4.2.5- Fiscal Policy and Supply-Side Policies
Fiscal Policy
Fiscal Policy involves the use of taxation, public spending and the manipulation of the government's
budgetary position to achieve the government's policy objectives
HOW FISCAL POLICY CAN BE USED TO INFLUENCE AD
• Demand-side fiscal policy- Using fiscal policy to increase or decrease the level of AD
• Deficit Financing- Deliberately running a budget deficit and borrowing to finance the deficit
• Expansionary/Contractionary Fiscal Policy- Policies to increase/decrease
• Discretionary Fiscal Policy- Involves making discrete changes to the budget deficit to manage AD
• Crowding Out- A Situation in which an increase in government spending displaces private sector
spending with little or no increase in AD
Expansionary fiscal policy- may involve increase in gov.
spending or reduction in taxation
Contractionary- vice versa
HOW FISCAL POLICY CAN BE USED TO INFLUENCE AS
• Supply-side Fiscal Policy- Used to increase the economy's
ability to produce and supply goods, through creating
incentives to work, save, invest and entrepreneurial,
through taxation for example
• Examples
◦ Increased spending on infrastructure
◦ Reduction in corporation tax
◦ Reduction in VAT
◦ Reduced welfare payments
◦ Subsidies paid to firms
MICROECONOMIC AND MACROECONOMIC FUNCTIONS OF
FISCAL POLICY
Micro:
◦ Can provide incentives to work (Laffer Curve)
◦ Can influence the pattern of economic activity-
Subsidies may increase production and consumption
of merit goods, indirect taxes may reduce production
and consumption of demerit goods
◦ May affect level of investment and R+D in firms
Macro:
◦ Can stimulate SR and LR EG
◦ Can cause cyclical unemployment through changes in AD
◦ Demand-Pull and Cost-Push Inflationary Pressures
◦ Changes in trade balance leads to changes in the current account
◦ Redistribution of income via progressive taxation and welfare benefits
, TAXATION
• Direct Tax- A tax which cannot be shifted by the person legally liable to pay the tax onto someone else.
Levied on income and wealth, e.g. corporation and income tax
• Indirect Tax- A tax which can be shifted by the person legally liable to pay the tax onto someone else,
levied on spending, e.g. VAT
• Governments levy taxes to:
◦ Raise revenue to finance government spending
◦ Manage AD
◦ Change the distribution of income and wealth
◦ To try to correct market failure
• Regressive Taxation- When the proportion of income paid in tax falls as income increases, e.g. Poll Tax
• Proportional Taxation- When the proportion of income paid in tax stays the same as income increases,
e.g. National Insurance
• Progressive Taxation- As incomes rise, a larger proportion of income is paid in tax, e.g. Income Tax
• Principles of Taxation
◦ Economy- cheap to collect in relation to the yielded revenue
◦ Convenient- convenient for taxpayers
◦ Certainty- reasonably certain amount of taxes to pay
◦ Equity- Fair
◦ Efficiency- achieve its desired objective with minimal unintended consequences
◦ Flexibility- easy to change to deal with circumstances
RELATIONSHIP BETWEEN BUDGET BALANCE AND NATIONAL DEBT
• National Debt- The total debt owned by the government: Previous budget deficit + current national debt
Generally, as the national debt increases, the budget balance worsens
PROS OF FISCAL POLICY
• Helps with distribution of income
• Can address market failure
• Can lead to supply-side improvements
• Can attract FDI
CONS OF FISCAL POLICY
• Difficult to fine tune AD if economic data is inaccurate
• Time lags to identify trends and problems, implement and have an impact through the multiplier effect
• Can lead to fiscal crowding out- Public sector debt and demand for credit can result in an increase of the
cost of borrowing which can deter private sector investment
• Has a political interference
Fiscal Policy
Fiscal Policy involves the use of taxation, public spending and the manipulation of the government's
budgetary position to achieve the government's policy objectives
HOW FISCAL POLICY CAN BE USED TO INFLUENCE AD
• Demand-side fiscal policy- Using fiscal policy to increase or decrease the level of AD
• Deficit Financing- Deliberately running a budget deficit and borrowing to finance the deficit
• Expansionary/Contractionary Fiscal Policy- Policies to increase/decrease
• Discretionary Fiscal Policy- Involves making discrete changes to the budget deficit to manage AD
• Crowding Out- A Situation in which an increase in government spending displaces private sector
spending with little or no increase in AD
Expansionary fiscal policy- may involve increase in gov.
spending or reduction in taxation
Contractionary- vice versa
HOW FISCAL POLICY CAN BE USED TO INFLUENCE AS
• Supply-side Fiscal Policy- Used to increase the economy's
ability to produce and supply goods, through creating
incentives to work, save, invest and entrepreneurial,
through taxation for example
• Examples
◦ Increased spending on infrastructure
◦ Reduction in corporation tax
◦ Reduction in VAT
◦ Reduced welfare payments
◦ Subsidies paid to firms
MICROECONOMIC AND MACROECONOMIC FUNCTIONS OF
FISCAL POLICY
Micro:
◦ Can provide incentives to work (Laffer Curve)
◦ Can influence the pattern of economic activity-
Subsidies may increase production and consumption
of merit goods, indirect taxes may reduce production
and consumption of demerit goods
◦ May affect level of investment and R+D in firms
Macro:
◦ Can stimulate SR and LR EG
◦ Can cause cyclical unemployment through changes in AD
◦ Demand-Pull and Cost-Push Inflationary Pressures
◦ Changes in trade balance leads to changes in the current account
◦ Redistribution of income via progressive taxation and welfare benefits
, TAXATION
• Direct Tax- A tax which cannot be shifted by the person legally liable to pay the tax onto someone else.
Levied on income and wealth, e.g. corporation and income tax
• Indirect Tax- A tax which can be shifted by the person legally liable to pay the tax onto someone else,
levied on spending, e.g. VAT
• Governments levy taxes to:
◦ Raise revenue to finance government spending
◦ Manage AD
◦ Change the distribution of income and wealth
◦ To try to correct market failure
• Regressive Taxation- When the proportion of income paid in tax falls as income increases, e.g. Poll Tax
• Proportional Taxation- When the proportion of income paid in tax stays the same as income increases,
e.g. National Insurance
• Progressive Taxation- As incomes rise, a larger proportion of income is paid in tax, e.g. Income Tax
• Principles of Taxation
◦ Economy- cheap to collect in relation to the yielded revenue
◦ Convenient- convenient for taxpayers
◦ Certainty- reasonably certain amount of taxes to pay
◦ Equity- Fair
◦ Efficiency- achieve its desired objective with minimal unintended consequences
◦ Flexibility- easy to change to deal with circumstances
RELATIONSHIP BETWEEN BUDGET BALANCE AND NATIONAL DEBT
• National Debt- The total debt owned by the government: Previous budget deficit + current national debt
Generally, as the national debt increases, the budget balance worsens
PROS OF FISCAL POLICY
• Helps with distribution of income
• Can address market failure
• Can lead to supply-side improvements
• Can attract FDI
CONS OF FISCAL POLICY
• Difficult to fine tune AD if economic data is inaccurate
• Time lags to identify trends and problems, implement and have an impact through the multiplier effect
• Can lead to fiscal crowding out- Public sector debt and demand for credit can result in an increase of the
cost of borrowing which can deter private sector investment
• Has a political interference
