Fiscal Policy & Supply-Side Policies | 4.2.5 | AQA A-Level Economics Notes

4.2.5.1 Fiscal Policy

• Fiscal policy involves the manipulation of government spending, taxation and the budget balance.
• Fiscal policy can have both macroeconomic and microeconomic functions.
• Expansionary fiscal policy is when there is an increase in government spending or a decrease in taxation. This leads to an increase in aggregate demand in an economy (and vice versa).
• Supply-side fiscal policy aim to use changes in spending or taxation to increase incentives in an economy. For example, corporation tax cuts will lead to an increase in SRAS, or decreases in income tax will create further incentives to work.
• Government spending can be on welfare benefits/ pensions, education and health systems, and defence.
• A direct tax is a tax that is imposed on income and they are paid directly from the taxpayer to the government.
• Indirect taxes are imposed on expenditure on goods and services. For example, ad valorem taxes (e.g. VAT) are percentages, and specific taxes are per unit (e.g. on petrol).
• Progressive taxes: as income rises, the proportion of income paid increases.
• Regressive taxes: as income rises, the proportion of income paid falls.
• Proportional tax: as income increases, the same proportion is taxed.
• The principles of taxation: the cost of collecting tax must be relatively low to the yield, timing and quantity should be made obvious to taxpayer, method of payment must be convenient and taxes should be equitable e.g. dependent on ability of taxpayer.
• A balanced budget is when government spending is equal to tax revenue in a year.
• A deficit is the difference between government spending and tax revenue.
• National debt is the accumulation of the net budget deficit over a number of years.
• Holding high levels of debt can lead to problems paying money back. This can lead to loss of trust from lenders, refusal to lend money in the future, or extremely high interest rates.
• Cyclical budget deficit is the part of the budget deficit which rises in the downswing of the economic cycle and falls in the upswing.
• Structural budget deficit is the part of the budget deficit which is not affected by the economic cycle, but results from structural changes in the economy (e.g. ageing population causing spending on healthcare and pension, wars causing spending on defence).
• The Office for Budget Responsibility is an advisory public body that provides independent economic forecasts and analysis of the public finances, as background to the preparation for the UK budget.
• They judge performance compared to the country’s objectives, and scrutinise tax and spending measures, while assessing the sustainability of policies.
• Crowding out effect: in expansionary fiscal policy, the government may have to borrow money in order to spend. For example, they may sell bonds, leading to investments from people or financial institutions on high incomes. That may hold back their spending in the near future, as well as raise market interest rates due to an increase in demand for loanable funds.

4.2.5.2 Supply-side Policies

• Supply side policies are government economic policies which aim to make markets more competitive and efficient, increase productive potential, and shift LRAS to the right.
• Supply-side improvements are reforms undertaken by the private sector to increase productivity by reducing costs and becoming more efficient and competitive. Often, they result from investment and innovation without prompting from the government.
• Free market supply-side policies include measures such as tax cuts, privatisation, deregulation and some labour market reforms.
• Interventionist supply-side policies include measures such as government spending on education and training, industrial policy and subsidising spending on research and development.
• Supply-side policies can involve government intervention to deal with market failures such as short-termism, as well as policies to improve economic incentives and the operation of markets.
• Supply-side policies can have microeconomic as well as macroeconomic effects.
• Supply-side policies, such as tax changes designed to change personal incentives, may increase the potential output of the economy and improve the underlying trend rate of economic growth.
• Supply-side policies can be used to reduce the natural rate of unemployment. For example, better education and training can help make workers more competitive, increasing the supply of workers, reducing real wages. Lower unemployment benefits can help increase the incentive to get a job, as can lower income tax.