fiscal policy

• Fiscal policy is the use of government revenue, spending and borrowing to influence the economy
• Gov set a range of different tax levels in different categories
• Increasing the rate of tax lowers aggregate demand, individuals will have less disposable income and firms will gain less profit
• Taxation can impact on unemployment, inflation and economic growth and is a very significant tool in controlling the economy
• Gov uses income from taxation for spending purposes ( pensions, health care, education , defense etc ) are paid for via taxation.

  By increasing expenditure gov can increase aggregate demand in economy, if income is below expenditure gov has to borrow leading to debts
• Direct taxes : Taxes imposed on the income of individuals or profits of businesses ( income, corporation tax )
• Indirect tax: Taxes imposed on goods and services ( VAT )
• ¥Taxation is the method used by government to raise income (revenue) through the imposition of a charge on individuals and firms
• VAT - value added tax, in the UK has 3 categories :

  1. 20% standard
  2. 5 % reduced
  3. 0 zero
• National insurance - Taxes paid by employees and employers to fund state benefits ( maternity leave and jobseekers allowance etc)
• Excise duties - specific taxes paid on certain products such as alcohol, cigarettes and petrol
• Corporation tax - A tax on the profits of businesses
• The UK gov gets its revenue from business rates:

  • taxes are levied on non-domestic properties such as shops, offices , warehouses etc
  • rateable value of businesses depends on their location
• The UK gov gets its revenue from council tax:

  1. Taxes that are levied on domestic properties dependent on their location
• The main areas of UK government spending include :

  1. pensions - money paid to those over the official retirement age
  2. Health care - NHS , free or cheap healthcare
  3. Welfare - child benefit, unemployment and housing
  4. education - Primary and secondary education mainly
  5. Interest payments - Gov borrow money to fund difference between revenue and spending, budget deficit. Debt grows - national debt
  6. Defense
• A balanced budget occurs when government revenue is equal to or greater than government expenditure
• Budgets are often in deficit when the economy has low economic growth or in a recession
• The budget deficit improves, moving towards balance when the economy is growing
• Running a budget deficit means that a government will have to borrow the difference between income and expenditure, this increases national debt making the interest on borrowing higher
• The budget deficit might be used to stimulate economic activity in a recession and then be paid off during a boom, when economic growth is high
• Running a budget surplus means that a government will be able to pay off the national debt
• A budget surplus however, puts pressure on households who may need to increase their personal debt, decrease in gov expenditure and household spending will impact negatively on economic growth
• Fiscal policy can be used to meet macroeconomic objectives - maintaining full employment :

  1. By lowering taxation there is a greater incentive for individuals to work
  2. In effect, the real wage rate will increase
  3. Firms will see an increase in profits if corporation tax falls
  4. This can be reinvested to create jobs
  5. By increasing expenditure government create an increase in aggregate demand
  6. This leads to more people working as firms demand more workers
• Fiscal policy can be used to meet macro economic objectives - ensuring price stability :

  1. Increased taxation reduces aggregate demand
  2. This leads to a fall in demand pull inflation rates
  3. It will also impact on the costs of a firm
  4. Higher taxes increase costs
  5. This will impact on supply as cost push inflation will occur
  6. By raising or lowering taxation the government can help the economy to meet its inflation target of between 1 and 3%
• Fiscal policy can be used to meet macroeconomic objectives - achieving economic growth :

  1. Reducing taxation gives firms a greater incentive to produce
  2. It reduces the costs of firms
  3. This leads to an increase in the supply of goods and services
  4. An increase in spending will lead to higher aggregate demand
  5. This will lead to increased output by firms
  6. GDP will increase as a result
• Fiscal policy can be used to meet macroeconomic objectives - having a strong balance of payments:

  1. A fall in taxation makes firms more competitive
  2. This is due to lower costs
  3. Firms have more funds to invest in production, leading to improvements and lower unit costs
  4. Increased spending can be targeted to help firms increase output
  5. Government can spend on education, training and infrastructure
  6. All of these are vital if UK firms are to be competitive with other countries
  7. This will lead to increased exports as we are producing goods and services that other countries want to buy