3.5 Fiscal Policy

Question 1

Fiscal policy definition

Answer 1

Fiscal policy is the use of taxation and government spending to influence the level of economic activity

Question 2

3 main areas of government spending

Answer 2

• social protection, aims to provide everyone with a basic standard of living
• health(NHS), everyone has access to basic healthcare services
• education, everyone has access to education

Question 3

Sources of goverment (taxation) revenue

Answer 3

Direct taxes - tax on income or wealth:
- income tax
- national insurance
- Corporation tax

Indirect taxes - a tax on spending, VAT

Question 4

Progressive taxes

Answer 4

Income tax, higher proportion of total income is payed by higher income earners, aims to reduce inequality, provides incentives for people to work

Question 5

Regressive taxes

Answer 5

VAT, takes the same amount from the tax payer regardless of income

Question 6

Government budget

Answer 6

Shows the difference between the total revenue gained from taxation and the total expenditure

Balanced budget: G = T

Budget deficit: G > T

Budget surplus: G < T

Question 7

Expansionary and contractionary fiscal policy

Answer 7

Expansionary: This is an increase in government spending or reduction in tax rates, used to generate short-run economic growth

Contractionary: this is a decrease in government spending or in an increase in taxation, used to reduce inflationary pressures

Question 8

Explain how government spending can cause employment

Answer 8

• increase goverment spending will generate employment in sectors which they spend on, also they can subsidise industries/products which they want to increase consumption in

Question 9

Eval of cost and benefits of fiscal policy

Answer 9

Depends on:

• consumer confidence, consumers are more likely to save rather than spend additional disposable income
• interest rates, reward for saving the additional disposable income is greater and therefore more likely to save
• competitiveness, low competition may lead to consumers to spend disposable income on imports
• how close to productive capacity, if the economy is already operating near productive capacity then inflation rates may increase rather than output

Question 10

Costs of fiscal policy

Answer 10

-opportunity costs, if government wants to avoid large deficits, they will have to reduce spending in other aspects of the economy

-time lags, if policy takes long time to take effect, then may not be a good short term solution to low levels of economic growth

-inflation, increased consumer spending leads to increase in demand therefore increase in the price level

Question 11

Evaluating the consequences of fiscal policy redistribution methods

Answer 11

• reduces inequality of income, since lower income earners pay a low percentage of tax. Depends if high income earners become incentivised to move abroad.
• reduces incentives, since people may desire better pay conditions less as they have to pay greater taxes, depends on the size of the tax
• lack of investment by firms, high level of corporation tax, leads to less investment decrease in the productive capacity. Also firms become less internationally competitive reducing exports, increase BOP deficit.

Question 12

Benefits of fiscal policy

Answer 12

• reduced unemployment government can cut taxes or increase spending, meaning there will be an increase in AD, and therefore output, this leads to a higher demand for labour.
• increase in economic growth, expansionary fiscal policy leads to greater output as consumers increase spending and firms increase investment.