Fiscal Policy (Edexcel IGCSE Economics)

An Introduction to Fiscal Policy

• Fiscal Policy involves the use of government spending and taxation (revenue) to influence economic growth

  • The government is responsible for setting fiscal policy

  • The UK Government present their fiscal policies to the country each year when it delivers the Government budget

• Fiscal policy is used to help the government achieve their macroeconomic objectives

• Specifically, the use of fiscal policy aims to:

  • Stabilise rates of economic growth

  • Maintain a low and stable rate of inflation

  • Maintain low unemployment

  • Stable current account balance payments

  • Redistribute income so as to ensure more equity

  • Achieve environmental protection

• When a policy decision is made, it creates a ripple effect through the economy, impacting the macroeconomic objectives of the government

Sources of Government Revenue

• The main source of government revenue is taxation

• Taxes broadly fall into one of two categories

  • Direct and indirect tax

Direct and Indirect Tax

•  Direct taxes are taxes imposed on income and profits

  • They are paid directly to the government by the individual or firm

    • E.g. Income tax, corporation tax, capital gains tax, national insurance contributions, inheritance tax

• Indirect taxes are imposed on goods and services

  • The supplier is responsible for sending the payment to the government

  • The less a consumer spends, the less indirect tax they pay

  • Examples of indirect taxes include Value Added Tax (France had a 20% VAT rate in 2024), taxes on demerit goods, excise duties on fuel, etc.

Graph: UK Government Revenue 2022/23

Sources of government revenue
Source: Gov.uk

Graph analysis

• In 2022/23, the UK's public sector’s income totalled £1,058 billion

• The main contribution to government revenue was from taxation

  • Income tax amounted to £250bn

  • National insurance contributions (NICs) reached £179bn

  • Value added tax (VAT) generated £162bn

• These three taxes raised around £591 billion in 2022/23

• Other significant contributions include corporation tax, capital taxes and council taxes

Why Governments Levy Taxes

• Taxes are needed to fund government expenditure 

• Taxes can be used to discourage consumption of demerit goods by increasing price

  • Excise taxes (on alcohol, cigarettes) can be used to reduce the consumption of demerit goods that create negative externalities 

  • Tariffs (taxes on imports) can reduce the volume of imported goods 

• Taxes should aid the redistribution of income

  • A good tax system raises revenue from high income households that can be redistributed in the form of welfare to low income households

  • Revenue could also be used to provide public sector services 

    • Eg. To fund law and order systems or transport systems

    • Public sector health care and education promote more opportunities for lower income earners

Government Expenditure

• Government expenditure can be broken down into three categories:

  • Current expenditure

    • This includes the day-to-day spending required to run the government and public sector

    • E.g. The wages and salaries of public employees such as teachers, police, members of parliament, military personnel, judges, dentists, etc

    • It also includes payments for goods and services such as medicines for government hospitals

  • Capital expenditure

    • This is spending on infrastructure and capital equipment

    • E.g. High speed rail projects; new hospitals and schools; new aircraft carriers

  • Transfer payments

    • These are payments made by the government for which no goods/services are exchanged

    • E.g. Unemployment benefits, disability payments, subsidies to producers and consumers, etc.

Graph: UK Expenditure 2022/23

Total UK government expenditure 2022/23, £1155 billion
Source: Institute for fiscal studies

Graph analysis

• The majority of UK government spending is spent on running the public sector

  • Health: Represents 18% of government spending, covering expenses such as the day-to-day wages of healthcare staff and running hospitals and doctor surgeries

  • Social security: Accounts for 22% of spending and includes various benefits such as state pensions, universal credit, disability benefits, etc

  • Education: Makes up 9% of government spending, covering costs like teacher salaries and school buildings

• These three sectors combined (health, social security, and education) represent over half of the UK government's spending in 2022/23