that governments set for each aim.

4.2.2 possible conflicts between macroeconomic Possible conflicts between aims: full employment
aims versus stable prices; economic growth versus balance
IGCSE ECONOMICS Page 1 of 8
of payments stability; and full employment versus
GOVERNMENT AND THE MACROECONOMYbalance of payments stability.

4.3 Fiscal policy

6
Topic Guidance
4.3.1 definition of the government budget

Fiscal policy
4.3.2 reasons for government spending

4.3.3 reasons for taxation

The main areas of government spending and the
reasons for and effects of spending in these areas.
Taxation as the main source of government revenue
Cambridge IGCSE Economics 0455 syllabus for 2023, 2024 and 2025. Subject content
and the reasons for levying taxation.
4.3.4 classification of taxes Examples of the different classifications of tax;
progressive, regressive, proportional; and direct,
y the end of this chapter students should e a le to
indirect.
★ defi
4.3.5 ne the
principles udget
of taxation The qualities of a good tax.
4.3 Fiscal policy continued
★ explain the reasons
4.3.6 impact of taxation for government spending
The impact of taxation on consumers, producers,
Topic
★ explain the reasons for taxation government and economy as a whole.
Guidance
Continued
★ understand
4.3.7 the
definition of fiscal various classifications of taxes
policy
★ understand
4.3.8 the principles of taxation The tax and spending changes, in the form of fiscal
fiscal policy measures
★ examine the impact of taxation on various policy, that cause budget balance or imbalance.
stakeholders
Including calculations of the size of a budget deficit
★ define fiscal policy or surplus.
★ understand fi scal policy measures
4.3.9 effects of fiscal policy on government How fiscal policy measures may enable the
16 www.cambridgeinternational.org/igcse Back to contents page
★ discuss the effects
macroeconomic aims of fiscal policy on macroeconomic aims.
government to achieve its macroeconomic aims.
Note: aggregate demand and aggregate supply are
not required.
The government budget
4.4 government
The Monetary policybudget refers to the government’s financial plans in terms of

dget
planned revenues and
Topicgovernment
The expenditure.
budget refers toThere are other sources
Guidance
the government’s of government
nancial revenue
plans in terms of
al (such
planned as government
revenues
4.4.1 definition and
of money borrowing
expenditure.
supply or
and monetaryprivatisation proceeds from the selling of state
anned assets) but tax revenues are by far the most significant source.
policy
x 4.4.2 monetary policy measures Changes in interest rates, money supply and foreign
nditure Tax revenues exchange rates. Government spending
, Incomeeffects
4.4.3 tax of monetary policy on government How monetary policy measures Communications
may enable the
are Corporation tax
macroeconomic aims Debt interest aims.
government to achieve its macroeconomic
Inheritance tax Defence
Sales tax Education
Import taxes Environment
4.5 Supply-side policy Healthcare
Non-tax revenues
Housing
Topic
Fines, tolls, fees and penalties Guidance
Law and order
Foreign aid
4.5.1 definition Postal services
Loans from banks of supply-side policy
Roads and motorways
4.5.2
Revenuesupply-side policy enterprises
from state-owned measures Possible supply-side policy measures include
Sewage systems
Donations education and training, labour Transport
market reforms, lower
direct taxes, deregulation, improving
Welfareincentives
benefits to
work and invest, and privatisation.
▲ Figure 26.1 Tax revenues and government spending
4.5.3 effects of supply-side policy measures on How supply-side policy measures may enable the
government macroeconomic aims government to achieve its macroeconomic aims.
If the government manages to balance its revenues and its spending, then a
balanced budget is said to exist. However, if the government spends more than
it collects from its revenues then a budget deficit exists. Finally, if there is more
government revenue than is spent, the government has a budget surplus.
In the long run, governments strive to balance their budgets. This is partly
because increasing government revenues by raising taxes is highly unpopular,
while government borrowing to fund a budget deficit is hugely expensive due to
fi
 tax — a type of indirect tax.
a Define the term indirect tax. [2
b Analyse the advantages
IGCSE ECONOMICS
and disadvantages for countriesPage
that 2do
of not
8
impose
• If the government sales to
manages taxes.
balance its revenues and its spending, then a [6
balanced budget is said to exist.
• Activity
If the government spends more than it collects from its revenues then a budget
de cit exists. Copy the table below. Place a tick in the correct section of the table to identify whether
the tax is direct or indirect. The first one has been completed as an example.
• If there is more government revenue than is spent, the government has a
budget surplus.Tax Direct Indirect
Airport tax
Capital gains tax
To discuss: What are the tax
Carbon reasons for taxation?
Corporation tax
Customs duties
Classi cation of taxes
Excise duties
Direct and indirect
Income tax
• Direct taxation — this type of tax is paid from the income, wealth or pro t of
Inheritance tax
individuals and rms.
Stamp duty
Examples: ________________________________________________________________
Tariffs
__________________________________________________________________________
VAT or GST
• Indirect taxation — these
Windfall tax are expenditure taxes imposed on spending on
goods and services.

Progressive, regressive and proportional taxation

Examples: ________________________________________________________________
Taxes can also be classified according to whether they are progressive, regressive
__________________________________________________________________________
or proportional.
Progressive taxation
Progressive, regressive and proportional taxation
Under this tax system, those with a higher ability to pay are charged a higher
• Under progressiverate of taxation, those that
tax. This means withasa the
higher ability
income, to pay
wealth are tcharged
or profi a
of the taxpayer rises
Study tip higher rate of tax.
a higher rate of tax is imposed (see Figure 26.2). Examples of progressive taxes
It is incorrect to define a are income tax, capital gains tax and stamp duty (see Table 26.1).
progressive tax system as
one in which the rich pay
more tax than the poor.
This would be the case even
T2 As the level of income
Tax rate (%)

if there were a flat-rate increases from Y1 to Y2,

income tax, for example — the rate of tax rises from
the amount paid by a higher T1 to T2
T1
income earner would be
greater than the amount
paid by a low income
earner. What is important O Y1 Y2
is the rate (percentage) of Income level
tax paid.
▲ Figure 26.2 Progressive taxes
18

CSE_Economics_2e_Sec-04.indd 181
fi
fi
fi
fi
 lower rate of tax — in other words, the wealthier the ind
paid as a percentage of the income level (see Figure 26.3
a high income earner pays the same amount of airport ta
fee as a less wealthy person, the Page
IGCSE ECONOMICS amount of 8tax paid is a
3 of
OLICY wealthier person’s income.
• Under regressive taxation, those
with a higher ability to pay are
actually
The taxcharged
burden arefers
lowerto
rate
theofamount
tax. of tax that households and firms have
With a specific amount
to pay. This can be measured in three ways.
T1
For a country, the tax burden
of tax paid,ishigh-income

Tax rate (%)

earners (those at Y2) pay
measured by calculating total tax revenues as a proportion of gross domestic
a smaller proportion of tax
product (GDP). For individuals and firms, the tax burden can be measured
(T by
2) than low-income
T2 earners (those on Y1 who
the absolute value of tax paid or by the amount of tax paid as a proportion
pay T1)
of their income or profits.
O Y1 Y2
• UnderActivity
proportional taxation, the Income level
percentage paid stays the same, ▲ Figure 26.3 Regressive taxes Irrespective of the
At the end of 2012, economists described the situation faced by the US government income level (Y1 or Y2),
irrespective of the taxpayer’s level

Tax rate (%)

as a ‘fiscal cliff’. Investigate what this means and its potential impact on the economy
the same rate of tax is
of in
income, wealth or pro ts. 20 charged, such as the
the short run and the long run. Be prepared to show your investigation to others in
Proportional taxation 20% VAT in Austria,
the class. Morocco, Senegal and
Under this tax system, the percentage
sam paid stays the
the UK
taxpayer’s level of income, wealth or profits (see Figure 2
a sales tax, such as VAT or GST. For example, Denmark ha
Classification of taxes O
whereas sales taxes
Y1 in India
Y2 and Japan are as low as 5 pe
Income level
Some of the main taxes are explained in▲Table
Figure26.1.
26.4 Proportional taxes

Table 26.1 Examples of taxes

Activities
Tax Definition
1 Study the data below and answer the questions that follow.
Income tax A direct tax levied on personal incomes — wages, interest, rent and
Income
dividends. In most countries, this ($ per
is the year)
main source of tax revenues Tax paid per year (
Corporation tax A direct tax on the profits of businesses Tax A Tax B
10,000 1000 1000
Sales tax An
182 indirect tax, such as VAT, charged on an individual’s spending
15,000 1000 1800
Excise duties Indirect inland taxes imposed on certain goods and services such as
20,000 1000 3000
alcohol, tobacco, petrol, soft drinks and gambling
25,000 1000 4500
Customs duties Indirect cross-border taxes on foreign imports
421271_IGCSE_Economics_2e_Sec-04.indd 182
a Identify the tax (A, B or C) that is progressive.
Capital gains tax A direct tax on the earnings made from investments such as buying shares
b Identify the tax (A, B or C) that is proportional.
and private property c Explain the difference between a regressive and a proporti
Inheritance tax A direct tax on the transfer2 ofStudy the and
income threewealth
tax systems below.
such as Calculate
property when the percentage
passed on to another person of income in order to determine whether the tax systems are
or proportional.
Stamp duty A progressive tax paid on the sale of commercial or residential property
Tax system A Tax system B
Carbon tax A tax imposed on vehicle manufacturers or firms that produce excessive
carbon emissions Annual Amount of Annual Amount of Annu
income ($) tax paid ($) income ($) tax paid ($) incom
Windfall tax A tax charged on individuals and firms that gain
4,500 900
an unexpected
10,000
one-off
1,500 8,00
amount of money, such as a person winning the lottery or a firm gaining
10,000 1,800 20,000 3,000 20,00
from a takeover bid
20,000 2,800 30,000 4,500 45,00

There are various classifications of taxes, as explained below.

Direct and indirect taxation

Taxes can be classified into direct and indirect taxation:
Principles of taxation
The phrase ‘principles of taxation’ refers to the qualities of
» Direct taxation — this type of tax is paid from the income, wealth or profit of
» Equitable (fair) — taxes should be based on the taxpa
individuals and firms. Examples are taxes on salaries,
principle is usedinheritance and company
to justify progressive taxation, since th
profits. ability to pay than the poor do.
fi
 O Y1 Y2
Income level

▲ Figure 26.4 Proportional taxes IGCSE ECONOMICS Page 4 of 8

Exercises:
Activities
1 Study the data below and answer the questions that follow.

Income ($ per year) Tax paid per year ($)

Tax A Tax B Tax C
10,000 1000 1000 1000
15,000 1000 1800 1500
20,000 1000 3000 2000
25,000 1000 4500 2500

a Identify the tax (A, B or C) that is progressive.

b Identify the tax (A, B or C) that is proportional.
c Explain the difference between a regressive and a proportional tax.
2 Study the three tax systems below. Calculate the percentage of tax paid on each level
of income in order to determine whether the tax systems are progressive, regressive
or proportional.

Tax system A Tax system B Tax system C

Annual Amount of Annual Amount of Annual Amount of
income ($) tax paid ($) income ($) tax paid ($) income ($) tax paid ($)
4,500 900 10,000 1,500 8,000 800
10,000 1,800 20,000 3,000 20,000 3,000
20,000 2,800 30,000 4,500 45,000 11,250

Principles of taxation
The phrase ‘principles of taxation’ refers to the qualities of a good tax:
» Equitable (fair) — taxes should be based on the taxpayer’s ability to pay. This
principle is used to justify progressive taxation, since the rich have a greater
ability to pay than the poor do.
» Economical — the tax should be easy and cheap to collect in order to
maximise the yield relative to the cost of collection.

183

c-04.indd 183 24/01/18 11:18 AM

 IGCSE ECONOMICS Page 5 of 8
Principles of taxation
- Equitable / fair
__________________________________________________________________________
__________________________________________________________________________
- Economical (for the government)
__________________________________________________________________________
__________________________________________________________________________
- Convenience
__________________________________________________________________________
__________________________________________________________________________
- Certainty
__________________________________________________________________________
__________________________________________________________________________
- E ciency
__________________________________________________________________________
__________________________________________________________________________
- Flexibility
__________________________________________________________________________
__________________________________________________________________________
ffi
 IGCSE ECONOMICS Page 6 of 8
Impact of taxation
- On price and quantity

- On economic growth

- On in ation

- On business location

- On social behaviour

- On government

- On the distribution of wealth

- On tax avoidance and tax evasion

Tax avoidance is the legal act of minimising payment of taxes, such as by
avoiding spending on items with a large sales tax.
Tax evasion is the illegal act of not paying the correct amount of tax, perhaps due
to a rm under-declaring its corporate pro ts.
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 IGCSE ECONOMICS Page 7 of 8
Fiscal policy
Fiscal policy is the use of taxation and government expenditure strategies to
in uence the level of economic activity and achieve macroeconomic aims such as
high employment, economic growth and the control of in ation. Fiscal policy is
also used to redistribute income and wealth in the economy.

Fiscal policy can be used either to expand or to contract economic activity in

order to achieve macroeconomic objectives and promote economic stability:
• Expansionary scal policy is used to stimulate the economy, by increasing
government spending and/or lowering taxes.
• Contractionary scal policy is used to reduce the level of economic activity by
decreasing government spending and/or raising taxes.

Some limitations:
• Political pressure
• Time lags
Some advantages:
• Direct and indirect impact of government spending
• Targeting speci c economic sectors
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 IGCSE ECONOMICS Page 8 of 8
E ects of scal policy on government macroeconomic aims
• Economic growth

• Low in ation (stable prices)

• Employment (low unemployment)

• Healthy balance of payments

• Redistribution of income
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