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Fiscal policy

This document defines key terms related to fiscal policy such as bond yield, budget deficit, cyclical fiscal deficit, direct and indirect taxation, national debt, and structural fiscal deficit. It then discusses what fiscal policy is, how it involves taxation, spending, and borrowing to affect aggregate demand. Changes to fiscal policy can impact both aggregate demand and supply. The document also provides breakdowns of UK government spending and revenues, and discusses different types of taxes and their progressiveness.

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Fiscal Policy EdExcel AS Economics 2.6.2
Fiscal Policy Economics – Some Key Terms Bond Yield The rate of interest paid on government debt Budget (Fiscal) Deficit The budget deficit is the difference between what the government receives in revenue and what it spends Cyclical Fiscal Deficit The size of the deficit is influenced by the state of the economy: in a boom, tax receipts are relatively high and spending on unemployment benefit is low Direct Taxation Taxes on income, profits and wealth, paid directly by the bearer to the tax authorities. Fiscal Policy Taxation and spending measures that allow the government to guide the economy. Indirect Taxation Taxes on expenditure (e.g. VAT). They are paid to the tax authorities, not by the consumer, but indirectly by the suppliers of the goods or services. National Debt Debt is the total amount owed by the government which has accumulated over the years. Structural Fiscal Deficit The structural deficit is that part of the deficit which is not related to the state of the economy. This part of the deficit will not disappear when the economy recovers.
What is Fiscal Policy? • Fiscal policy involves the use of government spending, direct and indirect taxation and government borrowing to affect the level and growth of aggregate demand, output and jobs • Fiscal policy is also used to change the pattern of spending on goods and services e.g. spending on health care and scarce resources allocated to renewable energy • Fiscal policy is also a means by which a redistribution of income & wealth can be achieved for example by changing tax rates on different levels of income or wealth • It is an instrument of micro-economic government intervention to correct for market failures such as pollution or the sub-optimal provision of public and merit goods • It is important to be aware that changes in fiscal policy affect both aggregate demand (AD) and aggregate supply (AS)
Total UK Government Spending and Tax Revenue Source: International Monetary Fund, data from 2015 onwards is a forecast 500 550 600 650 700 750 800 850 2010 2011 2012 2013 2014 2015* 2016* 2017* 2018* 2019* 2020* Revenue/Spendinginbillionpounds Revenue Spending
The Public and the Private Sector of the Economy Public sector businesses are owned and operated by the government, whilst the private sector is privately owned • The public sector is not profit-driven, while this is usually (but not always) the case with the private sector. • In September 2013, there were 5.7 million people working in the UK public sector (18.8% of people in employment). The National Health Service (NHS) employs over 1.5 million people • Public sector businesses / corporations include the following: • Met Office and Ordnance Survey • Channel 4, National Nuclear Laboratories • Eurostar, NATS (National Air-Traffic Control Services) • Network Rail • Royal Mail was part privatised in 2013 (Govt retains 30% stake)
Some Key Roles for Fiscal Policy Financing government spending Changing final income and wealth Providing a welfare state safety-net Managing the economic cycle Improving long run competitiveness Tackle important market failures Fiscal policy decisions have an impact on millions of consumers and businesses – in both the short and the long term
Breakdown of UK Government Spending in 2015-16 Welfare protection is the largest single element of government spending, with the NHS and Education the biggest single departmental items.
Government Spending Welfare Spending Transfer Payments Public Services Recurring spending State Investment Investment Projects Total UK government spending is forecast to be £745 billion in 2015 This is 43.1% of GDP. £50 billion or 7% will be on capital spending Spending on public services such as education & health is 22% of GDP Government spending is spending by the public sector on goods and services such as education, health care and defence
Government Current and Capital Spending Current spending – on providing public services Capital spending – new public infrastructure Salaries of NHS employees Drugs used in health care Road maintenance Army logistics supplies Construction of new motorways New equipment in the NHS Flood defence schemes Extra defence equipment
Economic Importance of Government Spending Is a Key Component of Aggregate Demand Has a big Regional Economic Impact Providing Public & Merit Goods Achieving greater Equity in Society
Economic Importance of Education & Health Spending Education and health are regarded by economists as merit goods. An increase in funding of both can affect the macro-economy Education spending • May increase the skills and productivity of workers • Improvement in human capital will lower structural unemployment • More innovation / competitiveness Health care spending • Improved health outcomes will boost active labour supply • Will also increase productivity • Lessens risks of relative poverty Evaluation Arguments 1. Effectiveness of education spending has been questioned 2. Money might be better spent targeting certain groups or ages Evaluation Arguments 1. Better health results can be achieved without increase in health funding 2. Will lower income families get the improved access
Median Age of the UK Population 34.9 35.1 35.5 35 34.2 33.9 34.4 35.3 35.8 36.5 37.6 38.7 39.8 40.5 0 5 10 15 20 25 30 35 40 45 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015* Medianageinyears The median age of the UK population is rising. This is likely to have both demand and supply-side effects on the UK economy in the years ahead. Source: Office for National Statistics
How Government Spending can affect Incomes Welfare state transfers • Universal child benefits / unemployment benefit • Public (state) pensions • Conditional welfare transfers e.g. Conditional on attending unemployment programmes • Targeted welfare payments- linked to income State-provided services (in-kind benefits) • Education - reduces inequality of market incomes • Health care – state provided health services • Social housing e.g. Provided by local authorities • Employment training
Welfare Spending by the UK Government £ billion per year 2014-15 2015-16 2016-17 Welfare capped spending Department of Work and Pensions (DWP) social security 74.4 76.0 74.8 of which: Housing benefit (not on JSA) 21.4 22.1 21.9 Disability living allowance and personal independence payments 15.3 15.6 15.1 Incapacity benefits 14.1 14.8 14.7 Winter fuel payments 2.1 2.1 2.1 Personal tax credits 29.7 29.5 25.3 Child benefit 11.6 11.5 11.4 Tax free childcare 0.0 0.0 0.1 Total welfare cap 119.1 120.6 115.2 Welfare spending outside the welfare cap DWP social security spending 92.0 94.0 96.1 of which: State pension 86.5 89.7 92.1 Jobseeker's allowance 3.1 2.2 2.3 Housing benefit (on JSA) 2.4 1.6 1.7 Total welfare outside the welfare cap 95.1 96.4 98.6 Total welfare 214.3 216.9 213.8
Sources of UK Government Tax Revenues in 2015-16 Income tax and VAT are the two biggest sources of government revenues
Direct and Indirect Taxation • Direct taxation is levied on income, wealth and profit • Direct taxes include income tax, inheritance tax, national insurance contributions, capital gains tax, and corporation tax (a tax on company profits) • The burden of a direct tax cannot be passed on • Indirect taxes are taxes on spending • Examples of indirect taxes include excise duties on fuel, cigarettes and alcohol and Value Added Tax (VAT) on many different goods and services • Producers may be able to pass on an indirect tax – depending on price elasticity of demand and supply
UK Government Tax Revenues by Size 2013/14 2014/15 Income tax 163.7 170.2 National insurance contributions 110.3 114.8 Value added tax 111.3 115.9 Corporation tax 42.9 43.1 Petroleum revenue tax 0.1 0.0 Fuel duties 27.2 27.1 Business rates 27.3 28.0 Council tax 27.9 28.4 VAT refunds 13.7 13.6 Capital gains tax 5.6 6.4 Inheritance tax 3.8 4.2 Stamp duty land tax 10.9 11.5 Stamp taxes on shares 2.9 3.2 Tobacco duties 9.3 9.1 Spirits duties 3.0 3.2 Wine duties 3.8 4.0 Beer and cider duties 3.6 3.5 Air passenger duty 3.2 3.1 Income Tax, National Insurance and VAT are far and away the biggest sources of tax revenue for the UK government.
Tax Revenues from UK Air Passenger Duty Text goes here 948 806 816 791 864 905 971 1,994 1,862 1,856 2,155 2,607 2,791 3,013 0 500 1000 1500 2000 2500 3000 3500 00/01 01/02 02/03 03/04 04/05 05/06 06/07 07/08 08/09 09/10 10/11 11/12 12/13 13/14 Airpassengerdutyreceipts£million Air Passenger Duty is charged for all travel in aircraft. It has two rates (standard and higher) and is also based on distance flown
Progressive, Proportional and Regressive Taxes • With a progressive tax, the marginal rate of tax rises as income rises. I.e. 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 • Examples: Income tax (basic and higher rates) • With a proportional tax, the marginal rate of tax is constant leading to a constant average rate of tax • Examples: National insurance contributions • With a regressive tax, the rate of tax falls as incomes rise – I.e. the average rate of tax is lower for people of higher incomes • Examples: Excise duties on tobacco and alcohol
Progressive, Regression and Proportional Taxation Percentage of gross income taken up by different taxes in the UK in 2013-14 Lowest 20% of Income 2nd Quintile 3rd Quintile 4th Quintile Highest 20% of Income All households Income Tax 2.5 4.4 8.2 11.2 16.9 11.8 VAT 11.0 7.9 7.7 7.0 5.5 6.8 Duty on alcohol 1.5 1.0 1.0 0.9 0.7 0.9 Duty on tobacco 2.8 1.7 1.3 0.6 0.3 0.8 All indirect taxes 28.1 19.1 17.8 15.3 11.3 15.3 Source: Office for National Statistics Income tax is progressive – notice how the average burden of income tax rises across income groups. Duties on tobacco and alcohol are regressive.
Original and Final Income – Redistribution in the UK The UK tax and welfare system is mildly progressive because it leads to a smaller gap between households when final income is measured. 0 200 400 600 800 1000 1200 1400 1600 1800 1 2 3 4 5 All households £ per week Disposable income quintile The effects of direct and indirect taxes and welfare benefits on household income by quintile groups, 2013/14 Original income Final income Source: Office for National Statistics
The Effects of Taxes and Benefits on Rich and Poor Benefits in kind include the estimated value to households of consuming services such as state education and the national health service. -700 -600 -500 -400 -300 -200 -100 0 100 200 300 400 1 2 3 (median) 4 5 All households £ per week Disposable income quintile Summary of the effects of taxes and benefits on all households, 2013/14 Indirect taxes Direct taxes Benefits in kind Cash benefits Net position Taxes and benefits lead to net increase in income Net decrease in income Source: Office for National Statistics
Taxation and Aggregate Demand Changes in tax rates and tax allowances can have direct and indirect effects on the level of aggregate demand (AD) Income tax and disposable income Corporation taxes and business investment Taxation of imports affects trade National insurance and labour demand VAT and levels of consumer spending Taxation and business R&D spending
Lower Taxes and Components of Demand Cut in personal income tax rates Boost to disposable income Adds to consumer demand Cut in indirect taxes e.g. VAT Lower prices – leads to higher real incomes Adds to consumer demand Adds to business capital spending Cut in corporation tax Higher “post tax” profits for businesses Cut in tax on interest from saving Boost to disposable income of people with net savings Adds to consumer demand Expansionary Fiscal Policy
Effect of a Lower Corporation Tax on Businesses Government cuts the rate of corporation tax Businesses get to keep a larger percentage of their profits Increase in post-tax profitability may lead to a rise in planned investment Investment can be by both domestic and overseas businesses Increased capital spending is an injection into the circular flow model Creates a multiplier effect on demand, output and employment Evaluation points 1. Effect depends on the scale of the tax cut 2. Many factors affect capital investment e.g. the pace of technological change and strength of market competition 3. There will be time lags between change in corporation tax and increased flow of actual investment 4. Some extra investment may lead to a loss of jobs through capital- labour substitution effects.
Impact of a rise in indirect taxes on the UK Economy All other things being equal, an increase in indirect taxes by the government is most likely to ….. Macroeconomic Objective Comment on the Effect Inflation Higher in short run as business pass on tax Economic growth Slower as real incomes and demand falls Unemployment Higher if aggregate demand weakens Balance of trade in goods & services Improved – falling incomes may cause demand for imports to contract Spare capacity in the economy Rising spare capacity from weaker demand Business investment Decline if businesses are hit by lower profits and weaker consumer spending Government fiscal balance Short run improvement from higher taxes but risk of falling revenues in medium term
Taxation and Aggregate Supply Changes in tax rates and tax allowances can have a direct and indirect effect on both short-run and long-run aggregate supply Work incentives / active labour supply Inward migration of key workers Capital investment e.g. FDI projects Enterprise / Entrepreneurship Taxation and incentives to study Tariffs affect import costs
How Could Tax Cuts Stimulate Economic Recovery? Low confidence – tax cuts likely to be saved rather than spent Businesses might choose to invest overseas instead Skills shortages might limit new job creation Consumer spending • Cuts in VAT or income tax to boost demand for goods and services Business investment • Lower corporation tax to increase investment and tax incentives for R&D Lower employment taxes • Reduced national insurance so that businesses create more jobs Lower fuel / carbon taxes • Lower costs for businesses, less inflation and higher profits Possible conflicts with environmental policies
Tax Competition between Countries Changes in business taxation in particular are now regarded as an important form of supply-side policy. • Tax competition happens when a national government uses reforms to the tax system as a supply-side strategy to attract investment and jobs into their economy. • A number of countries have introduced a flat tax system, examples include Russia, Estonia and Poland • Is tax competition between countries a fair way of bidding for investment? What might be some of the economic and social effects? Income Tax Lowest and Highest Rate the same (%) Russia 13% Ukraine 17% Mongolia 10% Costa Rica 15% Business Profits Tax (Corporation Tax) Standard rate (%) Macedonia 15% Hong Kong 17.5% Bahrain 0% Macao 12%
Evaluating the Arguments for a Low Tax Economy Lower Taxes Stimulates work incentives and productivity Helps to create more jobs because businesses have less tax to pay Encourages an inflow of FDI from businesses looking for low tax country Incentivizes enterprise and start-ups – a source of long term wealth and jobs Lower tax rates might end up increasing total tax revenues (Laffer Curve concept)
Evaluating the Arguments for a Low Tax Economy Higher Taxes Taxation is a key instrument for changing the final distribution of income and wealth. It is equitable for those with the greatest resources to pay more Tax cuts don’t necessarily lead to an increase in total tax revenues for the government Consider the relative success of countries such as Denmark, Norway and Sweden who have higher tax burdens Taxes are needed to fund high quality public services
Actual & Forecast Government Budget Balance Source: Office for Budgetary Responsibility, July 2015 The budget deficit is the difference between what the government receives in revenue and what it spends. The last year of budget surplus was in 2000. The UK budget deficit peaked at over 10% of GDP in 2009-10 Forecast The annual average UK budget deficit has been 3.5% of national income since 1970
The UK Budget Balance and National Debt Source: OBR, July 2015 Public Sector Borrowing % of GDP Public Sector Net Debt % of GDP 2007–08 2.7 36.7 2008–09 6.7 49.0 2009–10 10.2 62.0 2010–11 8.6 68.7 2011–12 7.0 72.3 2012–13 7.2 76.7 2013–14 5.7 79.1 2014–15 4.9 80.5 2015–16 4.0 80.2 What is government borrowing? Public sector borrowing is the amount the government must borrow each year to finance spending What is national debt? Public sector net debt is a measure of the accumulated national debt owed by the government sector
Government Borrowing and Bond Interest Rates When a government borrows it issues debt in the form of bonds. The yield on a bond is the interest rate paid on state borrowing Purchasers of government bonds include pension funds, insurance companies, households and overseas investors. The % yield on debt has been very low in recent years.
Economic Justifications for Budget Deficits Since 1970, the government has had a surplus in only six years – it is normal for government to have to borrow money 1. A rise in borrowing to fund extra government spending can have powerful effects on AD, output and employment when an economy is operating below full capacity output 2. There is an automatic rise in the budget deficit to cushion the fall in AD caused by an external economic shock. A higher fiscal deficit is needed to lift AD back towards pre-recession levels 3. If a fiscal stimulus works the budget deficit will improve as a result of higher tax revenues and reductions in welfare spending. A growing economy helps to shrink debt as a percentage of GDP 4. It makes sense for a government to borrow money if interest rates are low and if the deficit is being used for investment
Countries with Highest Government Debt in 2015 246.14% 172.73% 133.76% 132.82% 131.82% 129.24% 126.35% 121.08% 115.89% 107.75% 107.11% 106.91% 106.57% 105.67% 105.06% 0.0% 50.0% 100.0% 150.0% 200.0% 250.0% 300.0% Japan Greece Italy Jamaica Lebanon Enritrea Portugal Cape Verde Bhutan Ireland Grenada Antigua and Barbuda Belgium Cyprus United States Public (government) debt as a percentage of GDP
Countries with the Lowest National Debt in 2015 1.82% 3.28% 6.37% 8.32% 8.56% 8.87% 9.46% 10.13% 11.48% 11.88% 12.73% 13.62% 13.64% 14.75% 16.25% 0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 14.0% 16.0% 18.0% Saudi Arabia Brunei Darussalam Hong Kong SAR Uzbekistan Oman Kiribati Kuwait Estonia Nigeria Iran Botswana Solomon Islands Algeria United Arab Emirates Chile National (government) debt measured as a percentage of GDP, Source: IMF
Is a High Level of Public Debt Bad for the Economy? Public debt is the total stock of debt issued by a government that has yet to be re-paid – it is also known as the National Debt • High deficits cause rising debt interest payments which in 2015-16 are are forecast to be £47 billion or £700 per head of population • This interest burden has an opportunity cost for less interest on debt could free up extra spending on health and education. Borrowing of £70 billion is equivalent to £1,100 per head of the UK population • An increase in the national debt is likely to cause higher taxes in the future. This will cut the disposable incomes of tax payers and reduce growth in the private sector • It might be unfair if the rising tax burden falls more heavily on future generations of tax payers rather than people who benefit from government spending now. UK Debt Data UK government debt is forecast to reach 94% of GDP in 2013. This is lower than the average of advanced economies. Japan’s gross debt is 245% of GDP in 2013, while Greece’s is 179% of GDP.
Government Debt for a selection of EU Countries 2006 2008 2010 2012 2015 France % of GDP 81.9 87.7 103.5 113.4 127.5 Germany % of GDP 64.1 61.2 67.4 65.1 60.0 Greece % of GDP 103.4 109.4 145.7 156.8 186.0 Ireland % of GDP 44.1 84.4 280.3 334.0 316.0 Italy % of GDP 116.2 114.5 126.0 138.1 144.9 Spain % of GDP 45.7 47.1 66.7 91.0 118.6 United Kingdom % of GDP 42.5 51.8 76.4 85.8 90.0 Source: IMF
• The UK government has a fiscal deficit-reduction policy with the emphasis on cutting government spending in some areas in real terms and a series of direct and indirect tax increases: • Key policies for deficit reduction: 1. Rise in standard rate of VAT to 20% 2. Rise in employee national insurance contributions (11%) 3. Deep cuts in real government spending e.g. for local authorities 4. Welfare caps including £26k pa cap on welfare for each family Some taxes have been cut 1. A series of cuts to corporation tax (main rate is now 20%) 2. Freezing of fuel duties (meaning a cut in real terms) 3. Increases in the real value of the income tax free allowance 4. Cuts in employer national insurance for long term unemployed 5. Freezing of council tax (so that council tax falls in real terms) The UK Government has also been helped by lower interest rates on newly issued debt as a result of quantitative easing UK Government’s Fiscal Austerity Policies
In the July 2015 Budget, the Chancellor George Osborne announced a new fiscal rule. The government’s fiscal rules now include a target for a budget surplus by 2019/20 and for all subsequent years when in ‘normal times’. The economy will be viewed as being in ‘normal times’ if real annual growth is above 1% Balanced budget when G= T Normal times – a full economic recovery UK Government’s New Fiscal Rule (2015)
Fiscal Policy EdExcel AS Economics 2.6.2

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Fiscal policy

  • 1.
    Fiscal Policy EdExcel ASEconomics 2.6.2
  • 2.
    Fiscal Policy Economics– Some Key Terms Bond Yield The rate of interest paid on government debt Budget (Fiscal) Deficit The budget deficit is the difference between what the government receives in revenue and what it spends Cyclical Fiscal Deficit The size of the deficit is influenced by the state of the economy: in a boom, tax receipts are relatively high and spending on unemployment benefit is low Direct Taxation Taxes on income, profits and wealth, paid directly by the bearer to the tax authorities. Fiscal Policy Taxation and spending measures that allow the government to guide the economy. Indirect Taxation Taxes on expenditure (e.g. VAT). They are paid to the tax authorities, not by the consumer, but indirectly by the suppliers of the goods or services. National Debt Debt is the total amount owed by the government which has accumulated over the years. Structural Fiscal Deficit The structural deficit is that part of the deficit which is not related to the state of the economy. This part of the deficit will not disappear when the economy recovers.
  • 3.
    What is FiscalPolicy? • Fiscal policy involves the use of government spending, direct and indirect taxation and government borrowing to affect the level and growth of aggregate demand, output and jobs • Fiscal policy is also used to change the pattern of spending on goods and services e.g. spending on health care and scarce resources allocated to renewable energy • Fiscal policy is also a means by which a redistribution of income & wealth can be achieved for example by changing tax rates on different levels of income or wealth • It is an instrument of micro-economic government intervention to correct for market failures such as pollution or the sub-optimal provision of public and merit goods • It is important to be aware that changes in fiscal policy affect both aggregate demand (AD) and aggregate supply (AS)
  • 4.
    Total UK GovernmentSpending and Tax Revenue Source: International Monetary Fund, data from 2015 onwards is a forecast 500 550 600 650 700 750 800 850 2010 2011 2012 2013 2014 2015* 2016* 2017* 2018* 2019* 2020* Revenue/Spendinginbillionpounds Revenue Spending
  • 5.
    The Public andthe Private Sector of the Economy Public sector businesses are owned and operated by the government, whilst the private sector is privately owned • The public sector is not profit-driven, while this is usually (but not always) the case with the private sector. • In September 2013, there were 5.7 million people working in the UK public sector (18.8% of people in employment). The National Health Service (NHS) employs over 1.5 million people • Public sector businesses / corporations include the following: • Met Office and Ordnance Survey • Channel 4, National Nuclear Laboratories • Eurostar, NATS (National Air-Traffic Control Services) • Network Rail • Royal Mail was part privatised in 2013 (Govt retains 30% stake)
  • 6.
    Some Key Rolesfor Fiscal Policy Financing government spending Changing final income and wealth Providing a welfare state safety-net Managing the economic cycle Improving long run competitiveness Tackle important market failures Fiscal policy decisions have an impact on millions of consumers and businesses – in both the short and the long term
  • 7.
    Breakdown of UKGovernment Spending in 2015-16 Welfare protection is the largest single element of government spending, with the NHS and Education the biggest single departmental items.
  • 8.
    Government Spending Welfare Spending TransferPayments Public Services Recurring spending State Investment Investment Projects Total UK government spending is forecast to be £745 billion in 2015 This is 43.1% of GDP. £50 billion or 7% will be on capital spending Spending on public services such as education & health is 22% of GDP Government spending is spending by the public sector on goods and services such as education, health care and defence
  • 9.
    Government Current andCapital Spending Current spending – on providing public services Capital spending – new public infrastructure Salaries of NHS employees Drugs used in health care Road maintenance Army logistics supplies Construction of new motorways New equipment in the NHS Flood defence schemes Extra defence equipment
  • 10.
    Economic Importance ofGovernment Spending Is a Key Component of Aggregate Demand Has a big Regional Economic Impact Providing Public & Merit Goods Achieving greater Equity in Society
  • 11.
    Economic Importance ofEducation & Health Spending Education and health are regarded by economists as merit goods. An increase in funding of both can affect the macro-economy Education spending • May increase the skills and productivity of workers • Improvement in human capital will lower structural unemployment • More innovation / competitiveness Health care spending • Improved health outcomes will boost active labour supply • Will also increase productivity • Lessens risks of relative poverty Evaluation Arguments 1. Effectiveness of education spending has been questioned 2. Money might be better spent targeting certain groups or ages Evaluation Arguments 1. Better health results can be achieved without increase in health funding 2. Will lower income families get the improved access
  • 12.
    Median Age ofthe UK Population 34.9 35.1 35.5 35 34.2 33.9 34.4 35.3 35.8 36.5 37.6 38.7 39.8 40.5 0 5 10 15 20 25 30 35 40 45 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015* Medianageinyears The median age of the UK population is rising. This is likely to have both demand and supply-side effects on the UK economy in the years ahead. Source: Office for National Statistics
  • 13.
    How Government Spendingcan affect Incomes Welfare state transfers • Universal child benefits / unemployment benefit • Public (state) pensions • Conditional welfare transfers e.g. Conditional on attending unemployment programmes • Targeted welfare payments- linked to income State-provided services (in-kind benefits) • Education - reduces inequality of market incomes • Health care – state provided health services • Social housing e.g. Provided by local authorities • Employment training
  • 14.
    Welfare Spending bythe UK Government £ billion per year 2014-15 2015-16 2016-17 Welfare capped spending Department of Work and Pensions (DWP) social security 74.4 76.0 74.8 of which: Housing benefit (not on JSA) 21.4 22.1 21.9 Disability living allowance and personal independence payments 15.3 15.6 15.1 Incapacity benefits 14.1 14.8 14.7 Winter fuel payments 2.1 2.1 2.1 Personal tax credits 29.7 29.5 25.3 Child benefit 11.6 11.5 11.4 Tax free childcare 0.0 0.0 0.1 Total welfare cap 119.1 120.6 115.2 Welfare spending outside the welfare cap DWP social security spending 92.0 94.0 96.1 of which: State pension 86.5 89.7 92.1 Jobseeker's allowance 3.1 2.2 2.3 Housing benefit (on JSA) 2.4 1.6 1.7 Total welfare outside the welfare cap 95.1 96.4 98.6 Total welfare 214.3 216.9 213.8
  • 15.
    Sources of UKGovernment Tax Revenues in 2015-16 Income tax and VAT are the two biggest sources of government revenues
  • 16.
    Direct and IndirectTaxation • Direct taxation is levied on income, wealth and profit • Direct taxes include income tax, inheritance tax, national insurance contributions, capital gains tax, and corporation tax (a tax on company profits) • The burden of a direct tax cannot be passed on • Indirect taxes are taxes on spending • Examples of indirect taxes include excise duties on fuel, cigarettes and alcohol and Value Added Tax (VAT) on many different goods and services • Producers may be able to pass on an indirect tax – depending on price elasticity of demand and supply
  • 17.
    UK Government TaxRevenues by Size 2013/14 2014/15 Income tax 163.7 170.2 National insurance contributions 110.3 114.8 Value added tax 111.3 115.9 Corporation tax 42.9 43.1 Petroleum revenue tax 0.1 0.0 Fuel duties 27.2 27.1 Business rates 27.3 28.0 Council tax 27.9 28.4 VAT refunds 13.7 13.6 Capital gains tax 5.6 6.4 Inheritance tax 3.8 4.2 Stamp duty land tax 10.9 11.5 Stamp taxes on shares 2.9 3.2 Tobacco duties 9.3 9.1 Spirits duties 3.0 3.2 Wine duties 3.8 4.0 Beer and cider duties 3.6 3.5 Air passenger duty 3.2 3.1 Income Tax, National Insurance and VAT are far and away the biggest sources of tax revenue for the UK government.
  • 18.
    Tax Revenues fromUK Air Passenger Duty Text goes here 948 806 816 791 864 905 971 1,994 1,862 1,856 2,155 2,607 2,791 3,013 0 500 1000 1500 2000 2500 3000 3500 00/01 01/02 02/03 03/04 04/05 05/06 06/07 07/08 08/09 09/10 10/11 11/12 12/13 13/14 Airpassengerdutyreceipts£million Air Passenger Duty is charged for all travel in aircraft. It has two rates (standard and higher) and is also based on distance flown
  • 19.
    Progressive, Proportional andRegressive Taxes • With a progressive tax, the marginal rate of tax rises as income rises. I.e. 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 • Examples: Income tax (basic and higher rates) • With a proportional tax, the marginal rate of tax is constant leading to a constant average rate of tax • Examples: National insurance contributions • With a regressive tax, the rate of tax falls as incomes rise – I.e. the average rate of tax is lower for people of higher incomes • Examples: Excise duties on tobacco and alcohol
  • 20.
    Progressive, Regression andProportional Taxation Percentage of gross income taken up by different taxes in the UK in 2013-14 Lowest 20% of Income 2nd Quintile 3rd Quintile 4th Quintile Highest 20% of Income All households Income Tax 2.5 4.4 8.2 11.2 16.9 11.8 VAT 11.0 7.9 7.7 7.0 5.5 6.8 Duty on alcohol 1.5 1.0 1.0 0.9 0.7 0.9 Duty on tobacco 2.8 1.7 1.3 0.6 0.3 0.8 All indirect taxes 28.1 19.1 17.8 15.3 11.3 15.3 Source: Office for National Statistics Income tax is progressive – notice how the average burden of income tax rises across income groups. Duties on tobacco and alcohol are regressive.
  • 21.
    Original and FinalIncome – Redistribution in the UK The UK tax and welfare system is mildly progressive because it leads to a smaller gap between households when final income is measured. 0 200 400 600 800 1000 1200 1400 1600 1800 1 2 3 4 5 All households £ per week Disposable income quintile The effects of direct and indirect taxes and welfare benefits on household income by quintile groups, 2013/14 Original income Final income Source: Office for National Statistics
  • 22.
    The Effects ofTaxes and Benefits on Rich and Poor Benefits in kind include the estimated value to households of consuming services such as state education and the national health service. -700 -600 -500 -400 -300 -200 -100 0 100 200 300 400 1 2 3 (median) 4 5 All households £ per week Disposable income quintile Summary of the effects of taxes and benefits on all households, 2013/14 Indirect taxes Direct taxes Benefits in kind Cash benefits Net position Taxes and benefits lead to net increase in income Net decrease in income Source: Office for National Statistics
  • 23.
    Taxation and AggregateDemand Changes in tax rates and tax allowances can have direct and indirect effects on the level of aggregate demand (AD) Income tax and disposable income Corporation taxes and business investment Taxation of imports affects trade National insurance and labour demand VAT and levels of consumer spending Taxation and business R&D spending
  • 24.
    Lower Taxes andComponents of Demand Cut in personal income tax rates Boost to disposable income Adds to consumer demand Cut in indirect taxes e.g. VAT Lower prices – leads to higher real incomes Adds to consumer demand Adds to business capital spending Cut in corporation tax Higher “post tax” profits for businesses Cut in tax on interest from saving Boost to disposable income of people with net savings Adds to consumer demand Expansionary Fiscal Policy
  • 25.
    Effect of aLower Corporation Tax on Businesses Government cuts the rate of corporation tax Businesses get to keep a larger percentage of their profits Increase in post-tax profitability may lead to a rise in planned investment Investment can be by both domestic and overseas businesses Increased capital spending is an injection into the circular flow model Creates a multiplier effect on demand, output and employment Evaluation points 1. Effect depends on the scale of the tax cut 2. Many factors affect capital investment e.g. the pace of technological change and strength of market competition 3. There will be time lags between change in corporation tax and increased flow of actual investment 4. Some extra investment may lead to a loss of jobs through capital- labour substitution effects.
  • 26.
    Impact of arise in indirect taxes on the UK Economy All other things being equal, an increase in indirect taxes by the government is most likely to ….. Macroeconomic Objective Comment on the Effect Inflation Higher in short run as business pass on tax Economic growth Slower as real incomes and demand falls Unemployment Higher if aggregate demand weakens Balance of trade in goods & services Improved – falling incomes may cause demand for imports to contract Spare capacity in the economy Rising spare capacity from weaker demand Business investment Decline if businesses are hit by lower profits and weaker consumer spending Government fiscal balance Short run improvement from higher taxes but risk of falling revenues in medium term
  • 27.
    Taxation and AggregateSupply Changes in tax rates and tax allowances can have a direct and indirect effect on both short-run and long-run aggregate supply Work incentives / active labour supply Inward migration of key workers Capital investment e.g. FDI projects Enterprise / Entrepreneurship Taxation and incentives to study Tariffs affect import costs
  • 28.
    How Could TaxCuts Stimulate Economic Recovery? Low confidence – tax cuts likely to be saved rather than spent Businesses might choose to invest overseas instead Skills shortages might limit new job creation Consumer spending • Cuts in VAT or income tax to boost demand for goods and services Business investment • Lower corporation tax to increase investment and tax incentives for R&D Lower employment taxes • Reduced national insurance so that businesses create more jobs Lower fuel / carbon taxes • Lower costs for businesses, less inflation and higher profits Possible conflicts with environmental policies
  • 29.
    Tax Competition betweenCountries Changes in business taxation in particular are now regarded as an important form of supply-side policy. • Tax competition happens when a national government uses reforms to the tax system as a supply-side strategy to attract investment and jobs into their economy. • A number of countries have introduced a flat tax system, examples include Russia, Estonia and Poland • Is tax competition between countries a fair way of bidding for investment? What might be some of the economic and social effects? Income Tax Lowest and Highest Rate the same (%) Russia 13% Ukraine 17% Mongolia 10% Costa Rica 15% Business Profits Tax (Corporation Tax) Standard rate (%) Macedonia 15% Hong Kong 17.5% Bahrain 0% Macao 12%
  • 30.
    Evaluating the Argumentsfor a Low Tax Economy Lower Taxes Stimulates work incentives and productivity Helps to create more jobs because businesses have less tax to pay Encourages an inflow of FDI from businesses looking for low tax country Incentivizes enterprise and start-ups – a source of long term wealth and jobs Lower tax rates might end up increasing total tax revenues (Laffer Curve concept)
  • 31.
    Evaluating the Argumentsfor a Low Tax Economy Higher Taxes Taxation is a key instrument for changing the final distribution of income and wealth. It is equitable for those with the greatest resources to pay more Tax cuts don’t necessarily lead to an increase in total tax revenues for the government Consider the relative success of countries such as Denmark, Norway and Sweden who have higher tax burdens Taxes are needed to fund high quality public services
  • 32.
    Actual & ForecastGovernment Budget Balance Source: Office for Budgetary Responsibility, July 2015 The budget deficit is the difference between what the government receives in revenue and what it spends. The last year of budget surplus was in 2000. The UK budget deficit peaked at over 10% of GDP in 2009-10 Forecast The annual average UK budget deficit has been 3.5% of national income since 1970
  • 33.
    The UK BudgetBalance and National Debt Source: OBR, July 2015 Public Sector Borrowing % of GDP Public Sector Net Debt % of GDP 2007–08 2.7 36.7 2008–09 6.7 49.0 2009–10 10.2 62.0 2010–11 8.6 68.7 2011–12 7.0 72.3 2012–13 7.2 76.7 2013–14 5.7 79.1 2014–15 4.9 80.5 2015–16 4.0 80.2 What is government borrowing? Public sector borrowing is the amount the government must borrow each year to finance spending What is national debt? Public sector net debt is a measure of the accumulated national debt owed by the government sector
  • 34.
    Government Borrowing andBond Interest Rates When a government borrows it issues debt in the form of bonds. The yield on a bond is the interest rate paid on state borrowing Purchasers of government bonds include pension funds, insurance companies, households and overseas investors. The % yield on debt has been very low in recent years.
  • 35.
    Economic Justifications forBudget Deficits Since 1970, the government has had a surplus in only six years – it is normal for government to have to borrow money 1. A rise in borrowing to fund extra government spending can have powerful effects on AD, output and employment when an economy is operating below full capacity output 2. There is an automatic rise in the budget deficit to cushion the fall in AD caused by an external economic shock. A higher fiscal deficit is needed to lift AD back towards pre-recession levels 3. If a fiscal stimulus works the budget deficit will improve as a result of higher tax revenues and reductions in welfare spending. A growing economy helps to shrink debt as a percentage of GDP 4. It makes sense for a government to borrow money if interest rates are low and if the deficit is being used for investment
  • 36.
    Countries with HighestGovernment Debt in 2015 246.14% 172.73% 133.76% 132.82% 131.82% 129.24% 126.35% 121.08% 115.89% 107.75% 107.11% 106.91% 106.57% 105.67% 105.06% 0.0% 50.0% 100.0% 150.0% 200.0% 250.0% 300.0% Japan Greece Italy Jamaica Lebanon Enritrea Portugal Cape Verde Bhutan Ireland Grenada Antigua and Barbuda Belgium Cyprus United States Public (government) debt as a percentage of GDP
  • 37.
    Countries with theLowest National Debt in 2015 1.82% 3.28% 6.37% 8.32% 8.56% 8.87% 9.46% 10.13% 11.48% 11.88% 12.73% 13.62% 13.64% 14.75% 16.25% 0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 14.0% 16.0% 18.0% Saudi Arabia Brunei Darussalam Hong Kong SAR Uzbekistan Oman Kiribati Kuwait Estonia Nigeria Iran Botswana Solomon Islands Algeria United Arab Emirates Chile National (government) debt measured as a percentage of GDP, Source: IMF
  • 38.
    Is a HighLevel of Public Debt Bad for the Economy? Public debt is the total stock of debt issued by a government that has yet to be re-paid – it is also known as the National Debt • High deficits cause rising debt interest payments which in 2015-16 are are forecast to be £47 billion or £700 per head of population • This interest burden has an opportunity cost for less interest on debt could free up extra spending on health and education. Borrowing of £70 billion is equivalent to £1,100 per head of the UK population • An increase in the national debt is likely to cause higher taxes in the future. This will cut the disposable incomes of tax payers and reduce growth in the private sector • It might be unfair if the rising tax burden falls more heavily on future generations of tax payers rather than people who benefit from government spending now. UK Debt Data UK government debt is forecast to reach 94% of GDP in 2013. This is lower than the average of advanced economies. Japan’s gross debt is 245% of GDP in 2013, while Greece’s is 179% of GDP.
  • 39.
    Government Debt fora selection of EU Countries 2006 2008 2010 2012 2015 France % of GDP 81.9 87.7 103.5 113.4 127.5 Germany % of GDP 64.1 61.2 67.4 65.1 60.0 Greece % of GDP 103.4 109.4 145.7 156.8 186.0 Ireland % of GDP 44.1 84.4 280.3 334.0 316.0 Italy % of GDP 116.2 114.5 126.0 138.1 144.9 Spain % of GDP 45.7 47.1 66.7 91.0 118.6 United Kingdom % of GDP 42.5 51.8 76.4 85.8 90.0 Source: IMF
  • 40.
    • The UKgovernment has a fiscal deficit-reduction policy with the emphasis on cutting government spending in some areas in real terms and a series of direct and indirect tax increases: • Key policies for deficit reduction: 1. Rise in standard rate of VAT to 20% 2. Rise in employee national insurance contributions (11%) 3. Deep cuts in real government spending e.g. for local authorities 4. Welfare caps including £26k pa cap on welfare for each family Some taxes have been cut 1. A series of cuts to corporation tax (main rate is now 20%) 2. Freezing of fuel duties (meaning a cut in real terms) 3. Increases in the real value of the income tax free allowance 4. Cuts in employer national insurance for long term unemployed 5. Freezing of council tax (so that council tax falls in real terms) The UK Government has also been helped by lower interest rates on newly issued debt as a result of quantitative easing UK Government’s Fiscal Austerity Policies
  • 41.
    In the July2015 Budget, the Chancellor George Osborne announced a new fiscal rule. The government’s fiscal rules now include a target for a budget surplus by 2019/20 and for all subsequent years when in ‘normal times’. The economy will be viewed as being in ‘normal times’ if real annual growth is above 1% Balanced budget when G= T Normal times – a full economic recovery UK Government’s New Fiscal Rule (2015)
  • 42.
    Fiscal Policy EdExcel ASEconomics 2.6.2