The Fiscal Policy Continuum
• gov’t budgetary position = T-G
deficit
0
balanced
budget
+
surplus
• movement to the right is contractionary /
deflationary
• movement to the left is expansionary /
reflationary
What are Taxes For?
• Raise revenue
• Reduce the demand for de-merit goods
• Internalise external costs
• Discourage imports
• Redistribute income
Types of Taxes
• Direct Tax
• Indirect Tax
Regressive Tax
• takes a higher proportion of income from lower
income earners
(eg. council tax – assume identical homes to identical
tax payable)
Income
Tax
Payable
Tax Rate
£10,000
£2000
20%
£40,000
£2000
5%
£100,000
£2000
2%
Proportional Tax
• takes an equal proportion of income from all earners
(eg. UK corporation tax – in the UK, most corporations
pay the ‘main rate’ – > £300K profit)
Income
(Profit)
Tax Rate
Tax
Payable
Average
Tax Rate
£300,000
21%
£63,000
21%
£500,000
21%
£105,000
21%
£1M
21%
£210,000
21%
Progressive Tax
• takes a higher proportion of income from higher
income earners (eg. UK income tax)
Income
Taxable
Income
Tax Rate
Tax
Payable
Average
Tax Rate
£10,000
£0
0%
£0
0%
£42,000
£32,000
20%
£6,400
15%
£150,000
32K @ 20%
118K @ 40%
£53,600
36%
32K @ 20%
118K @ 40%
150K @ 45%
£121,100
40%
£150,000
£300,000
(£10K allowance
gone)
£300,000
Question to consider?
• National Insurance works like this:
• Based on weekly gross earnings
• First £0 - £153 / week – 0%
• Next £153 - £805 / week – 12%
• Anything above £805 / week – 2%
• Is this regressive, proportional or progressive?
Evaluation of a Tax:
How do we decide if it’s a good tax?
• Equity: the impact of the tax on people at different
levels of income (regressive, progressive,
proportional)
• Efficiency: does the tax raise enough revenue
without distorting the mkt? (eg. Income taxes may ↓
incentive to work, indirect taxes  prices to creative
allocative inefficiency)
• Transparency & Certainty: does it cost a lot to
implement & can it be reliably collected (black mkts)
Financing of Gov’t Expenditure
• Taxes - central gov’t
• Taxes - local authorities (eg. council tax)
• National insurance contributions paid by employees and
employers
• Borrowing (PSNBR)
• Sale of assets
Functions of Gov’t Expenditure
• Provision of Public and Merit Goods & Services
• Provision of Social Security
• Regulation of Economic Activity
• Improving Efficiency of Allocation of Resources
• Influencing the Level of Economic Activity
Categories of Gov’t Expenditure
• Current Expenditure
• Capital Expenditure
• Transfer Payments
• Debt Interest
Factors Influencing Level of
Gov’t Expenditure
• Economic Cycle
• Demographic Changes
• Social / Cultural Changes
• Demand for Goods & Services
• Demand for Public / Merit Goods
• Political Views
• Interest Rates
• Risk of Conflict
Automatic v Discretionary Fiscal Policy
• Automatic: changes in tax rev. & spending brought about
by cyclical changes in GDP (during recession, more people
on benefits, less tax rev. ∴ boosts AD)
• Discretionary: active demand management (during
recession, chancellor may decide to lower taxes to boost
AD)
When Expenditure ＞Tax Revenue
• Structural Deficit – occurs when gov’t deliberately runs
a budget deficit to increase AD (may seek to unemp. or
 econ.growth)
• Cyclical Deficit – result of a cyclical fall in economic
activity (recession or slowdown) that  tax rev. &  gov’t
expenditure
• PSNCR (public sector net cash requirement) or
PSNBR (borrowing) – amount by which gov’t spends
more than it raises in revenue –financed by borrowing
money from the private sector, or overseas or by selling
assets (will be a negative number when gov’t runs a
surplus – some nat’l debt can be repaid)