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Fiscal Policy | O Level Economics 2281 & IGCSE Economics 0455 | Detailed Free Notes To Score An A Star (A*)

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  • Budget
    • It is a forecast statement
    • It shows where the government will get its revenues from
    • Where the government will spend its revenues
    • Generally, the focus is on a balanced budget
  • Government Spending
    • Public goods and services are with the government
    • It is part of the economic aggregate demand
    • It includes spending on education, water, salaries, pensions and subsidies etc.
  • Reasons for government spending
    • Public goods won’t be supplied by the government
    • Merit goods also have to be supplied.
    • Welfare payments and benefits payments
    • Supply-side improvements are created
    • Negative externalities are to be reduced such as pollution control.
    • Industries have to subsidized to ensure that they can keep producing and ensure that they receive financial support from the government – or to reduce prices.
    • Income redistribution can occur and equality can be created
    • Economic growth can be supported
  • Effects of Spending by the government
    • Economic growth increases – inflation will allow demand to stimulate and more output.
    • Public goods and merit goods increase, productivity increases
    • Inequality reduces as government spending on welfare schemes increases
    • Private sector invests may get crowded out – as government invests, private sector may not invest – at the same time it could reduce the private sector investment
  • Taxation
    • Interests on loans on bonds can provide revenue to government
    • Fines, grants and aids, public property earnings etc can increase govenrnment earning
    • The main source of government earning is taxation
      • It is compulsory payment to the government
      • Why so?
        • Source of government income so it finances its expenses
        • Income redistribution so that inequality reduces
          • People with higher income give taxes, spent on those who are less fortunate
        • Consumption and production of demerit goods is taxed
          • We can put excise duty on them
        • Home industries are protected by taxes on foreign goods
          • Customs duty and tarriffs
        • Economy management occurs
          • Less taxes can increase demand and boost economy
          • High taxes can reduce inflation and bring down the pricing in the country
    • Classification
      • Direct Taxes
        • Taxes that are directly placed on income
        • Burden of payment is on the person earing the money
        • Income tax is on individual disposable income
          • Higher tax will reduce spending
        • Corporate tax
          • Company profuts
          • Lower profits if higher taxes so less dividend, less spending, less reinvestment
        • Capital gain tax
          • Profit on sale of asset ta is held for more than 1 year is taxed
        • Inheritance tax
          • Inherited wealth is taxed
        • Property tax
          • Tax on property or la d
        • Pros
          • Direct taxation creates more revenue for the government as tax slabs are created
          • Inequality in income can be reduced with progressive taxation system
        • Cons
          • Incentive to earn more reduce as it has to be paid in taxes
          • Enterprise incentive reduce as business has to pay more taxes
          • Legal loopholes are considered to evade taxation so tax evasion occurs
      • Indirect taxes
        • Taxes that are placed on spending
        • You only pay it when you purchase a product or service
        • General Sales Tax GST/ Value Added Tax (VAT): it is placed on spending. It increases price of goods so demand falls
        • Customs Duty
          • Import and export tariffs
        • Excise duty
          • Tax on demerit goods within the country
        • Benefits
          • Cost-effective as collection is easier
          • Tax-base expands – people paying the tax increase
          • Specific aims can be achieved like reducing imports or consumption of demerit goods
          • Flexible as they can be changed and altered easily
        • Cons
          • Can cause inflation as prices increase
          • Regressive in nature so people with lower income pay a greater proportion of their incomes in these taxes
          • Tax evasion such as not paying customs duty etc.
  • Progressive taxes
    • Taxes that burden rich more tham the poor
      • Income taxes with increasing tax rates at higher slabs are called progressive taxes
    • Regressive taxes
      • Where a greater proportion of the income of those who earn less is taken
      • Indirect taxes are usually regressive
    • Proportional taxes
      • Tax rate on the disposable income remains equal for everyone, irrespective eof the income
  • Good Tax System
    • Equity and justifiable
    • Certainty of how much tax has to be paid
    • Economic to collect the taxes and lowest costs of collection
    • Convenient timing and payment method
    • Elasticity which means its easier to change based on income changes
    • Simplicity so that everyone can understand the system easily.
  • Impacts of taxation
    • Government spending is financed
    • Less disposable income so people spend less, less inflation
    • Incentive to work is reduced on higher taxes
      • Substitution effect
        • Lower disposable income so people will prefer to work less as it substitutes working more for leisure
      • Income effect
        • higher tax causing lower income will make people want to work longer hours to earn more
      • Which effect is greater will determine what people do
    • Less incentive to produce
      • Corporate taxes high
  • Fiscal policy
    • Adjusts government spending and taxation
    • Impacts the economy
    • A budget surplus means a government will have an expansionary fiscal policy where it will spend more and tax less to achieve a balance
    • A budget deficit means government will use a contractionary policy where it will spend less and tax more.
    • It can also impact inflation and unemployment as well
Hunain Zia

Hunain Zia has previously achieved considerable success in the high-school educational stream, gaining a massive 154 Total A Grades and 7 Major Distinctions, a process in which he broke/ set 11 different world records, including the most A grades ever achieved, most subjects ever appeared in, most distinctions, gaining distinctions across two separate boards (Pearson Edexcel and CAIE) within the same year/ ever, and even 19 hours of constant examination. All records stand intact today. Hunain pursued his Honors Accounting Degree from the prestigious Bentley University, and then completed an LLB (in Honors) from University of London. Currently, he manages multiple social and commercial projects, has founded digital streams and works tirelessly in the education sector.

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