Government spending and fiscal policy
Contractionary fiscal policy is an increase in
taxes and a decrease in government spending shifting AD to the left - (a fall in national income) (might be compensated by a rise in private sector consumer and/or investment spending.)
The budget is
the annual statement of planned spending and tax revenue
The national debt is the
the total outstanding debt. In years when there is a budget deficit the national debt grows. The graph shows how the national debt has risen since 2003.
The budget (fiscal) deficit is
When government spending exceeds tax revenue
The budget (fiscal) surplus is
When tax revenue exceeds government spending
Direct taxes are seen as
progressive and are seen to be much fairer
The problems associated with debt are:
1) The size of the national debt may become so large that investors worries that its unsustainable and so the UK government won't be able to pay and then will refuse to lend anymore money to the government 2) Debt interest payments
As the budget deficit is being reduced, we are currently experiencing
contractionary fiscal policy
Government spending represents an
injection into the circular flow of income
A budget deficit will cause a net
injection into the circular flow of income.
The Success of Fiscal Policy will depend on several factors:
Size of the multiplier, State of the economy, other factors in the economy, bond yields
The government raises the personal allowance each year because
Supply side policy to increase motivation to work & to prevent fiscal drag. (More people having to pay tax as incomes rise which has the effect of raising government tax revenue without explicitly raising tax rates.)
*Government spending* There are three types of spending (all equal total managed spending) -
Transfer payments, current government spending and capital spending
During phases of high economic growth, automatic stabilizers will help to reduce the
growth rate and avoid the risks of an unsustainable boom and accelerating inflation.
A direct tax is
levied on income, wealth and profit, e.g. Income tax, National insurance contributions, Capital gains tax, Corporation tax
A indirect tax is
levied on spending by consumers on goods and services, e.g. VAT, or specific taxes on fuel and alcohol, car tax
Conversely in a recession, economic growth becomes negative but automatic stabilizers will help to
limit the fall in growth.
Fiscal policy is the
manipulation of government spending and taxation to change aggregate demand and achieve macroeconomic objectives
Expansionary fiscal policy will also cause a fall in unemployment if new jobs are created in the public sector or if the rise in spending means
more demand for private sector goods and the creation of new jobs in the private sector.
A budget surplus occurs when tax revenue exceeds government spending. This takes spending
out of the economy with negative multiplier effects. This is known as contractionary fiscal policy and is recommended in times of fast growth or boom
A regressive tax is the
percentage rate of tax falls as incomes rise
Proportional taxes: the
percentage rate of tax is constant, e.g. income tax 25% across all incomes
A progressive tax is the
percentage rate of tax rises as income rises.
A budget deficit occurs when government spending exceeds tax revenue. The net effect is to
pump spending power into the economy. The multiplier magnifies the effect of this boost. This is expansionary policy
A decrease in the budget deficit will decrease
AD
The main changes in UK income tax from 2011 to 2015 are
Increase in personal allowance to help low paid, 40% higher rate paid on lower incomes leading to fiscal drag, Top rate reduced from 50 to 45% from April 2013
The Keynesian school argues that fiscal policy can have powerful effects on demand, output and employment when the economy is operating
below full capacity national output, and where there is a need to provide a demand-stimulus.
Transfer payments: i.e. welfare payments made to
benefit recipients such as state pension and the Jobseeker's Allowance
A fall in taxes will cause a rise in
disposable income and a rise in consumer spending - there will be a multiplier effect on this
Monetarist economists believe that government spending and tax changes only have a temporary effect on aggregate demand, output and jobs and that the tools of monetary policy are a more
effective instrument in controlling inflation and maintaining macroeconomic stability
Contractionary fiscal policy, i.e. a fall in G or a rise in T or a cut in the budget deficit, will cause AD to
fall. This will cause a fall in national income and have a negative multiplier effect. It will also cause job losses.
Discretionary fiscal policy is deliberate changes in tax rates or spending by a
government in response to changes in economic conditions.
Expansionary fiscal policy is an increase in
government spending and a decrease in taxes shifting AD to the right - (can lead to job creation and a fall in unemployment)
Indirect taxes are seen as
regressive and seen to be less fair
Capital spending: i.e. infrastructure spending such as
spending on new roads, hospitals, motorways and prisons
Current government spending: i.e. spending on
state-provided goods and services such as education and health.
During the credit crunch, unemployment was high so there was less
tax revenue coming form income tax. Government spending increased as well due to extra benefits spending
Evaluation - Fiscal policy has
time lags as it takes time for effect, Government spending can be inefficient and wasteful, expansionary fiscal policy can lead to high borrowing costs, Crowding out - (Expansionary fiscal policy may not increase AD, because higher govt spending may crowd out the private sector. This is because govt have to borrow from the private sector who will then have lower funds for private investment)
A budget surplus will cause a net
withdrawal from the circular flow of income.
Taxation represents a
withdrawal from the circular flow of income.
