Transcript Fiscal-Policy

Fiscal Policy
• You are the PM. There
is unemployment as
shown
• What do you do?
Price
Level
LRAS
SRA
S
P
AD
0
Y Yf
Real Output
GDP
Output
gap
Time
Fiscal policy – what is it
Government use of taxation and spending to influence the level
of aggregate demand. The aim is to achieve the 4 main
macroeconomic objectives (and 3 others)
• Changes in fiscal policy affect aggregate demand (either
increasing/decreasing G, or by influencing C and I by changing
taxes or welfare payments)
• In the UK, the Treasury is in charge of fiscal policy decisions
• Other effects and uses of fiscal policy
• To redistribute income & wealth
• To change the pattern of spending on goods and services
• To correct for market failure
• Also can affect aggregate supply
Fiscal Policy
Government Taxation
Direct
Indirect
Government Spending
Capital
Expenditure
Current
Expenditure
transfers
Fiscal Policy
Taxation
Direct: paid directly to the tax authority (HM
Revenue and Customs in the UK), eg income tax,
corporation tax, national insurance
Indirect: charged on spending on goods and
services (collected by producers) eg VAT, excise
duties, stamp duty
Current Expenditure: spending on day-to-day
running of public services, eg paying teachers,
doctors, purchasing paper for publications
Government Spending
Capital Expenditure: spending on infrastructure to
increase the country’s assets, eg building a new
hospital, HS2
Transfers: benefits given to households who are
considered vulnerable or needing support. Pensions,
tax credits, child benefits etc.
Debt vs Deficit
Budget deficit: annual spending > annual revenue
(government must borrow to cover shortfall – by selling bonds to the
public)
Surplus: annual spending < annual revenue
(government uses extra funds to pay off previous debt)
Debt: the total money owed by government from all borrowed money,
past and present
Debt increases each time the government has a deficit and decreases
each time there is a surplus (not that this happens)
What is the deficit expected to be this year, and what is the size of the
National Debt?
More details on taxes
Taxes 2014/15
Direct
Income tax
National Insurance
Capital Gains Tax
Inheritance tax
Corporation tax
Bank Levy
163.1
110.4
5.6
3.8
43.0
2.7
Total direct
Total indirect
Grand total
328.6
186.7
515.3
£b
% total
31.7%
21.4%
1.1%
0.7%
8.3%
0.5%
63.8%
36.2%
Indirect
VAT
Fuel duties
Stamp duty
Spirits/beer/wine/cider duties
Tobacco duties
Air Passenger Duty
Customs Duties
Insurance Premium Tax
Betting & Gaming
Other
£b
111.4
27.2
13.7
10.5
9.5
3.2
3.0
3.0
2.1
3.2
% total
21.6%
5.3%
2.7%
2.0%
1.9%
0.6%
0.6%
0.6%
0.4%
0.6%
You do not need to remember all these details. However, you do need to know the difference
between direct and indirect, and know which the main ones are – direct: income tax and
corporation taxes, indirect: VAT and excise duties such as those on alcohol and tobacco
More detail on taxes
Taxable income
• Taxes can be progressive or
regressive
Tax rate
2014/15
2015/16
20%
£0 - £31,865
£0 - £31,785
• Progressive taxation: as income
rises, a larger % of income is paid
in tax. Income tax is progressive in
nearly all countries, so acts to
redistribute income
• Regressive taxation: as income
rises, a smaller % of income is paid
in tax. In general indirect taxes are
regressive
40%
£31,865 - £150,000
£31,785 - £150,000
45%
£150,000 +
£150,000 +
• For example, poor and rich households
may consume the same quantity of
alcohol and tobacco, and so pay the
same tax. The tax is therefore a
smaller proportion of a richer
households income than a poorer one.
• Recognising this (evaluation), VAT is
not levied on many necessities such as
food, but is paid on luxuries (which
richer households consume more of)
Tax-free
allowance £10,000
£10,600
The tax free allowance means for the current year (ending April 5th
2016) the first £10,600 of income is tax free.
Taxable income means income in excess of the allowance. Taxable
income up to £31,785 over £10,600 (ie up to £42,385) is then taxed
at 20%, which means someone earning say £25,600 pays 20% tax
on £15,000 (the amount in excess of £10,600) or £3,000.
Taxable income above £31,785 but below £150,000 is taxed at 40%,
and any income above £150,000 is taxed at 45%. These are
marginal tax rates so it is only the income above these thresholds
which is taxed at the higher rate.
For example, with earnings of £75,000, £10,600 is tax free, £31,785
is taxed at 20% and the balance of £32,615 is taxed at 40%
Automatic and discretionary fiscal policy
• What happens to
government spending and
taxes during a recession?
• ‘Automatic stabiliser’
means taxes fall and
spending on benefits
increases in a recession and
vice versa
• This acts to smooth the
cycle as shown in blue
• Active fiscal policy (as we
will see in the budget) is
when the government
chooses to change taxes or
spending
GDP
Time
Time lags and timing
• When does the
government make
changes to tax and
spending?
GDP
• Are these changes felt
immediately (does AD
change immediately)?
Time
The multiplier
• Often sensible to talk about the multiplier with
fiscal policy
• Advanced: is the multiplier higher or lower when
interest rates are low?
• Can discuss the size of the multiplier as evaluation
Crowding out
(used for evaluation after explaining how fiscal policy works)
• If the government employed all the workforce, how many people would
work in the private sector?
• If the government massively increased spending, what would happen to
interest rates? Step at a time, bringing the price of bonds into the
analysis