Lecture 3 - Fiscal Policy

Fiscal Policy

Learning Outcomes

  • Explain the meaning of macroeconomics

  • Identify typical government economic objectives

  • Explain government policy instruments

  • Identify possible conflicts of government economic objectives

Macroeconomics

Government Economic Objectives

  • Economic growth

  • Stable prices

  • Low levels of unemployment

  • A favorable balance of trade

Policy Instruments

Types of Economic Tools

  • Fiscal Policy:

    • Involves changing government spending and taxation rates

  • Monetary Policy:

    • Controls the money supply and interest rates

Key Policy Instruments

  • Government Spending

  • Taxation and Benefits

  • Interest Rates

  • Control of the Money Supply

Examples of Government Policy Changes

  • Cut income tax rates, increasing consumer spending (affecting aggregate demand)

  • Increase spending in sectors like health and defense (affecting aggregate demand)

  • Lower interest rates to stimulate borrowing (monetary policy affecting aggregate demand)

  • Make borrowing easier for investments (monetary policy affecting aggregate supply)

  • Reduce unemployment benefits to incentivize work (fiscal policy affecting aggregate supply)

Fiscal Policy Explained

  • Defined as the government's decisions regarding taxation and spending

  • It encompasses various taxes, benefits, and public services

  • A significant tool for modifying economic performance and resource distribution

Government Spending Includes:

  • Defense

  • Social Security Benefits

  • Education

  • Repayments on Previous Borrowing

UK Public Sector Spending (2018-19)

  • Social Protection: £252bn

  • Health: £155bn

  • Education: £102bn

  • Defence: £49bn

  • Other Sectors: Various allocations including transport, housing, and personal social services

Public Sector Receipts (2018-19)

  • Income Tax: £185bn

  • VAT: £145bn

  • National Insurance Contributions: £134bn

  • Total Revenue Sources include various other taxes and non-tax revenues

Government Revenue

Sources of Government Funding

  • Tax Revenue

  • Borrowing

Taxation Types

Direct Taxes

  • Paid on income and profits

  • Examples:

  • Income Tax

  • Corporation Tax

  • Capital Gains Tax

  • Inheritance Tax

Indirect Taxes

  • Incurred during purchases

  • Examples:

    • VAT

    • Excise Duties

    • Customs Duties

Taxation Systems

Types of Taxation

  • Progressive: Average tax rate increases with income

  • Regressive: Average tax rate decreases as income increases

  • Proportional: Constant percentage paid regardless of income

Effective Taxation System

Features

  • Understandable

  • Cost-effective to administer

  • Difficult to evade

  • Non-distortionary

Fairness of Taxation

  • Horizontal Equity: Similar taxpayers pay similar amounts

  • Vertical Equity: Taxpayers with greater ability to pay owe more

Using Taxation as a Policy Instrument

  • Higher tax rates may disincentivize work (poverty trap)

  • Tax cuts can incentivize labor and potentially increase overall tax revenue

The Laffer Curve

  • Illustrates the relationship between tax rates and tax revenue

  • Initially, increasing tax rates boost revenue

  • Eventually, higher rates can reduce revenue due to disincentives

Types of Benefits

  • Means-Tested Benefits

  • Universal Benefits

  • Benefits in Kind

Government Borrowing and Deficits

Understanding Borrowing Needs

  • Government deficits arise when spending exceeds revenue

  • Deficits measured in monetary terms and as a percentage of national income

Public Sector Net Borrowing (PSNB)

  • Represents the annual difference between government spending and income

  • Government finances deficits via borrowing or selling securities

UK Government Deficit

Data Overview

  • Shows annual deficit as a percentage of GDP from 2009-2017

Government Budgets and Deficits

  • Explains the relationship between government budget position and national income

Budget Changes

Automatic and Discretionary Changes

  • Automatic Stabilizers: Taxes and expenditures that change with national income

  • Discretionary Policies: Changes enacted in response to economic conditions

Types of Fiscal Policies

Reflationary Fiscal Policies

  • Aim to increase aggregate demand

  • Actions include increasing spending or reducing taxes

Contractionary Fiscal Policies

  • Aim to decrease aggregate demand

  • Actions include decreasing spending or increasing taxes

Issues with Fiscal Policy

  • Problems include fiscal drag, public cash requirements, and national debt

Summary

  • Fiscal policy involves changes in taxation and spending to meet macroeconomic objectives, including both expansionary and contractionary policies

Conclusion

  • Overview of macroeconomics

  • Discussion on policy instruments, particularly fiscal policy, and the role of taxation systems.