Fiscal Policy

==Key Features:==

==Fiscal Policy== - Involves ==government spending== and ==taxation== to influence firms and individuals.
It is used to stimulate AD - * ==Reflationary Fiscal Policy==: Boosting AD by increasing government spending or lowering taxes. Could include a budget deficit (Government spending > Revenue)

Most likely used during a recession as it can increase economic growth and reduce unemployment.

Could increase inflation and worsen the current account of balance of payments as more money is spent on imports and income increases. * ==Deflationary Fiscal Policy==: Reducing AD by reducing government spending or increasing taxes. Could include a budget surplus (Government spending < Revenue)

Likely to be used during a boom as it can reduce price levels and better the current account of balance of payments as less money is spent on imports.

This may lead to higher unemployment levels and a reduced economic growth.

Two important features: * Automatic Stabilisers - This would mean that some fiscal policies may automatically be implemented. For example during a recession, government spending will increase as they will pay out more benefits. The government also end up with less tax revenue due to higher levels of unemployment * Discretionary Policy - Governments change their level of spending and tax.

==Cyclical and Structural Budget:==

Structural Budget position is government’s long term fiscal stance. Budget position over a whole period of the economic cycle.
Cyclical Budget position is government’s fiscal stance in the short term. Affected by where the economy is in the economic cycle.

==Tax System:==

Taxes should be cheap to collect, easy to pay, hard to avoid and do not create any undesirable disincentives.
Governments want to achieve horizontal and vertical equity. * Horizontal equity - People who have similar incomes and ability to pay tax should pay the same amount * Vertical equity - People with higher incomes and greater ability to pay tax should pay more than those with a lower income.
Taxes to promote equality - for example using tax to reduce differences in people’s disposable income or to raise revenue to pay for state provision services.
Direct Taxation - Income tax
Indirect Taxation - VAT
Progressive taxation - Individuals taxes rise as their income rises. This tax is used to redistribute income and reduce poverty for example investing more money into benefits and other merit goods increasing equality. This shows vertical equity.
Regressive taxation - Individuals taxes fall as their income rises. This can be used by the government to stimulate supply side growth. The government hope that the economy will benefit from the trickle down effect and that a regressive economy will incentive people to work harder and earn more income.

\ The Laffer Curve

Proportional taxation - Everyone pays the same amount of tax no matter their income level. It can achiever horizontal equity but is quite difficult to achieve. It could bring in less tax overall compared to the variable tax system.

==Various Types of Taxes:==

Sales tax aka VAT is a proportional tax. It is at a fixed percentage but can also be seen as a regressive tax as the percentage of the total income that the rich spend is less compared to that of the poor.
Progressive system of VAT might be to tax luxury goods at a higher tax rate.

==Size of Government Spending:==

Size and structure of country’s population affects the level of government spending.
Policies on inequality, poverty and the redistribution of income will alter the amount of government spending.
Fiscal policies governments use to tackle problems will also have an effect.

==Large Budget Deficits can cause Big Problems:==

A budget deficit must be paid for by public sector borrowing so that the government can spend more money than it earns in revenue.
Government can borrow money from UK banks, which creates deposits. Government can borrow money from the private sector by selling Treasury bills.
Short-run borrowing is fine as it can be used to stimulate demand but excessive borrowing is bad.
Excessive borrowing can cause demand-pull inflation as it increases the money supply so there is more money than can match the output. * This inflation can cause an increase in interest rates. Higher interests rate may discourage firms to invest which will end up making their exports less price competitive.
Borrowing will increase the country’s national debt causing problems. Long-term national debt can cause many problems: * High debt may cause firms and countries to stop lending money constraining the ability to grow * Taxpayers will be left with high-interest payments on debt to pay off. Future governments may need to cut spending to pay off the debt which can harm economic growth. * The large national debt can show excessive borrowing which increases inflation and can cause interest rates to rise. * Countries with higher debt are less attractive to foreign direct investment (FDI) because of uncertainty about the future.

==Budget Surpluses are not Ideal:==

Might suggest that taxes are too high or government is not spending enough in the economy.

==Governments follow Fiscal Rules to Avoid Overspending:==

Governments can borrow to invest in things i.e. infrastructure but cannot borrow to spend in current expenditure.
Fiscal policy can influence the behaviour of business and consumers by increasing confidence in the economy.
OBR (Office for Budget Responsibility) * Analysis UK public spending, tax and predicts government future spending * Assess performance of the government against the fiscal policies set * How sustainable government spending and revenue is

==Fiscal policy to tackle poverty :==

Governments spending money on benefits - to help the unemployed or unable to work
Spend tax revenue on goods/services - NHS, education
Providing good/services to poorer services good increase human capital in those areas which in the long run can increase labour
Progressive taxation can narrow gaps of peoples incomes (vertical equity).