AQA A-level Economics: Fiscal policy: spending, taxation and the policy tools (7136) – Practice Questions

These are original questions written for Marlbridge, for revision and practice on this content. They are not reproduced past-paper questions, and they do not replicate the exam’s exact structure, question count or mark tariffs – examination boards hold copyright in their own papers. Use these alongside the official past papers from your board or school.

The questions below draw on the AQA AS and A-level Economics specification (version 1.3, 29 June 2022) sub-section Fiscal policy, numbered 3.2.5.1 on the AQA website (4.2.5.1 in the combined PDF). None of this content is labelled AS-only or A-level-only. All figures are invented. Start with the study guide and revision notes first. See also the AQA A-level Economics hub, the printable checklist and the free 10-minute diagnostics.

Questions

1. Distinguish between a direct tax and an indirect tax, giving one example of each. [4]

2. In Country C, the marginal propensity to save is 0.10, to pay tax 0.30 and to import 0.20.

(a) Calculate the multiplier and the change in national income if government spending rises by 9bn. [3] (b) Explain one reason why the actual change in real output might be smaller. [2]

3. In Country C, income tax has a tax-free allowance of 15,000, a rate of 12% on income from 15,000 to 35,000 and 32% on income above 35,000.

(a) Find the tax bill and the average rate for incomes of 30,000 and 80,000. [3] (b) State whether the tax is progressive, proportional or regressive, with a reason. [2]

4. A government charges every household a fixed licence fee of 150. Two households have incomes of 15,000 and 60,000. Calculate the fee as a percentage of each income and classify the charge. [3]

5. Country D has GDP of 1,200bn. Its public spending (billions) is: pensions and benefits 105, health 69, education 45, defence 21, new road and rail construction 30, public order and administration 30.

(a) Calculate transfer payments as a percentage of total spending and of GDP, and total spending as a percentage of GDP. [3] (b) Explain one reason why a government might undertake the capital spending shown. [3]

6. Explain how fiscal policy can be used to influence aggregate supply. [6]

7. Explain the difference between vertical equity and horizontal equity as principles of taxation. [4]

8. Analyse how government spending and taxation can affect the pattern of economic activity. [8]

9. Evaluate the case for raising more tax revenue through a broad tax on spending rather than through income tax. [9]

10. Country E has a marginal propensity to withdraw of 0.4. It considers a rise in government spending of 8bn, or a tax cut of 8bn of which 50% is spent on domestic goods.

(a) Calculate the change in national income under each policy. [4] (b) Evaluate which policy would be better for the economy. [6]

11. Country A raises 300bn in tax, 200bn direct and 100bn indirect, and plans to raise 150bn from each. Assume every household’s direct tax falls by 25% and its indirect tax rises by 50%. Household L has income of 20,000, spends 90% of it and pays direct tax of 5% of income. Household H has income of 100,000, spends 60% of it and pays direct tax of 25% of income. Indirect tax is an effective 10% of spending.

(a) Calculate the total tax paid by each household as a percentage of income before and after the change. [4] (b) Assess the economic significance of the change in the distribution of taxation. [8]

12. Explain one macroeconomic and one microeconomic function of fiscal policy, and show how a single measure can serve both. [5]

Answers

1. A direct tax is levied on income, profit or wealth [1] and paid by the person or firm taxed, such as income tax [1]. An indirect tax is levied on spending [1] and collected by the seller who passes it on in the price, such as a sales tax or an excise duty [1]. [4] Examiner insight: A definition plus an example for each type covers a “distinguish” command. Two examples with no contrast leave the difference unstated.

2. (a) MPW = 0.10 + 0.30 + 0.20 = 0.60 [1]. Multiplier = 1 / 0.60 = 1.67 [1]. Change in income = 9 × 1.67 = 15bn [1]. (b) If the economy is near full capacity [1], extra demand raises prices rather than output, so real output rises by less than 15bn [1]. (Alternatives: time lags, or crowding out of private spending.) [5] Examiner insight: Show the three withdrawals being added before the division. Link any reason to the size of the output change.

3. (a) At 30,000: (30,000 − 15,000) × 0.12 = 1,800 [1]. At 80,000: 20,000 × 0.12 + 45,000 × 0.32 = 2,400 + 14,400 = 16,800 [1]. Average rates: 6% and 21% [1]. (b) The tax is progressive [1] because the average rate rises as income rises [1]. [5] Examiner insight: Working band by band shows where each rate applies. Comparing average rates, not amounts paid, supports the classification.

4. 150 / 15,000 = 1.0% [1]. 150 / 60,000 = 0.25% [1]. The share of income falls as income rises, so the charge is regressive [1]. [3] Examiner insight: Classification depends on the percentage of income, so give both percentages before naming the type.

5. (a) Total spending = 105 + 69 + 45 + 21 + 30 + 30 = 300bn. Transfers: 105 / 300 = 35% of total spending [1]; 105 / 1,200 = 8.75% of GDP [1]; total spending 300 / 1,200 = 25% of GDP [1]. (b) Roads and rail raise the economy’s productive capacity [1]. Private firms may underprovide them because the benefits are spread widely and hard to charge for [1]. Lower transport costs raise productivity and potential output, and construction adds to demand in the short run [1]. [6] Examiner insight: Pick the right denominator for each percentage, as the same 105 gives two figures. For the reason, link the spending to a market failure or growth effect.

6. Spending on infrastructure lowers firms’ costs and raises productivity [1], shifting long-run aggregate supply right [1]. Spending on education and training improves workers’ skills [1], raising potential output [1]. Tax incentives, such as lower tax on extra earnings or relief on investment, raise labour supply or investment [1], though the response is uncertain and slow [1]. [6] Examiner insight: Write each route as a short chain ending in a shift of aggregate supply.

7. Vertical equity means that people with a greater ability to pay should pay more tax [1], for example higher earners paying a higher share of income [1]. Horizontal equity means that people in similar circumstances should pay the same tax [1], for example two employees on equal pay paying equal tax regardless of how they spend [1]. [4] Examiner insight: Give each term its own definition and example, so the two ideas stay apart.

8. A fuel tax raises the cost of road travel [1], shifting demand to rail and efficient vehicles [1]. Spending on regional transport raises firms’ profitability in that region [1], attracting investment and jobs, so activity shifts between areas [1]. Subsidies for one industry lower its costs [1] and draw labour and capital from others [1]. Higher public spending raises the public sector’s share of output [1]; if borrowing raises interest rates, private investment may be crowded out [1]. [8] Examiner insight: “Pattern of activity” needs a before and after, such as from one sector, region or mode to another. Write examples as chains of cause and effect.

9. For a spending tax: a broad base makes it hard to avoid and gives stable revenue [1], and it leaves the return from extra work untaxed, so work incentives are less affected [1]. It can also target harmful goods to correct externalities [1]. Against: it is often regressive, because low-income households spend a larger share of income [1], so a household spending 95% of income pays a larger share than one spending 55% [1]. Income tax can be progressive, supporting vertical equity [1] and protecting low earners with an allowance [1], but high rates may weaken incentives and encourage avoidance [1]. Judgement: the better choice depends on whether the government values equity or incentives more [1]. [9] Examiner insight: A one-sided list of merits stays descriptive. Tie each tax to a principle, and close on a judgement and say what it hinges on.

10. (a) k = 1 / 0.4 = 2.5 [1]. Spending: 8 × 2.5 = 20bn [1]. Tax cut: first-round injection = 8 × 0.5 = 4bn [1]; 4 × 2.5 = 10bn [1]. (b) Spending gives a larger boost because the whole sum is injected at once [1]. A tax cut leaves the choice with households and can raise work incentives, but some is saved, more if confidence is low [1]. With spare capacity either policy raises output; near full capacity both raise prices [1]. Capital projects can also raise aggregate supply, while wasteful spending raises demand only [1]. Projects take time to start while a tax cut acts quickly [1]. Judgement: spending is stronger in a deep recession, but a tax cut may suit if efficiency and choice matter more [1]. [10] Examiner insight: Carry the calculated figures into the evaluation: 20bn against 10bn beats a general claim.

11. (a) Household L before: direct 1,000 plus indirect 18,000 × 0.10 = 1,800, total 2,800, so 14% [1]. After: direct 750 plus indirect 2,700 = 3,450, so 17.25% [1]. Household H before: direct 25,000 plus indirect 6,000 = 31,000, so 31% [1]. After: 18,750 plus 9,000 = 27,750, so 27.75% [1]. (b) The poorer household pays a larger share and the richer one a smaller share, so the tax system is less progressive [1]. Post-tax incomes are 17,200 and 69,000 before (a ratio of 4.01) and 16,550 and 72,250 after (4.37) [1], so inequality in disposable income widens [1]. Lower direct tax may improve incentives to work and invest [1], supporting aggregate supply [1]. Indirect taxes are harder to avoid [1]. Household L spends more of its income, so lower disposable income cuts consumption more [1]. The result rests on the assumption of equal proportional changes, and on the government’s priorities [1]. [12] Examiner insight: Use the calculated percentages as evidence, and name both a gain (incentives) and a loss (equity) before judging.

12. A macroeconomic function is influencing aggregate demand, such as cutting income tax to raise consumption in a downturn [1], which raises output and employment [1]. A microeconomic function is changing outcomes in a market, such as a tax on a good that causes pollution [1], which raises its price and reduces output towards the socially efficient level [1]. A fuel tax does both: it corrects an externality in one market and also raises revenue and reduces demand across the economy [1]. [5] Examiner insight: Label which example is macro and which micro, using a different measure for each before showing the overlap.

Where marks are usually lost

• Calling a tax progressive because the amount paid rises, without comparing average rates.
• Applying the top rate to the whole income instead of the top slice only.
• Counting the whole of a tax cut as the injection when part is saved or spent on imports.
• Using the wrong denominator when expressing spending as a percentage.
• Describing a tax without judging it against a principle.
• Ending an evaluation without a judgement tied to a condition.

Next steps

• Go back over the revision notes and study guide.
• Use the course hub and the checklist to plan what to revise next.
• Take the free 10-minute diagnostics for all topics.
• Book a free trial class.

Official syllabus

AQA AS and A-level Economics specification (7135 and 7136), version 1.3, 29 June 2022, published by AQA. Sub-section: Fiscal policy (first part).