Cambridge IGCSE Economics 0455
Syllabus points
- Define fiscal policy, government spending and taxation.
- Distinguish direct from indirect taxes and progressive from regressive taxes.
- Explain how fiscal policy affects the government's aims.
What is fiscal policy?
Fiscal policy is the government's use of spending and taxation to influence the economy. It affects the level of demand, output, jobs and prices.
- Expansionary fiscal policy — higher spending and/or lower taxes to boost demand (fights unemployment and slow growth).
- Contractionary fiscal policy — lower spending and/or higher taxes to reduce demand (fights inflation).
Key definitions
| Term | Definition |
|---|---|
| Fiscal policy | Using government spending and taxation to influence the economy. |
| Direct tax | A tax on income or wealth (e.g. income tax). |
| Indirect tax | A tax on spending (e.g. VAT/sales tax). |
| Progressive tax | Takes a higher percentage of income as income rises. |
| Regressive tax | Takes a higher percentage of income from the poor than the rich. |
Types of tax
- Direct taxes are paid directly to the government on income, profits or wealth (income tax, corporation tax).
- Indirect taxes are added to the price of goods and services (sales tax/VAT, duties on fuel and tobacco).
- A progressive tax (like income tax) takes a larger share from higher earners, reducing inequality. A regressive tax (like a flat sales tax) hits the poor harder as a share of income.
Effects on the aims
- Higher spending or lower taxes → more demand → more growth and jobs, but possibly more inflation.
- Higher taxes or lower spending → less demand → lower inflation, but possibly slower growth.
Expansionary fiscal policy fights unemployment; contractionary fiscal policy fights inflation.
Worked example
In a recession, a government cuts income tax and raises spending on infrastructure. Households have more to spend and construction firms hire workers, so demand and employment rise. The risk is a larger budget deficit (spending exceeding tax revenue) and, if the economy is near capacity, higher inflation.
Common exam mistakes
- Confusing fiscal policy (spending and tax) with monetary policy (interest rates).
- Mixing up direct (income) and indirect (spending) taxes.
- Confusing progressive and regressive taxes.
Exam technique
State whether the policy is expansionary or contractionary, trace its effect on demand and the aims, then evaluate side effects (budget deficit, inflation).
Quick revision
- Fiscal policy = government spending + taxation.
- Expansionary → growth/jobs; contractionary → lower inflation.
- Direct (income) vs indirect (spending); progressive vs regressive.