3.5 - fiscal policy

government spending \[term\]

the total amount of money spent by the government in a given period of time

direct tax \[term\]

a tax on income or wealth

government revenue \[term\]

the source of finance for government spending

indirect tax \[term\]

a tax on spending, often defined as a tax on goods and services

balanced government budget \[term\]

when tax revenue is equal to government spending

budget deficit \[term\]

when government spending is greater than tax revenue

budget surplus \[term\]

when tax revenue is greater than government spending

fiscal policy \[term\]

a policy that uses government spending and taxation to affect the economy as a whole

income and wealth redistribution \[term\]

government action, using mainly taxation and benefits, to reduce inequalities of income and wealth

progressive tax \[term\]

a tax which takes a greater percentage of tax the higher the income

main areas of UK government spending

• healthcare

• wellfare

• education

• interest payments

• defence

main causes of UK government revenue

• income tax

• Value added tax

• National insurance

• Excise duties

• Corporation tax

• Business rates

• Council tax

example of two countries usually in a budged deficit

• UK

• USA

example of a country running on a budget surplus

germany

what is meant by fiscal policy

• By increasing the rate of tax it effectively lowers aggregate demand

  • Individuals will have less disposable income

  • Firms will have less profit

  • Taxation can impact on unemployment, inflation, and economic growth

• Fiscal policy affects levels of income an expenditure within the economy

  • Government use the income from taxation for spending purposes

  • Pensions, health care, education, wellfare, infrastructure and defence are all paid for out of taxation

  • By increasing expenditure government can increase aggregate demand in the economy, and vice versa

  • When income is below expenditure the government will have to borrow

    • This leads to an increase in debt and therefore higher interest payments

how can fiscal policy help achieve full employment

• By lowering taxation there is a greater incentive for individuals to work

• In effect, the real wage rate will increase

• Firms will see an increase in profits if corporation tax falls

• This can be reinvested to create jobs

• By increasing expenditure government create an increase in aggregate demand

• This leads to more people working as firms demand more workers

how can fiscal policy help ensure price stability

• Increased taxation reduces aggregate demand

• This leads to a fall in demand pull inflation rates

• It will also impact on the costs of a firm

• Higher taxes increase costs

• This will impact of supply as cost push inflation will occur

• By raising or lowering taxation the government can help the economy to meet its inflation target of between 1 and 3%

how can fiscal policy help achieve economic growth

• Reducing taxation gives firms a greater incentive to produce

• It reduces the costs of firms

• This leads to an increase in the supply of goods and services

• An increase in spending will lead to higher aggregate demand

• This will lead to increased output by firms

• GDP will increase as a result

how fiscal policy can help having a strong BOP

• a fall in taxation makes firms more competitive

• This is due to lower costs

• Firms have more funds to invest in production, leading to improvements and lower unit costs

• Increased spending can be targeted to help firms increase output

• Government can spend on education, training and infrastructure

• All of these are vital if uk firms are to be competitive with other countries

• This will lead to increased exports as we are producing goods and services that other countries want to buy

how might direct taxes affect markets

• may affect labour markets

  • workers may not think that seeking a job with higher wage is worth their while if income tax is high

• if corporation tax is reduced firms will have more disposable income

  • they could use this to expand therefore increasing profits

how taxes ensure price stability

Increase taxes > people have less money > cant buy as much > reduces aggregate demand > reduces demand pull inflation > ensures price stability