Fiscal Policy

  • Created by: BKaur
  • Created on: 22-11-18 13:20

Fiscal Policy

  • FISCAL POLICY: the taxation and government spending decisions of the government
  • Government can change tax rates, impose new taxes, and what it takes
  • The main sources of tax revenue are income tax, national insurance, corporation tax and VAT
  • Government can decide where and on what to spend their revenue from taxation
  • Main areas of government spending are the NHS, education, the welfare system and debt repayment
  • Pensions are the main drain, as part of the welfare system, due to an ageing population
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There are 2 different categories taxes fall into:

  • DIRECT TAXES: these are taxes that are taken directly from pay or profit, such as income tax and national insurance contributions
  • INDIRECT TAXES: these are taxes that are placed on products, such as VAT or Alcohol duty

Taxes can also be defined as:

  • PROGRESSIVE TAXES: taxes that take a greater percentage from the income of the rich; direct taxes are progressive
  • REGRESSIVE TAXES: taxes that take a greater percentage from the income of the poor; indirect taxes are regressive
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Fiscal Policy and Budget Position (1)


  • BUDGET DEFICIT: when government spending > tax revenue
  • Public Sector Net Borrowing (PSNB): when the government borrows money
  • Budget deficit = Positive PSNB


  • PSNB contributes to the national debt
  • Public Sector Net Debt: the accumulated debt of the country, since the founding of the Bank of England in 1694
  • Positive PSNB = National debt grows
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Fiscal Policy and Budget Position (2)


  • BUDGET SURPLUS: when tax revenue > government spending
  • used to pay off the national debt
  • Budget surplus = Negative PSNB


  • BALANCED BUDGET: when the government spends exactly what it receives in tax
  • National debt will stay at the same level
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Fiscal Policy and AD

  • As a demand-side policy, the aim of any fiscal policy is to influence AD
  • Since government spending is a component of AD:
    • if the governments increases government spending, AD should increase
    • if the government cuts government spending, AD should fall
  • If the government lowers tax rates, this is likely to increase AD
  • If they cut income tax or national insurance contributions, this increases the disposable income for consumers - so consumer spending and investment will rise, so AD will rise
    • However, some of the increased disposable income could be spent on imports and could lower AD through lower net trade
  • If the government cuts VAT or other indirect taxes, consumers may increase spending as products become cheaper - consumer spending increases so AD rises
  • If they cut corporation tax, firms will retain more profit so have more money to invest - investment increases so AD increases
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