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Fiscal Policies
You all owe me
• Wolverhampton – unemployment…
• Past paper due next lesson…
Which EU country is this?
Aims
• Understand the practical application of fiscal policy
• To be aware of the impact of budget deficits on aggregate demand.
• An analyse the usefulness of fiscal policy as a short term and long term tool for macro economic objectives
http://www.informationisbeautiful.net/visualizations/the-billion-pound-o-gram/
Fiscal policies…
• Influencing the level of economic activity though manipulation of government income and expenditure
• Associated with Keynesian Demand Management Policies
• Influence Aggregate Demand – – Tax regime influences consumption (C) and investment (I)– Government Spending (G)
• Influences key economic objectives
• Acts as an ‘automatic stabiliser’
What does this mean?
Measured as a percentage of national income
UK Government Spending and Taxation
Total tax revenues as a share of GDP Government spending as a share of GDP
Source: OECD World Economic Outlook
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
36
37
38
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40
41
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43
44
45
46
47
48
49
Pe
r ce
nt
of
GD
P
36
37
38
39
40
41
42
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44
45
46
47
48
49
Total Tax Revenue
Government Spending
Budget deficit and
budget surplus… can you
see them?
Measured as a percentage of national income
UK Government Spending and Taxation
Total tax revenues as a share of GDP Government spending as a share of GDP
Source: OECD World Economic Outlook
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
36
37
38
39
40
41
42
43
44
45
46
47
48
49
Pe
r ce
nt
of
GD
P
36
37
38
39
40
41
42
43
44
45
46
47
48
49
Total Tax Revenue
Government Spending
Deficit Surplus
Deficit
Watch this
• Watch carefully and make a note of…
• The different types of tax mentioned
• How much the government forecast it’s debt to be
• Now much the UK debt is predicted to overshoot this forecast…
How many taxes can you
think of?
Taxation options
• Corporation • Capital Gains Tax• Inheritance• Excise duties• Business rates• Council tax• Income tax• VAT• Betting Tax• Insurance premium tax• Royalties
• Tariffs• Road tax• TV licence• Council tax• NI contributions• Congestion Charge• Stamp duty• Airport tax• Pigouvian tax –
environment
Tax revenue generated…
Why does the government tax?• Revenue
• To raise revenue to finance government spending (e.g. on public and merit goods and services)
• Managing aggregate demand • To help meet the government’s macroeconomic objectives such as stable
inflation and economic growth
• Changing the distribution of income and wealth • A progressive system of taxation can help bring greater equality in income &
wealth between households• The government may intervene directly through fiscal policy to on grounds of
equity
• Market failure and environmental targets• Taxes can correct for externalities – a source of market failure
Government spending
Government spending (G)
• Government (or public) spending each years takes up over 40% of gross domestic product
• Spending by the public sector can be broken down into three main areas:(1) Transfer Payments: i.e. welfare payments made to benefit
recipients such as the state pension and the Jobseeker’s Allowance
(2) Current Government Spending: i.e. spending on state-provided goods & services such as education and health
(3) Capital Spending: i.e. infrastructural spending such as spending on new roads, hospitals, motorways and prisons
Public Sector Spending
Why Have Government Spending?
• Direct government (public sector) provision of– Public Goods– Merit Goods
• Provide welfare support for low income households / the unemployed
• Government spending is also a means of redistributing income within society e.g. to reduce the scale of relative poverty
• Government spending can also be used as a tool to manage aggregate demand (GDP) as part of macroeconomic policy
Budget Deficit or Surplus?
Any chance of a balanced budget?
The budget deficit / surplus
• The budget deficit measures how much the government sector needs to borrow each year to finance its own spending
• The national debt is the total amount of borrowing undertaken by the government that has not yet been repaid
• A budget deficit arises when government expenditure exceeds government revenue (G>T) and a positive PSNCR.
The budget deficit / surplus
• The budget deficit measures how much the government sector needs to borrow each year to finance its own spending
• The national debt is the total amount of borrowing undertaken by the government that has not yet been repaid
• A budget deficit arises when government expenditure exceeds government revenue (G>T) and a positive PSNCR.
Never ever to be Confused with
Current account deficit / surplusBoP
PSNCR
• Public Sector Net Cash Requirements:
• In 2011 – govt intends to spend
• £704bn
• It’s hoping to receive £541bn
• What’s the PSNCR for 2011?
£163bn
Annual borrowing, £bn at current prices
UK Public Sector Net Borrowing
Source: Reuters EcoWin
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09
bill
ion
s
-100
-90
-80
-70
-60
-50
-40
-30
-20
-10
0
10
20
GB
P (
bill
ion
s)
-100
-90
-80
-70
-60
-50
-40
-30
-20
-10
0
10
20
Government budget balances
£ billion at current prices, monthly data
UK Government Net Debt
Source: Reuters EcoWin
90 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08
bill
ion
s
150
200
250
300
350
400
450
500
550
600
650
GB
P (
bill
ion
s)
150
200
250
300
350
400
450
500
550
600
650
What’s the difference between current and real?
Taxation and Aggregate Demand
How can taxes have a big effect on aggregate demand?
The fiscal policy transmission mechanism
Cut in personal income tax
Boost to disposable income
Adds to consumer demand
Cut in indirect taxes
Lower prices – higher real incomes
Adds to consumer demand
Adds to business capital spending
Cut in corporation tax
Higher “post tax” profits for businesses
Rise in government spending
Direct boost to aggregate demand
Possible multiplier effects on national income
Expansionary Fiscal Policy
Fiscal Policy & automatic stabilisers!
Automatic Stabilisers…
•Boom • What happens to Tax
revenue?• Increases
• What happens to transfer payments?
• Falls
•Recession• What happens to Tax
revenue?• Falls
• What happens to transfer payments?
• Increases
Got to here!
• Which one of the following is an example of fiscal policy? A decision by the government to
• A decrease the exchange rate.• B raise the minimum wage.• C increase its budget surplus.• D reduce the rate of interest.
• A current account deficit on the UK’s balance of payments means that generally
• A the total value of imports exceeds the total value of exports.
• B government expenditure exceeds government revenue.• C the value of imports of services is less than the value of
exports of services.• D the volume of imports of goods and services exceeds the
volume of exports of goods• and services.
• In the short run, an increase in the government’s budget deficit is most likely to reduce
• A imports.• B unemployment.• C interest rates.• D inflation.
• Demand-pull inflation is most likely to be caused by• A total spending exceeding productive capacity.• B an increase in output.• C a rise in raw material prices.• D a rise in interest rates.
UK debt & deficit
• In the financial year 2009/10 the UK recorded general government net borrowing of £159.8 billion, which was equivalent to 11.4 per cent of gross domestic product (GDP).
• At the end of March 2010 general government debt was £1000.4 billion, equivalent to 71.3 per cent of GDP.
UK debt & deficit
• The Maastricht Treaty's Excessive Deficit Procedure sets deficit and debt reference levels of 3 per cent and 60 per cent respectively for all EU countries.
The collapse in tax revenues
• Tax revenues tend to fall during a recession
– More people unemployed – less money from income tax
– Squeeze on business profits – less revenue from corporation tax
– Decline in consumer spending – hits income from VAT and duties
– Drop in average house prices – affects revenue from stamp duty
– Possible rise in tax avoidance and tax evasion
– Cuts in bonuses and other payments e.g. overtime pay
• The latest figures for the government show a big drop in tax receipts
• These reflect the slowdown in 2008 rather than the recession
• Prospect of much worse to come in 2009-2010
Main Sources of Revenue
Current Prices, £ billion. Source: HM Treasury
Income Tax, VAT & Corporation Tax
Source: Reuters EcoWin
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08b
illio
ns
0
25
50
75
100
125
150
175
GB
P (
bill
ion
s)
0
25
50
75
100
125
150
175
VAT
Corporation tax
Income tax
Should we be worried about a reduction in tax take?
• No– In a recession, tax revenues fall automatically – this is part of what is known
as the automatic stabilisers
– Some of the reduced tax revenue comes from decisions by the government to cut taxes to boost the economy
– Some comes from lower oil/petrol prices
• Yes– This is a sign of an economy heading into a very deep recession
– The drop in revenues is causing a huge rise in the budget deficit - public sector net borrowing is now almost three times higher than at the same stage last year
– The result will be an enormous deficit which will required either higher taxes in the future or cut-backs in government spending
– Some of the tax cuts introduced have been ineffective in increasing AD
Borrowing as a percentage of GDP, data for 2009 is a forecast from the OECD
UK Government Borrowing
Source: OECD World Economic Outlook
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09
-10.0
-7.5
-5.0
-2.5
0.0
2.5
5.0
7.5
Pe
r ce
nt
-10.0
-7.5
-5.0
-2.5
0.0
2.5
5.0
7.5
Cyclically adjusted government borrowing
Government borrowing
£ billion at current prices, monthly data
UK Government Net Debt
Source: Reuters EcoWin
90 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08
bill
ion
s
150
200
250
300
350
400
450
500
550
600
650
GB
P (
bill
ion
s)
150
200
250
300
350
400
450
500
550
600
650
Current spending at constant 2003 prices, seasonally adjusted, £bn per quarter
General Government Spending in Real Terms
Source: Reuters EcoWin
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08
bill
ion
s
45.0
47.5
50.0
52.5
55.0
57.5
60.0
62.5
65.0
GB
P (
bill
ion
s)
45.0
47.5
50.0
52.5
55.0
57.5
60.0
62.5
65.0
