Fiscal Policy

• Fiscal policy refers to changes in government spending, borrowing and taxation.
• Government spending is borrowing overseas.
• Government spending is done through transfers of benefits and pensions, public services and capital spending/ infrastructure.
• Taxation are indirect and direct taxes. Indirect are on goods and services. Direct are on income and wealth.
• Fiscal policy can stabilise and stimulate AD growth and corrects market failures.
• Progressive tax is as income increases, the percentage of tax paid, increases.
• Regressive tax is as income increases, the percentage or tax paid, decreases.
• Regressive tax disproportionally effects low income workers.
• Regressive tax is an indirect tax because it is not based on income or wealth. (Standard VAT is 20% for all incomes).
• Progressive tax is a direct tax because it is based on income and wealth (income tax).
• Tax avoidance is avoiding tax by not showing a high amount of income.
• Tax evasion is when you don't pay taxes.
• Tax incidence is when the company pays the majority of the tax so they don't raise their prices.
• Income tax is a direct tax.
• VAT is an indirect tax.
• Corporation tax is a direct tax.
• The standard VAT is 20% on all goods and services.
• VAT is charged on expenditure.
• Fiscal balance = total tax revenue - total expenditure
• National debt refers to the total of government debt accumulated.
• A budget deficit is good because:

  • Increases in government spending
  • Lower taxes so higher disposable income
  • Multiplier effect leads to the accelerator effect
• A budget deficit is bad because:

  • More borrowing is needed to finance the deficit
  • Higher interest rates because of reduced borrowing
  • Expectations of higher taxes if taxes are low now. People may cut back on spending.
• 'Crowding cut' is when there is an increase in Government borrowing so less funds for private investment. This decreases AD.
• Automatic fiscal stabilisers are when the economy enters a boom and slump with no change in government policies.
• In a boom, higher income means more income tax so tax revenue increases. This decreases the need for benefits because more are employed so there is a budget surplus. (T>G).
• In a slump, there is less tax revenue collected so benefits increase because less are employed. This creates a budget deficit (G>T).
• The economy might get stuck in a recession if there is a lack of consumer confidence or a lack of business investment. AD does not increase.
• If the economy is stuck in a recession, the government may have to implement a discretionary fiscal policy.
• A discretionary fiscal policy is when the government has to deliberately change policies to recover AD.
• The impact of the automatic fiscal stabilisers depend on whether the government allows them, how generous the benefits are and how much people spend and save.
• The expansionary and contractionary fiscal policy are both discretionary fiscal policies because there are deliberate changes being done through lower taxes and higher government spending.
• An expansionary fiscal policy closes the negative output gap and creates a higher equilibrium level because AD and SRAS increase.
• A contractionary fiscal policy closes the positive output gap and lowers the equilibrium level because of the decrease in AD and SRAS.
• A fiscal multiplier estimates the final changes in national income GDP that results from the inital injection.
• The fiscal multiplier depends on:

  • the marginal propensity to consume
  • the impact on consumer and business confidence
  • the degree to which the economy is open to imports (leakages)
• A high fiscal multiplier increases aggregate demand when recovering from a recession.
• Spending through an expansionary fiscal policy:

  • education (capital and current spending)
  • skills (more spending in apprenticeships and training)
  • transport (opens up jobs and supply can be distributed at a faster rate)
• Taxes that can be cut through an expansionary fiscal policy include:

  • VAT
  • employer national insurance
• Free market economists argue that cutting tax creates an incentive to earn more because tax rates are low which would increase GDP. However, the laffer curve disagrees.
• As tax revenue falls, there is a disincentive to work and stay on benefits as well as a loss of highly skilled jobs.