Explain fiscal policy, the main types of taxation and government spending, the budget balance, and how fiscal policy is used to influence the economy.

What this dot point is asking

Fiscal policy is one of the government's two main tools for managing the economy, and CCEA examines it closely. You must explain what fiscal policy is, the main types of taxation (direct and indirect, and progressive versus regressive), the main areas of government spending, the budget balance (deficit and surplus), and how expansionary and contractionary fiscal policy is used to influence the economy. This is core Section 4 content and is often paired with monetary policy in evaluation questions.

What fiscal policy is

Fiscal policy is the use of government spending and taxation to influence the level of activity in the economy. By changing how much it taxes and spends, the government can raise or lower total demand, and so affect growth, unemployment and inflation. Fiscal policy is set by the government (in the UK, in the Budget), unlike monetary policy, which is run by the central bank.

Taxation

Taxes are the government's main source of revenue, and CCEA expects you to classify them.

A direct tax is a tax on income or wealth, paid directly by the person or firm it is charged on. Examples are income tax (on earnings), corporation tax (on company profits) and inheritance tax (on wealth passed on).

An indirect tax is a tax on spending, collected by the seller and passed on to the government, so it is paid indirectly when goods are bought. Examples are VAT and the duties on fuel, alcohol and tobacco.

Taxes can also be described by how they fall on different incomes. A progressive tax takes a higher percentage from higher incomes (income tax with rising rates). A regressive tax takes a higher percentage from lower incomes (indirect taxes hit the poor harder, because they spend a larger share of their income).

Government spending and the budget balance

The government spends on public services and transfers: health, education, defence, infrastructure (roads, railways) and welfare benefits such as pensions and unemployment benefit. This spending provides services the market may under-supply and supports demand and incomes.

The budget balance compares spending with revenue. A budget deficit occurs when the government spends more than it raises in tax, so it must borrow, adding to the national debt. A budget surplus occurs when revenue is greater than spending, which can be used to repay debt. A balanced budget is when the two are equal.

Using fiscal policy to influence the economy

The government changes taxes and spending depending on the state of the economy.

Expansionary fiscal policy means cutting taxes and/or raising government spending. This puts more money into the economy, raising total demand, so firms sell more, expand output and take on workers. It is used in a recession to fight cyclical unemployment and lift growth. The risks are a larger budget deficit and, if the economy is near capacity, demand-pull inflation.

Contractionary fiscal policy means raising taxes and/or cutting spending. This takes money out of the economy, lowering demand, which can control inflation and reduce a budget deficit, but it can also slow growth and raise unemployment.

Why this matters

Fiscal policy is one of the two main tools for hitting the macroeconomic objectives, and it is examined through definitions, calculations and extended evaluations, often alongside monetary policy. It connects directly to unemployment (expansionary policy creates jobs), inflation (contractionary policy cools demand) and market failure (taxes and spending correct it). Examiners reward candidates who classify taxes correctly, explain the budget balance, and evaluate a fiscal policy with both its benefits and its costs before reaching a judgement.