Unit 4: Fiscal Policy OUTLINE PART 1: Taxation

What is Fiscal Policy? 

Fiscal Policy can be said to be the manipulation of public spending, taxation and borrowing to achieve the government’s macroeconomic objectives. 

  • It is based on the two components of Taxation and Expenditure
  • An increase in expenditure and a decrease in taxation would mean a boost to aggregate demand.
  • However fiscal reforms can also help to influence the supply side of the economy aswell.


What are the main objectives of Taxation?

  • Funding government spending
  • Managing the economy as a whole
  • Redistribution of income
  • Correct market failure  

There are Direct and Indirect Taxes. Direct taxes are taxes that are paid directly to Her Majesty’s Revenue and Customs. This would include income tax, inheritance tax, capital gains tax and also corporation tax. While Indirect Taxes would include VAT on goods they make buy, goods like tobacco, alcohol would normally have excise duties on their goods aswell..

Some people would say taxes are bad but most people would say there should be some kind of tax in order to finance some essential goods like healthcare. Therefore in order to judge taxation is good they would have to go under Adam Smith’s Principle of Taxation. Taxes should be: 

  1. Economical
  2. Equitable
  3. Convenient
  4. Certain 
  5. Efficient
  6. Flexible 

There could also be HYPOTHECATION where taxes are earmarked for a specific purpose. For example taxes on cigarette packets were raised to help tackle smoking related diseases by the NHS and also take money from those creating negative externalities. 

What are the benefits and downturns of indirect taxes


  • Influencing spending patterns- indirect taxes can help change what goods and services consumers would spend their money on. 
  • Correcting externalities 
  • Incentive effects – Indirect taxes have less impact of work vs leisure choies.
  • Flexibility – can be changed more easily compared to direct taxes( only changed once a year at the time of the budget)
  • Choice – allows people to choose if they should consume the good or not instead of direct taxes which leave people with less of their take home play which are also hard to avoid.


  • Crime 
  • Distributional effects( regressive tax)- can take more off the poorer people than richer people.
  • Inflationary effects – trigger cost push inflation as taxes would increase cost for firm.
  • Lack of announcement effects – people are uncertain how much they are paying with indirect taxes. 

Taxes can be progressive– which is where the proportion of the person’s income would increase as income increases. The income tax in the UK is indeed progressive as the average tax from brackets of £5000-7499 increased from 2% to almost 18% for people in the £30,000-49,999. 

Regressive is where the proportion paid in tax falls as income increases. E.g. Indirect taxes

Proportional is where the proportion of income paid in tax stays the same as income increases. 

NEXT—> FISCAL PART 2 Government Expenditure


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