Demand Management

Fiscal policy is used to maintain the aggregate demand of an economy.

Expansionary Fiscal Policy is when government increases budget deficit 9reduce surplus) by decreasing taxes and income spending to increase the aggregate demand of an economy.

Contractionary Fiscal Policy is when a government reduces aggregate demand by spending less and increasing taxes in order to reduce deficit/increase surplus.

Inflation

To decrease inflation, Contractionary Fiscal Policy may be used. Inflation may be due to aggregate demand increasing too quickly and Contractionary Fiscal Policy may be used to decrease demand.

Government may ↓ spending or ↑ taxes. This will ↓ disposable income and ↓ demand as well as inflation.

Economic Growth

Expansionary Fiscal Policy may be used to ↑ economic growth. An ↑  in government spending will ↑ Aggregate Demand.

↓ in Taxes can also ↑ Aggregate demand as firms and households will have an  ↑ in spending power.

COMPLETE NOTES ON UNEMPLOYMENT, CURRENT ACCOUNT DEFICIT AND FISCAL POLICY AND THE ENVIRONMENT. 

Environmental Taxes

Taxes that are designed to protect the environment and maintain sustainability are called environmental taxes.

Landfill Tax – Taxes imposed on disposal of waste in landfill sites

Climate Change Levy – A relatively new tax imposed to help the UK meet its target to reduce greenhouse gases.

Indirect Taxes

Taxes on spending are indirect taxes.

Key Indirect taxes include: 

VAT (Value Added Tax) – Tax on amount y which value of a product has increased in each stage of production/distribution. Firms will small turnovers aren’t required to pay a VAT. 

Duties – Heavy taxes on goods such as alcohol, tobacco, petrol, etc. 

Vehicle Excise Duty – Taxes imposed on vehicle owners. Tax depends on size of engine as larger engine = more carbon emissions

Customs Duties – Taxation on imports imposed by government.

Council Tax – Taxation on households of local authorities based on an estimated value of property and number of occupants. This goes to helping pay for local services such as refuse collection.

Business Rates – Collected by local authorities and contribute to provisions of local community services. They are paid by businesses and are based on value of business property.

Stamp Duties – Paid when assets such as houses and shares are bought.

Direct Taxes

Taxes that are imposed on firms and individuals are called direct taxes. Each type of tax is linked to income and wealth.

Key direct taxes include:

Income Tax – A Direct tax on earnings/income of an individual. Both employed and self employed people must pay this tax.

National Insurance Contribution – Similar to the income tax, these taxes are imposed on peoples incomes but these taxes go towards collection for pensions, benefits and the National Health Service (NHS).

Corporation Tax – imposed on profits made by limited companies. Businesses such as partnerships and sole traders pay income tax.

Capital Gains Tax – Tax on profits gained from selling a good.

Inheritance Tax – Taxes imposed on property/money acquired through inheritance.

Limited Company

 

A limited company is a company that has shareholders but is operated by directors. As a result of having shareholders, different people own different shares of the company thus giving owners of the company limited responsibility/liability for it.

Reasons why government may implement taxes

Why might government implement taxes?

• To fund public sector services
• To discourage activities that are harmful towards the environment and other people (e.g. smoking, alcohol, etc)
• To help control aggregate demand in an economy
• To balance the distribution of wealth

 

Government Expenditure

Total government expenditure as well as how much money they intends to spend on each category is shown in the government budget annually.

Sometimes, government spending is split into 2 categories. Mandatory spending and Discretionary Spending. Mandatory spending is a type of spending where it is required, an example of mandatory spending is a pension. While discretionary spending means that its optional and an example of discretionary spending is building a new motorway.

Fiscal Policy and the Budget

Decisions about government expenditure, taxation and borrowing which affect an economy’s aggregate demand is fiscal policy.

Different categories of expenditure include:

• Social Protection
• Education
• Health
• Defense
• Law and Order
• Transport and Communication
• etc.

Every year, the government outlines how much money they intend to spend on each category. The amount of money that will be raised to fund expenditure and plans on how the government will borrow money must be shown and published in the government’s budget.

When a government’s spending exceeds its revenue this is called a budget deficit. The government borrows money through selling government bonds and each bond is paid back in its full amount + interest. The amount borrowed is called PSNCR (Public Sector Net Cash Requirement).

When a government has more revenue than it can spend, this is called a budget surplus. A budget surplus is used to repay government debts.