Fiscal policy and the government budget, the use of taxation and government spending to influence AD and AS, the budget balance and national debt, and the limitations of fiscal policy.

What this dot point is asking

AQA wants you to explain fiscal policy and the government budget, how taxation and spending influence aggregate demand and supply, the budget balance and national debt, and the limitations of fiscal policy. The deficit-versus-debt distinction and the AD-AS chain are tested often.

Fiscal policy and the budget

Taxes are direct (on income and profits, such as income tax and corporation tax) or indirect (on spending, such as VAT and excise duties), and can be progressive (the average rate rises with income, like income tax), proportional (a flat rate), or regressive (taking a larger share of low incomes, like VAT). The choice of tax affects both AD and the distribution of income.

Influencing AD and AS

The multiplier means a change in government spending has a larger final effect on national income, because the initial spending becomes income that is partly re-spent. The size of the effect on output versus prices depends on the slope of AS and the output gap.

The budget balance and national debt

Automatic stabilisers smooth the cycle without active decisions: in a boom, tax revenue rises and benefit spending falls, dampening AD; in a slump, the reverse cushions the fall. This means a deficit can widen in a recession even with no policy change, a cyclical deficit, as opposed to the structural deficit that remains at full employment.

Limitations

Fiscal policy faces several limits: time lags (recognition, decision and implementation, so policy may act too late), crowding out (government borrowing raising interest rates and reducing private investment, though this is weak in a recession), imperfect information about the size of the output gap and the multiplier, the risk of rising national debt and interest costs, and possible conflicts with other objectives such as the current account.