Unit 5.2 - Fiscal policy

• Fiscal policy


  The use of taxation and government spending to influence aggregate demand to achieve the government's macroeconomic aims
• Terminology


  • Balanced budget
  • Budget deficit
  • Budget surplus
  • Structural deficit
  • Cyclical deficit
  • Tax base
  • Automatic stabilisers

  
• Balanced budget


  Government revenue equaling spending
• Budget deficit


  Government expenditure exceeding revenue
• Budget surplus


  Government revenue exceeding expenditure
• Structural deficit


  Caused by an imbalance between government spending and taxation
• Cyclical deficit


  A budget deficit caused by a decline in economic activity

  
• Tax base


  The coverage of what is taxed
• Automatic stabilisers


  Automatic changes in spending and taxation to reduce fluctuations in AD
• National debt


  • The total amount of government debt
  • Often expressed as a percentage of GDP
  • A budget deficit adds to the national debt
  • Opportunity costs of interest payments
  • National debt vs external debt

  
• Types of taxation


  • Direct taxes
  • Indirect taxes
• Direct taxes


  Taxes on income and wealth
• Indirect taxes


  Taxes on the sale of goods and services (spending)
• Types of indirect taxes


  • Specific taxes
  • Ad valorem taxes
• Specific taxes


  Taxes that are charged as a set amount per unit
• Ad valorem taxes


  Based on a percentage of the price
• Sin taxes


  An excise duty placed on products considered harmful to consumers
• Types of direct taxes

  • Income tax
  • Corporate tax
• Income tax


  Taxed on income earned
• Corporate tax


  Taxed on profits
• Types of tax rates

  • Proportional
  • Progressive
  • Regressive
• Proportional tax


  Takes the same % of the income of all income groups
• Progressive tax


  Takes a higher % of the income as that income rises
• Regressive tax


  Takes a larger % of the income of those on low incomes
• Marginal rate of tax (MRT)


  The proportion of extra income taken in tax
• Average rate of tax (ART)

  The proportion of total income that is taxed
• Types of government spending

  • Capital spending
  • Current spending
  • Spending on transfer payments

  
• Capital spending


  Spending on investment
• Current spending


  Spending on providing goods and services
• Spending on transfer payments


  Spending which uses resources. Counted in AD and GDP

  
• Reasons for government spending

  • To influence AD and level of economic activity
  • To try influence AS
  • To alleviate income inequality, poverty, to overcome market failure
  • To win political popularity
• Types of fiscal policy

  • Discretionary
  • Non-discretionary
• Discretionary fiscal policy


  Deliberate changes in (G) and (T)
• Non-discretionary fiscal policy


  Automatic stabilisers
• Expansionary fiscal policy


  Increases (G) and cuts in (T) designed to increase AD ⇒ budget deficit
• Contractionary fiscal policy


  Reduces (G) and increases (T) ⇒ budget surplus

  
• Automatic stabilisers are government spending and taxation that changes without deliberate action from government, to offset fluctuations in GDP
• The diagram shows the difference between government's cyclical and budget deficit

  
• To reduce demand-pull inflation

  Contractionary fiscal policy: Increase income tax rates / tax threshold reduced to widen the tax base, Cuts in government spending
• To increase output and raise employment

  Expansionary fiscal policy: Cutting direct and indirect tax to stimulate higher consumer expenditure and investment - increases AD