What is Fiscal Policy?,igcse notes

Fiscal Policy

Fiscal policy refers to government policy that attempts to influence the direction of the economy through changes in government taxes or through some spending.

The two main instruments of fiscal policy are government spending and taxation.

Changes in the level and composition of taxation and government spending can impact on the following variables in the economy:

• Aggregate demand and the level of economic activity.
• The pattern of resource allocation.
• The distribution of income.

How Fiscal Policy works?

Scenario one: High rate of Inflation

High rate of inflation is caused by too much aggregate demand in the economy. Government will use deflationary fiscal policy. Government will try to influence aggregate demand by reducing its public spending. The government will spend less on construction of roads, bridges and other public spending and thus aggregate demand will fall. On the other hand, Government may increase the tax rates. An increase in tax rates will take away the extra disposable income out people’s pocket resulting in a lower demand.

Scenario two: Low rate of Inflation 

In an economic recession, aggregate demand, output and employment all tend to fall. Now the Government wants to increase employment in the economy, it can attempt to do so by increasing aggregate demand. The Government will increase the public spending resulting in a rise in aggregate demand. Government may reduce the tax rates so that people have more disposable income to spend and instigate demand in the economy.

Watch a Video

Problems with Fiscal Policy

Reduce incentive to work

Raising taxes on income and profits reduce work incentives, employment and economic growth. An effort to reduce aggregate demand may cause disincentives to work, if this occurs there will be a fall in productivity and Aggregate supply could fall.

Adverse effect of lowering Public Spending

Reduced govt spending to Increase Aggregate demand could adversely affect public services such as public transport and education causing market failure and social inefficiency.

‘Crowding out’ effect

With an increase in government expenditure, there will be greater competition for limited resources. This will offset private investments resulting in shrinking of the private sector.

Inaccurate forecasting

If the Government’s estimate or forecasting is wrong or inaccurate the Fiscal policy will suffer. For example, if a recession is expected and the government practices deficit budget, and yet the recession turns out to be a boom, this will cause inflation.

Implementation of the Policy

Planning for the spending is done once by most of the governments. If there is a delay in the implementation of the fiscal policy, it might reduce the effectiveness of the policy. Thus the time lag is important.

IGCSE-GCEO Level Taxation notes

Taxation

A Tax is a financial charge or other levy imposed on an individual or a legal entity by a state or a functional equivalent of a state.Taxes consist of direct tax or indirect tax.

A tax may be defined as a "pecuniary burden laid upon individuals or property to support the government […] a payment exacted by legislative authority."

Purposes of Taxation

Financing government spending:

Taxes are justified as they fund government expenditure and activities that are necessary and beneficial to society.

Reduce gap between rich and poor

Progressive taxation can be used to reduce inequality in a society. According to this view, taxation in modern nation-states benefits the majority of the population and social development. Progressive tax system where higher income groups have to pay more tax is an effective way of reducing inequality of income.

Reduce consumption of demerit Goods

Taxes can be used as an effective tool to reduce the consumption of demerit goods like alcohol and tobacco. Higher taxes on these goods reduce the consumption. Examples include cigarette tax and excise duty.

Control Inflation

One of the causes of inflation is ‘too much money chasing too few goods’. Government can take away the extra disposable income of the people through higher taxes and thus reduce the aggregate demand in the economy and resulting in low inflation rate.

Balance of payments

Tariffs are taxes on imports. Government can correct an unfavourable balance of payment situation by increasing the tariffs. This will result in imports becoming expensive and will cause a fall in demand for the imported goods.

Protecting local industries

Government uses taxes as a mean to protect local/infant industries. Increasing tariffs on imports and charging lower taxes to local/infant industries may boost the demand for goods and services produced by domestic industry.

Classification of taxes

Progressive taxes

A progressive tax is a tax imposed so that the tax rate increases as the amount subject to taxation increases. In simple terms, it imposes a greater burden (relative to resources) on the rich than on the poor. It can be applied to individual taxes or to a tax system as a whole. Progressive taxes attempt to reduce the tax incidence of people with a lower ability-to-pay, as they shift the incidence disproportionately to those with a higher ability-to-pay. The result is people with more disposable income pay a higher percentage of that income in tax than do those with less income.

Example of Progressive tax in New Zealand
Income (New Zealand Dollar)	Tax rate (%)
Up to 38,000	19.5
38001-60,000	33
Above 60,001	49
Example of Progressive tax in Australia
Income (Australian Dollar)	Tax rate (%)
Up to 6000	0
6001-25000	15
25001-75000	30
75001-150000	40
Above 150000	45

Regressive Tax

The opposite of a progressive tax is a regressive tax, where the tax rate decreases as the amount subject to taxation increases. It imposes a greater burden (relative to resources) on the poor than on the rich. Regressive taxes attempt to reduce the tax incidence of people with higher ability-to-pay, as they shift the incidence disproportionately to those with lower ability-to-pay.
For example, if Jane has $10 and John has $5, a tax of $1 on a purchase would result in a different percentage of total income applied to taxation, 20% for John and 10% for Jane. Thus, a tax that is fixed to the value of the good/service would likely, in effect, result in a higher burden of taxation to people with less money.

Proportional Tax

A proportional tax is one that imposes the same relative burden on all taxpayers—i.e., where tax liability and income grow in equal proportion. In simple terms, it imposes an equal burden (relative to resources) on the rich and poor. Proportional taxes maintain equal tax incidence regardless of the ability-to-pay and do not shift the incidence disproportionately to those with a higher or lower economic well-being.

Direct taxes

Taxes which are collected directly from income and wealth are known as direct taxes.

Types of Direct taxes

Income tax

Income tax is collected on all incomes received by private individuals after certain allowances are made. In most of the economies Income tax is a major source of Government revenue.

Corporation tax

This tax is levied on profits earned by companies. It is a proportional tax which is levied at the constant rate.

Petroleum revenue tax

It is a tax levied on the profits of companies involved in drilling of oil and gas. This tax may or may not exist in other countries.

Capital gains tax

Capital gains tax is charged on the profit realized on the sale of a non-inventory asset that was purchased at a lower price. The most common capital gains are realized from the sale of stocks, bonds, precious metals and property. Not all countries implement a capital gains tax and most have different rates of taxation for individuals and corporations.

Property Tax

Many countries have Property tax, or millage tax. It is the tax which the owner pays on the value of the property being taxed.
The taxing authority requires and/or performs an appraisal of the monetary value of the property, and tax is assessed in proportion to that value. Forms of property tax used vary between countries and jurisdictions.

Stamp duty

Stamp duty is a form of tax that is levied on documents relating to immovable property, stocks and shares. Apart from transfers of shares and securities, stamp duties are also charged on the issue of bearer instruments and certain transactions involving partnerships.

Indirect Taxes

Indirect tax (such as sales tax, value added tax (VAT), or goods and services tax (GST)) is a tax collected by an intermediary (such as a retail store) from the person who bears the ultimate economic burden of the tax (such as the customer). The intermediary later files a tax return and forwards the tax proceeds to government with the return.An indirect tax may increase the price of a good so that consumers are actually paying the tax by paying more for the products.

Examples would be fuel, liquor, and cigarette taxes. An excise duty on motor cars is paid in the first instance by the manufacturer of the cars; ultimately the manufacturer transfers the burden of this duty to the buyer of the car in form of a higher price. Thus, an indirect tax is such which can be shifted or passed on.

All Indirect Taxes are regressive in nature. The poor will feel the pinch more than the rich.

Types of Indirect Taxes

Value added Tax

Value added tax (VAT), or goods and services tax (GST), is a consumption tax levied on value added. In contrast to sales tax, VAT is neutral with respect to the number of passages that there are between the producer and the final consumer; where sales tax is levied on total value at each stage, the result is a cascade (downstream taxes levied on upstream taxes).

Exports are consumed abroad and are usually not subject to VAT; VAT charged under such circumstances is usually refundable. This avoids downward pressure on exports and ultimately export derived revenue.

A VAT is an indirect tax, in that the tax is collected from someone who does not bear the entire cost of the tax.

Excise duties

Excise duty is a type of indirect tax charged on goods produced within the country. Lists of such goods are readily provided by governments.

Why does government spend?

There are many reasons for government spending. These can be

To Provide Public goods

Public good is that good, consumption by one individual does not reduce availability of the good for consumption by others; and that no one can be effectively excluded from using the good. These goods are of importance to the general public and hence are provided by the government. Example defence, street lighting etc.

To provide Merit goods

A merit good is a commodity which is judged that an individual or society should have on the basis of a norm. The government feels that everybody should enjoy these goods irrespective of their incomeFor example, health and education. In most of the economies, governments spend a major part of their expenditure on health and education.

To maintain and promote economic growth

Public spending has an important role to play in maintain and promoting economic growth in the economy. Increases in government spending on state provided goods and services add to total domestic demand and can have multiplier effects on the final level of equilibrium national income.

Ensure welfare of the state

One of the government’s main objective is to provide reduce the gap between rich and poor and thus government provides services like health and education to the economically weaker sections of the society free of cost or at a subsidised rates. The social security system also tries to provide a safety-net for those who suffer unexpected falls in income arising from unemployment, separation and bereavement.

USEFUL LINKS FOR FURTHER STUDY

• Article on BBC 'What the budget has in store'
• US Government Spending data

Economic Objectives of the Government

Most of the governments round the world have four main objectives. These are

• Keep inflation under control
• Maintain a low level of unemployment
• Achieve a high level of economic growth rate
• Maintain a healthy balance of payments.

Government spending or government expenditure is classified by economists into three main types.

• Government purchases of goods and services for current use are classed as government consumption.
• Government purchases of goods and services intended to create future benefits, such as infrastructure investment or research spending, are classed as government investment.
• Government expenditures that are not purchases of goods and services, and instead just represent transfers of money, such as social security payments, are called transfer payments.

Public Limited Companies and Stock Exchange

Public Limited Companies and Stock Exchange

This short video gives an insight into the forming of a Public LImited Company and the process of listing it on the Stock Exchange.

Public Limited company

Limited companies which can sell share on the stock exchange are Public Limited companies. These companies usually write PLC after their names. Minimum value of shares to be issued (in UK) is £50,000.

Advantages

• There is limited liability for the shareholders.
• The business has separate legal entity. There is continuity even if any of the shareholders die.
• These businesses can raise large capital sum as there is no limit to the number of shareholders.
• The shares of the business are freely transferable providing more liquidity to its shareholders .

Disadvantages

• There are lot of legal formalities required for forming a public limited company. It is costly and time consuming.
• In order to protect the interest of the ordinary investor there are strict controls and regulations to comply. These companies have to publish their accounts.
• The original owners may lose control.
• Public Limited companies are huge in size and may face management problems such as slow decision making and industrial relations problems.

• Public Limited Companies and Stock Exchange

  This short video gives an insight into the forming of a Public LImited Company and the process of listing it on the Stock Exchange.

Limited companies

Also known as Joint stock companies. These are business where a number of owner(shareholder) pool in their resources to do a common business and to share the profits and losses proportionally.
In a limited company, the debts of the company are separate from those of the shareholders. As a result, should the company experience financial distress because of normal business activity, the personal assets of shareholders will not be at risk of being seized by creditors. Ownership in the limited company can be easily transferred, and many of these companies have been passed down through generations.

Difference between Limited companies and partnership

Limited companies can issue shares whereas partnership business cannot.

Shareholders enjoy limited liability in Limited companies. It means that if the company experience financial distress because of normal business activity, the personal assets of shareholders will not be at risk of being seized by creditors. Whereas partnership business does not have limited liability except for limited partnerships.

Separate Identity: Limited companies are considered as human beings in the eyes of the law. They are born and die in the eyes of law. They can sue and get sued on their own name.

Continuity: There is continuity of existence in limited companies and are their existence is not affected by the death, bankruptcy or sickness of their owner. This is not the case in Partnership or sole trader businesses.

There are two main types of Limited companies. These are:

• Private Limited Company
• Public Limited Company

• Private limited Companies

  These are closely held businesses usually by family, friends and relatives.
  Private companies may issue stock and have shareholders. However, their shares do not trade on public exchanges and are not issued through an initial public offering.
  Shareholders may not be able to sell their shares without the agreement of the other shareholders.

  Advantages

  Limited Liability: It means that if the company experience financial distress because of normal business activity, the personal assets of shareholders will not be at risk of being seized by creditors.
  Continuity of existence: business not affected by the status of the owner.
  Minimum number of shareholders need to start the business are only2.
  More capital can be raised as the maximum number of shareholders allowed is 50.
  Scope of expansion is higher because easy to raise capital from financial institutions and the advantage of limited liability.

  Disadvantages

  Growth may be limited because maximum shareholders allowed are only 50.
  The shares in a private limited company cannot be sold or transferred to anyone else without the agreement of other shareholders.

IGCSE -GCE O LEVEL Partnership Deed, Economics

Partnership Deed

Before starting a partnership business, all the partners have to draw up a legal document called a Partnership Deed of Agreement.

It usually contains the following information:

• Names of included parties - includes all names of people participating in this contract
• Commencement of partnership- includes when the partnership should begin. The date of the contract is assumed as this date, if none is given.
• Duration of partnership - includes how long the partnership should last. It is automatically assumed that the death of one of the contracting parties breaks the contract, unless otherwise stated.
• Business to be done - includes exactly what will be done in this partnership. This section should be very particular to avoid confusion and loopholes.
• Name of firm - includes the name of the business entity.
• Initial investments - includes how much each partner will invest immediately or by installments.
• Division of profits and losses - includes what percentages of profits and losses each partner will receive. If it is not a limited partnership, then there is unlimited liability (each partner is responsible for all partners' debts, including their own).
• Ending of the business - includes what happens when the business winds down. Usually this includes three parts: 1) All assets are turned into cash and divided among the members in a certain proportion; 2) one partner may purchase the others' shares at their value; 3) all property is divided among the members in their proper proportions.
• Date of writing - includes simply the date that the contract was written.