Chapter 26 fiscal policy
(Basic knowledge)
Fiscal policy = The decision on taxation and government spending to influence aggregate demand.
Budget Deficit = Tax revenue < Government Spending
Budget Surplus = Tax revenue > Government Spending
(About Tax)
There are 2 categories of tax:
Indirect tax = tax on expenditure, which cannot be pass to the third party
Example: Sales tax, excise duties
Direct tax = tax on wealth and income, which can be pass to the third party
Example: income tax, cooperate tax, inheritance tax
And there are 3 types tax:
Progresive
Regresive
Proportional
Higher income
= pay higher
rate
Higher income
= pay lower
rate
all income =
pay same rate
This is like
normal income
tax, when you
earn more the
rate will
increase
This is like sales tax,
because the price of the
item is fixed, ie. Apple, is
the same (RM 5).
so for people with higher
income, rm5 is a smaller
portion of their income
compare to those with
lower income
Rarely happen,
only some
special case
like some
Europe
countries set
the fixed
income tax
rate (ie. 10%)
for everyone
Why do Government impose tax?
-
to redistribute income
-
Discourage the consumption of demerit good (ie. Tax heavily on alcohol so it become very
expensive and less people willl buy it)
(Continue)
-
To protect domestic / local firms from imports (ie. Tax heavily on imported goods and make
them expensive so less people buy it)
-
Influence economics activity (ie. Increase income tax can reduce people’s spending, hence
reduce demand pull inflation)
Remember the two main reasons that government
impose tax:
1)
To make the product more expensive, and hope less people can
buy it (ie. Alchohol, cigarettes, imported goods)
2)
To increase/reduce people's income (by increase or reduce
income tax)
(About the uses of fiscal policy)
Expansionary Fiscal policy =
Tax
G.S.
Imagine this is to increase economics growth (expand):
1. Reduce T can make people spend more, consumption increase will lead to GDP
increase
2. Increase in GS will lead to increase in GDP, Plus if government spend on like
Education or health care it can benefit the economics in long term
Contractionary Fiscal policy =
Tax
G.S.
Imagine this is to reduce economics growth (contracting)
Although sounds a bit weird to reduce economics growth, but this can help to
reduce Demand-pull inflation (= inflation cause by increase in Aggregate demand)
1. Increase T make people have less residual income (income after tax) hence
consumption decrease will lead to GDP decrease, but this potentially can reduce
inflation
2. Decrease in GS will lead to decrease in Aggregate demand, hence potentially
reduce demand pull inflation