RI H1 Economics Lecture Notes 7 Fiscal Policy

2019 Y6 H1 Economics Macroeconomics 44 RAFFLES INSTITUTION YEAR 6 H1 ECONOMICS 2019 1 Introduction 2 Fiscal Policy 2.1 Objectives 2.2 Rationale for Intervention 2.3 Fiscal Policy Tool – The Government Budget 2.3.1 Sources of Government Revenue 2.3.2 Government (Public Sector) Expenditure 2.4 Types of Fiscal Policy 2.4.1 Non-Discretionary Fiscal Policy (Automatic Stabilisers) 2.4.2 Discretionary Fiscal Policy 3 Effects of Discretionary Fiscal Policy on the Economy 3.1 Using Expansionary Fiscal Policy to Boost Growth and Lower Unemployment 3.1.1 How the Policy Works? 3.1.2 Factors Limiting the Effectiveness of Expansionary Fiscal Policy 3.2 Using Contractionary Fiscal Policy to Reduce Demand-Pull Inflation 3.2.1 How the Policy Works? 3.2.2 Factors Limiting the Effectiveness of Contractionary Fiscal Policy 4 Fiscal Policy in Singapore Appendices: Appendix 1: Goods and Services (GST) in Singapore Appendix 2: Economic Effects of Different Types of Taxation and Expenditure References: 1 Case, K. E. & Fair, R. C, Principal of Economics, Prentice Hall 2 Miller, R., Economics Today, 18th Edition, Addison-Wesley 3 Sloman, J., Economics, 8th Edition, Pearson 4 http://www.singaporebudget.gov.sg Lecture Objectives: After the series of lectures, students should be able to: - Distinguish between automatic stabilisers and discretionary fiscal policy. - Analyse the impact of discretionary fiscal policy on the macroeconomic aims of an economy using AD/AS analysis. - Explain the intended and unintended consequences of government policy decisions on the other economic agents (consumers and producers). - Explain the factors limiting the effectiveness of fiscal policy. - Demonstrate a good understanding of recent economic trends and developments, particularly the Singapore economy. MACROECONOMIC POLICIES FISCAL POLICY @dream

2019 Y6 H1 Economics Macroeconomics 45 1 INTRODUCTION The government can use different policy tools to influence the level of economic activity. They are either used to increase the rate of economic growth and reduce unemployment or lower the inflation rate. Such policies work to affect the aggregate demand or aggregate supply of goods and services. Fiscal and Monetary Policies affect aggregate demand and are known as demand-management policies. Conversely, supply-side policies affect the aggregate supply. 2 FISCAL POLICY 2.1 Objectives Fiscal policy is the deliberate management of government spending and taxation designed to influence the level of economic activity in order to achieve the economic goals of the government, such as: i. Macroeconomic goals i. to smooth out the ever-present fluctuations in economic activity ii. to promote economic growth iii. to push the economy closer to full employment iv. to maintain price stability ii. Microeconomic goals i. To achieve a more efficient allocation of resources ii. To achieve a more equitable distribution of income 2.2 Rationale for Intervention Decisions by the private sector are made mainly based on self-interest. Thus changes in consumption spending by households and investment expenditure by firms can cause the economy to land in an equilibrium state that is not desirable. While weak private sector spending results in cyclical unemployment, excessive spending can lead to demand-pull inflation. Therefore, government action is necessary to reduce the harmful impact of unemployment and inflation. 2.3 Fiscal Policy Tool – The Budget The Budget is an estimate of government expenditure and revenue for the coming Financial Year. It is a careful planning of the government expenditure to be spent and forecasts of tax and other revenue received in the coming year. Budget planning is necessary to facilitate raising of necessary revenue to cover spending programs. A government can deliberately plan for a budget deficit or surplus. This is known as discretionary fiscal policy, and the fiscal stance can be either an expansionary or contractionary fiscal policy. In Singapore, the National Budget is an annual statement of government accounts spelling out the estimated expenditure and revenue for the forthcoming financial year; it is from 1st April of the current year to 31st March of the following year. The Budget is debated before it is passed by Parliament. Balanced budget: Government revenue (T) = Government expenditure (G) Budget surplus: Government revenue (T) > Government expenditure (G) Budget deficit: Government revenue (T) < Government expenditure (G) @dream

2019 Y6 H1 Economics Macroeconomics 46 2.3.1 Sources of Government Revenue Government revenue comes from: 1) Sale of Goods and Services, including: • State Enterprises - fees from postal, telecommunications and public utilities services, earnings from commercial and industrial undertaking, state trading. • Investments in securities by the Government Investment Corporation of Singapore (GIC). • License fees and fines e.g. marriage licence, hawker's licence, and littering fines. 2) Taxation Taxes are compulsory payments made by individuals or firms (i.e. the private sector) to the government without any services rendered in return. It is a transfer of funds from the private sector to the government. There are two main sources of government taxation revenue: a. Direct Taxes Personal income taxes and corporate income taxes are examples of direct taxes. These are taxes on income and wealth paid direct to the Tax Department (Inland Revenue Authority of Singapore). The burden of such taxes is borne by the person or company the tax is imposed on. The impact and incidence is usually on the same party and is not easily shifted to others. • Personal income taxes are imposed on all incomes derived from or remitted into the country. Most personal income taxes are progressive. This means the rate of tax increases as income increases i.e. progressive tax takes a larger proportion of income from the rich than from the poor (refer to Appendix 2). Therefore, a progressive tax system serves to improve equity. In Singapore, personal income tax rates ranges from 2% to 20% for the year of assessment 2012 till 2016. Personal income tax is capped at 20% for the highest income bracket till 2016, and is considered low compared to many developed countries. The objective of making income taxes less progressive is to prevent brain drain and attract foreign talent. However, with the concern about rising income inequality, personal income tax will increase in the year of assessment 2017. Currently, the income tax rate is at 22% for the highest income bracket. • Corporate income tax is tax on a company’s chargeable income i.e. the profits of the company. Over the years, corporate income taxes had been reduced from 20% to 18%, and it stands at 17% from 2010. The objectives of a lowered corporate tax are to encourage entrepreneurship and attract foreign direct investment. Currently, Singapore’s corporate tax rate is considered one of the lowest for developed economies. b. Indirect Taxes Indirect Taxes are taxes on expenditure or production of goods and services. They are called indirect taxes because although the producers are legally liable to pay the taxes to the government, the consumer is often made to share part of the burden in the form of higher prices for the goods and services. The impact and incidence may not be on the same person. The main indirect tax in Singapore is the Goods and Services Tax (GST). Singapore Budget 2018: @dream

2019 Y6 H1 Economics Macroeconomics 47 Some examples of indirect tax: • Value-added tax (VAT) is collected at different stages of production. In Singa