Econ: Fiscal Policy

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Fiscal policy is carried out by the government. The goals of fiscal policy is to achieve or maintain full employment, to achieve or maintain a high rate of economic growth, and to stabilize prices and wages. The two main instruments of discretionary fiscal policy are government expenditures and taxes. The government collects taxes in order to finance expenditures on a number of public goods and services such as highways and national defense.

Government Spending
The government has two types of expenditures: goods and services, and transfer payments. The government buys many goods, such as tanks, planes, ships, space shuttles, office buildings, land for parks, and capital goods for schools and laboratories. This spending affects the distribution of income and competes with the private sector for scarce resources. As a result, this spending has a large impact on the nation’s economy.

Congress and the president work together to prepare an annual budget showing federal expenditures and revenues for the year. The largest components of the federal budget are Social Security, national defense, income security, and health care services. Most years, the government spends more than it collects in taxes, causing a budget deficit. The budget deficit is the amount that the government borrows for a given year. The national debt is the total amount of debt for the federal government. Each year’s budget deficit adds to the national debt. The national debt affects the distribution of income and transfers purchasing power from the private to the public sector. Attempts to control the deficit have taken the form of mandated deficit targets and pay-as-you-go provisions.

Taxes
Each year governments raise billions of dollars in revenues in a variety of ways, including taxes, license fees, tuition fees, and customs duties, to name just a few. Taxes and other governmental revenues influence the economy by affecting resource allocation, consumer behavior, and the nation’s productivity and growth. The three criteria used to determine if a tax is effective are equity, simplicity, and efficiency. The benefit-received principle of taxation and the ability-to-pay principle of taxation are used to help decide the group or groups that should bear the burden of the tax. Taxes can be proportional, progressive, and regressive, depending on the way the average tax per dollar changes as taxable income changes.

There have been four major tax revision bills since 1980. The first reduced the progressiveness of the individual income tax and the second made it more proportional. The third, passed in 1993, made it more progressive again. The fourth, passed in 1997, provided wealthy individuals with significant tax relief for long-term investments, and provided modest tax relief for child and educational expenses. Recent talk of tax reform has centered around a Value Added Tax, which is a tax on consumption rather than income, and a flat tax, which would replace all tax brackets with a single tax rate.

Fiscal Policy
Expansionary fiscal policy used to combat a recession is defined as an increase in government expenditures, a decrease in taxes, or both increase in government expenditures and decrease in taxes, that causes the government’s budget deficit to increase and its budget surplus to decrease.

Contractionary fiscal policy used to combat inflation is defined as a decrease in government expenditures, an increase in taxes, or a decrease in government expenditures and an increase in taxes, which causes the government’s budget deficit to decrease and its budget surplus to increase.