government expenditures Either of these policies will reduce total Yfe Y2 real GDP spending, income and employment, and the average price level.

Consumer

________ spending Low confidence- tax Cuts in VAT or income tax to boost cuts likely to be saved demand for goods and services rather than spent.

P2 AD3

________ On employment: In order to increase their output in the short- run, firms must hire more AD2 workers, reducing unemployment in the AD1 economy On the price level: The increase in total Y2 Yfe real GDP spending increases the scarcity of output and resources, causing demand- pull inflation.

Enterprise Taxation

________ and Tariffs affect import Entrepreneurship incentives to study costs Economic Justifications for Budget Deficits Since 1970, the government has had a surplus in only six years- it is normal for government to have to borrow money.

government bonds

 Higher interest rates on ________ cause the supply of loanable funds to decrease to S1.

£70 billion

Borrowing of ________ is equivalent to lower than the £1, 100 per head of the UK population average of An increase in the national debt is likely to cause higher advanced taxes in the future.

P2 Inflation

________ is higher than desired and output is AD1 beyond the full employment level The government can bring AD down by Pfe using contractionary fiscal policy.

Flat

________ (Specific) Ad- Valorem An indirect tax of an absolute (Percentage) (constant) amount levied per An indirect tax, which is unit of a commodity ex: a tax of expressed as a proportion $ 5 per unit.

net effect

The ________ on aggregate demand depends on the governments budget balance.

medical breakthroughs

Research and development: Government- funded research and development can lead to scientific, technological, and ________ that may spur new industries and promote growth across the private sector.

percentage of GDP

A growing economy helps to shrink debt as a(n) ________.

VAT

________ leads to higher demand Expansionary real incomes Fiscal Policy.

Expansionary fiscal policys

________ effect on the interest rate: Fiscal stimulus requires that a government increases its deficit.

Capital Expenditures

________: These are investments made by the government in capital equipment and infrastructure, such as money spent on roads, bridges, schools, hospitals, military equipment, courthouses, etc,

Fiscal policy

________ alone can not lead to long- run economic growth, since it is first and foremost a ‘ demand- side policy.

Fiscal Policys

________ positive supply- side effects When government supports a modern infrastructure, including for transportation and Infrastructure communications, the private sector is given the resources it needs to grow and succeed in the spending: long- run Human capital is perhaps the most important resource a nation requires for long- run economic Education spending: growth.

Direct Indirect

________ A tax on income or on A tax on expenditure (spending) corporations.

fiscal stimulus

If a(n) ________ works the budget deficit will improve as a result of higher tax revenues and reductions in welfare spending.

supply curve

The ________ represents household savings  At higher interest rates, households save more  At lower rates, households save less The demand curve represents investment  At higher interest rates, firms invest less  At lower interest rates, firms invest more Fiscal Policy The Crowding- out effect.

private borrowers

Illustrating the Crowding- out Effect Interest rates paid by ________ in a nation are a primary determinant of the levels of savings, investment, and consumption.

Expansionary Fiscal Policy

________- Illustrating the effect Describe the impact of a tax cut or increase in government on 1) AD, 2) Real RDP, 3) Employment, 4) Price level On AD: AD increases by an amount determined LRAS by the initial change in spending from AD1 to PL AD2, and then ultimately to AD3 depending on SRAS the size of the multiplier On real GDP (output): Output increases as the total demand in the economy increases.

contractionary fiscal policy

The Role of Fiscal Policy- To Combat Inflation If an economy is experiencing abnormally high inflation as a result of an increase in AD beyond the full employment level, ________ can be used to reduce AD and bring inflation under control.

medical development

Research and Government- funded research and development can lead to scientific, technological, and ________: breakthroughs that may spur new industries and promote growth across the private sector.

Transfer payments

________: This type of government spending does not contribute to GDP (unlike those above), because income is only transferred from one group of people to another in the nation.

Government Budget

The ________- Surpluses and Deficits In a particular year, a governments budget can either be balanced, in surplus or in deficit.

automatic rise

There is a(n) ________ in the budget deficit to cushion the fall in AD caused by an external economic shock.

Government Current

________ and Capital Spending Current spending- on Capital spending- new public providing public services infrastructure.

Fiscal policy

________ involves the use of government spending, direct and indirect taxation and government borrowing to affect the level and growth of aggregate demand, output and jobs ________ is also used to change the pattern of spending on goods and services e.g.

Fiscal stimulus

________ (both tax cuts and spending increases) lead to a budget deficit  Assuming a government started with a balanced budget, if it wanted to stimulate AD, the government would have to incur a deficit.

Fiscal Policy

________ and Long- run Economic Growth Economic Growth, defined as an increase in total output over time, is only possible in the long- run if both AD and AS increase.

Fiscal Policy

________ and the Crowding- out Effect The use of fiscal policy in times of recession is highly controversial.

Fiscal Policy

Taxation and spending measures that allow the ________ government to guide the economy.

Fiscal Policy Economics

Some Key Terms Bond Yield The rate of interest paid on government debt

The budget deficit is the difference between what the Budget (Fiscal) Deficit government receives in revenue and what it spends withing a year The size of the deficit is influenced by the state of the Cyclical Fiscal Deficit economy

in a boom, tax receipts are relatively high and spending on unemployment benefit is low Taxes on income, profits and wealth, paid directly by the Direct Taxation bearer to the tax authorities

spending on health care and scarce resources allocated to renewable energy Fiscal policy is also a means by which a redistribution of income & wealth can be achieved for example by changing tax rates on different levels of income or wealth It is an instrument of micro-economic government intervention to correct for market failures such as pollution or the sub-optimal provision of public and merit goods It is important to be aware that changes in fiscal policy affect both aggregate demand (AD) and aggregate supply (AS)  Taxation

why Why do we tax

The Government Budget

Surpluses and Deficits In a particular year, a governments budget can either be balanced, in surplus or in deficit

A balanced budget

A governments budget is in balance if its expenditures in a year equals its tax revenues for that year

A budget surplus

If, in a year, the government collects MORE in taxes than it spends, the budget is in surplus

A budget deficit

If a governments expenditure in a year a greater than the tax revenue it collects, the governments budget is in deficit

The national debt

A nations debt is the sum of all its past deficit minus its past surpluses

Fiscal Policy

Changes in the level of government spending and taxation aimed at either increasing or decreasing the level of aggregate demand in an economy to promote the macroeconomic objectives

The Government Budget

Sources of Revenue Fiscal policy puts the governments budget into action to stimulate or contract AD as needed

Tax revenues

A governments primary source of revenues is through the collection of taxes

Direct taxes

Taxes on incomes earned by households and firms

Indirect taxes

Taxes on consumption are indirect, meaning they are actually paid by the sellers goods, but they are born by both producers and consumers

The Government Budget

Types of Expenditures While a governments revenues come from the taxes it collects

Current Expenditures

This is the day to day cost of running the government

Capital Expenditures

These are investments made by the government in capital equipment and infrastructure, such as money spent on roads, bridges, schools, hospitals, military equipment, courthouses, etc,

Transfer payments

This type of government spending does not contribute to GDP (unlike those above), because income is only transferred from one group of people to another in the nation

The Role of Fiscal Policy

During a Recession If an economy has experienced a fall in aggregate demand, it might be in a demand-deficient recession

To combat such a slump in economic activity, a government can use expansionary fiscal policies Assume an economy is experiencing a recessionary gap as seen here

Explain what you would do Private spending in the economy has fall To make up the gap, the government can attempt to use expansionary fiscal policies

The Role of Fiscal Policy

To Combat Inflation If an economy is experiencing abnormally high inflation as a result of an increase in AD beyond the full employment level, contractionary fiscal policy can be used to reduce AD and bring inflation under control

Expansionary Fiscal Policy

When the Economys at Full Employment What if a government implements an expansionary fiscal policy when the economy is already producing at its full employment level

Cut in indirect Lower prices

Adds to consumer taxes e.g

Improved

falling incomes may cause Balance of trade in goods & services demand for imports to contract

Lower Stimulates work incentives and productivity Taxes Helps to create more jobs because businesses have less tax to pay Encourages an inflow of FDI from businesses looking for low tax country Incentivizes enterprise and start-ups

a source of long term wealth and jobs Lower tax rates might end up increasing total tax revenues (Laffer Curve concept)  Evaluating the Arguments for a Low Tax Economy

Consumer spending Low confidence

tax Cuts in VAT or income tax to boost cuts likely to be saved demand for goods and services rather than spent

Enterprise / Taxation and Tariffs affect import Entrepreneurship incentives to study costs  Economic Justifications for Budget Deficits Since 1970, the government has had a surplus in only six years

it is normal for government to have to borrow money

Public debt is the total stock of debt issued by a government that has yet to be re-paid

it is also known as the National Debt High deficits cause rising debt interest payments which UK Debt Data in 2015-16 are are forecast to be £47 billion or £700 UK government per head of population debt is forecast to reach 100% of This interest burden has an opportunity cost for less GDP in the next interest on debt could free up extra spending on health few years

UK Governments Fiscal Austerity Policies In 2010 UK government had a fiscal deficit-reduction policy with the emphasis on cutting government spending in some areas in real terms and a series of direct and indirect tax increases

Where did/could it save, generate money

There is a reason for this

A tax cut is an INDIRECT injection into the nations economy

 More workers receive government unemployment benefits When output increases

Tax revenues increase because households incomes and firms revenues increase

Research and development

Government-funded research and development can lead to scientific, technological, and medical breakthroughs that may spur new industries and promote growth across the private sector

Incentives for private investment

Creating a tax policy that rewards innovation and entrepreneurship, rather than punishes it by taking the ‘winners in an economy will encourage private businesses to invest and thereby help the economy grow

Research and Government-funded research and development can lead to scientific, technological, and medical development

breakthroughs that may spur new industries and promote growth across the private sector

Creating a tax policy that rewards innovation and entrepreneurship, rather than punishes it by Incentives for private taking the ‘winners in an economy will encourage private businesses to invest and thereby help investment

the economy grow

Expansionary fiscal policys effect on the interest rate

Fiscal stimulus requires that a government increases its deficit

Government bonds

These are certificates of debt that a government sells in order to borrow money to finance an expansionary fiscal policy

The cost of borrowing

When a government has a history of balanced budgets, investors will be willing to lend it money at very low interest rates, therefore the government does not need to offer a high rate of interest on its bonds

Crowding-out

The increase in interest rates that often accompany a deficit-financed fiscal stimulus may cause private investment and consumption in the economy to decrease

The Loanable Funds Market

A nation's loanable funds market represents the money in commercial banks that is available to be loaned out to firms and households to finance private investment and consumption