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Fiscal policy
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Fiscal policy is how the government uses taxes and its own spending to influence the economy.
Revenue and spending
Fiscal policy: the use of government spending and taxation to influence the economy.
Direct taxes are taken from income and wealth, such as income tax and corporation tax (on company profits).
Indirect taxes are taxes on spending, such as VAT and excise duties on fuel and tobacco.
Main areas of spending include health, education, welfare benefits, defence and infrastructure.
Direct taxes are taken from income and wealth, such as income tax and corporation tax (on company profits).
Indirect taxes are taxes on spending, such as VAT and excise duties on fuel and tobacco.
Main areas of spending include health, education, welfare benefits, defence and infrastructure.
Deficits and surpluses
Fiscal (budget) deficit: government spending > tax revenue in a year. It must be financed by borrowing, which adds to national debt.
Fiscal surplus: tax revenue > spending. It can repay debt.
A large deficit may mean higher future taxes or spending cuts.
Fiscal surplus: tax revenue > spending. It can repay debt.
A large deficit may mean higher future taxes or spending cuts.
Using fiscal policy
Expansionary: cut taxes or raise spending. Boosts demand, growth and jobs, but may raise inflation and worsen the current account (more imports).
Contractionary: raise taxes or cut spending. Reduces inflation, but may slow growth and raise unemployment.
Contractionary: raise taxes or cut spending. Reduces inflation, but may slow growth and raise unemployment.
A government spends $420 billion and collects $390 billion in taxes. What is the fiscal balance?
- Revenue − spending
- 390 − 420
Answer: −$30 billion (a fiscal deficit)
Fiscal policy uses taxes and government spending. Direct taxes are on income; indirect taxes on spending. Deficit: spending > revenue. Expansionary policy boosts growth but risks inflation; contractionary policy cuts inflation but may raise unemployment.
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