1. Fiscal Policy What you need to know:
Explain what is meant by the government budget
Identify the main sources of tax revenue and government expenditure in the UK economy
Distinguish between current and capital government expenditure
Distinguish between progressive, proportional and regressive taxation
Distinguish between direct and indirect taxation
Explain the features of a ‘good’ tax
Evaluate the advantages and disadvantages of a flat rate tax system

2. Macroeconomic Policies

3. Monetary Policy

4. Fiscal Policy

5. Fiscal Policy
The manipulation of taxation, government expenditure and the government budget to influence the level of AD and other variables in the economy such as output & jobs
Tax regime influences C & I,
Government spending (G) has direct influence on AD
Acts as an automatic stabiliser (see below)
Associated with Keynesian economics

6. Fiscal Policy - purposes
Reduce income inequalities.
Redistribution of income through taxation, benefits and government spending on services
Correction of market failure
Encourage consumption of merit goods – e.g. spending on healthcare & education
Provision of public goods – e.g. roads (quasi-public)
Discourage consumption of demerit goods – e.g. provide information, police
Regulation of economic activities – e.g. spending on legal system, introducing regulations & standards
Influences AS through supply side policies
e.g. spending on infrastructure, investing in transport systems / healthcare research

7. Reflationary or Deflationary
Measures designed to increase AD are called REFLATIONARY
Also called expansionary or loose fiscal policy
Increase government spending (G)
Reduce tax
Measures designed to reduce AD are called DEFLATIONARY
Also called contractionary or tight fiscal policy
Cuts in government spending
Rises in taxes

8. Fiscal Policy In ActionAS
Inflation
Assume an initial equilibrium position with a level of National Income giving an unemployment rate of 5% (U = 5%)
The rise in AD leads to an increase in real national income, ceteris paribus, unemployment would fall to 3% but at a cost of higher inflation
AD=C+I+G+(X-M)
Apart from G, C and I are also likely to be affected directly or indirectly by the policy change.
If government ‘reduces taxes’ (remember the subtleties) and or increases spending, it will have various effects:
AD therefore shifts to the right to AD1
2.5%
2.0%
AD 1 AD
U=5%
U=3%
Real National Income

9. How fiscal policy feeds through to the economy
Boost to
disposable
income
Adds to consumer
demand
Cut in personal
Income tax
Lower prices
- leads to
higher income
Adds to consumer
demand
Cut in indirect
taxes
Expansionary Fiscal Policy
Higher ‘post-tax’
profits for
businesses
Cut in
Corporation
tax
Adds to business
capital spending
Adds to
consumer
demand
Boost to disposable
income of people
with net savings
Cut in tax on
interest from
saving
Any injection into the circular flow of income will be reinforced by the MULTIPLIER EFFECT – although some increase will be dissipated by an increase in the price level

10. Discretionary Fiscal Policy
Deliberate changes in government spending and taxation designed to influence aggregate demand
Acting counter-cyclically
Smooth out peaks and troughs of economic cycle to create greater economic stability

11. Discretionary Fiscal Policy
Likely budget surplus
Smooth out cycle
-= create more stability
Likely budget deficit
= borrowing

12. Managing the Recession
Examples of fiscal stimuli include:
Reduction in VAT to 15%
Car scrappage scheme (£2000 to trade in your old car)
£500 million support for house building to deliver 1000s new homes, including £100 for green housing
Double main capital allowance to 40% - enhanced tax relief to support investment

13. Automatic Stabilisers
Forms of government spending and taxation that change automatically to offset fluctuations in economic activity
Example
Government spending on job seekers’ allowance falls automatically when economic activity increases
When real GDP rises, so the government will receive more income tax revenue
This fall in government spending and increase in tax revenue will reduce growth in AD and help prevent inflation

14. Government budget
This sets out the government’s income and expenditure plans for the forthcoming year.
Income raised via taxation
Expenditure items – health, education, social welfare, defence, law and order, overseas development, infrastructure….

15. Government budget
The government’s budget will indicate if a deficit or surplus is expected
Deficits – require funding through borrowing
Surpluses – enable repayment of previous borrowing/debt
SPRING 2017 BUDGET – KEY POINTS

16. Total UK Government Spending and Tax Revenue
Source: International Monetary Fund, data from 2015 onwards is a forecast

17. Government Spending
Government spending is spending by the public sector on goods and services such as education, health care and defence
Welfare Spending
Transfer Payments
Public Services
Recurring spending
State Investment
Investment Projects

18. Breakdown of UK Government Spending in 2016-17
Social protection (welfare) is the largest single element of government spending, with the NHS and Education the biggest single departmental items.

19. Breakdown of UK Government Spending
Social protection (including pensions)
NHS
Education
Debt interest
Police, law courts, prisons
Defence

20. Government Spending - types
Capital Expenditure
Current Expenditure
Current expenditure is recurring.
The wages that will be paid to the nurses and doctors, and the money for drugs and the upkeep of a hospital will all be recurring and are recorded as current expenditure.
Spending on running public services such as refuse collection, libraries, museums are all current expenditure
This includes any spending that adds to the capital stock of the UK.
Can be seen as 'once-and-for-all' expenditure
Building new schools and hospitals count (although the wages of teachers and nurses do not) as do new roads and the investment by the government in a new nuclear deterrent.

21. Sources of UK Government Tax Revenues in 2016-17
Income tax and VAT are the two biggest sources of government revenues

22. Sources of UK Government Tax Revenues
Income Tax
VAT
National Insurance Contributions
Excise duties
Corporation tax
Council Tax and Business Rates

23. Types of Taxation Direct Taxation
A direct tax is levied on the economic agent who pays it – individual/organisation - usually on incomes.
Income tax – workers/householders – basic rate = 20%
Corporation tax – on company profits – rate = 19%
Tax on savings interest
Property taxes, business rates…

24. Types of Taxation Indirect Taxation
An indirect tax is levied on goods and service
They can be passed on to others in the form of higher prices.
Examples include:
VAT – current rate = 20%
Customs & Excise duty – taxes on specific products such as alcohol, cigarettes, petrol
Tariffs – tax on imports

25. Progressive Taxation
A progressive tax takes a higher percentage of tax from people with higher incomes. It means that the more a person earns, the higher his average rate of tax will be. The aim of progressive tax is: To help reduce inequality – taking lower average levels of tax from low wage earners, and taking more from higher taxes. To increase the incentive for people to take low paid jobs, e.g. move off benefits into work. If low income work has a low incidence of tax, it encourages people to enter the labour force and take a job.

26. Progressive Tax - Calculations
Calculate the tax paid if income is
(a) £9, (b) £ (c) £38 000
(d) £ (e) £
Band
Taxable Income
Rate
Personal Allowance
Up to £11,500 0%
Basic rate
£11,501 to £45,000
20%
Higher rate
£45,001 to £150,000
40%
Additional rate
Over £150,000
45%

27. Proportional Taxation
The proportion of the tax paid remains constant as income rises. The actual amount paid will rise!
Calculate the tax paid if income is
£ (b) £ (c) £38 000
(d) £ (e) £
Income (£)
Tax Rate(%)
0 – 25

28. Regressive Taxation
The proportion of income paid as tax falls as income rises. The actual amount paid will rise!
Calculate the tax paid if income is
£9999 (b) £ (c) £38 000
(d) £ and (e) £
Income(£)
Tax Rate
0 to 0% –
25% –
20% 5%

29. Regressive Taxation
Indirect taxes such as VAT have regressive effects because they account for a larger proportion of low income consumers’ expenditure/income Regarded as unfair/inequitable Or they don’t have to buy!

30. Features of a good tax
Adam Smith’s Canons of Taxation – set out 4 characteristics of a good tax
Equity – tax payers should contribute in proportion to their ability/in proportion to their respective revenues/incomes. The tax should be fair.
Certainty – “the tax which each individual is bound to pay ought to be certain and not arbitrary.”
The amount paid, time paid and method should be clearly understood so there is no disincentive effect or incentives for corruption.

31. Features of a good tax
3. Convenience – the time and manner of payment should be convenient to the payer. 4. Economy – costs of collection and administration should be minimised. Taxes should be simple and not open to interpretation – avoidance! on/top-4-principles-or-canons-of-a-good-tax- system/38120/

32. Features of a good tax Using these canons a tax may be assessed on:
The incidence of the tax
The burden/share paid by different agents
e.g. VAT shared between consumer and producer. Is this fair?
Efficient implementation
Cost of collection and incentives/disincentives
i.e. impact on resource allocation in terms of investment and consumption.

33. Features of a good tax
Trade – countries that trade closely or are members of trade blocs should have compatible tax rates – no unfair advantage. Inflation – tax changes should take account of inflation e.g. raising tax thresholds/tax free allowances or VAT rates adjusted so goods are affordable.

34. Flat - rate tax system
A system of income tax in which each taxpayer pays the same rate of tax regardless of their income.
It has a constant marginal rate – a proportional tax
Advantages
Certain – beneficial impact on incentives/disincentive
Efficient to implement – low collection costs. Systems with multiple rates are expensive and complex – avoidance is encouraged! UK has a complex tax code. Evasion and avoidance are discouraged
Incentives for high income groups to work and take risks – progressive taxes take away a larger % of incomes.
Simple to administer and would raise revenue – opinion!

35. Flat - rate tax system
Disadvantages Equity – inequitable. A progressive system enables redistribution from high income groups to lower income groups Low income groups would pay more – this depends on the rate and size of the tax free allowance Would not raise revenue/may fall – higher income groups pay more under a progressive tax system – opinion!

36. Flat - rate tax system
“Currently the top 10% of all income tax payers in the UK pay about 59% of all income tax. They also pay tax at higher rates than anyone else. That is why they pay so more, but that's also because they earn more than most, of course.
Under a flat tax system they would enjoy substantial - maybe massive - tax cuts. “
Source

37. Evaluate the advantages and disadvantages of a flat rate tax system
Size/degree of impact – how significant are the advantages and disadvantages e.g. how much extra revenue will be raised?
It may depend on the rate set – will it incentivise workers and entrepreneurs, will lower groups pay more/less?
It may depend on the size of the tax free allowance.
How far will it meet the canons of taxation?
Flat rate tax systems – Baltic states, Ukraine, Russia