Definition
Fiscal policy refers to the use of government revenue collection (mainly taxes) and expenditure to influence a country’s economy. It is associated with the decision of governments on what level of public spending and taxes should be, which can affect major macroeconomic variables, such as GDP and unemployment rates. The primary economic impact of any change in the government budget is felt by particular groups—a tax cut for families with children, for example, may raise their disposable income.
Key Takeaways
- Fiscal Policy refers to the use of government revenue collection (taxes) and expenditure (spending) to influence a country’s economic condition. It’s a strategy that the government implements to monitor and influence a nation’s economy.
- Fiscal Policy is further divided into two types: Expansionary and Contractionary. Expansionary fiscal policy is when the government increases spending or decreases taxes to stimulate economic growth, while Contractionary fiscal policy involves decreasing spending or increasing taxes to slow economic growth.
- Fiscal Policy is a critical element in managing a country’s economy. It’s not just about adjusting spending and revenues, but it’s also about redistributing income, creating public goods, stabilizing the economy, and managing public borrowing.
Importance
Fiscal policy is crucial as it is a key tool for governments to manage their economies, primarily by adjusting spending and taxation levels. It directly influences the state of an economy, impacting factors like employment, inflation, and economic growth.
Taxation adjustments affect disposable income and thus consumer spending, which is a major component of a nation’s overall economic activity. Government spending decisions, on the other hand, can stimulate or cool the economy.
Fiscal policy can also help buffer against economic downturns or help manage inflation during economic booms. Overall, fiscal policy plays a crucial role in managing a country’s economic performance and stability.
Explanation
Fiscal policy is a critical economic management tool that governments utilize to manage and influence a nation’s economy. Its primary purpose is to encourage economic stability by using measures such as tax rates, government expenditures, and public debts.
Through these instruments, governments can control the economic pace, either stimulating the economy during a recession with increased spending and reduced taxes, or slowing down growth when there are concerns of overheating by hiking taxes and cutting spending. Furthermore, fiscal policy is utilized to redistribute income, often responding to social demands for a fair and equitable society.
This comes in the form of progressive tax systems where high-income earners pay a higher rate of taxes than lower-income earners, and the revenue is then allocated to programs such as safety nets and public services, benefiting the less fortunate. Hence, fiscal policy essentially works as a mechanism to ensure economic stability and promote equitable growth, serving as a bridge between the government’s broader economic objectives and the well-being of its citizens.
Examples of Fiscal Policy
Economic Stimulus Package: An example of fiscal policy is the economic stimulus package introduced by the U.S. government in response to the 2008 financial crisis. This package included tax cuts and increased government spending on infrastructure projects in order to stimulate economic activity and prevent a deep recession.
Managing Budget Deficits: In 2009, the UK government decided to reduce its chronic budget deficit through a fiscal policy that included raising personal taxes and VAT (value-added tax), as well as reducing public spending on social services. This fiscal policy was designed to decrease the budget deficit and reduce national debt.
COVID-19 Relief Bills: A more recent example is the array of fiscal policies enacted by governments worldwide in response to the COVID-19 pandemic. For instance, the U.S. government passed the CARES Act in 2020, a $2 trillion spending bill that included individual stimulus payments, expanded unemployment benefits, and financial support for businesses and local governments. This was aimed at mitigating the economic impact of the pandemic and encouraging recovery.
Fiscal Policy FAQs
What is Fiscal Policy?
Fiscal Policy refers to the use of government revenue collection (mainly taxes) and expenditure (spending) to influence a country’s economy. The two main instruments of fiscal policy are changes in the level and composition of taxation and government spending in various sectors.
What are the types of Fiscal Policy?
The two main types of fiscal policy are expansionary and contractionary. Expansionary fiscal policy involves the government expanding money supply in the economy, using tools such as reducing taxes and increasing government spending. Contractionary fiscal policy involves the government reducing money supply in the economy, typically through raising taxes and reducing spending.
What is the purpose of Fiscal Policy?
The purpose of fiscal policy is to stabilize the economy during a recession or to prevent the economy from overheating during an expansion. By influencing the amount of money available for spending on goods or services, fiscal policy can increase or decrease economic growth.
How does Fiscal Policy impact the economy?
Fiscal policy can impact the economy in a few ways. By lowering taxes, the government can give households more money to spend, which can stimulate economic activity. Increase in government spending, can also stimulate the economy by creating jobs and income for businesses and households, leading to more spending. On the other hand, if the government increases taxes or cuts spending, it can slow the economy down.
Who controls Fiscal Policy?
In most economies, fiscal policy is controlled by the government, specifically government ministries, departments, or the treasury. Decision on taxes, public spending, and borrowing are made by these entities.
Related Entrepreneurship Terms
- Government Spending
- Taxation
- Budget Deficit
- Public Debt
- Expansionary Fiscal Policy
Sources for More Information
- Investopedia: For definitions of terms and detailed articles explaining the concepts and implications of fiscal policy.
- International Monetary Fund (IMF): For insights on fiscal policy from an international perspective, including its effects on global economies.
- Federal Reserve: To understand how national banks interact with fiscal policy in the U.S.
- Brookings Institution: For expert analyses and opinion pieces on fiscal policy and other economic topics.
