Fiscal policy

Fiscal policy

Definition:
1. Fiscal policy involves the Government changing the levels of Taxation and Government spending in order to influence AD+AS and therefore the level of economic activity(output/jobs)
Purpose:
1. •Keep inflation low, (UK government has a target of 2%) •Stimulate economic growth in a period of a recession. •Basically, fiscal policy aims to stabilise economic growth, avoiding a boom and bust economic cycle.
Demand side policies
1. Expansionary= •This involves trying to increase AD. •Therefore the govt will increase spending (G) and / or cut taxes. Lower taxes will increase consumers spending because they have more disposable income(C) •This will increase the government's budget deficit.
  1. multiplier effects of an expansionary fiscal policy depend on how much spare productive capacity the economy has; how much of any increase in disposable income is spent rather than saved or spent on imports. And also the effects of fiscal policy on variables such as interest rates
2. Discretionary=• deliberate attempt by the govt to affect AD and stabilise the economy, e.g. in a boom the govt will increase taxes to reduce inflation •Injections (J): This is an increase of expenditure into the circular flow, it includes govt spending(G), Exports (X) and Investment (I) •Withdrawals (W): leakages from the circular flow This is household income that is not spent on the circular flow. It includes: Net savings (S) + Net Taxes (T) + Net Imports (M) •Fiscal Policy was particularly used in the 50s and 60s to stabilise economic cycles. These policies were broadly referred to as 'Keynesian' In the 1970s and 80s governments tended to prefer monetary policy for influencing the economy. •There are many factors which make successful implementation of fiscal policy difficult.
3. Contractionary=•This involves trying to decrease AD. •Therefore the govt will cut govt spending (G); and or increase taxes. Higher taxes will reduce consumer spending (C). •This will lead to an improvement in the government budget deficit
Evaluation / Criticism of Fiscal Policy
1. 5.Budget Deficit Expansionary fiscal policy (cutting taxes and increasing G) will cause an increase in the budget deficit which has many adverse effects.Higher budget deficit will require higher taxes in the future and may cause crowding out (see below 6.Other Componenets of AD. If the governmentt uses fiscal policy its effectiveness will also depend upon the other components of AD, for example if consumer confidence is very low, reducing taxes may not lead to an increase in consumer spending. 7.Depends on Multiplier And change in injections may be increased by the multiplier effect, therefore the size of the multiplier will be significant. 8.Crowding Out Increased Govt spending (G) to increased AD may cause “Crowding out” Crowding out occurs when increased government spending results in decreasing the size of the private sector.
2. •For example if the govt increase spending it will have to increase taxes or sell bonds and borrow money, both method reduce private consumption or investment. If this occurs AD will not increase or increase only very slowly. •Also Classical economists argue that the govt is more inefficient in spending money than the private sector therefore there will be a decline in economic welfare •Increased government borrowing can also put upward pressure on interest rates. To borrow more money the interest rate on bonds may have to rise, causing slower growth in the rest of the economy. 9.Monetarist Critique. Monetarists argue that in the LR AS is inelastic therefore an increase in AD will only cause inflation to increase
3. 1.Disincentives of Tax Cuts. Increasing Taxes to reduce AD may cause disincentives to work, if this occurs there will be a fall in productivity and AS could fall. ^ taxes do not always mean a reduce incentives to work if the income effect is strong. 2.Side Effects on Public Spending. Reduced govt spending to Increase AD could effect public services (public transport and education )= market failure and social inefficiency. 3.Poor Information Fiscal policy will suffer if the govt has poor information. E.g. If the govt believes there is going to be a recession, they will increase AD, however if this forecast was wrong and the economy grew too fast, the govt action would cause inflation. 4.Time Lags. If the govt plans to increase spending this can take along time to filter into the economy and it may be too late.Spending plans are only set once a year. There is also a delay in implementing any changes to spending patterns.
Automatic fiscal stabilisers:
1. •If the economy is growing, people will automatically pay more taxes ( VAT and Income tax) and the Government will spend less on unemployment benefits. The increased T and lower G will act as a check on AD. •In a recession the opposite will occur with tax revenue falling but increased government spending on benefits, this will help increase AD
Supply side policies
1. Many economists believe that fiscal policy changes can help to improve the working of markets and boost total supply.
2. Reduction in income taxes: increases incentive to work since workers get to keep more of their hard earned wages Reduction in corporate taxes: increases incentive to invest in new capital. An increase in the nation's capital stock increases potential output of the economy Reduction in trade union power: Unions fight for higher wages, which increases firms' costs. Lower wages will lower costs to firms and increase their ability to produce more output Reduction or elimination of minimum wages: Lower minimum wage will lower firms' costs, increasing their potential output and aggregate supply Reduction in unemployment benefits: Generous benefits for the unemployed reduce the incentive to find work, reducing the supply of available labor. Fewer benefits increase supply of labor and AS Deregulation: Burdensome regulations of business can increase costs for firms. Deregulating business operations will lower firms' costs.
3. Privatization: Transferring state-run firms to the private sector may lead to greater efficiency as firms compete to minimize costs and maximize profits Anything that increases the quantity or the quality of productive resources or decreases firms' costs will increase AS
taxation types
1. DIRECT= income tax, inheritance tax, NI, corporation tax, capital gains tax(differnce on buying a house from selling it only if u have multiple houses)
2. INDIRECT= txes on spending, excise duties on fuel ,cigarettes, alcohol, VAT.
3. PROGRESSIVE TAXES= income tax (gov gets most £ from income tax)
4. PROPORTIONAL TAX= corporation tax, NI
5. REGRESSIVE TAX= avg rate of tax is lower for ppl with ^ income.
where does revenue come from
1. SALE OF ASSETS. TAXES. BORROWING FROM ABROAD
Govnt spending
1. TAXATION= welfare payments- giving money to people
2. CAPITAL SPENDING= infrarstructre
3. CURRENT GOVNT SPENDING= state provided goods+services
4. JUSTIFICATIONS= provide efficient level of public/merit goods to overcome market failure. Provide necessary infrastructure . Used to measure and manage level of growth of AD

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