4.5 Government Economic Policy

Taxation• The government contributes greatly to economic growth

through its own expenditure. To finance this spending, the government will raise money through taxation:– Indirect Taxes – taxes places on expenditure, in others words,

you pay these taxes depending on what you use. IE: VAT, customs duties placed on imported goods, excise duties (taxes placed on specific goods such as petrol, alcohol and tobacco)

– Direct Taxes – taxes placed on incomes earned. IE: Income Tax, National Insurance, Corporation Tax.

– Other Taxes – IE: Stamp duty (placed on the purchase price of a house); Council tax (charged on each house and varies according to the value of the property); Inheritance tax (paid on any inheritance earned when an estate passes on to someone else when an individual dies)

Government Expenditure (Categories of spending)

• Social Protection – includes welfare payments paid to those in need. (Some are based on a person’s circumstances – Jobseeker’s Allowance, others are paid regardless of status – Child benefits)

• Health – NHS, 2nd largest component of gov’t spending, as UK population is ageing, the demands on NHS are likely to rise in the future.

• Other categories: Transport, Education, Defence, Debt interest, Public order and safety, Environment, Agriculture, Employment and training . . .

Fiscal Policy

• Decisions made by the government on government expenditure and taxation– As governments spend large amounts in the

economy, changes in government expenditure have a major impact on economic performance and their ability to reach their economic objectives

– High expenditure means taxes are very significant in funding this expenditure. Therefore changes in taxation will have a significant effect on the performance of the economy.

The Effects of Fiscal Policy• Changes in the level of government spending, and changes in the level of

taxation, will affect each of the government’s economic objectives:Economic Objective

Government Spending Taxation

Inflation

Economic Growth

Full Employment

Balance of Payment

Monetary Policy

• Decisions which control the supply or cost of money.– Involves changes in interest rates which represent

the cost of borrowing money.– Is set by the Bank of England (UK’s central bank)– Interest rates are used to control inflation and

economic growth

How does Monetary Policy . . .

• Control Inflation?

• Control Growth?

Supply-side policies• Economic growth can be increased with more

spending.• However, if spending rises quicker than the rate at

which output increases, it will lead to inflation. (ie: there is a shortage of items to purchase)

• Therefore, it is important that an economy can produce more output over time.

• Policies to raise the rate of growth of output without boosting spending are known as SUPPLY-SIDE POLICIES.

• Supply-side policies allow economies to grow faster with fewer risks of inflation.

What are supply-side policies?• Education and training – increasing the quality and

quantity of education and training should make people more productive, this higher productivity should lead to higher national output.

• Competition – encouraging competition between businesses should lead to higher output levels and lower prices because of the pressure between businesses to retain customers (ie: aid for small businesses, privatisation, deregulation)

• Labour market policies – decreasing direct taxes provides workers with incentives to rejoin the workforce, and for firms to recruit more workers, a reduction in trade union power also encourages firms to recruit more workers