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Chapter 31: Fiscal Policy - Coggle Diagram
Chapter 31: Fiscal Policy
The National Budget
Annual statement of the expenditures and receipts of the govt. of SA together with the laws and regulations
Purpose of national budget:
to finance national govt. programmes and activities
acieve macroeconomics objectives
Budget Surplus or deficit
Budget balance = Govt. Revenues - Govt. Expenditures
if revenues > expenditures:
Budget surplus
if expenditures > revenues:
Budget deficit
if revenues = expenditures:
Balanced budget
Government Revenue
comes from:
Personal Income tax
Corporate income tax
Value added tax
Customs and excise duties, fuel revenues etc
Government expenditure
is classified as:
Functional classification:
expenditure according to the function of government for which it is intended e.g expenditure for education, police etc
.
Economic classification:
expenditure according to its nature as either
current payments
(salaries to govt. employees),
transfers and subsidies
(social grants) or
payments for capital assets
(purchase of govt. vehicles or buildings)
Laffer curve
Relationship between the
tax rate
and the
amount of tax revenue collected
.
A higher tax rate doesn't always = higher tax revenue
a higher tax rate brings in more revenue per rand earned. BUT because a higher tax rate
decreases the number of rands earned
, the two forces operate in
opposite directions
on the tax revenue collected
Below T*
: an
increase
in the tax rate
increases
tax revenue
At T*
: tax revenue is
maximised
Above T*
: an
increase
in the tax rate
decreases
tax revenue
see pg 681
Supply side effects of fiscal policy
The effects of income tax:
income tax lowers the full employment quantity of labour (∴lower potential GDP, lower AS) as it
weakens the incentive to work and drives a wedge between the wage of workers and the cost of labour to firms
.
This shifts supply of labour curve to
left
- Demand for labour
doesn't change
- Vertical distance between the
LS curve
and the
LS+tax
curve is known as the tax wedge
.
an
income tax cut
would would increase the full employment quantity of labour, equilibrium employment and increase potential GDP and AS
see pg 679
Taxes on expenditure and the tax wedge:
• Taxes on consumption expenditure add to the tax wedge. This is because a tax on consumption raises the prices paid for consumption goods and services and is equivalent to a cut in the real wage rate.
The
higher
the taxes on goods and services and the
lower
the after-tax wage rate, the
less is the incentive to supply labour
& vice-versa
e.g if income tax rate is 25% and the tax rate on consumption expenditure is 10%, a Rand earned only buys 65 cents worth of goods and services.(100-25-10 = 65) The tax wedge is 35 per cent
Taxes and the incentive to save and invest:
a tax on interest income weakens the incentive to save and drives a wedge between the after tax interest earned by savers and interest rate paid by firms.
.
a tax on capital gains
lowers the quantity of saving and investment
and
slows the growth rate of RGDP
inflation increases the true tax rate on capital gains
Capital gains tax has no effect on the demand for loanable funds. Capital gains tax weakens the incentive to save and lend (∴ decrease the supply of loanable funds)
This causes saving to decrease and supply of loanable funds
shifts left
to
SLF + tax
curve.
The amount of tax payable is measured by the vertical distance between the supply of loanable funds curve
see pg 680
Fiscal stimulus
The use of fiscal policy to increase production and employment
Automatic fiscal policy:
a fiscal policy action triggered by the state of the economy with no action by govt.
Discretionary fiscal policy:
a fiscal policy action initiated by an act of Parliament
Automatic fiscal policy
Tax revenue:
Tax revenue depends on the tax rates enforced by govt. & incomes people earn
Incomes vary with RGDP ∴ tax revenues depends on RGDP
.
When RGDP increases during a business cycle expansion, wages and profits rise ∴ tax revenue ↑
When RGDP decreases during a recession, wages and profits fall ∴ tax revenue ↓
Needs tested spending:
Transfer payments to qualified people based on specific needs
When the economy expands, unemployment falls, the number of people experiencing economic hardship decreases ∴ needs tested spending ↓
When the economy is in a recession, unemployment rises etc
∴ needs tested spending ↑
Cyclical and structural budget balances
Structural surplus or deficit: budget balance that would occur if the economy were at full employment
.
Cyclical surplus or deficit: actual surplus or deficit minus the structural surplus or deficit
See pg 682 for curves and shifts
Discretionary fiscal stimulus
Government expenditure multiplier
: the quantitative effect of a change in govt. expenditure on RGDP
Increase in govt. expenditure
increases
aggregate expenditure and RGDP
Tax multiplier:
quantitative effect of a change in taxes on RGDP
the demand side effects of a tax cut are likely to be smaller than an equivalent increase in govt. expenditure. This is because a tax cut influences AD by increasing disposable income, only part of which gets spent
:warning: a tax cut has similar "crowding out" consequences to a spending increase, as govt. borrowing ↑ (or govt. spending ↓ in a budget surplus), real interest rate ↑ and investment ↓
∴ tax multiplier effect on AD is likely to be small
see pg 683 for more info
An increase in govt. expenditure or a tax cut
shifts AD curve right
, the
multiplier increases consumption and aggregate expenditure
and
price level rises
• An increase in govt. expenditure or a decrease in govt. revenues can
stimulate production and jobs
• An increase in expenditure on goods and services directly
increases aggregate expenditure
• An increase in transfer payments or a decrease in tax revenues
increases disposable income
, which enables people to increase consumption expenditure
• Decrease in taxes
increases the incentives to work and invest