4.2.5 Fiscal policy and supply-side policies Flashcards
(88 cards)
1
Q
What is fiscal policy?
A
It involves the manipulation of government spending, taxation and the budget balance in order to manage the economy.
2
Q
What is the aim of fiscal policy?
A
To stimulate economic growth and stabilise the economy.
3
Q
What does the UK government spend the majority of their budget on?
A
Pensions and welfare benefits, followed by health and education.
4
Q
What is the biggest source of tax revenue in the UK?
A
Income tax.
5
Q
What is expansionary fiscal policy?
A
Fiscal policy aimed at increasing AD, by increasing spending or reducing taxes, leading to a worsening budget deficit
6
Q
What is contractionary/deflationary fiscal policy?
A
- Fiscal policy aimed at decreasing AD, by cutting spending or raising taxes, reducing consumer spending
- Leads to an improvement of the government budget deficit
7
Q
How can fiscal policy be used to manage AD?
A
Expansionary or contractionary fiscal policy.
8
Q
What are the consequences of expansionary fiscal policy?
A
- Cutting taxes can potentially result in a very low multiplier, due to leakages from increased savings (but UK is a spending economy)
- Short term increased budget deficit results in a greater need to issue bonds, potentially needing to raise interest rates to attract investors, increasing debt interest spending, resulting in an opportunity cost of government spending
- Time lags can result in the impact of policy not having the intended effect, such as an increase in exports in a now improved economy potentially becoming inflationary
- Ricardian equivalence means that more government spending today may lead to some citizens realising taxes will increase in the LR, increasing savings, a leakage, but this depends on the quantity of people
9
Q
What does the result of fiscal policy to manage AD depend on?
A
- The current state of the economy
- What is being spent/cut in terms of taxes
- The current debt to GDP ratio, as cutting taxes is unlikely to be an issue if debt is less than GDP, as GDP will increase from the policy more than the debt from newly issued bonds
- If the deficit is cyclical, as it will sort itself over the economic cycle, or structural, like in the UK
10
Q
What are the consequences of contractionary fiscal policy?
A
- Increasing taxes can potentially result in a high multiplier, due to spending, and could cause demand-pull inflation
- Short term improved budget deficit results in less need to issue bonds, decreasing debt interest spending, so revenue can be spent elsewhere
11
Q
What would be the Keynesian argument for expansionary fiscal policy?
A
It will increase AD, leading to more employment and growth, increasing tax revenue and decreasing government spending.
12
Q
How can fiscal policy be used to manage AS?
A
Supply-side fiscal policy.
13
Q
What is supply-side fiscal policy?
A
Fiscal policy aiming to boost AS and potential output of the economy.
14
Q
What are examples of supply-side fiscal policy?
A
- Reducing income and corporation tax to encourage spending and investment
- Subsidising training or spend more on education, lowering costs for firms as they will have to train fewer workers
- Spending on healthcare, which can improve the quality of the labour force, contributing towards higher productivity
- Increasing spending on infrastructure, such as improving roads and schools
15
Q
What is the government debt?
A
The accumulation of the government deficit over time, and the amount they owe to its creditors
16
Q
Why does the government tax?
A
- To create revenue to provide public goods and services, and merit goods to increase consumption
- To decrease consumption of demerit goods
- To redistribute income/wealth
- To manage the economy using AD
- To attempt to balance the budget
17
Q
What are direct taxes?
A
- Taxes imposed on income and are paid directly to the government from the tax payer, so it cannot be passed on
- Examples include income tax, corporation tax, NICs and inheritance tax
18
Q
What are indirect taxes?
A
Taxes imposed on expenditure on goods and services, increasing production costs for producers, increasing market prices.
19
Q
What are the two types of indirect taxes?
A
- Ad valorem taxes are percentages, such as VAT, adding 20% of the unit price, and is the main indirect tax in the UK
- Specific taxes are a set tax per unit, such as the 58p per litre fuel duty on unleaded petrol
20
Q
What are proportional taxes?
A
- Taxes with a fixed rate for all tax payers, so the marginal rate of tax is constant, which could encourage people to earn higher incomes
- The incidence of taxes is equal, regardless of the ability of the taxpayer to pay
21
Q
What are progressive taxes?
A
- The average rate of taxation increases as income increases, so as income increases, the proportion of income taxed increases, such as income tax in the UK
- Help to reduce inequality as those on lower incomes pay less, as it is based on the payer’s ability to pay
22
Q
What are regressive taxes?
A
- Taxes unrelated to income, but mean that those on lowest incomes have a higher average rate of tax, so the proportion of income paid as tax is higher for those on lower incomes than those on higher incomes
- Lead to a less equitable distribution of income
23
Q
What would be an example of a proportional tax?
A
A constant income tax rate of 20% for all taxpayers.
24
Q
What would be an example of a progressive tax?
A
Direct taxes, such as income and corporation tax.
25
What would be an example of a regressive tax?
Indirect taxes, such as VAT or council tax.
26
Describe the Laffer curve.
As the tax rate increases from 0%, tax revenue increases up to the tax rate t*, then tax revenue decreases as tax rate increases further to 100%.
27
What are the reasons for tax revenue falling when tax rate increases shown by the Laffer curve?
- Increased tax avoidance/evasion
- Disincentives to work
- ‘Brain drain’, as high income earners leave the country
28
What are the principles of taxation?
- Economical - the cost of collecting the tax must be low relative to the yield
- Clear - the timing and quantity paid must be obvious to the tax payer
- Convenient - the timing and way of paying must be convenient for the tax payer
- Equitable - should be imposed depending on the ability to pay
- Efficient - should not limit efficiency and there should only be a minimum loss of efficiency
- Compatible - should be compatible with tax systems of other countries, such as the UK and the rest of Europe
- Flexible - should adjust with inflation and be easy to change
29
What are limitations of fiscal policy?
- Governments may have imperfect information about the economy, leading to inefficient spending
- Significant time lags involved with employing fiscal policy can lead to unintended effects
- Crowding out resulting from borrowing from the private sector leaving fewer funds available for the public sector, as interest rates increase to attract buyers, decreasing private investment
- The bigger the size of the multiplier, the bigger the effect on AD and the more effective the policy
- If interest rates are high, fiscal policy might not be effective for increasing demand, as saving might increase
- There could be difficulties paying back the debt if the government spends too much, making it difficult to borrow in the future
30
What are the types of public expenditure?
- Current government expenditure
- Capital government expenditure
- Transfer payments
31
What is current government expenditure?
- Recurring spending on goods and services which are consumed and last for a short period of time
- Such as on drugs for the health service
32
What is capital government expenditure?
- Spending on assets which can be used multiple times
- Such as on roads or building a school
33
What are transfer payments?
- Welfare payments from the government, aiming to provide a minimum standard of living for those on low incomes
- No goods or services are exchanged for transfer payments
- Such as JSA, income support, child benefit or the state pension
34
What are the reasons for public expenditure and levying of taxes?
- To ensure people have a basic standard of living and to help reduce the level of inequality in society
- Transfer payments are a means for the government to redistribute income from the rich to the poor
35
What are the reasons for the changing size and composition of public expenditure in the UK?
- The UK government spends most of their budget on pensions and welfare benefits, followed by health and education
- Income tax is the biggest source of tax revenue
- Education spending has remained relatively constant, as it is protected
- After the war people saw social security payments (payments from the government to assist those who have low incomes) as necessary, so there has been a general increase in spending
- Defence spending is falling in the UK
36
How is productivity and growth impacted by public expenditure?
- Supply-side policies improve human capital and boost long run growth
- Human capital is important for competitiveness
- Education and training can mean higher value products can be made and productivity can be improved
37
How is crowding out impacted by public expenditure?
- Spending may be funded using taxes or running a budget deficit, leaving fewer funds in the private sector for firms, crowding them out of the market
- Lots of government borrowing might increase interest rates, discouraging spending and investment among the private sector, which is the crowding out of investment
38
How is the level of taxation impacted by public expenditure?
The tax rate might increase if government debt gets too high.
39
How is equality and living standards impacted by public expenditure?
- Progressive taxes could be used to reduce inequality, as the poorest in society pay the smallest proportion of their income on tax
- Those on the lowest incomes helped by redistributive policies and welfare payments
- Capital spending on housing and public services provision, such as education and welfare, ensures even those on low incomes can afford a good standard of healthcare and education
- All members of society can achieve a minimum standard of living
40
What is the government budget comprised of?
Tax revenues and government expenditure
41
When does a government have a budget surplus?
When tax receipts exceed expenditure
42
When does a government have a budget deficit?
When expenditure exceeds tax receipts in a financial year
43
When does a government have a balanced budget?
When expenditure is equal to revenue
44
What is the relationship between the budget balance and the national debt?
- If the government is continuously running a deficit, the size of the debt increases
- If the size of the deficit is reduced, the rate of increase of the total debt is slower, but the debt is still increasing
- If a budget surplus is run, the size of the national debt decreases
45
What is a cyclical budget deficit?
- A temporary deficit related to the business cycle
- Might occur during recessions, when governments increase spending to stimulate the economy
46
What is a structural budget deficit?
A deficit due to an imbalance in the revenue and expenditure of the government, so exists at every point in the business cycle.
47
What are the consequences of a budget deficit for macroeconomic performance?
- A fiscal deficit could be inflationary if it increases AD
- More government spending could lead to crowding out of the private sector, as borrowing leaves fewer funds for firms to use, crowding them out of the market, decreasing private investment
- It could lead to increased interest rates, as the government has to offer investors an attractive rate to encourage them to buy the debt
48
What is the significance of the size of the national debt?
- The cost of borrowing could increase, as the government is increasing the demand for credit in the economy by borrowing
- Interest rates might rise to encourage investors to buy bonds to finance the debt if confidence is lost in the government’s ability to repay the debt
- It could lead to higher taxes and austerity measures, especially if the debt becomes uncontrollable
49
What is the role of the Office for Budget Responsibility?
- Provide analysis of the UK’s finances
- Produce 5-year forecasts for the economy, including the impact of tax and spending changes announced in the Budget
- Assess the likelihood of the government meeting its targets and judge its performance against its fiscal targets to balance the budget 5 years ahead
- Scrutinise tax and welfare spending measures
50
What are supply-side policies?
Policies aimed at improving the long run potential of the economy by making markets more competitive and efficient.
51
What are supply-side improvements?
Improvements to the long run productive potential of the economy by the private sector.
52
What are the strengths of supply-side policies?
They are the only policies which can deal with structural unemployment.
53
Why are supply-side policies the only policies which can deal with structural unemployment?
The labour market can be directly improved with education and training.
54
Which type of policies are better at dealing with cyclical unemployment and why?
Demand-side policies, as they can reduce the size of the negative output gap and shift the AD curve right.
55
What are the weaknesses of supply-side policies?
- Demand-side policies are better at dealing with cyclical unemployment, as they can reduce the size of the negative output gap and increase AD
- Significant time lags
- Market-based supply-side policies, such as reducing the rate of tax, could lead to a more unequal distribution of wealth
56
What is the difference between market-based and interventionist policies?
- Market-based policies limit the intervention of the government and allow the free market to eliminate imbalances, using the forces of supply and demand
- Interventionist policies rely on the government intervening in the market
57
What are examples of free market supply-side policies?
- Reducing income tax
- Reducing corporation tax
- Cutting unemployment benefits
- Reducing trade union power
- Privatisation
- Deregulation
58
What is the supply-side impact of reducing income tax?
- Incentive to work increases
- Incentive to work more productively increases
59
What is the impact of reducing income tax on the main macroeconomic objectives?
- AD increases due to increased consumption
- Decreased voluntary unemployment
- Non-inflationary growth
60
Evaluate the implementation of the free market supply-side policy of reducing income tax.
- Tax revenue may increase, depending on the tax rate before and after (Laffer curve)
- But the budget deficit may increase
61
What is the supply-side impact of reducing corporation tax?
- Increased profit increases investment
- Incentivises MNCs to move to the country, increasing competition and efficiency
62
What is the impact of reducing corporation tax on the main macroeconomic objectives?
- Increased AD due to more investment
- Non-inflationary growth as LRAS also increases due to an increase in the productive potential of the economy
63
Evaluate the implementation of the free market supply-side policy of reducing corporation tax.
- Tax revenue may increase, depending on the tax rate before and after (Laffer curve)
- But the budget deficit may increase
- Pros and cons of MNCs
64
What is the supply-side impact of cutting unemployment benefits?
- The supply of labour increases
- Increased incentive to work
65
What is the impact of cutting unemployment benefits on the main macroeconomic objectives?
- Increased AD due to increased consumption
- Non-inflationary growth as LRAS also increases due to the increase in the productive potential of the economy
- Budget deficit decreases due to less government spending and more tax revenue
66
Evaluate the implementation of the free market supply-side policy of cutting unemployment benefits.
- The poverty trap will lessen due to increased incentive to work
- Budget deficit decreases due to less government spending and more tax revenue
- Inequality increases due to more poverty, as those that need welfare payments are worse off
67
What is the supply-side impact of reducing trade union power?
- Increased productivity as less time is lost to striking
- As trade unions aim to increase wages, costs for firms will decrease
- Efficiency will increase as trade unions aim to achieve the opposite
68
What is the impact of reducing trade union power on the main macroeconomic objectives?
- Increased long run growth
- More exports due to efficiency improvements
- Unemployment decreased
69
Evaluate the implementation of the free market supply-side policy of reducing trade union power.
- Less unemployment at the cost of worse standard of living for the employed due to lower wages
- More exports possibly improving trade deficit depending on a change in imports
- Maybe less motivated workers due to less opportunity for higher wages and better working conditions
70
What is the supply-side impact of privatisation?
- More competition and competitors
- Profit maximisation incentivises cost cutting and efficiency
71
What is the impact of privatisation on the main macroeconomic objectives?
- Increased long run growth
- More exports
- Decreased budget deficit
72
Evaluate the implementation of the free market supply-side policy of privatisation.
- Improved budget due to selling to the private sector and more corporation tax
- Pros and cons of privatisation
73
What is the supply-side impact of deregulation?
- Business made easier due to less red tape
- Easier to start a business, increasing contestability, increasing efficiency
74
What is the impact of deregulation on the main macroeconomic objectives?
- Increased long run growth
- More exports
- Decreased unemployment from new firms
75
Evaluate the implementation of the free market supply-side policy of deregulation.
- Improved trade deficit depending on change in imports
- Possibly less government spending due to admin for enforcing regulation
76
What are examples of interventionist supply-side policies?
- Education and training
- Subsidies for new firms
- Infrastructure improvements
- Competition policy
77
What is the supply-side impact of education and training?
- Improved labour productivity
- Increased efficiency
78
What is the impact of education and training on the main macroeconomic objectives?
- Decreased cyclical and structural unemployment
- Increased competitiveness increases exports, increasing world output and reducing the trade deficit
- AD increases due to more consumption
- SRAS decreases due to lower costs for firms as they will do less training for their workers
- Therefore non-inflationary growth
79
Evaluate the implementation of the interventionist supply-side policy of education and training.
- Possibility for brain drain
- Opportunity cost of spending, such as healthcare
- Worsening budget deficit
- Time lag
- Possibility for government inefficiency due to imperfect information
80
What is the supply-side impact of subsidies for new firms?
- More contestability
- More competition increases efficiency and investment
81
What is the impact of subsidies for new firms on the main macroeconomic objectives?
- Decreased cyclical and structural unemployment
- Increased exports, increasing world output and reducing the trade deficit
- AD increases due to more consumption
- Increased long run growth due to a higher productive potential in the economy
- Non-inflationary growth
82
Evaluate the implementation of the interventionist supply-side policy of subsidies for new firms.
- Opportunity cost of spending, such as healthcare
- Worsening budget deficit
- Time lag
- Possibility for government inefficiency due to imperfect information
- Depends on the market structure
- Firms could become reliant on subsidies, causing inefficiency
83
What is the supply-side impact of infrastructure improvements?
- Improving transport infrastructure can improve the geographical mobility of labour
- Improving schools and healthcare infrastructure increases productivity and efficiency
84
What is the impact of infrastructure improvements on the main macroeconomic objectives?
- Worsening budget deficit
- Long run growth
- Decreased structural unemployment due to geographical immobility
85
Evaluate the implementation of the interventionist supply-side policy of infrastructure improvements.
- Opportunity cost of spending
- Worsening budget deficit
- Time lag
- Possibility for government inefficiency due to imperfect information
86
What is the supply-side impact of competition policy?
- Reduces monopoly power, increasing competition
- Increases contestability, allowing new firms to enter markets
87
What is the impact of competition policy on the main macroeconomic objectives?
- Increased LRAS and non-inflationary growth
- Decreased unemployment
88
Evaluate the implementation of the interventionist supply-side policy of competition policy.
- Budget deficit may worsen depending on admin costs of enforcing policy
- Reduces supernormal profit, possibly reducing dynamic efficiency and innovation
