Fiscal Policy

• Fiscal policy is the use of government spending, taxation, and the budget balance to achieve economic objectives.
• The budget balance is the annual difference between government spending and taxation.
• Fiscal policy can be used to tackle microeconomic policy aims and macroeconomic objectives.
• Taxes can be categorized as direct or indirect, and as regressive, progressive, or proportional.
• Government expenditure can be categorized as current or capital spending.

Fiscal policy refers to the use of government spending, taxation, and the budget balance to achieve economic goals. The budget balance is the difference between government spending and taxation in a given year. A budget deficit occurs when spending exceeds taxation, while a budget surplus occurs when taxation exceeds spending. It is important to differentiate between the budget deficit and the national debt, which is the total accumulated government borrowing over time. Fiscal policy can be used to address microeconomic issues, such as market failures, by implementing taxes on specific goods or investing in healthcare. However, the focus is primarily on using fiscal policy to achieve macroeconomic objectives, such as maintaining low inflation, reducing unemployment, boosting real GDP, and achieving balance in the balance of payments. There are two main types of taxes: direct and indirect. Direct taxes, such as income tax and corporation tax, are levied on incomes and profits. Indirect taxes, such as VAT and excise duties, are levied on expenditure. Taxes can also be categorized based on their impact on inequality, with regressive taxes taking a higher proportion from lower incomes and progressive taxes taking a higher proportion from higher incomes. Government spending can be allocated to various areas, with social protection being the largest expenditure in the UK. Other major areas include health, education, debt interest payments, military defense, public order, housing, and transport. Government expenditure can be further categorized into current spending, which covers day-to-day running costs, and capital spending, which involves long-term investments in fixed assets. Fiscal policy primarily operates as a demand-side policy, influencing aggregate demand. Expansionary fiscal policy involves increasing government spending or reducing taxation to stimulate aggregate demand, leading to higher real GDP and reduced unemployment. However, it can also result in rising inflation. On the other hand, contractionary fiscal policy involves reducing government spending or increasing taxation to decrease aggregate demand, controlling inflation but potentially leading to lower real GDP and increased unemployment. It is important to note that fiscal policy can also have supply-side impacts. For example, government spending on infrastructure projects can increase the productive capacity of the economy, while an increase in corporation tax may discourage business investment and reduce long-run aggregate supply.