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    1 - Fiscal Policy

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    1 - Fiscal Policy

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    1 - Fiscal Policy

    Uploaded by

    zsy1104537534

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    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
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    CHAPTER 5

    Government Macro
    Intervention

    Fiscal Policy

    Prepared by Ms Viky
    Course: AL-ECO
    Today`s Discussion
    • Use of government policy to achieve macroeconomic objectives: price stability, low
    unemployment, economic growth (policy conflicts and trade-offs are not required)

    •Meaning of government budget

    •Distinction between a government budget deficit and a government budget surplus

    •Meaning and significance of the national debt

    •Taxation:
     types of taxes: direct/indirect, progressive/regressive/proportional
     rates of tax: marginal and average rates of taxation (mrt, art)
     reasons for taxation

    •Government spending:
     types of spending: capital (investment) and current
     reasons for government spending

    •Distinction between expansionary and contractionary fiscal policy

    •AD/AS analysis of the impact of expansionary and contractionary fiscal policy on the
    equilibrium level of national income and the level of real output, the price level and
    employment
    Aims of Macro Economic Policy

    • Economic policy is the deliberate attempt from


    government to increase economic welfare.

    • Government may have certain objectives to achieve and


    would use different policy instruments to meet the goals.

    • There are 2 branches of economics focuses on different


    economic objective: policy objective and policy
    instruments
    Aims of Macro Economic Policy

    • Main government macroeconomic policy:


    ▫ Full employment
    ▫ Low and stable inflation
    ▫ Balance of payments equilibrium
    ▫ Steady and sustained economic growth
    ▫ Avoidance of exchange rate fluctuations
    ▫ Sustainable economic development
    Types of Policy
    • Policy instruments available to meet
    macroeconomic objectives:
    ▫ Fiscal policy
    ▫ Monetary policy
    ▫ Supply-side policies

    • Fiscal policy is the use of taxation and


    government spending to influence aggregate
    demand.
    Government Budget
    • Budget: an annual statement in which the
    government outlines plans for its spending and tax
    revenue.
    ▫ Announce by finance minister or treasury on
    government plans for its spending and taxation for
    the year ahead.

    • Balance budget is where government spending


    matches tax revenue.
    Government Budget
    Outlines government spending and taxation plans for the year ahead

    Budget balance Government expenditure = tax revenue


    Budget surplus Tax revenue > government expenditure
    Budget deficit Tax revenue < government expenditure
    Government Budget
    • Budget surplus arises when tax revenue exceeds
    government spending.
    ▫ Government is able to pay off debt using tax
    revenue, save for future etc.

    • Budget deficit is where government spending


    exceeds tax revenue.
    ▫ Government unable to pay off its debt with tax
    revenue, may need to increase tax rates in future.
    Government Budget
    • Budget deficit that caused by changes in economic
    activity is known as cyclical budget deficit.
    ▫ Due to automatic stabilisers, budget position
    deteriorate as economies slow (tax revenue fall,
    welfare spending increase).
    ▫ Over time will move towards budget balance as
    economic activity increases.
    Government Budget
    • Budget deficit that caused by an imbalance between
    government spending and taxation is called
    structural budget deficit.
    ▫ This arises as government committed too much
    spending relative to its tax revenue.
    ▫ Could happen even when economy is at its full
    employment (full capacity).
    National Debt
    • The national debt is the amount of money
    the federal government has borrowed to
    cover the outstanding balance of expenses
    incurred over time.

    • In a given fiscal year (FY), when spending (ex.


    money for roadways) exceeds revenue (ex.
    money from federal income tax), a budget
    deficit results.
    National Debt
    Significance of National Debt

    • If government spending is already greater


    than tax revenue, the size of the deficit
    will increase.

    • It also follows that the national debt will


    increase, meaning that future taxpayers have
    more debt to repay and more interest on the
    debt.
    Taxes – Direct and
    Indirect
    • Direct tax: one that tax on income of people and firms
    and cannot be avoided.
    • Tax levied directly on individual or organisation.
    ▫ E.g. income tax, corporate tax (25%), capital gain tax
    (30%)

    • Indirect tax: tax that is levied on goods or service.


    ▫ E.g. VAT on retail sales of goods and services, excise
    duties on fuel, alcohol and tobacco products.
    ▫ Also includes council tax and business rates that charged
    locally on the ownership of houses, apartments, and
    business premises.
    Taxes – Direct and
    Indirect
    • There are 2 types of indirect tax:

    1. Ad valorem tax – tax which is charged as a given proportion or


    percentage of the price.
    • Final price paid by consumer is inclusive of such tax

    • E.g. VAT, GST

    2. Specific tax – tax that is fixed per unit


    • Tax on expenditure whereby it increases the price of the good
    as customer is paying the tax by paying more for the product.
    • E.g. excise duty
    Other Taxation Issues
    • Average rate of taxation: total taxes paid divided
    by total income

    • Marginal rate of taxation: the extras taxes paid


    on an additional dollar of income.

    • Marginal tax rate is the highest rate at which a


    person is taxed, but average tax rate reflects the
    actual tax a person paid.
    Marginal Rate of Taxation

    US Marginal Tax
    Rates
    Proportional Tax
    • Proportional tax: one that takes the same proportion or
    percentage from those who have to pay it

    • Amount of tax paid remain the same while the income


    of taxpayer changes; tax rate is therefore constant.
    ▫ Same tax rate across low, middle and high income groups
    ▫ E.g. VAT
    ▫ With proportional tax, the marginal rate of tax is constant
    leading to a constant average rate of tax.
    Proportional Tax
    • Proportional tax:

    Total price: RM 100 Total price: RM 3,000


    6% GST: RM 6 6% GST: RM 180
    Total price + GST: RM 106 Total price + GST: RM 3,180
    Progressive Tax
    • Progressive tax: one that takes a higher
    percentage from those with higher incomes.

    • Amount of total paid in tax increases as income rises.


    ▫ Tax on individual based on their “ability to pay”
    ▫ With progressive tax, the marginal rate of tax rises as
    income rises.
    ▫ Eg: As people earn more income, the rate of tax on
    each extra pound goes up. This causes a rise in the
    average rate of tax.
    Regressive Tax
    • Regressive tax: a tax that takes a greater percentage
    from those on lower incomes.
    • When income rises, the amount of tax paid over the
    person’s total income falls.
    ▫ The average and marginal rate of taxation are falling.
    ▫ The average rate of tax is lower for people on higher
    incomes but the burden of taxation is higher for lower
    income households.
    ▫ Tax that is applied uniformly – bigger impact on lower-
    income individuals.
    ▫ Cigarette tax, petrol tax, GST
    GST as Regressive Tax

    Individual A Individual B

    Income: RM 2K Income: RM 5K
    Expenses on petrol: RM Expenses on petrol: RM
    500 500
    GST paid on petrol: RM 30 GST paid on petrol: RM 30

    Tax / income: 1.5% Tax / income: 0.6%


    Reasons for Taxation
    Reasons for Government Taxation:

    1.To pay for government spending

    2.To manage aggregate demand through


    fiscal policy

    3.To redistribute income

    4.To correct for market failure


    Government Spending
    Government Spending
    • Reasons for Government Spending
    Fiscal Policy
    • Reflationary or expansionary fiscal policy is
    designed to increase AD.
    ▫ Involve government increasing its spending , cutting
    tax rates or tax base.

    • Deflationary or contractionary fiscal policy is


    intended to lower AD.
    ▫ Involve government reducing its spending, increase
    tax rates or tax base.
    Fiscal Policy
    • There are 2 types of fiscal policy.
    1. Discretionary fiscal policy – deliberate changes in
    government spending and taxation.
    2. Automatic stabilisers – changes in government
    spending and taxation occur to reduce fluctuations in
    AD without any alteration in government policy.
    ▫ Where tax and transfer payment systems design to
    offset fluctuations in economic activity without direct
    intervention by government.
    ▫ Government spending change without deliberate action.
    Fiscal Policy
    • E.g. during recession, tax revenue will fall but
    government spending on unemployment benefits
    will rise.
    • Initially the economy is operating below full
    employment at Y, with significant gap between
    government spending and taxation.
    • As GDP rises, government spending on benefits falls
    as tax revenue rises with more people in
    employment and receiving more income.
    Fiscal Policy
    Key Terms
    TERMS EXPLANATION
    Fiscal policy The use of taxation and government spending to influence aggregate
    demand
    Discretionary fiscal Deliberate changes in government spending and taxation
    policy
    Automatic stabilizers Changes in government spending and taxation that occur to reduce
    fluctuations in aggregate demand without any alteration in government
    policy
    Budget An annual statement in which the government outlines plans for its
    spending and tax revenue
    Cyclical budget deficit A budget deficit caused by changes in economy activity

    Structural budget A budget deficit caused by an imbalance between government


    deficit spending and taxation
    Monetary policy The use of interest rates, direct control of the money supply and the
    exchange rate to influence aggregate demand
    Interest rate The price of borrowing money and the reward for saving

    Money supply The total amount of money in a country

    Supply side policy Measure designed to increase aggregate supply

    Expenditure switching Policy measure designed to encourage people to switch from buying
    policy foreign produced products to buying domestically produced products
    Expenditure Policy measures designed to reduce imports and increase exports by

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