Chapter 13

Question 1

What are the 2 types of gov taxes?

Answer 1

Direct taxes = taxes on different forms of income
Indirect taxes = taxes on expenditure

Question 2

Taxation finances what?

Answer 2

Gov expenditure

Question 3

Define fiscal policy

Answer 3

Changes in gov spending or taxation to achieve economic change

Question 4

Define direct tax

Answer 4

Taxes which cannot be avoided and are normally levied on incomes

Question 5

Define indirect tax

Answer 5

Taxes which can be passed on to others and are normally expenditure

Question 6

Explain progressive taxes

Answer 6

Are paid in bands of income
In the UK, 0%, 20%, 40% and 45% tax rates are used as incomes rise

Question 7

Explain regressive taxes

Answer 7

Taxes on expenditure and fixed-sum taxes are often regressive if the expenditure is paid by all the income earners in similar amounts.
VAT may be regressive if necessities are taxed

Question 8

Explain proportional taxes

Answer 8

VAT may be proportional if only luxuries are taxed

Question 9

What are the UK’s 9 main taxes?

Answer 9

Income tax - paid on income from employment
National insurance contributions
Corporation tax
Capital gains tax
Inheritance tax
Value added tax (VAT)
Excise duties
Council tax
Stamp duty

Question 10

What are the benefits/cons of taxes on incomes (i.e. income tax, corporation tax)?

Answer 10

Pros/
Progressive tax may be equitable and alleviate relative poverty

Cons/
Income taxes create incentives to work
High income taxes encourage tax evasion/avoidance
High business taxes may cause a ‘brain drain’ (or a failure to attract FDI)

Question 11

What are the pros/cons of taxes on expenditure (i.e. VAT)?

Answer 11

Pros/
Change patters of expenditure (i.e. taxing demerit goods)
Do not create incentives to work/invest

Cons/
Possibly regressive
Lead to underground/black markets

Question 12

What are the 5 reasons for government levying taxes?

Answer 12

Raise rev to finance expenditure
Change patterns of economic activity (i.e. taxes on demerit goods)
Redistribute income (possibly via progressive taxes)
Manage the macroeconomy (to change AD)
Raise money for particular causes - hypothecated taxes

Question 13

Define progressive tax

Answer 13

A tax that increases as a proportion of income as income rises

Question 14

Define regressive tax

Answer 14

A tax that increases as a proportion of income as income falls

Question 15

Define proportional tax

Answer 15

A tax that is paid as an equal proportion of income at all levels of income

Question 16

What are the principles of taxation?

Answer 16

A good tax should be:
Economical
Equitable
Efficient
Convenient
Certain
Flexible

Question 17

Explain public (gov) expenditure

Answer 17

Current expenditure - spending on day-to-day costs in providing public services (i.e. NHS salaries)
Capital expenditure - spending on long term projects (i.e. infrastructure)

Question 18

What are the 6 reasons for gov expenditure?

Answer 18

Provision of welfare
Provision of public goods
Provision of merit goods
Servicing the national debt
Macroeconomic management (affecting AD)
Supply-side improvements/investment

Question 19

What do changes in tax and gov spending affect?

What 3 things does changes in the fiscal policy affect?

Answer 19

AD

Level of real GDP
Unemployment rate
Inflation rate

It will also affect AD via effects on consumption, investment and gov expenditure.

Question 20

Explain the expansionary fiscal policy

Answer 20

Is a fiscal policy that increases AD.
Higher gov expenditure
Lower rates of taxation

Question 21

Explain the contractionary fiscal policy

Answer 21

Is a fiscal policy that decreases AD.
Lower gov expenditure
Higher rates of taxation

Question 22

Explain the fiscal policy in regards to aggregate supply

Answer 22

Changes in fiscal policy also affect AD
Changes in indirect taxes affect SRAS (i.e. higher VAT shifts SRAS leftwards)
Changes in gov expenditure can affect LRAS (i.e. improvements to education)
Changes in tax rates can encourage higher business investment in research, leading to supply-side improvements (LRAS)

Fiscal policy can have microeconomic effects:
- subsidies used to encourage consumption of certain goods
- indirect taxes change patterns of behaviour

Question 23

Explain the budget balance

Answer 23

Measures the difference between gov spending and rev from taxation.

Measures a gov’s fiscal stance (how easy/loose or tight/restrictive currency policy is)
Budget deficits are financed by the issue of bonds, adding to national debt
Budget surpluses allow the partial repayment of national debt

Question 24

What is a budget deficit?

Answer 24

Gov spending > taxation

Question 25

What is a budget surplus?

Answer 25

Taxation > gov spending

Question 26

Define the budget balance

Answer 26

Measures the difference between gov spending and rev from taxation

Question 27

How can a budget deficit be caused?

Answer 27

Expansionary fiscal policy Low economic growth leading to low taxation revenue

Question 28

Budget deficits can be split into 2 components

Answer 28

Cyclical budget deficits Structural budget deficits

Question 29

What are the features of cyclical deficits?

Answer 29

Budget deficits resulting in lower than average economic growth When economic growth is lower than average, taxation rev falls and gov welfare spending increases Cyclical deficits are eliminated by faster economic growth

Question 30

What are the features of structural deficits?

Answer 30

Budget deficits remaining when economic growth is average or above Faster economic growth reduces a budget deficit but the structural component remains Structural deficits are eliminated by reductions in gov spending or increases in tax rates

Question 31

What are the 3 outcomes of budget deficits and budget surplus?

Answer 31

Economic growth - budget deficits add to AD and increase economic growth, whereas surpluses reduce AD and reduce economic growth. Economic growth also affects the budget balance: - faster growth generates higher tax rev and reduces a deficit - lower growth generates lower tax rev and adds to a deficit Unemployment - expansionary fiscal policy increases a budget deficit and reduces unemployment. Contractionary fiscal policy decreases a budget deficit and increases unemployment. Inflation - expansionary fiscal policy adds to AD and increases demand-pull inflation. Contractionary fiscal policy reduces AD and decreases demand-pull inflation

Question 32

What is the significance of the national debt?

Answer 32

National debt represents accumulated past budget deficits. Larger national debt = higher interest payments to service this debt (paid on each bond issued) If national debt becomes too large = investors buying bonds will demand higher interest rates on each bond issued - increasing gov spending

Question 33

What does national debt (as a percentage of GDP) do if it grows at a slower rate than the rate of growth in GDP (economic growth)

Answer 33

It falls

Question 34

Define the term cyclical budget deficit

Answer 34

A budget deficit caused by the effects of lower economic growth

Question 35

Define the term structural budget deficit

Answer 35

A budget deficit which remains even when economic growth is average or higher

Question 36

Define the term national debt

Answer 36

The accumulated stock of outstanding bonds issued, due for eventual repayment

Question 37

Explain the OBR

Answer 37

Office for Budget Responsibility = provides independent analysis of fiscal policy. Makes it harder for gov to use fiscal policy for political motives.

Question 38

What are the 5 main functions of the OBR?

Answer 38

Economic forecasting Evaluating fiscal policy Analysis of public finances sustainability Evaluation of fiscal risks Analysis of tax and welfare costing

Question 39

What is long run economic growth a result of?

Answer 39

Improvements/increases in the supply side of the economy

Question 40

What do supply-side policies (improvements) allow?

Answer 40

Increases GDP without inflationary pressures emerging.

Question 41

What are the economic effects of supply side policies on GDP?

Answer 41

Increasing the supply side of the economy should lead to higher GDP Long-run growth is increased with supply side reform. Actual growth can be increased through policies designed to increase (LR)AS and AD

Question 42

What are the economic effects of supply side policies on unemployment?

Answer 42

Lower income taxes discourage people being voluntarily unemployed Reduced welfare benefits discourage voluntary and/or frictional unemployment Deregulation of markets (and privatisation) encourages competition, allowing businesses to expand - needing more workers Improvements in education should reduce occupational immobility and reduce structural unemployment Investment in infrastructure (especially transport) should reduce geographical immobility and reduce structural unemployment

Question 43

What are the economic effects of supply side policies on inflation?

Answer 43

Increase in LRAS means AD can be increased without demand-pull inflation emerging Trade union reform should reduce cost-push pressure (as wage increases are moderated) More competition in markets lead to less upward pressure on prices

Question 44

What are the economic effects of supply side policies on the current account of the balance of payments?

Answer 44

Downward pressure on inflation should increase export competitiveness. More productive workforce should mean exports are produced more cheaply Quality of output should improve, increasing demand for UK exports

Question 45

Define supply-side policies

Answer 45

Gov policies to increase the productive capacity of the economy

Question 46

Define supply-side improvements

Answer 46

Natural increases in the productive capacity of the economy (i.e. higher birth rate etc)

Question 47

What are the 6 free market supply side policies?

Answer 47

Income tax cuts and personal incentives Reduction in trade union power Reduction or elimination of the min wage Reduction in unemployment benefits Reduction in labour protection Privatisation and deregulation

Question 48

Explain the free market supply side policy of income tax cuts and personal incentives

Answer 48

Cuts in income tax are a supply-side policy Lower income tax rates mean workers keep more of each £ earned = encourages more people to supply their labour and will increase the tax rev earned as more people work. Can be seen on the Laffer curve diagram

Question 49

Explain the free market supply side policy of reduction in trade union power

Answer 49

Trade unions use collective strength to push wages above the free market equilibrium level. Reducing trade union power makes it easier for firms to hire/fire workers

Question 50

Explain the free market supply side policy of reduction or elimination of the min wage

Answer 50

Min wages create real-wage unemployment Reducing or abolishing min wages should move the wage rate back to its free market equilibrium level. A min wage will add to or create real-wage unemployment - therefore reducing or abolishing the min wage will reduce this type of unemployment

Question 51

Explain the free market supply side policy of reduction in unemployment benefits

Answer 51

Benefits make being unemployed more attractive and workers will take longer to move between jobs. Reducing the level of benefits or making it harder to qualify for benefits reduces voluntary and frictional unemployment

Question 52

Explain the free market supply side policy of reduction in labour protection

Answer 52

Minimising or cancelling labour protection legislation reduces unemployment. Firms are more willing to employ workers if the cost of employing workers is lower. Employment is more likely if its easier for firms to shed surplus labour. 0 hours contracts are a good example of how firms can choose when to hire workers, but not pay for them when they're not needed. Reductions in restrictions on working hours and making paternity and maternity. leave less costly for businesses would also encourage them to recruit more workers.

Question 53

Explain the free market supply side policy of privatisation and deregulation

Answer 53

Transferring businesses from the public to the private sector should make businesses more efficient due to private businesses being more likely to pursue profits. Privately owned businesses are more likely to cut costs and expand (and employ) than a public business Privatisation may be accompanied by deregulation to ensure actual competition Allowing private sector firms to compete with previously state-owned businesses should lead to lower prices and higher output (and higher quality as well) Private businesses are more likely to invest in new tech

Question 54

What are the 6 interventionist supply-side policies?

Answer 54

Education Training Industrial policy Research and development subsidies Infrastructure investment Entrepreneurship

Question 55

Explain the interventionist supply-side policy of education

Answer 55

Expansion of education and reform of education should increase LRAS in 2 ways: 1. Higher productivity of workers= due to future workers becoming more skilled in school or at college 2. Less structural unemployment as education can give the future workforce more transferable skills, allowing them to move between different jobs more easily

Question 56

Explain the interventionist supply-side policy of training

Answer 56

Increased training should boost productivity and improve the skills base of the workforce. This can be provided directly by the gov or by the private sector through subsidies/tax breaks

Question 57

Explain the interventionist supply-side policy of industrial policy

Answer 57

Gov can encourage investment through grants, tax breaks and subsidies Other aspects of supply-side reform (labour market reform, educational reform) can also help industrial policy

Question 58

Explain the interventionist supply-side policy of R and D subsidies

Answer 58

Increased spending on R&D encourages technological advances and new innovations (all of which increases LRAS) Can be achieved through legislative changes as well as gov spending and tax reform

Question 59

Explain the interventionist supply-side policy of infrastructure investment

Answer 59

Govs spend money on infrastructure to improve economy's supply side. Improvements to transport links (i.e. development of HS2) and improvements to digital communication make the economy function more efficiently (and may also reduce geographical immobility)

Question 60

Explain the interventionist supply-side policy of Entrepreneurship

Answer 60

Govs can encourage more people to create business start ups through: 1. Provision of grants and other assistance for new start ups 2. Improving enterprise education in schools and colleges 3. Removing barriers to setting up a business (this would be a free market supply-side policy)

Question 61

Some supply side policies can also be fiscal policy. Give 3 examples.

Answer 61

Tax changes Investment in education or infrastructure Provision of subsidies Note: other supply-side policies do not involve fiscal policy (i.e. deregulation, labour market reform)

Question 62

Define the term free market supply side policies

Answer 62

Policies to increase the productive capacity by making markets work more efficiently

Question 63

Define the term interventionist supply side policies

Answer 63

Policies to increase the productive capacity by direct intervention in the macro economy (i.e. spending on infrastructure)

Question 64

Explain the supply-side policies and the natural rate of unemployment (NRU)

Answer 64

The NRU consists of voluntary, frictional and structural unemployment. It can be reduced by supply side policies i.e. - Improvements to education to reduce factor immobility - Incentives to increase training - Investment in infrastructure - Lower taxes on incomes - Less generous welfare benefits - Encouraging R&D

Question 65

The level of employment in an industry can also be studied using what?

Answer 65

Labour market analysis

Question 66

What are the 6 limitations of supply side policies?

Answer 66

Tax cuts often favour high-earners Welfare cuts fall disproportionately on lower income earners Relative poverty is increased There is a long time-lag with most policies Investment in infrastructure is expensive and may be wasted Worker's rights are reduced