AQA Economics A-level: Macroeconomics

Topic 5: Fiscal and Supply Side Policies

5.1 Fiscal Policy

• Definition: Manipulation of government spending, taxation, and budget balance with macroeconomic and microeconomic effects.
• Instruments:
  • Government spending and taxation
  • Influence circular flow by adjusting government budget, spending, and taxes
  • Targeted spending for economic stimulation

Objectives of Fiscal Policy

• Stimulate economic growth
• Stabilize the economy
• UK focuses on pensions, welfare, health, and education
• Largest tax revenue: Income tax

Fiscal Policy Impact on AD

• Expansionary Fiscal Policy:

  • Increases AD by boosting spending or cutting taxes
  • Results in a higher budget deficit and potential borrowing
  • May lead to a government budget deficit

• Deflationary Fiscal Policy:

  • Decreases AD by cutting spending or increasing taxes
  • Improves budget deficit

Fiscal Policy Impact on AS

• Reduce taxes to encourage spending and investment
• Subsidize training, enhance education
• Invest in healthcare to boost labor productivity
• Infrastructure investments (e.g., roads, schools)

Government Budget and Deficit

• Budget Deficit: Expenditure > Tax receipts
• Budget Surplus: Tax receipts > Expenditure
• Debt vs. Deficit:
  • Debt: Accumulation of deficits
  • Deficit: Difference between expenditure and revenue

Taxation Types

• Direct Taxes: Income, corporation, NICs, inheritance
• Indirect Taxes: VAT, fuel duty
  • Ad valorem: Percentage taxes (e.g., VAT)
  • Specific Taxes: Fixed amount per unit (e.g., fuel duty)

Tax Structures

• Proportional Tax: Flat rate
• Progressive Tax: Increases with income
• Regressive Tax: Higher burden on lower incomes

Principles of Taxation

• Low collection cost relative to yield
• Clear timing and quantity for taxpayers
• Convenience in payment
• Based on ability to pay and equity
• Maintain efficiency and align with international systems
• Adjust for inflation

Limitations of Fiscal Policy

• Imperfect information
• Time lags
• Crowding out private sector
• Multiplier effect importance
• Interest rate influence
• Debt repayment issues

Public Expenditure Types

• Current Expenditure: Recurring spending (e.g., healthcare drugs)
• Capital Expenditure: Asset investment (e.g., roads, schools)
• Transfer Payments: Welfare support (e.g., pensions, benefits)

Public Expenditure Trends

• Focus on pensions and welfare
• Constant education spending
• Increasing social security post-war
• Decreasing defense spending

Effects on Economic Variables

• Productivity and Growth: Investment in human capital
• Crowding Out: Reduced private investment
• Taxation Level: Potential tax increase with debt
• Equality and Living Standards: Progressive taxes, public services

Budget Balance and National Debt

• Surplus, Deficit, Balanced Budget: Tax vs. expenditure
• Debt: Accumulated deficits
• Reducing Debt: Surplus needed

Deficit Types

• Cyclical Deficit: Business cycle related
• Structural Deficit: Revenue-expenditure imbalance

Consequences of Deficits/Surpluses

• Inflationary potential
• Crowding out
• Interest rate increase

National Debt Significance

• Increased borrowing costs
• Confidence impact
• Potential high taxes and austerity

Role of the Office for Budget Responsibility (OBR)

• Analyzes UK finances
• Produces 5-year forecasts
• Monitors fiscal targets
• Scrutinizes tax and welfare
• Assesses long-term sustainability