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ECONOMICS TEST REVISION

FISCAL POLICY
The federal government implements fiscal policies to reduce the
failures of the market and economy to continue strong prosperous
growth. The fiscal policy affects the level of economic activity,
resource allocation and income distribution. The two main
instruments of fiscal policy are government expenditure and
taxation. Changes in the level and composition of taxation and
government spending can impact on the following variables of the
economy such as:
Aggregate demand and the level of economic activity
The pattern of resource allocation
The redistribution of income

FISCAL POLICY STANCES


A balanced budget (fiscal policy neutral stance) is when G
= T:
Government revenue finances all of government spending and the
budget balance is 0. A neutral stance of fiscal policy implies that
government spending is fully funded by tax revenue and overall
the budget outcome has a neutral effect on the level of economic
activity.
A budget deficit is where (fiscal policy expansionary
stance) G > T:
Government spending exceeds government revenue and the
budget balance is negative. An expansionary stance will lead to a
larger budget deficit or smaller budget surplus, leading to an
increase in economic activity. This would be used in recession
since there is little growth and the government would want to
stimulate growth.
A budget surplus is where (fiscal policy contractionary
stance) G < T:
Government spending is less than government revenue and the
budget balance is positive. Contractionary stance would lead to a

lower budget deficit or a larger surplus, associating with a budget


surplus. Contractionary fiscal policy is the application of built in
stabilizers, which reduce cyclical fluctuations automatically.
During booms the high levels of income earners receive higher
level taxes which is known as progressive tax. This tax (statistic)
increase reduces the Marginal Propensity to Consume. This is an
instance of the government reducing consumption to lower high
rates of inflation during economic booms.

STRUCTURAL AND CYCLICAL COMPONENTS OF


BUDGET OUTCOME
The two main components of budget outcome are the structural
or discretionary components and the cyclical or non-discretionary
components. The structural component refers to deliberate
changes in government spending/ taxation that affect the budget
outcome. The cyclical or non-discretionary component refers to
changes in government spending or revenue which are caused by
changes in the level of economic activity or income that affect the
budget outcome.
Non-discretionary (or cyclical component) is changes in
fiscal policy caused
by changes in the level of economic
activities. In recession periods, budget deficit will increase where
during strong economic growth Budget deficit will contract or the
budget will shift into surplus.
Discretionary (or structural component) is changes in fiscal
policies that are deliberate changes such as reduced spending or
changing taxation rate.
Discretionary changes influence the
structural component of the Budget outcome.

Automatic or inbuilt stabilizers


Part of the budgetary structure involves automatic changes to revenue
collections and outlays which occur when the level of economic activity
changes. These are known as automatic or inbuilt stabilizers which help to
offset the extremes of the business cycle without the government needing to
change the stance of fiscal policy. The two of the main automatic stabilizers
are the system of progressive taxation and spending on transfer payments
through social security and welfare systems.

Progressive taxations means that taxpayers pay an increasing


proportion of their income in tax, as incomes rise in a boom, and a
lower proportion of their income in tax as incomes fall in a recession.
Taxation revenue rises as economic activity expands through a boom,
helping to contain the growth in aggregate demand and inflation.
Taxation revenue falls as economic activity contracts through a
recession, helping to maintain spending and aggregate demand, thus
offsetting the trend towards lower economic activity and higher levels
of unemployment during a recession.
Expenditure on unemployment benefits to the unemployed rises when
the rate of unemployment increases in a recession. This happens
automatically as eligible persons register for the receipt of their
benefits. This increases government expenditure which helps to raise
aggregate demand. IN a period of increasing economic activity,
unemployment falls as jobs are created, and government expenditure
on unemployment benefits fall, helping contain the growth in
aggregate demand and inflationary pressures.

REALLOCATION OF RESOURCES
Fiscal policies influence resource allocation through changes to
the taxation systems and spending decisions. This can influence
the allocation of resources in the economy directly or indirectly
changes in tax rates or types of tax will impact on how resources
are allocated between various types of production.
During the 2000-01 budget, the government introduced The New
Tax System which included the abolition of existing indirect taxes
such as wholesale sales tax, excise duties and custom duties, and
their replacement by a 10% Goods and Services Tax on the retail
price of most goods and services. Previous indirect taxes such as
sales tax tended to penalize the production of certain categories
of goods such as cars, business inputs and electrical appliances
and distorted resource allocation because it was applied at
different rates but left services untaxed, although they
contributed up to 80% of GDP. The indirect influences of fiscal
policy covers tax and spending decisions that make it more or
less attractive for resources to be used in particular ways such as,
increasing taxes in cigarettes would discourage tobacco
consumption, which in a longer term may reduce the costs to the

health care system arising from treating tobacco-related diseases.


Further example, is removing taxes from ethanol productions
which encourage farmers to use more of their wheat, sugar and
other crops to produce ethanol.
Governments are more likely to use direct measures if they
expect that markets will not provide the resources momentarily
quickly enough, without government intervention. For example, in
the most urgent cases, such as natural disasters, governments
will usually step in and direct relief operations so that emergency
resources are made available to the victims of a disaster. In
addition, the governments might pay directly to provide a public
good which, the private sector is unlikely to pay for, and which is
difficult to prevent anyone else from using. Examples of public
goods include defense and environment sustainability and
protection agencies.

REALLOCATION OF RESOURCES
Market failure occurs when market forces produce undesirable
outcomes that are not social or economically favorable. To
address these issues the government reacts by the reallocation of
resources, which involves changing the pattern of production in
the economy directing resources towards desirable goods and
away from goods that are undesirable. The government
reallocates its income to invest in the public sector in the
economy, as without government intervention the public sector
would result in market failure. To prevent market failure, the
government subsidizes the health, education, environment,
defense and infrastructure sectors that form the public sector.

REALLOCATION OF RESOURCES
Fiscal policy is a macroeconomic policy, which involves the use of federal budget to achieve
government economic objectives. By varying the amount of government spending and revenue, the
budget outcome can impact on the level of economic activity, which subsequently will influence
economic growth, inflation, unemployment and the external indicators in the economy. The federal
government can use fiscal policy to stabilise economic activity, redistribute income and reallocate
resources In assessing the impact of the budget on the level of economic activity, economists suggest
that it is important to distinguish between the cyclical and structural components of the budget
outcome. The cyclical component of the budget outcome refer to that part of the budget outcome that
results from the influence of automatic stabilisers, such as progressive income tax and unemployment
benefits. The structural component of the budget outcome refers to that part of the budget outcome
that results from deliberate, discretionary government decisions. The Australian government plays an
important role in stabilising the economy and sustaining economic growth through direct discretionary
decisions. This can be determined by the budget outcome where the government can change the
economic activity by changing its own leakages and injections. Such decision has helped Australia
maintain a sustainable rate of economic growth of 3-4%. During a downturn, the Australian
government aims to stimulate Australias economic growth by adopting an expansionary fiscal stance.
This was shown during the GFC in 2008 when a budget deficit occurred in order to stimulate economic
activity and increase the level of aggregate demand within the economy. The increase in aggregate
demand leads to a decline in interest rates and induces household and business sectors to increase
consumption and investment expenditures, increasing business activity. A deficit occurs when the

planned government revenue is greater than planned government expenditure The increase in
aggregate demand is a result of consumers having more spending power to purchase goods and
services. Consumers can do this because the Government has used their discretion in increasing
expenditure to encourage consumers to buy and therefore, demand more. The global financial crisis of
2008 saw the Australian government record a deficit of 4.3% in 2010, in an attempt to promote
liquidity in the financial systems. The result of this budget deficit was evident, as Australia in
comparison to other countries was impacted very minutely by the recession with the GDP growth rate
increasing from 1.77% in 2009 to 2.33% in 2010. Fiscal policy has important impact on the distribution
of income. In general, the government uses the progressive income tax system, combined with its
social welfare expenditure, to redistribute income from higher income earners to lower income earners.
Social welfare payments include unemployed, aged, disabled, and single parents families. Social
welfare constitutes the largest proportion of Federal government expenditure $158.61 billion or 35.2%
of total government expenditure in 2016-17 Budget. This dramatically reduces inequality as high
income earners who earn $180, 000 and above, are taxed at a rate of 45% for each dollar over $180,
000. On the other hand, low income earners who earn 6001 to 37000 are taxed at a rate of 15% for
each dollar over $6000.
The reallocation of resources influences the amount and type of G&S produced. When the government
reallocates resources, it changes the pattern of production in the economy and directs resources to the
production of more desirable G&S and also promotes efficient use of limited resources. The
government can influence the price of goods and services through direct and indirect tax, and thus
influence consumer demand through taxes and charged levies. They can either have the effect of
diverting resources away from certain types of economic activity, or attracting resources to a specific
sector. Government have used indirect taxes to discourage consumers from purchasing harmful
products such as tobacco and leaded petrol by charging it at high prices. Statistics show that the
country 2.5 million smokers will be hit, with four annual rises of 12.5% in the tobacco excise. Similarly,
the government can promote Governments sometimes involve themselves directly in the production
process to achieve a better allocation of resources. Investment in economic infrastructure (such as
telecommunications and transport networks) and social infrastructure (for example, schools, hospitals
and public housing) has a major bearing on the communitys wellbeing. Commonwealth governments
have an important influence on the provision of such infrastructure.
Governments sometimes involve themselves directly in the production process to achieve a better
allocation of resources. Investment in economic infrastructure (such as telecommunications and
transport networks) and social infrastructure (for example, schools, hospitals and public housing) has a
major bearing on the communitys wellbeing. Commonwealth governments have an important
influence on the provision of such infrastructure as there the usually the only system which can
accommodate and supply these necessities. According to the 2016-17, $32.3 billion was invested in
the defence budget. Comparing it to last years budget, there was an increase of 2%. The government
had decided to modernise, expand and radically improve the defence force. Over a 10 year period, the
estimated costs of defence building project is about $195 billion. Measures will ensure at least 3600
jobs. Statistics show, there will be a $5 billion kitty for major building projects across the country. NSW
will get $2.2 billion and Victoria $2.4 billion for road and rail projects. New infrastructure projects
should improve the productivity of the economy by reducing travel times and making the roads/public
transport more efficient.

REDISTRIBUTION OF INCOME
The fiscal policy plays the most important role of any government
policy in influence the distribution of income in the economy.
People on higher incomes pay higher rates of income tax, allowing
the government to use this money for transfer payments,
community services and other types of social expenditure, which
in particular assist people on lower incomes.

The high income earner tax bracket is $180,000 and above, are
taxed 45% for each dollar that goes over $180,000. Lower tax
rates, increase the households disposable income, allowing
consumers to increase their spending. Social welfare payments
are a method the Federal Government uses to redistribute its
taxation revenue to low income earners via social welfare
payments.
Changes to taxation arrangements can affect income distribution
imperatively. For example, reductions in tax rates at the upper
end of income scale would make the tax system less progressive
and may create a less equality distribution of income. Similarly, if
the government were to increase the rates of Goods and Services
tax, this would make the tax system less progressive and would
result in lower0income earners paying a relatively higher
proportion of their incomes into ax, increasing income inequality.
Budgetary manipulations involving government spending can also
influence income distribution significantly. Reductions in
government expenditure on community services such as
education, health care and labour market programs for
unemployed people are all likely to have the e greatest impact on
lower income groups in the community, as they have to pay for
services that were previously free. Thus, government spending
cuts often increase income inequality because low income earners
tend to be more reliant on government services than higher
income earners.

REDISTRIBUTION OF INCOME
The Australian government also redistributes income in order to try and
improve the income inequality and create opportunities for socio economic
households. Australia has a progressive income taxation system that is the

force between most income redistribution. It follows the concept that the
more an individual earns, the higher the percentage of their income taxed.
The government continually seeks to tax those on high incomes to
redistribute their income to low income earners and achieve income equality.
Budgetary changes involving government spending on social security
systems can impact on the distribution of income. Social welfare payments
include, aged, disabled and single parents families. The social welfare
constitutes 35.2% of government expenditure in the 2016-17 budget as it
compensates for $158.61 billion. This significantly reduces the income
inequality as high income earners who earn $180, 000 and above, are taxed
at a rate of 45% for each dollar over $180, 000. On the other hand, low
income earners who earn $6001 to $37000 are taxed at a rate of 15% for
each dollar over $6000. The low income earners are taxed at a lower rate as
compared to high income earners, as their disposable income would reduce
if they were to be taxed more. According to the 2016-17 budget, the tax
bracket increased from $80,000 to $87,000 with a tax rate of 37% which is
said to benefit 25% of Australians that are currently working. Their tax
percentage is reduced due to the higher bracket increase, improving
inequality as more individuals are able to have extra earnings of up to $400,
improving the standard of living.
Income is furthermore distributed through transfer payments such as the
superannuation, low income earners that have incomes of up to $37,000
receive funds of up to $500 in their super account. The government also
receives their revenue through superannuation accounts by taxation.
Currently, the Government doubled the rate of tax on super contributions for
people earning over $250,000 from 15% to 30%. As a result, the government
is able to obtain more income from the top 4% of the wealthiest income
earners in Australia. The concessional contribution cap is reduced from
$30,000 to $25,000 for everyone. Hence, the Australian government can
spend and fund money in reducing inequality and creating prosperous
growth. The government is able to use their revenue to fund new programs
such as the youth job paths programs to provide job employment benefits for
young adolescents under 25 that are seeking work.

STABILISATION OF ECONOMY
The free market system produces severe fluctuations over a period of time in a cycle of peaks and
troughs associated with booms and recessions. Extreme high growth or boom will lead to higher
inflation given that the people have more income leading to more consumption increasing demand.
This can result in an overall decline in the standard of living, during 2008 was 5% (RBA statistics),
increases the price of goods and services for the current demand to meet supply placing pressure on
household consumption. The government intervenes in the economy by encouraging saving and
reducing consumption to lower inflation rates, achieving currently inflation rates of 1.3%, increasing
the standard of living.
In contrast, low or negative growth such as a recession can be described as a period where supply
exceeds demand. It is detrimental to an economy as it leads to fewer goods being demanded with
household consumption at a standstill. Leading to a decrease in growth as supply exceeds demand.
The government can intervene in the economy by giving tax cuts to people to encourage spending and
bring about an increase in demand to meet supply resulting in economic growth.
The government attempts to stabilize the economy by using policies. Through this the government can
stabilize growth, maintain full employment and achieve low inflation rates. The government can
counter the extremes of the economy through implementing fiscal policies. In addition, the Reserve
Bank of Australia continually monitors inflation to stabilize economic growth.

The federal government can use fiscal policy to stabilise economic activity, redistribute income and
reallocate resources In assessing the impact of the budget on the level of economic activity,
economists suggest that it is important to distinguish between the cyclical and structural components
of the budget outcome. The cyclical component of the budget outcome refer to that part of the budget
outcome that results from the influence of automatic stabilisers, such as progressive income tax and
unemployment benefits. The structural component of the budget outcome refers to that part of the
budget outcome that results from deliberate, discretionary government decisions. The Australian
government plays an important role in stabilising the economy and sustaining economic growth
through direct discretionary decisions. This can be determined by the budget outcome where the
government can change the economic activity by changing its own leakages and injections. Such
decision has helped Australia maintain a sustainable rate of economic growth of 3-4%. During a
downturn, the Australian government aims to stimulate Australias economic growth by adopting an
expansionary fiscal stance. This was shown during the GFC in 2008 when a budget deficit occurred in
order to stimulate economic activity and increase the level of aggregate demand within the economy.
The increase in aggregate demand leads to a decline in interest rates and induces household and
business sectors to increase consumption and investment expenditures, increasing business activity. A
deficit occurs when the planned government revenue is greater than planned government expenditure
The increase in aggregate demand is a result of consumers having more spending power to purchase
goods and services