OCR A Level Economics: Fiscal policy 1: the budget and taxation (H460) – Revision Notes

These notes condense the first part of the topic Fiscal policy from the OCR A Level Economics (H460) specification, Version 3.0 (June 2026), for first assessment in 2021, under The application of policy instruments (Macroeconomics). The specification labels no content as AS or Extension. All figures are made up as examples, and money is in currency units (cu). The study guide has the full explanations.

Also use the OCR Economics hub, the printable checklist, the free diagnostics, the practice questions and the macroeconomics revision notes. Deficits, debt, stabilisers and fiscal rules are in the next unit.

Key definitions

Term	Meaning
Government budget	Planned receipts and spending over a period, usually a year
Current expenditure	Day-to-day running costs and transfers: wages, benefits, debt interest
Capital expenditure	Spending on lasting assets: roads, buildings, equipment
Progressive tax	Average rate rises as income rises
Proportional tax	Average rate is the same at all incomes
Regressive tax	Average rate falls as income rises
Direct tax	On income, profit or wealth; liability and burden usually fall on the same person
Indirect tax	On spending; paid to the government by sellers, who may pass it on
Budget surplus / deficit / balanced	Receipts above / below / equal to spending
Fiscal stance	Whether fiscal policy is expansionary, contractionary or neutral
Cyclical balance	The part of the balance due to the economy being above or below trend
Structural balance	The part that would remain with the economy at trend

UK revenue sources to recall: VAT, income tax, National Insurance contributions, corporation tax, excise duties, council tax and business rates. Main spending areas: social protection, health, education, debt interest, defence, transport, public order and safety.

Formulas

Quantity	Formula
Average tax rate	tax paid / income × 100
Marginal tax rate	change in tax / change in income × 100
Tax revenue	tax rate × tax base
Overall budget balance	total receipts - (current + capital spending)
Current budget balance	receipts - current spending
Structural balance	actual balance - cyclical balance

Method: tax calculations in steps

1. Split income into the bands. Apply each rate only to the slice inside its band.
2. Add the slices to get total tax.
3. Divide by total income for the average rate.
4. For the marginal rate, find the tax on the next block of income and divide by that block.
5. State the type of tax by comparing average rates at two or more incomes.

Worked reminder. Country B charges 0% up to 8,000 cu, 15% from 8,000 to 30,000 cu and 35% above 30,000 cu. At 50,000 cu: tax = 22,000 × 15% + 20,000 × 35% = 3,300 + 7,000 = 10,300 cu. Average rate = 10,300 / 50,000 = 20.6%. At 80,000 cu: 3,300 + 50,000 × 35% = 20,800 cu, an average of 26.0%. The average rises, so the system is progressive. Marginal rate above 30,000 cu is 35%.

Must-know distinctions

• Average versus marginal: average is tax over total income; marginal is the rate on the extra income. In a progressive system, marginal exceeds average.
• Progressive versus regressive: test the average rate, not the cu paid.
• Direct versus indirect: income, profit and wealth against spending. The legal payer of an indirect tax is the seller, but the burden may fall on the buyer.
• Current versus capital: lasting assets against running costs. Debt interest is current.
• Overall versus current budget: the overall balance includes capital spending, the current balance does not.
• Budget position versus fiscal stance: position is the balance; stance is the direction policy pushes demand.
• Cyclical versus structural: cyclical changes with the economic cycle without any new decision. Structural needs a policy change or lasting economic change.

Features of a good tax

Equity (vertical and horizontal), certainty, convenience, economy (cheap to collect), efficiency (few distortions) and adequate yield. Evaluate by saying which criteria matter most for the aim in the question. A tax that is equitable but costly to collect, or simple but regressive, scores differently on different criteria.

Laffer Curve notes

• Revenue is zero at a 0% rate and may be zero at a 100% rate. In between there is a maximum.
• Revenue peaks where the extra revenue from a higher rate is exactly offset by the revenue lost as the base shrinks.
• With a linear base B = a - bt, revenue = t(a - bt)/100 peaks at t = a/(2b).
• Example: base = 800 - 10t gives a peak at t = 800 / 20 = 40%, with revenue 40 × 400 / 100 = 160 bn cu. At 30% revenue is 150 and at 60% it is 120.
• Evaluation: the real peak is unknown; the response of behaviour differs by tax, country and time; avoidance routes matter; revenue is not the only aim.

Flat tax in one view

• For: simple, cheaper to run, less reason to avoid, possible incentive gains at the top.
• Against: less redistribution, lower revenue unless the rate rises, low earners may lose.
• Example: 20% above a 6,000 cu allowance on 15,000 cu income gives 1,800 cu, an average rate of 12.0%.

Cyclical and structural reminders

Example: deficit 3.5% of GDP, output gap +2%, and each 1% of gap shifts the balance by 0.5% of GDP (illustrative). The boom adds 2 × 0.5 = 1.0% of GDP to the balance, so the structural deficit is 3.5 + 1.0 = 4.5%. When the boom ends, the deficit would widen with no policy change.

Overall versus current: Country B receipts 410 bn cu, current spending 395, capital spending 40, GDP 2,500. Overall = 410 - 435 = -25 (1.0% of GDP, deficit). Current = 410 - 395 = +15 (0.6% of GDP, surplus).

Quick self-test

1. Using Country B’s bands, find the tax on 30,000 cu and the average rate.
2. Using Country B’s bands, find the marginal rate on a rise from 30,000 to 40,000 cu.
3. A fixed charge of 300 cu is paid by every adult. Find its average rate at incomes of 10,000 and 60,000 cu and classify it.
4. For base = 800 - 10t, find revenue at 30% and 60%, and the revenue-maximising rate.
5. A flat tax of 20% applies above a 6,000 cu allowance. Find the tax and average rate at 30,000 cu.
6. Classify as direct or indirect: VAT, corporation tax, fuel duty, National Insurance contributions.
7. Classify as current or capital: teachers’ pay, a new rail line, debt interest, a school building.
8. Receipts 410, current spending 395, capital 40 (bn cu). Find the overall and current balances.
9. Deficit 3.5% of GDP, output gap +2%, each 1% of gap changes the balance by 0.5% of GDP. Find the structural deficit.
10. Name two features of a good tax.
11. Give one reason the Laffer Curve cannot tell a government what its tax rate should be.
12. Distinguish budget position from fiscal stance.

Answers

1. 22,000 × 15% = 3,300 cu; average = 3,300 / 30,000 = 11.0%.
2. Extra tax = 10,000 × 35% = 3,500; marginal rate = 3,500 / 10,000 = 35%.
3. 300 / 10,000 = 3.0%; 300 / 60,000 = 0.5%. The rate falls as income rises, so it is regressive.
4. At 30%: 30 × 500 / 100 = 150. At 60%: 60 × 200 / 100 = 120. Peak at 800 / 20 = 40%, revenue 160.
5. (30,000 - 6,000) × 20% = 4,800 cu; average = 16.0%.
6. VAT indirect; corporation tax direct; fuel duty indirect; National Insurance contributions direct.
7. Teachers’ pay current; rail line capital; debt interest current; school building capital.
8. Overall = 410 - 435 = -25 (deficit); current = 410 - 395 = +15 (surplus).
9. The boom adds 1.0% to the balance, so without it the deficit would be 3.5 + 1.0 = 4.5% of GDP.
10. Any two: equity, certainty, convenience, economy, efficiency, adequate yield.
11. The peak rate is unknown and varies with the tax, the time period and ease of avoidance.
12. Position is the size of the surplus or deficit; stance is whether policy is expanding or contracting demand, and is better judged from the structural balance.

Where marks are usually lost

• Applying one rate to all income instead of only the slice in each band.
• Calling a tax progressive because the amount paid rises, rather than the average rate.
• Quoting the average rate when the question asks for the marginal rate.
• Listing features of a good tax without applying them to the tax named.
• Drawing the Laffer Curve with no peak, or treating it as a fact, not a model.
• Saying a deficit means expansionary policy without considering the cycle.
• Forgetting that the current budget excludes capital spending.
• Conclusions that repeat points instead of judging which matters most and why.

Official syllabus

OCR, A Level in Economics (H460), Version 3.0 (June 2026), first assessment 2021, Component 2 content: The application of policy instruments, topic Fiscal policy, the first part. Published by OCR (Oxford Cambridge and RSA).