An element of macroeconomics, fiscal policy refers to the taxation and expenditure policies a government adopts and implements. In other words, the policy helps a government decide how much money it should spend (on roads, schools, etc.) and the sum it must collect from its citizens through taxes – so that the economy is in some sort of order, or a sluggish economy gets a boost or a fast-growing economy is curtailed.
In combination with monetary policy, fiscal policy helps regulate economic activity, balance of payments, inflation, resources distribution between the private and public sector, and influences employment and wealth distribution. Generally, a fiscal policy’s short-term objective is addressing rising inflation, boosting an ailing economy, etc. The long-term goals are sustaining growth or decreasing poverty by effecting improvements in education and employment. In short, fiscal policy is the medium through which a government keeps a check on the economy.
Fiscal policy may affect all or a few groups of the society, depending on the policymakers’ objectives and political inclinations. For example, tax cuts may only affect the middle class – usually the biggest economic group of any state. Similarly, when there are spending adjustments made, the impact could only be on a few. For example, investing in public infrastructure projects such as roads and bridges would create job opportunities only for construction workers and other construction industry experts. The general public is unlikely to benefit monetarily from such developments.
Fiscal policies have not always been in prominence. In fact, before the Great Depression and the historic Wall Street crash (1929), governments across the globe had a laissez-faire approach to fiscal policies, or they left things to churn their own paths. However, after the huge financial turmoil, policymakers wanted governments to play a major role in shaping up economies. In other words, fiscal policies became more prominent or active during that period. Though government role and involvement have altered over the years, the state continues to play a primary role in influencing the economy.
Expenditures (Expansionary Policy)
Government expenditures pour in huge chunks of money into citizens’ hands, which means revenue for businesses and funds for personal expenses. Also, when the government buys goods and services (pencils or airplanes) from private firms, the transactions contribute to job creation since the businesses are selling and there’s work for employees to take care of. Government expenditures tend to have a larger impact during times of depression, recession, and high unemployment. When a government spends more and cuts taxes, the fiscal policy is called loose or expansionary. Generally, such expansionary fiscal policies are in place during a recession or depression.
Taxation (Deflationary Policy)
A government not just produces or sells – like any other consumer, it also requires money or credit to make its purchases. And tax revenues is a government’s primary income source. Governments levy taxes on income, property transfers, sales, and many other similar matters of finance. However, the state cannot be aggressive with its tax policies as that would leave lesser money in the hands of citizens and private firms, indirectly forcing the government to spend more. When a government makes more money and spends less, the fiscal policy is considered tight, contractionary or deflationary. Deflationary policies are implemented when an economy’s growth rate is beyond control, which may cause asset bubbles and inflation.
In theory, fiscal policy sounds simple and straightforward. However, the challenges appear when devising and implementing the policy. Since the policy pertains to a particular nation or state and there are multiple variables involved, drafting a fiscal policy and putting it into action is easier said than done. For instance, balance needs to be maintained between ever-changing public spending and tax rates. Lowering taxes or pushing up spending in a slack economy can cause a rise in inflation as money proliferation can cause the currency’s value to go down.