Fiscal Policy

Influencing the level of economic activity though manipulation of government income and expenditure Associated with Keynesian Demand Management Policies Now seen in wider terms:

Fiscal Policy Influence Aggregate Demand – –Tax regime influences consumption (C) and investment (I) –Government Spending (G) Influences key economic objectives Acts as an ‘automatic stabiliser’ BUT:

Fiscal Policy Also used to influence non-economic objectives and provide framework for supply side policy e.g. education and health, poverty reduction, welfare reform, investment, regional policies, promotion of enterprise, etc.

Government Income Tax Revenue Sale of Government Services – e.g. prescriptions, passports, etc. Borrowing (PSNCR)

Public Sector Income Source:

Government Income (£ billion) Source: Inland Revenue Income Tax (gross of tax credits) Income Tax Credits Corporation Tax Windfall Tax Petroleum Revenue Tax Capital Gains Tax Inheritance Tax Stamp Duties NICs Total Inland Revenue

Government Income (£ billion) Source: Customs and Excise VAT Fuel Duties Tobacco Duty Spirits Duties Wine Duties Beer and Cider Duties Betting and Gaming Duties Air Passenger Duty Insurance Premium Tax Land Fill Tax Climate Change Levy Aggregates Levy Customs Duties and Levies Total Customs and Excise

Government Income (£ billion) Source: VED Oil Royalties Business Rates Council Tax Other Taxes and Royalties Net Taxes and NICs conts Interest and Dividends Gross Operating Surplus and Rent Other Receipts and Accounting Adjustments Current Receipts

Government Income – Inland Revenue Source:

Government Income – Customs and Excise Source:

Other Government Income Source:

Fiscal Policy Need to remember subtleties in use of fiscal policy –Adjustment of income tax allowances rather than rates of income tax –Extending or amending range of goods covered by VAT –Changing the rules under which tax has to be paid – married persons allowances, inheritance taxes, stamp duties, etc. –Abolishment of certain tax allowances – MIRAS (Mortgage Income Relief At Source) –Accusations of ‘stealth taxes’ – much of it is a ‘tinkering’ with the tax system to achieve certain aims – mostly non-economic (governments these days, for example, rarely ‘increase taxes’ to dampen down the economy) Be aware of these subtleties when you are writing!

Government Expenditure Social Security Law and Order Emergency Services Health Education Defence Foreign Aid Environment Agriculture Industry Transport Regions Culture, Media and Sport

Public Spending Source:

Public Sector Net Cash Requirement (PSNCR) Source:

The Golden Rule! Fiscal policy framework The Government's fiscal policy framework is based on the five key principles set out in the Code for fiscal stability - transparency, stability, responsibility, fairness and efficiency. The Code requires the Government to state both its objectives and the rules through which fiscal policy will be operated. The Government's fiscal policy objectives are:

The Golden Rule! over the medium term, to ensure sound public finances and that spending and taxation impact fairly within and between generations; and over the short term, to support monetary policy and, in particular, to allow the automatic stabilisers to help smooth the path of the economy.

The Golden Rule! These objectives are implemented through two fiscal rules, against which the performance of fiscal policy can be judged. The fiscal rules are: the golden rule: over the economic cycle, the Government will borrow only to invest and not to fund current spending; and the sustainable investment rule: public sector net debt as a proportion of GDP will be held over the economic cycle at a stable and prudent level. Other things being equal, net debt will be maintained below 40 per cent of GDP over the economic cycle.

The Golden Rule! The fiscal rules ensure sound public finances in the medium term while allowing flexibility in two key respects: –the rules are set over the economic cycle. This allows the fiscal balances to vary between years in line with the cyclical position of the economy, permitting the automatic stabilisers to operate freely to help smooth the path of the economy in the face of variations in demand; and –the rules work together to promote capital investment while ensuring sustainable public finances in the long term. The golden rule requires the current budget to be in balance or surplus over the cycle, allowing the Government to borrow only to fund capital spending. The sustainable investment rule ensures that borrowing is maintained at a prudent level. To meet the sustainable investment rule with confidence, net debt will be maintained below 40 per cent of GDP in each and every year of the current economic cycle. Source of information about the Golden Rule: Crown Copyright, reproduced under licence

Fiscal Policy In Action Inflation Real National Income AS AD 2.0% U=5% Assume an initial equilibrium position with a level of National Income giving an unemployment rate of 5% (U = 5%) If government ‘reduces taxes’ (remember the subtleties) and or increases spending, it will have various effects: AD=C+I+G+(X-M) Apart from G, C and I are also likely to be affected directly or indirectly by the policy change. AD 1 AD therefore shifts to the right to AD1 2.5% U=3% The rise in AD leads to an increase in real national income, ceteris paribus, unemployment would fall to 3% but at a cost of higher inflation

Fiscal Policy In Action Fiscal Policy influences AD in the short term but can be used to affect AS in the long run – depending on the nature of the policy. Try your hand at Fiscal Policy by going to the Virtual Economy ( dvisors/fiscal.htm)