Fiscal Policy Tools

Government Spending

Transfer payments are welfare payments made through the social security system (e.g. payments for state pensions, housing benefits, tax credits and income support for poorer families, child benefits, unemployment benefits, and job search allowances). Income for low-income households, change the overall income distribution.

Not included in GDP.

Current government spending involves spending on goods and services that are provided on a regular, recurring basis—including health, education, and defense.

Big impact on a country’s skill level and overall labor productivity.

Capital expenditure includes infrastructure spending on roads, hospitals, prisons, and schools.

Add to a nation’s capital stock and affect productive potential for an economy.

Government Revenue

Direct taxes are levied on income, wealth, and corporate profits and include capital gains taxes, national insurance (or labor) taxes, corporate taxes, local income or property tax for both individuals and businesses, inheritance tax.

Indirect taxes are taxes on spending on a variety of goods and services in an economy—such as the excise duties on fuel, alcohol, and tobacco as well as sales (or value-added tax).

Four desirable attributes of a tax policy:

Simplicity: Ease of compliance by the taxpayer and enforcement by the revenue authorities.

Efficiency: Taxation should interfere as little as possible in the choices individuals make in the market place.

Fairness: People in similar situations should pay the same taxes (“horizontal equity”) and that richer people should pay more taxes (“vertical equity”).

Revenue sufficiency: There may be a conflict with fairness and efficiency. Increasing income tax rates to reduce fiscal deficits reduces labor effort. Tax rate increases are thus an inefficient policy tool.