The document discusses aspects of fiscal policy, including government spending, taxation, and borrowing. It provides examples of fiscal policies that could be used to influence aggregate demand and supply to achieve objectives like low inflation and high employment. There is debate around using austerity versus stimulus, as well as spending on infrastructure to boost productivity and attract investment.

1. AS Macro-Economics - March 2015
AS Macro-Economics Revision Workshop
March 2015
Session 3:
Aspects of Fiscal Policy
Geoff Riley
Page

2. AS Macro-Economics - March 2015
AS Macro-Economics Revision Workshop
March 2015
Revision Support
Geoff Riley @tutor2u_econ
Website: www.beta.tutor2u.net
Page 3

3. AS Macro-Economics - March 2015
Linda Yueh
@lindayueh
Robert Peston
@Peston
Kamal Ahmed
@BBCkamal
Keep following the business and
economics news as part of your revision!

4. AS Macro-Economics - March 2015
Page 22
Fiscal policy is the use of…..
Government
Spending
Taxation
Government
Borrowing

5. AS Macro-Economics - March 2015
Page 22
Fiscal policy is used to influence aggregate
demand and aggregate supply to achieve the
main macro objectives of:
Stable
Low
Inflation
High
employment or
Low
Unemployment
Sustainable
Economic
Growth
Sustainable
Balance of
Payments

6. AS Macro-Economics - March 2015

7. AS Macro-Economics - March 2015
£7 per second

8. AS Macro-Economics - March 2015
Page 22
Inflation is currently relatively low (<1%) but has
exceeded the upper levels of the government’s 2%
target in recent years. You have 2 minutes to suggest 3
possible fiscal policies that could be uses to keep
inflation close to the 2% mark if it were too high

9. AS Macro-Economics - March 2015
Page 22
Policy
suggestion 1
Policy
suggestion 2
Policy
suggestion 3
Fiscal austerity –
i.e. increase
income tax –
reduce consumer
spending to put
downward
pressure on prices
Lower the rate of
VAT or freeze the
level of duties on
fuel / alcohol /
tobacco
Cut pollution taxes
Invest in
infrastructure – to
boost nation’s
productive
capacity and
productivity
Lost real GDP from
contracting demand
Environmental
objectives conflicted
Long time lags to take
full effect

10. AS Macro-Economics - March 2015
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Taxation:

11. AS Macro-Economics - March 2015
Weak growth of tax revenues
• Falling real wages for many people in work
• Rise in part time employment
• Corporate tax avoidance
• Low inflation – hits revenue from indirect
taxes such as VAT

12. AS Macro-Economics - March 2015
Page 24
Key taxation changes made in the Budget 2015
• Rise in the income tax free allowance to £10,600
• Diverted profits tax (Google Tax) to take effect
• Rise in the bank levy on bank balance sheets
• 1st £1000 of interest on savings now free of tax
• £13bn of infrastructure investment for the North

13. AS Macro-Economics - March 2015
Income Tax – The Basics
• Personal tax free allowance £10,600
• Basic rate of income tax 20%
• 40% rate of income tax on gross incomes
above £41,185
• 45% rate of income tax on gross incomes
above £150,000
Tax allowances have become an important part of the fiscal
policy debate – please be aware of this in your AS macro revision

14. AS Macro-Economics - March 2015
Page 24
Analysis:
If the income tax free allowance is rising why do we expect the
government income from direct taxation to increase?
Reason 1 Reason 2
Reducing direct tax
incentivises work – some
people will increase hours
of work to boost their
post-tax income
Keeping more income
reduces the incentive to
evade or avoid taxation.
More declaration of
earnings will be made &
tax revenues will grow
Evaluation: Consider different ways to improve incentives for lower paid workers –
i.e. larger tax allowances, a higher minimum wage / living wage or supply-side
policies to boost skills and create more higher paid jobs?

15. AS Macro-Economics - March 2015
Original income and Final income by quintile
groups for ALL households, 2012/13
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The tax and welfare system
is progressive – lowering
the income and wealth gap

16. AS Macro-Economics - March 2015
Welfare benefits – the basics
• State pension £115.93
• Child benefit £20.70 for 1st child
• £13.70 for other children
• Household benefit cap: Limits total household
benefits at £500 per week for a family and
£350 per week for a single person with no
children

17. AS Macro-Economics - March 2015
Does this redistribution of income lead to an
increase in aggregate demand? Argument for…
Page 25
Point
Explanation
Evidence/
Example
Evaluation
Lower earners will receive more in welfare benefits
Redistribution of income leads to increase in
earnings for poorer families enabling them to
increase their demand and consumption
New ‘Universal Credit’ is a mechanism for giving
welfare payments to those who fall below a certain
income threshold
Will the extra demand of poorer outweigh the
reduced consumption of the wealthier?

18. AS Macro-Economics - March 2015
Does this redistribution of income lead to an
increase in aggregate demand? Argument against…
Page 25
Point
Explanation
Evidence
Evaluation
Higher tax rates incentivises wealth-creators to move
to countries with relatively lower taxation
Those with higher incomes have a greater capacity to
live and work in foreign countries with lower
taxation, consuming less in the UK as a result
Formula 1 Racing World Champion, Lewis Hamilton,
is a tax exile (a resident of Switzerland)
Tax revenues from the richest are an important
source of government revenue – the richest 1% pay
27% of total income tax revenues each year

19. AS Macro-Economics - March 2015
The Government needs to borrow because its
spending outstrips its revenue. This has been
the case since 2001.
However, both major political parties have
pledged to move the budget from deficit to a
small surplus by the end of the decade.
The majority of deficit reduction is coming from
real cuts in government spending
Page 26

20. AS Macro-Economics - March 2015

21. AS Macro-Economics - March 2015
• Fiscal conservatives argue that strong action is needed to lower the
budget deficit
1. Lower borrowing means that the UK will keep a high credit rating -
this will mean lower interest rates on government debt
2. Less interest paid on debt frees up money for key public services
such as health, transport or education
3. Reducing debt opens up the possibility of tax cuts – thereby
stimulating growth in the private sector
4. Tighter control of government spending means that the Bank of
England can keep their policy interest rates low for a longer period
of time (this point is good for linking monetary and fiscal policy)

22. AS Macro-Economics - March 2015
Keynesian economists favour the active use of fiscal policy as the
may way of managing demand and economic activity
Counter
cyclical
policies
Targeted
direct and
indirect tax
changes
Higher
government
capital
spending
Government
borrowing
can pay for
itself
Active measures
needed to inject
extra demand can
drag the economy
out of a recession
Tax cuts for lower
income groups
with higher
propensity to
spend boosts AD
Depending on the
size of the fiscal
multiplier –
borrowing will
create more tax
revenues
Keynesians favour
labour-intensive
projects e.g.
transport
infrastructure and
new housing

23. AS Macro-Economics - March 2015
Possible impacts of deep cuts in state spending
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Impact 1 Impact 2 Impact 3
Jobs
Higher
unemployment –
many public sector
areas (e.g. armed
forces, local
authorities) have
seen many
redundancies
Public services
Lower standard
and quantity of
public and merit
goods such as
education and
local authority
services
Economic growth
Negative
multiplier effects
e.g. many private
sector jobs
depend on public
sector demand

24. AS Macro-Economics - March 2015
Despite austerity to cut the deficit, the Government has
continued to increase spending. Why?
Page 27
Improve
Productivity
Improve
Infrastructure
Increase
investment
Increased spending on the Youth Contract which
includes a big expansion of apprenticeships
Earmarked funds and proposals for HS2 are in
advanced stages + plans for East-West transport links
Creation of many more ‘Enterprize Zones’ in UK –
funding designed to attract inward investment

25. AS Macro-Economics - March 2015
Examples of UK infrastructure projects
• 2nd Forth Road Bridge
• Cross Rail and High Speed Rail project (HS2)
• London Gateway Port & new London super sewer
• Nuclear power plants including Hinkley Point
Economic significance of infrastructure
• Potentially high multiplier effects from multi-
billion investment projects – boosts AD and jobs
• Lack of infrastructure may discourage FDI
• Increases the capital stock / productive potential

26. AS Macro-Economics - March 2015
Examples of UK infrastructure projects
• 2nd Forth Road Bridge in Scotland
• 1,400 new flood defence projects
• Cross Rail and High Speed Rail project (HS2)
• London Gateway Port & new London super sewer
• Nuclear power plants including Hinkley Point
Economic significance of infrastructure
• Potentially high multiplier effects from multi-billion
investment projects – boosts AD and jobs
• Lack of infrastructure may discourage FDI
• Increases the capital stock / productive potential
• Reminder that fiscal policy affects AD and LRAS!

27. AS Macro-Economics - March 2015
Linda Yueh
@lindayueh
Robert Peston
@Peston
Kamal Ahmed
@BBCkamal
Keep following the business and
economics news as part of your revision!

28. AS Macro-Economics - March 2015
Key Takeaway Points
• Fiscal policy affects both aggregate demand
and aggregate supply (really important!)
• There is a huge debate between fiscal
conservatives and Keynesian economists
• Fiscal austerity will last for another four years
• Economic importance of infrastructure
spending accepted by all UK political parties

29. AS Macro-Economics - March 2015
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