Fiscal policy

Question 1

Describe the history of UK government spending

Answer 1

Peaked during WW2
Fell until another peak in 2009/10
Fell again due to the austerity agenda since 2010
Rose again due to pandemic

Question 2

Why does spending fluctuate so much

Answer 2

1. Automatic stabilisers, which are the automatic fiscal changes that occur due to the economic cycle
   i.e. increased spending on welfare in a recession as there is high unemployment
2. The government has intervened more to correct inefficiencies and inequity in recent times, which costs money

Question 3

What are reasons to why would the government would increase spending

Answer 3

1. They want to correct market failure by providing more merit, public goods, infrastructure and welfare benefits
2. They want to boost AD in pursuit of macroeconomic objectives
3. They want to boost LRAS through investing in infrastructure, education/training

Question 4

Explain the difference between a big government and small government

Answer 4

• Big government has high government spending in pursuit of microeconomic agenda (efficiency and equity) and macroeconomic agenda (AD and LRAS)
• Small government believes tax and high spending is bad for supply side (because of crowding out and less incentive to work) so we should use monetary policy where necessary

(UK have high tax and spending but also a lot of privatisation but big gov labour and small gov conservative)

Question 5

Describe how the UK government allocates its spending

Answer 5

• Most of it on public services
• 8% on interest on national debt (rising and worrying)
• 1.8 million households of working age get at least 80% of their income from benefits, government spends a lot on tax credit, housing benefits and disability benefits

Question 6

By how much has Britain reduced spending (austerity)

Answer 6

• Fallen from 45% of GDP in 2010 to 36% in 2020
• After adjusting for an ageing population, spending per person on the NHS has fallen since 2010 in England

Question 7

What is the tax burden

Answer 7

Tax revenue as a % of GDP

Question 8

Why does the tax burden fluctuate from year to year

Answer 8

1. Automatic stabilisers due to the rate of economic growth
2. Discretionary tax changes such as VAT and income tax changes

Question 9

Explain the functions of tax

Answer 9

a) to fund government spending without debt
b) method of fiscal policy to fine-tune AD
c) progressive tax for equity by redistributing income and wealth
d) indirect tax to correct market failure caused by negative externalities

Question 10

What were Adam Smith’s conditions for a good tax

Answer 10

1. simplicity - average person can understand the system
2. Convenient for the tax payer
3. Cost of collecting it should be low compared to revenue (high profit)
4. Equity
5. Support economic growth by not reducing incentives, investment, enterprise, international competitiveness

Question 11

Describe the 2 different types of tax

Answer 11

• Direct tax is a tax on income and wealth paid directly to government e.g. income tax, national insurance, corporation tax
• Indirect tax is a tax on spending, where the consumer pays the tax but the firm pays it to the government e.g. VAT, customs and excise duties

Question 12

What is the most yielding tax (highest revenue)

Answer 12

Income tax

Question 13

Explain income tax bands

Answer 13

• Personal allowance up to £12500
• Progressive so higher income pay a higher tax rate
  e.g. top 1% earners pay 30% of tax revenue and top 10% pay 60%

Question 14

Explain national insurance

Answer 14

• Direct tax paid by both employee and employer
• To the employer, it is additional cost of labour and to the employee, it is additional income tax
• 2019/20 employees paid 12% NI on income between £166 and £962 per week and 14% above that
• 2019/20 employers paid 13.8% NI on all earning above £166

Question 15

Explain corporation tax

Answer 15

• Tax paid by companies on their profits
• Currently at 19% for small businesses and 25% for large businesses

Question 16

Explain the 2 types of tax on capital (wealth)

Answer 16

• Capital gains tax is paid on the profit made when you sell an asset that increased in value (either 18% or 24% depending on size of asset and individuals income
• Tax paid when you die if you had over 325,000 of wealth or gave away 325000 in gifts in the 7 years before they died (40%)

Question 17

Explain stamp duty

Answer 17

Tax paid when buying a residential property
(Varies between 2% and 12% depending on value of property)

Question 18

Explain VAT

Answer 18

• Tax on spending for some goods and services
• Went from 17.5% to 15% to stimulate economy during financial crisis and then back up to 17.5% and later 20% for the 2010 Austerity agenda

Question 19

Explain customs duty and excise duty

Answer 19

Excise duties are levied on goods produced in this country
Customs duties are levied on goods imported into the country

Good example is the sugar tax on soft drinks industry, which is on both domestically produced and imported goods

Question 20

Explain the difference between progressive, proportional and regressive tax

Answer 20

• Progressive tax takes a larger % of income as income rises so marginal rate of tax rises when people get richer e.g. income tax
• Proportional tax takes up a constant % of people’s income
• Regressive tax takes smaller % of income as income rises e.g. indirect tax, especially excise duties

Question 21

Why is VAT not as regressive as excise duties

Answer 21

Some essential goods like food are zero-related i.e. 0%

People might buy more fuel, tech and leisure facilities as their incomes rise but not alcohol and tobacco (as there is more of a limit)

Question 22

Describes the equity of the UK tax system (one of the cannons of taxation)

Answer 22

Quite proportional meaning they poorest people lose a similar % of gross income to tax compared to rich people

However, though slightly, poorer people lose the highest % of income to tax

Question 23

Which tax is the best based on Adam Smith’s cannons of taxation

Answer 23

a) Indirect taxes are best for economy, convenience and simplicity
b) Progressive direct taxation is best for equity
c) People think indirect is better for economic growth due to the Laffer curve for direct taxes

Question 24

Explain the Laffer curve for direct taxes

Answer 24

Revenue is 0 when tax is 0%
As tax rises, revenue will rise until a point when the incentive to work fall and people fall into unemployment trap so tax revenue = 0 at 100% tax rate

Therefore, cutting direct tax may not help economic growth at low tax rates
In addition, if tax rates are too high, firms will leave the UK so the government has less revenue to spend on fiscal policy

Question 25

Explain the income and substitution effect of a tax cut

Answer 25

Income effect is where a cut in tax means disposable income is rising so people make the same money with less hours worked so hours worked drops Substitution effect is where the reward for an hour worked is higher than the reward for leisure so the opportunity cost of leisure increase so more hours worked This determines the net change in hours worked due to a tax cut

Question 26

How does a tax cut help the unemployment and poverty trap

Answer 26

If substitution effect is greater than income effect, hours worked increases so people are relying less on benefits

Question 27

What are 2 other benefits of taxation

Answer 27

1. Tackling externalities and market failure with indirect taxes 2. The government can change taxes like VAT very quickly, e.g. during financial crisis so it is good for fiscal policy

Question 28

What is a budget deficit

Answer 28

When across 1 year G exceeds T This is also known as Public Sector Net Borrowing The government finances the deficit by selling bonds to the private sector to borrow money

Question 29

What is a budget surplus

Answer 29

When across 1 year T exceeds G This is also known as Public Sector Debt Repayment The government redeems some bonds sold in the past

Question 30

What is National Debt

Answer 30

The cumulative net total of all past budget deficits minus any budget surpluses

Question 31

Explain the difference between automatic stabilisers and discretionary changes

Answer 31

Automatic stabilisers naturally occur based on whether the country is in a boom or recession so the government doesn't need to do anything e.g. in a recession more people get unemployment benefits and there is less VAT and income tax revenue so budget deficit increases Discretionary changes are where the government physically changes the tax rate or introduces spending changes e.g. VAT cut in 2009

Question 32

What was the aim of the 2010 austerity agenda implemented by George Osborne

Answer 32

To eliminate the structural budget deficit and turn it to a surplus by 2020 and see the debt to GDP ratio fall

Question 33

What were the criticisms of the 2010 austerity agenda

Answer 33

- Was implemented too soon after the recession so was bad for recovery from the financial crisis (Osborne said the economy was still capable of recovering) - Should have focussed on tax changes rather than less G spending (Osborne said less G spending is better for supply side)

Question 34

Explain the difference between a cyclical and structural budget deficit

Answer 34

Cyclical is due to automatic stabilisers in a recession and are highly desirable for recovery and when growth increases again a budget surplus will form Structural is far more dangerous as the deficit will remain even if the economy is growing strongly

Question 35

Was the UK's large budget deficit during the financial crisis structural or cyclical

Answer 35

over 50% was structural which was why Osborne wanted to eliminate the deficit

Question 36

What are the disadvantages of a structural budget deficit

Answer 36

1. Continuously rising national debt as a % of GDP 2. Crowding out effect caused by a structural budget deficit in a boom

Question 37

Explain the crowding out effect

Answer 37

Less factors of production available for firms if the government is using them so less investment from private sector

Question 38

Why is national debt bad with an example

Answer 38

If investors think that budget deficits are normal they might lose confidence in the governments ability to pay back bonds and only buy them if there are higher interest rates. This is unaffordable for the government and can cause the country to go bankrupt In Greece, the private sector went on a bond strike so the government couldn't borrow money

Question 39

What 3 other factors apart from the type of deficit and size of debt determine whether a budget deficit is bad

Answer 39

1. Future growth means debt as a percentage of GDP may still fall so investors will stay confident 2. The bank can print money and buy bonds as a last resort (QE) 3. If the money is spent on capital investment will be beneficial for future generations (intergenerational equity) but if the money is spent on current spending, debt will be imposed on future generations through higher taxes with no benefit for them (intergenerational unfairness)

Question 40

What are the arguments for the 2010 austerity agenda

Answer 40

1. The budget deficit and national debt has decreased 2. The economy recovered well due to expansionary monetary policy even with austerity

Question 41

What are the arguments against the 2010 austerity agenda

Answer 41

1. The economy would have recovered far more strongly with austerity 2. In a weak economy, austerity may be cancelled out by automatic stabilisers so debt and the budget deficit stay the same or worsen. So austerity is better in a strong economy

Question 42

What are the supply-side impacts of fiscal policy

Answer 42

- Unemployment trap affecting NAIRU and activity rate - Education and training programmes - Changes to tax impact investment and R&D - Spending on infrastructure

Question 43

What are the 2 roles of the OBR created in 2010

Answer 43

- Produce forecasts for the economy - Judge progress towards fiscal targets