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Fiscal Policies

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Title: Fiscal Policies


1
Fiscal Policies
2
Aims
  • Understand the practical application of fiscal
    policy
  • To be aware of the impact of budget deficits on
    aggregate demand.
  • An analyse the usefulness of fiscal policy as a
    short term and long term tool for macro economic
    objectives

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  • Influencing the level of economic activity though
    manipulation of government income and expenditure
  • Associated with Keynesian Demand Management
    Policies
  • Influence Aggregate Demand
  • Tax regime influences consumption (C) and
    investment (I)
  • Government Spending (G)
  • Influences key economic objectives
  • Acts as an automatic stabiliser

5
Budget deficit and budget surplus can you see
them?
6
Surplus
Deficit
Deficit
7
Watch this
  • Watch carefully and make a note of
  • The different types of tax mentioned
  • How much the government forecast its debt to be
  • Now much the UK debt is predicted to overshoot
    this forecast

8
How many taxes can you think of?
9
Taxation options
  • Corporation
  • Capital Gains Tax
  • Inheritance
  • Excise duties
  • Business rates
  • Council tax
  • Income tax
  • VAT
  • Betting Tax
  • Insurance premium tax
  • Royalties
  • Tariffs
  • Road tax
  • TV licence
  • Council tax
  • NI contributions
  • Congestion Charge
  • Stamp duty
  • Airport tax
  • Pigouvian tax environment

10
Why does the government tax?
  • Revenue
  • To raise revenue to finance government spending
    (e.g. on public and merit goods and services)
  • Managing aggregate demand
  • To help meet the governments macroeconomic
    objectives such as stable inflation and economic
    growth
  • Changing the distribution of income and wealth
  • A progressive system of taxation can help bring
    greater equality in income wealth between
    households
  • The government may intervene directly through
    fiscal policy to on grounds of equity
  • Market failure and environmental targets
  • Taxes can correct for externalities a source of
    market failure

11
Government spending
12
Government spending (G)
  • Government (or public) spending each years takes
    up over 40 of gross domestic product
  • Spending by the public sector can be broken down
    into three main areas
  • Transfer Payments i.e. welfare payments made to
    benefit recipients such as the state pension and
    the Jobseekers Allowance
  • (2) Current Government Spending i.e. spending on
    state-provided goods services such as education
    and health
  • (3) Capital Spending i.e. infrastructural
    spending such as spending on new roads,
    hospitals, motorways and prisons

13
Public Sector Spending
14
Why Have Government Spending?
  • Direct government (public sector) provision of
  • Public Goods
  • Merit Goods
  • Provide welfare support for low income households
    / the unemployed
  • Government spending is also a means of
    redistributing income within society e.g. to
    reduce the scale of relative poverty
  • Government spending can also be used as a tool to
    manage aggregate demand (GDP) as part of
    macroeconomic policy

15
Budget Deficit or Surplus?
  • Any chance of a balanced budget?

16
The budget deficit / surplus
  • The budget deficit measures how much the
    government sector needs to borrow each year to
    finance its own spending
  • The national debt is the total amount of
    borrowing undertaken by the government that has
    not yet been repaid
  • A budget deficit arises when government
    expenditure exceeds government revenue (GgtT) and
    a positive PSNCR.

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Government budget balances
Whats the difference between current and real?
19
Browns Fiscal Rules
  • The golden rule
  • Government borrowing finances investment but not
    current expenditure over the course of the
    economic cycle
  • The sustainable investment rule
  • Requires net government sector debt to be at a
    stable and prudent level over economic cycle
    probably around 40 of GDP
  • These rules do not have to be met each year -
    they are designed to provide targets for
    government borrowing (and hence spending and tax
    decisions) over the medium term / economic cycle

20
Taxation and Aggregate Demand
How can taxes have a big effect on aggregate
demand?
21
The fiscal policy transmission mechanism
Expansionary Fiscal Policy
22
Fiscal Policy automatic stabilisers!
23
Automatic Stabilisers
  • Boom
  • What happens to Tax revenue?
  • Increases
  • What happens to transfer payments?
  • Falls
  • Recession
  • What happens to Tax revenue?
  • Falls
  • What happens to transfer payments?
  • Increases

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The collapse in tax revenues
  • Tax revenues tend to fall during a recession
  • More people unemployed less money from income
    tax
  • Squeeze on business profits less revenue from
    corporation tax
  • Decline in consumer spending hits income from
    VAT and duties
  • Drop in average house prices affects revenue
    from stamp duty
  • Possible rise in tax avoidance and tax evasion
  • Cuts in bonuses and other payments e.g. overtime
    pay
  • The latest figures for the government show a big
    drop in tax receipts
  • These reflect the slowdown in 2008 rather than
    the recession
  • Prospect of much worse to come in 2009-2010

26
The latest figures
Nearly 7bn down on Jan 2008
27
Main Sources of Revenue
28
Housing has been a boon for the government in
recent years
29
Should we be worried about a reduction in tax
take?
  • No
  • In a recession, tax revenues fall automatically
    this is part of what is known as the automatic
    stabilisers
  • Some of the reduced tax revenue comes from
    decisions by the government to cut taxes to boost
    the economy
  • Some comes from lower oil/petrol prices
  • Yes
  • This is a sign of an economy heading into a very
    deep recession
  • The drop in revenues is causing a huge rise in
    the budget deficit - public sector net borrowing
    is now almost three times higher than at the same
    stage last year
  • The result will be an enormous deficit which will
    required either higher taxes in the future or
    cut-backs in government spending
  • Some of the tax cuts introduced have been
    ineffective in increasing AD

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34
Homework
  • Fiscal Policies past paper Qs
  • What is meant by a budget deficit (Extract 1,
    line 13)? (2)
  • From Figure 1, calculate the percentage change in
    total spending on health and education from
    2004-05 to 2007-08. (2)
  • Using aggregate demand and supply analysis,
    assess the likely long-run impact on the UK
    economy of the planned increase in health and
    education spending. (8)
  • 12 marks in total
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