Fiscal Policies

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Fiscal Policies
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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

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Budget deficit and budget surplus can you see
them?
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Surplus
Deficit
Deficit
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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

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How many taxes can you think of?
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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

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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

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Government spending
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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

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Public Sector Spending
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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

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Budget Deficit or Surplus?

• Any chance of a balanced budget?

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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?
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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

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Taxation and Aggregate Demand
How can taxes have a big effect on aggregate
demand?
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The fiscal policy transmission mechanism
Expansionary Fiscal Policy
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Fiscal Policy automatic stabilisers!
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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

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The latest figures
Nearly 7bn down on Jan 2008
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Main Sources of Revenue
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Housing has been a boon for the government in
recent years
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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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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