3.1 Fiscal policy

DEFINITIONS:

1. Fiscal policy: Fiscal policy refers to the use of government spending and taxation to influence the economy.

2. Direct Tax: Direct tax is a type of tax levied directly on an individual's or organization's income or wealth.

3. Indirect Tax: Indirect tax is a type of tax collected by an intermediary from the person who bears the ultimate economic burden of the tax.

4. Progressive Tax: Progressive tax is a tax system in which the tax rate increases as the taxable amount increases.

5. Regressive Tax: Regressive tax is a tax system where the tax rate decreases as the taxable amount increases.

6. Proportional Tax: Proportional tax is a tax system where the tax rate remains constant regardless of the taxable amount.

   

7. Automatic Stabilisers: Automatic stabilisers are economic policies and programs designed to offset fluctuations in a nation's economic activity without government intervention.

Explain:

3.1.1 Government budget

A government budget is a financial statement presenting the government's proposed revenues and spending for a particular fiscal year. It outlines how the government plans to allocate its resources among various public services and sectors, and indicates whether it aims to run a surplus (where revenues exceed expenditures), a deficit (where expenditures exceed revenues), or balance its accounts. This budget is crucial for economic planning and policy-making, impacting taxation, public services, and overall economic stability.

3.1.2 Direct, indirect, progressive, proportional and regressive taxation

3.1.3 Current and capital government expenditure

Current government expenditure refers to the spending by the government on day-to-day operations and services. This includes expenditures such as salaries for public sector workers, healthcare services, education, and maintenance of infrastructure. These are recurring expenses necessary for the government's functioning and provision of public services.

Capital government expenditure, on the other hand, involves spending on long-term investments that contribute to the future productive capacity of the economy. This includes expenditures on infrastructure projects like roads, bridges, schools, and hospitals. These are typically one-time expenses that create assets expected to provide benefits over many years.

3.1.4 Budget surplus, deficit and balanced budget

• Budget Surplus: A budget surplus occurs when a government's revenue exceeds its expenditures over a specific period. This means the government collects more money in taxes and other revenues than it spends on public services, infrastructure, and other expenditures.
• Budget Deficit: A budget deficit happens when a government's expenditures exceed its revenue over a particular period. This indicates that the government is spending more money than it collects from taxes and other sources, often leading to borrowing to cover the shortfall.
• Balanced Budget: A balanced budget is when a government's revenue equals its expenditures over a given period. This means the government is neither in surplus nor deficit, spending exactly what it collects in revenue.

3.1.5 Cyclical and structural budget position

Cyclical Budget Position

The cyclical budget position refers to the government's fiscal balance (surplus or deficit) that varies with the economic cycle. During periods of economic growth, tax revenues typically increase and government spending on welfare decreases, leading to a cyclical surplus. Conversely, during economic downturns, tax revenues fall and welfare spending rises, resulting in a cyclical deficit. This position is influenced by temporary economic fluctuations rather than long-term trends.

Structural Budget Position

The structural budget position, on the other hand, is the government's fiscal balance adjusted for the economic cycle, reflecting the underlying fiscal stance. It indicates whether the government would run a surplus or deficit if the economy were operating at its full potential (i.e., at the natural rate of output). This measure helps to assess the sustainability of fiscal policy by isolating the effects of economic cycles, focusing instead on the impact of policy decisions and long-term factors.

3.1.6 National and government debt

National debt, also known as public debt, is the total amount of money that a country's government has borrowed and still owes. It includes all the government liabilities accumulated over time through deficit spending, where expenditures exceed revenues.

Governments issue various types of securities, such as bonds, to finance their debt. Managing national debt involves balancing the need for borrowing to fund public services and investments with the responsibility to maintain fiscal sustainability and avoid excessive interest obligations.

3.1.7 Discretionary fiscal policy and automatic stabilisers

Discretionary Fiscal Policy: Discretionary fiscal policy refers to deliberate changes made by the government to its levels of spending and taxation to influence the economy. This type of policy is enacted through legislative action, such as passing a new budget or stimulus package, with the aim of managing economic fluctuations, stimulating economic growth, or addressing specific economic issues like unemployment or inflation. For example, during a recession, the government might increase public spending or cut taxes to boost aggregate demand.

Automatic Stabilisers:

Automatic stabilisers are economic policies and programs designed to offset fluctuations in a nation's economic activity without direct intervention by policymakers. These stabilisers automatically adjust to economic conditions. Key examples include unemployment benefits and progressive tax systems. During an economic downturn, unemployment benefits increase as more people lose their jobs, providing income and maintaining consumer spending. Similarly, progressive tax rates automatically lower the tax burden during downturns as incomes fall, which helps stabilize disposable income and consumption levels. Conversely, during economic booms, these stabilisers help prevent the economy from overheating by reducing government spending and increasing tax revenues.

3.1.8 Explain Crowding out

Crowding out in economics occurs when increased government spending leads to a reduction in private sector investment. This can happen because government borrowing raises interest rates, making it more expensive for businesses and individuals to borrow and invest. As a result, the government's attempt to stimulate the economy through increased spending might be offset by a decrease in private investment.

3.1.9 Explain the Laffer curve

The Laffer Curve illustrates the relationship between tax rates and tax revenue. It posits that starting from a tax rate of 0%, increasing the tax rate will initially increase tax revenue. However, beyond a certain point, further increases in tax rates will lead to a decrease in tax revenue. This occurs because excessively high tax rates discourage work, investment, and economic activity, leading to lower overall taxable income. Thus, the curve suggests there is an optimal tax rate that maximizes revenue without overburdening taxpayers.

Explanation & Calculation

3.1.10 Average and Marginal Tax Rates

Average Tax Rate (ATR):

The average tax rate is the proportion of total income paid in taxes. It is calculated by dividing the total tax paid by the total income and is often expressed as a percentage.

Marginal Tax Rate (MTR):

The marginal tax rate is the rate at which the last pound of income is taxed. It indicates the tax rate applied to the next unit of currency earned. Marginal tax rates are important in progressive tax systems where the rate increases as income increases.