igcse fiscal policy

1. Fiscal Policy Refers to the GOVT’s use of spending and taxation to influence the economy.

2. Government Budget • Government budget-financial plan of planned revenues (mainly tax revenue)and expenditure (healthcare,education). • Expenditure =revenue(balanced budget) • Budget deficit=expenditure is more than revenue Budget surplus-revenue is more than expenditure.

3. Reasons for taxation • 1)To raise GOVT revenue • 2)To limit the output of certain demerit goods. • 3)Tariffs imposed on foreign goods to domestic firms. • Tax burden-refers to the amount of tax that household and firms have to pay.

4. Types of taxation • Direct taxation-paid from the income, wealth or profit of individual and firms. Example-taxes on salaries, inheritance and company profit. • Indirect taxation-these are taxes on spending and on purchase of goods and services,Ex-GST,VAT,taxes on petrol,alcohol and cigrettes.

5. Progressive T-Those with higher ability to pay are charged a higher rate of tax. EX-income tax,capital gians tax,stamp duty. • Regressive taxation-under this tax system the tax rate decreases as income increases,meaning lower income earners pay a larger proportion of their incomes in taxes than higher-income earners. • Ex-taxes on alcohol,tobacco.

6. Proportional tax • Under this tax system,the percentage paid stays the same irrespective of the taxpayer income, wealth or property. • Ex-GST,

7. Fiscal policy measures • Expansionary fiscal policy-isused to stimulate the economy by increasing government spending(unemployment benefits and state pensions)and lowering the taxes(disposable income increase). • This type of fiscal policy is used to reduce the effect of economic recession(by boosting GDP and reducing unemployment).

8. Contractionary fiscal policy • It is used to reduce the level of economic activity by decreasing government spending and by raising taxes. These policies are used to reduce inflationary pressure during economic boom.

9. Impact of taxation • Impact on price and quantity-The imposition of a sales tax will shift supply curve to the left due to higher cost of production. • Depending on the PED for the product tax revenue of GOVT gets impacted.

10. Impact of taxation on economic growth • Taxation tends to reduce the incentive to work and to produce. • Impact on inflation-taxation tends to reduce the spending ability of individual and profits of the firms, it aims to reduce the likelihood of inflation. • Impact on business location-high corporation tax discourage companies to locate.

11. Social behaviour • Aims to reduce the consumption of demerit goods, taxes are also used to protect the natural environment by charging those who pollute and damage it. • Tax avoidance-is the legal act of minimising payment of taxes, such as avoiding spending on items with a large sales tax. • Tax evasion-is the illegal act of not paying the correct amount of tax by under declaring its corporate profits.

12. Effects of fiscal policy on government macroeconomic aims

13. Who makes Fiscal Policy? • Congress and the President make fiscal policy through the federal budget. • The Federal Reserve (another government agency) DOES NOT make fiscal policy. We will discuss the Federal Reserve next class.

14. What is the Federal Budget? • The Federal budget is a written document that indicates the amount of money the government expects to receive for a certain year and authorizes the amount of money the government can spend that year. • Every Fiscal Year (a 12 month period, not necessarily from Jan. to Dec.) the government makes a new budget. It may add to it through supplementary budgets from time to time.

15. Fiscal Policy and the Economy • The total level of government spending can be changed to help increase or decrease the output of the economy • Expansionary Policies: Policies that try to increase the output of the economy • Contractionary Policies: Policies that try to decrease the output of the economy

16. Expansionary Policies • During a contraction or recession, the government can do two things: • Decrease Taxes Or • Increase Spending

17. Decreasing Taxes • Gives people more money to spend • More money = more demand • More demand = more production • More production = more jobs • More jobs = more demand etc. etc.

18. Increase Spending • Increases demand for goods • More demand = more production • More production = more jobs • More jobs = more demand etc. etc.

19. Decreasing Taxes Favored by Republicans Let people decide what to spend their money on and let those who earned the money benefit from it. Increase Spending Favored by Democrats Government should spend to redistribute wealth to the poor, rather than give the rich a tax cut Who favors which policy

20. Contractionary Policies • During a period of excessive inflation (during a period of expansion), the government can do two things: • Increase Taxes Or • Decrease Spending

21. Increase Taxes • People have less money to spend • Less money = less demand • Less demand = lower inflation

22. Decrease Spending • Less money in economy • Less money = less demand • Less demand = lower inflation

23. Who favors which policy? Trick Question! Neither party favors Contractionary Fiscal Policies!!! This is one of the problems with Fiscal Policy

24. Problem with Fiscal Policy • It is unpopular to raise taxes or cut government spending. So, elected officials worried about re-election rarely do either. Ex. In 1984, Walter Mondale ran for president saying a slight tax increase would help equalize the U.S. economy. Ronald Regan defeated him in one of the biggest landslides in U.S. history!

25. Problems with Fiscal Policy • If the government cuts taxes, they have less money to spend or they go into debt. The federal debt is in the trillions of dollars, so the government has to borrow money by selling bonds. These bonds have to be paid back with interest, costing the government more money!