3.4.2 Managing the National Economy
Fiscal Policy
With reference to the 10 year time line drawn last lesson take it in
turns to choose one change in fiscal policy and explain the impact.
Where possible use diagrams to support your explanation.
How would you describe the current government’s attitude to fiscal
policy?
AQA ECON4: T HE NATIONAL
AND INTERNATIONAL ECONOMY
F ISCAL P OLICY






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You should be able to discuss the issue of the budget balance and be able to
evaluate the possible economic consequences of a budget deficit or budget
surplus and the possible corrective measures
You should be able to assess the economic significance of changes in the level
and distribution of public expenditure
You should be able to analyse and evaluate the microeconomic significance of
taxation and the various roles and relative merits of the different UK taxes
You should be aware of the taxation principles which are likely to underlie a
taxation system, such as the ability to pay and the impact on incentives
You should be aware of the introduction of fiscal rules such as the Stability and
Growth Pact within the euro area
You should be able to assess the economic significance of changes in the level
of the national debt
Note: given the requirements of this Unit and those of Unit 2, it is expected that
you will have an understanding of both the potential demand-side and supplyside effects of fiscal policy, including its microeconomic role and the influence
over the pattern of economic activity
F ISCAL P OLICY - R ECAP
This section extends the knowledge you have gained in ECON2. Key
points and terms to remember are:
 Definition

Test yourself!
Can you draw
2 diagrams to
show the
impact of
expansionary
and
contractionary
fiscal policy on
an economy?

Expansionary fiscal policy


A policy designed to expand aggregate demand through increases
in government spending or cuts in taxation
Contractionary fiscal policy


“The manipulation of government spending, taxation and
government borrowing to influence the level of economic
activity”
A policy designed to contract aggregate demand through cuts in
government spending or increases in taxation
Budget deficits and surpluses


Budget deficit – where Government spending is greater than tax
revenue
Budget surplus – where tax revenue is greater than government
spending
F ISCAL P OLICY – R ECAP
P URPOSE
F ISCAL P OLICY
ON THE
OF
The underlying purpose of fiscal policy in the economy is to:
 Manage the economy
 Promoting growth, economic stability and international
competiveness
 Fund government spending
 Redistribute income
 Correct market failure
Class discussion.
To what extent do you think
that the tax system and
government spending is an
effective way to meet these
objectives?
T HE B UDGET B ALANCE
The budget balance is a situation where:
government spending = tax revenue
Does the UK
have a balanced
budget?

Government spending comprises all expenditure on:
 capital projects e.g. schools, hospitals and infrastructure
 current spending e.g. teachers and nurses wages
 transfer payments e.g. benefits

Tax revenue is comprised of all income received from:
 direct taxes e.g. income and corporation tax
 indirect taxes e.g. VAT and duties
B UDGET D EFICITS (1)
Automatic
stabilisers – when
an economy falls
into recession, we
would expect GDP
to fall. However,
because
government
spending on welfare
and thus the deficit
automatically
increases during a
recession, this has
the effect of
stabilising the
economy to some
degree. This should
reduce the overall
impact of the
recession.
There are two components of the overall budget deficit:
1.
Cyclical Deficit
 The part of the deficit that arises as a result of fluctuations
in the economic cycle
 When aggregate demand falls during a recessionary period,
government spending will rise i.e. welfare benefits and tax
revenue will fall i.e. lower levels of government income e.g.
income tax receipts
 However, the cyclical deficit should be reduced or
eliminated during upturns in the economic cycle, as tax
revenues recover and outgoings on welfare are reduced
 Given the nature of economic cycles, it is generally
accepted that the cyclical deficit is a less serious economic
issue
B UDGET D EFICITS (2)
2.
Structural Deficit
 The part of the overall deficit that persists regardless of the
position of the economy in the economic cycle, and as a
consequence is regarded as a more serious issue
 Even if the economy is operating at full employment, the
structural deficit remains
 The size of the structural deficit is a key indicator of the
governments overall financial management
T HE C YCLICAL B UDGET D EFICIT
It should be
clear to see the
increase in the
cyclical budget
deficit that
occurred in the
UK as the
recession began
in 2008.
The cyclical
budget deficit is
forecast to
reduce and
move to surplus
by 2017/18.
To what extent
do you think this
is an accurate
prediction?
What will it
depend on?
T HE S TRUCTURAL B UDGET D EFICIT
Compare and
contrast the
data for the UK’s
structural deficit
compared to the
cyclical deficit
shown in the
previous slide.
How are they
different?
Are there any
similarities?
C ONSEQUENCES
OF A
B UDGET D EFICIT

Any form of deficit implies that the government needs to borrow money to meet its
spending commitments

The money that the government borrows is often referred to as the Public Sector Net Cash
Requirement (PSNCR)

The government will borrow from a range of sources, including the banking sector and/or
issuing government debt through the sale of government bonds

Borrowing money involves the repayment of interest, which reduces the amount of
expenditure that might be spent elsewhere in the economy

For example, in 2013 the UK government spent approximately £46.5bn in interest payments

Crowding Out - If the UK government increase their demand for borrowed funds, then this
may bid-up the rate of interest, which makes borrowing by firms for investment projects
more costly, and therefore less attractive. As a consequence, higher budget deficits can be
said to “crowd out” private sector enterprise

If the overall deficit is predominantly structural, then in order to repay it, tax rises and/or
significant reductions in government spending in future years may be required
B ENEFITS
OF A
B UDGET D EFICIT
Whilst it is generally assumed that budget deficits have
negative economic consequences, they may be
beneficial in some situations
 Keynesian economists would argue that increases in
government spending during periods of
recession/downturn are desirable and a vital stimulus
to aggregate demand and wider economic activity
 If governments borrow money to spend on capital
projects to improve the infrastructure of the country,
then this will improve long-run productive potential
and shift the LRAS curve to the right, boosting overall
capacity
C ORRECTIVE
Looking at the
corrective
measures
opposite,
construct a plan
for how you
might reduce
the budget
deficit the
current UK
government
faces.
Consider
carefully the
impact of your
decisions. Does
an optimum
solution exist?
MEASURES
Faced with a budget deficit, the government must consider a range of
possible solutions to reduce or manage the deficit. These include:
 Raise taxes


This is regarded as a contractionary fiscal policy and will have negative
effects upon aggregate demand and therefore economic growth and
unemployment
However, the precise impact of this will depend upon which taxes are raised,
by how much and the extent to which economic agents respond to them
 Cut government spending


Also a contractionary fiscal policy
The precise extent of the impact on the budget deficit depends upon which
areas of government spending are cut, by how much and the sensitivity of
economic agents to the cuts
 Expand the economy

Keynesian economists would argue that a short-run worsening of the budget
deficit will provide a vital stimulus to the economy, which if successful, will
boost tax revenues and reduce the budget deficit in the long-run
P RINCIPLES
Consider the
different
taxes that
exist in the
UK.
TAXATION
Adam Smith first introduced the concept of ‘good’ and ‘bad’ taxes.
A good tax will be:
1. Economical

2.

3.
4.
It should be easy for the taxpayer to pay
Certain
The taxpayer should know the size and timing of the payment of
tax
Efficient

6.
Fair and based on taxpayers ability to pay
Convenient

5.
Cheap and easy to collect
Equitable

To what
extent do
you think
they are
“good”
taxes?
OF
The tax should improve economic incentives e.g. encourage work,
discourage consumption of de-merit goods
Flexible

Must be easily adjusted if economic circumstances dictate this is
required
T YPES
Discuss the
relative merits of
different types of
taxation.
Which do you
think will gather
the most
revenue?
What will the
impacts of tax
rises/cuts be of
different types of
tax?
OF
TAXES
 Direct taxes
 Taxes imposed on an individual or property
 e.g. income tax, corporation tax, national insurance, stamp duty
 Indirect taxes
 Taxes on a transaction and imposed on a producer
 e.g. VAT, duties, air passenger duty
 Hypothecated taxes
 Taxes raised for a specific purpose. In theory, the revenue
raised is ring-fenced for a clearly identified use
 e.g. TV licence
is a form of taxation where all revenues go
towards the provision of broadcasting through the BBC
How predictable
are taxes?
Should tax raised on the sale of alcohol
be used to fund rehabilitation?
P ROGRESSIVE , R EGRESSIVE AND
P ROPORTIONAL TAXATION
Income tax is
considered a
progressive tax
through the
imposition of
tax bands,
whilst VAT is
regressive in
nature.
Progressive
Proportional
Proportion of tax paid as
percentage of income
Different types
of tax have
different effects
upon the
economy.
Regressive
Amount of Income
P ROGRESSIVE , R EGRESSIVE
AND P ROPORTIONAL
TAXATION

Work in pairs to complete the table below
Progressive
Regressive
Proportional
Definition
Examples
Advantages
Disadvantages
Advantages
Disadvantages
Advantages
Disadvantages
F ISCAL R ULES

The UK operates under a number of fiscal rules. These have
changed over the years, and you should keep up to date with
new or changing rules
Do you think
these are
effective and
purposeful
rules?

George Osborne currently has two fiscal rules
1. Eliminate the current structural deficit within 5 years
2. Ensure that debt is falling as a share of GDP by 2015-16
Conduct some
research and
examine how
successful the
UK government
is being in terms
of operating
within the rules
it has set itself.

In addition, as part of the European Union, the UK has signed up
to the Stability and Growth Pact, which aims to promote
budgetary discipline amongst member states. This primarily
comprises of:
1. Each country must have an annual budget deficit of less
than 3% of GDP
2. Each country must have a national debt lower than 60% of
GDP
Look at the
current fiscal
rules opposite.
K EY C RITICISMS , L IMITATIONS AND
E VALUATION OF F ISCAL P OLICY
 Tax Burdens

Whilst vital to raise tax revenue for government spending on
a range of public goods and services, governments must be
conscious that if taxes become too high, they may act as
disincentives to work or invest
 International Competitiveness

In an increasingly globalised economic environment, the
government should also ensure that its taxation policies
ensure the UK remains internationally competitive
 Information Issues


Governments do large amounts of research to ensure that
taxes are set appropriately, however, this information may be
difficult to gather. If so, then poor fiscal decisions are
possible
In addition, it is vital that government spending is clearly and
accurately targeted
K EY C RITICISMS , L IMITATIONS AND
E VALUATION OF F ISCAL P OLICY
 Multiplier


Impacts
The overall impact of fiscal policy will depend upon the size of the
multiplier
Despite the range of statistical tools used by the government, this is
very hard to predict accurately and so the impact of fiscal policy
may be larger or smaller than expected
 Time Lags


Policy decisions may take some time to have an effect
The Chancellor only announces policy decisions, through the
budget, annually and the full effects of these might not be felt for
many months or years into the future
 Microeconomic

effects
Whilst fiscal policy is primarily aimed at enhancing the macro side
of the economy, it will also have a variety of microeconomic effects,
which may significantly alter the pattern of demand for different
goods and services
IN
Download the
Jan 2013
ECON4 paper
and mark
scheme from
www.aqa.org.
uk.
Look at section
B question 2.
You should:
a) Write an
essay plan
b) Write an
answer
PAIRS

Collect data to review the level of national debt
over a number of years

Represent this data diagrammatically

Identify any key policies that have influenced the
level of national debt in the last 2 to 4 years

Present your findings to the rest of the class
spending time to explain the economic
significance of the changes you have identified