Fiscal Policy

Fiscal policy
● Federal Government budgets and budget outcomes
● effects of budgetary changes on resource use, income distribution and economic ac-
tivity
● methods of financing deficits
● use of a surplus

Past HSC questions

Fiscal Policy
● Fiscal Policy is the manipulation of government spending and taxation in the budget to
achieve economic objectives.
● By varying spending and revenue the government can alter AD which influences eco-
nomic growth, internal balance and external balance.
● This occurs through the annual budget in May stating the planned revenue and expendi-
ture.
● Minor changes are often released as part of the Mid-Year Economic and Fiscal Outlook
statement in December. This also includes revised forecasts for the economy and the bud-
get.
Budget Outcomes

● Budget Outcomes can either be:

○ Fiscal Surplus- When tax revenue exceeds government expenditure. This is a con-
tractionary policy to slow AD.
○ Fiscal Deficit- When government expenditure exceeds tax revenue. This is an ex-
pansionary policy to increase AD.
○ Fiscal Balance- Where government expenditure is equal to tax revenue. This will
neither increase or decrease aggregate demand.

● The government’s main aim is to achieve fiscal balance, on average over the course of the
economic cycle.
● Two types of change occur in expenditure and tax:
● Non-Discretionary Changes occur where economic conditions change leading to
an increase/decrease in spending and tax.
● E.g. declining AD results in increasing unemployment benefits and gov-
ernment expenditure as well as decreasing income tax
 ● E.g. increasing AD results in decreasing unemployment benefits and gov-
ernment expenditure as well as increasing income tax
● These are referred to as automatic stabilisers are counter-cyclical; slowing
growth during booms and increasing growth during contractions
● Discretionary Changes are deliberate changes in fiscal policy. For example delib-
erate choices to increase/decrease spending on education or changes to income tax
brackets
● Two main types of automatic stabilisers exist:
● Unemployment Benefits-
● During boom periods, unemployment decreases leading to declining ex-
penditure on unemployment benefits. This decreases government expendi-
ture and AD.
● During contractions, unemployment increases leading to increasing spend-
ing on unemployment benefits. This increases government expenditure and
AD.
● The progressive tax system-
● During boom periods, income increases leading to taxpayers increasing tax
brackets. This lowers income leading to declining income, consumption
and AD.
● During contractions, income falls leading to taxpayers decreasing tax. This
increases income, consumption and AD.
● Automatic stabilisers are rarely used on their own. They are not powerful enough to
counter the effects of the economic cycle, they merely reduce the severity of the problem.
The government will still largely rely on discretionary policy.

Impacts of Fiscal Policy

The Impact on Resource Use

● Government policy can influence where resources are allocated either directly or indi-
rectly.
● Direct Policy involves allocating funds to the construction of infrastructure and
provision of services. Examples include:
● The Education Revolution invested $5.9b into Education.
● The National Broadband Network investing $43b
● The Gonski Plan for Education funding which invested $18.6b
● Indirect policy involves the government changing tax policy causing an indirect
impact on the allocation of resources. Examples include:
● The Minerals Resource Rent Tax and the Carbon Pricing Mechanism
(Carbon Tax) distribute the benefits of the Mining boom to the rest of the
economy.
● Governments often use direct measures where they believe that markets will not provide
sufficient quantity quickly enough for the benefit of citizens.
● This may occur in emergency relief situations (ie. post bushfires).
● Similarly the Government may step in to provide public goods
● The government may also choose to impose taxation in order to discourage the consump-
tion of certain products. i.e. the AlcoPops tax which raises the cost of Alcoholic bever-
 ages (like Smirnoff Ice, Bacardi Breezers) that are often consumed by younger demo-
graphics.

The Impact on Income Distribution

● Fiscal policy is used to redistribute income resulting in a more equitable distribution of

income.
● It does this through the progressive tax system and transfer payments
● The progressive tax system means that as incomes rise marginal tax rates increase.
This means as incomes rise so does the proportion of tax paid. Adjustments are
made to the progressive tax rates to avoid bracket creep.
● Spending on transfer payments transfer money to low income earners and disad-
vantaged groups.
● A number of other policies are used to redistribute income including:
● The Henry Tax review aimed to make the tax system fairer, simpler and more effi-
cient through
● A tax on the super profits of mining companies through the Minerals Re-
source Rent Tax. This tax is redistributed to low income earners
A number of transfer payment policies are used to redistribute income including:
● A 3.7bn aged care package (Living Longer, Living Better) to improve the effi-
ciency of aged care system
● The National Disability Insurance Scheme with expenditure over $22bn per year

The Impact on Economic Activity

● Fiscal Policy has a significant impact on economic activity:
● Expansionary Fiscal policy is used to increase economic activity and AD.
● Decreasing tax revenue results in increases in income, consumption and
AD.
● Increasing government expenditure results in increased AD and increased
economic activity
● This was seen in the government’s response to the GFC. With expansion-
ary policy implemented through the Stimulus Package and, the Education
Revolution (BER) program
● Contractionary Fiscal policy is used to decrease economic activity and AD.
● Increasing tax revenue results in decreased income, consumption and AD.
● Decreasing government expenditure results in decreased AD and de-
creased economic activity
● Neutral Fiscal policy is one in which the difference between revenue and expen-
diture remains steady from the last budget.
● Between 1996 and 2007 under the Howard Government the stance was largely contrac-
tionary. Although exceptions included:
● The 2000-01 budget which introduced The New Tax System which introduced the
GST but cut income tax and increased welfare to compensate for the impact of the
GST
● The 2001-02 budget which increased spending to compensate for the slowdown in
global economic growth
● The GFC (2008-09) lead to a dramatic change in the fiscal stance from contractionary
policy to expansionary policy through:
● A decrease in tax revenue from non-discretionary policy as tax revenue fell as in-
come fell.
● An increase in government expenditure as Rudd used discretionary policy to in-
crease AD through the stimulus package measures which included:
● These measures where estimated to boost Australia’s real GDP by 2.75% in 2009-
10 and 1.5% in 2010-11.
● The Abbott, Turnbull and Morrison government’s have focused on trying to return the
budget to surplus through tightening fiscal policy by returning to contractionary policy.
● The Abbott government in 2013 implemented a budget repair strategy cutting
spending and increasing tax aimed at running a budget surplus by 2017-18. The
treasury estimated this would slow growth by between 0.3% and 0.5%
● The 2019-20 budget estimated a small surplus of $7.1b despite slow growth.

Methods of Financing a Deficit

● When a government runs a budget deficit it has to finance the deficit from one or more
sources. These sources include:
● Borrowing from the private sector
● Borrowing from overseas investors
● Borrowing from the Reserve Bank.

Borrowing from the private sector

● Borrowing from the private sector is the main form of deficit financing.
○ This occurs through the sale of Treasury Bonds domestically. The tender process
involves the government setting a value of bonds it wants to sell (i.e. the size of
the deficit) and then purchasers tender to buy a certain amount at a particular rate
of interest. The government accepts the tenders from the lowest to the highest rate
of interest until all the bonds are sold
● The main advantage of this is that it does not impact the Australia’s NFD and CAD, as no
overseas borrowing occurs.
● The most significant disadvantage of this system is the Crowding-Out Effect. This oc-
curs where the deficit is financed through borrowing from the private sector. Banks and
other institutions will lend to the government first due to their lower risk. There is as such
a shortage of borrowable funds and upward pressure on interest rates. This ‘crowds out’
private sector investors and forces them to borrow from overseas worsening the NPI and
CAD.
● This may also lead to an appreciation as higher interest rates lead to a greater investment
into Australia increasing the demand for the AUD causing an appreciation.

Borrowing from Overseas

● Governments may choose to borrow from overseas to minimise the crowding out effect,
whilst stimulating growth.
● The advantage of this is that it doesn’t impact the interest rates charged in Australia.
● The disadvantage of this is that it causes an appreciation of the AUD as well as a worsen-
ing of the NPI and CAD.
● The government can avoid an appreciation by buying foreign currency to balance out the
increased demand for AUD caused by overseas lending to Australia.

Borrowing from the RBA

● The Government may simply borrow from the RBA to finance the deficit. This is referred
to as monetary financing the deficit.
● In this case the RBA simply prints more money to finance the debt. There are significant
issues with this and achieving the outcome of keeping inflation within its target of 2-3%
● For this reason the government has not borrowed since 1982 from the RBA.
● This has meant there is no longer any connection between the implementation of mone-
tary policy and fiscal policy. Although often the settings of both policies are often inter-
twined.
● The advantage is this is there no change in interest rates. The disadvantage of this is that
it increases money supply causing inflation.
●
Methods of using Budget Surpluses

● When the government budgets for a surplus, it can use the surplus in three ways:
● Using it to pay off debt accumulated overseas. This reduces NPI and CAD.
● Using it to pay off public sector debt. This was the option of choice for the
Howard Government from 1996 to 2005-06 until all public sector debt was re-
tired. And also use it for domestic investment
● Placing the money in a specially established, government-owned investment fund
(like the Future Fund). This was done in the 2007-2008 budget by Howard and
Rudd again in 2007-08 with the Education Endowment Fund and Building Aus-
tralia Fund. This ended as a result of the GFC.

Recent Trends in Fiscal Policy

● Australia’s medium term fiscal strategy is focused on achieving four main objectives:
○ Investing in the economy by increasing infrastructure spending
○ Maintain fiscal discipline so resources can be used by the private sector to drive
‘jobs and growth’
○ Supporting tax growth by encouraging ‘jobs and growth’
○ Improving the governments’ net financial position over the medium term
● Australia’s long term fiscal strategy is shaped by a series of intergenerational reports
which identified issues which identified the implications of an ageing population and rec-
ommended the development of a future fund
○ The First Intergenerational Report (2002) assessed the impact of an ageing popu-
lation on government policy. It found Australia was well placed to deal with fu-
ture challenges through compulsory superannuation, a targeted and means tested
welfare system, broad based tax system and low levels of government debt. How-
ever there needed to be advances in health care and medical research.
 ○ The Second Intergenerational Report (2007) found the long term fiscal sustain-
ability has improved since the first report but the ageing population still remained
a threat.
○ The Third Intergenerational report (2010) suggested that there was increased
pressure as a result of climate change and argued for an emissions trading scheme
to manage carbon emissions.
○ The Future Fund was established in 2005-06 to save for the government's future
public sector superannuation liabilities to reduce the future strain on government
budgets. The future fund were estimated at $148bn.
● Insert 2020-21 budget here

ANSWERS
Q3 2016 C

Q9 2016 B
Q11 2016 C
Q8 2015 A
Q3 2014 D
Q9 2014 D
Q6 2013 C
Q8 2012 D
Q12 2011 B
Q19 2011 B