The impact of fiscal policy on spending and taxes in the economy

  • May 12 2022
  • by
  • Analyst AZA
The impact of fiscal policy on spending and taxes in the economy

The impact of fiscal policy on spending and taxes in the economy

Fiscal policy can be defined as the actions taken by the government to influence spending and taxes in the economy. Aggregate demand can be influenced in many ways. For example, the government can reduce the taxes it levies on people, which will increase people's income after tax deductions. Also, they can reduce the taxes paid by enterprises, this will increase the profits of companies, thereby increasing wages. It is worth noting that these applications will not work all the time and will depend on the economic situation in the country. When the economy is in a depression, people will lose their jobs, and tax cuts can be ineffective by increasing savings because people tend to save money when they are unsure of the future economic outlook. Economists assess the impact of fiscal policy on the economy in different ways.

Proponents of Keynesian theory believe that government intervention is critical to the stability of the labor market, production and demand, especially in the recession phase of the business cycle. On the contrary, monetarists believe that government intervention is very limited and only has an impact in the short term. Monetarists are confident in using monetary policy to influence output and employment. When employment is high and inflation is high, fiscal policy can be cut or tightened by cutting government spending or raising taxes. This makes it important for market participants to know if a government has a budget deficit or a budget surplus in a given period of time, as this may indicate the position the government has taken. When the economy is in a recession, automatic stabilizers are automatically activated to offset the effects of the recession, this does not require any ability to perform as it happens automatically.

This can be achieved by stimulating the unemployed or by reducing the prices charged by government organizations to society. When a government has a deficit account, it means that its revenues are less than its expenditures, which leads to an increase in public debt. This will result in the government seeking credit from the private sector and repaying the money with interest, so these payments become part of government spending. This tells us that the growth of the country's debt is unfavorable for the state of the economy. History has shown us that, in the long run, countries are more likely to run deficits than surpluses. Let's now look at the tools used by fiscal policy makers to achieve their goals. First, we have transfer payments, these are payments to the poor, pensioners, and children.

These payments are direct government assistance to the people. This type of grant will help close the gap between people with higher living standards and the poor, and they are effective when they are paid to the poorest people, who are more likely to spend all the funds received than the average population. and the upper classes, who could save the money for future use. The government will also spend funds on services that people need such as schools, student funding, hospitals, etc. Spending on infrastructure such as roads and bridges will increase the development of the economy. For example, investing in paved roads will improve the trading industry and reach more isolated areas, thus creating jobs and innovation. The government can also influence consumer choice.

For example, imposing taxes on tobacco and alcoholic beverages may lead to reduced consumption of these products as a result of higher prices. There has been controversy around this topic because it will cause manufacturers of these products to face a decrease in demand for their products. There have been arguments about whether the rich should pay more taxes than the poor, or whether taxes should remain the same for everyone. The advantage of taxes is that they can be changed at the same time they are made public. Therefore, their impact on the economy will not be delayed. Against the backdrop of the tools used to implement fiscal policy, some taxes need to be changed with prior notice, especially direct taxes, because the technology equipment they use is automated and will take longer to update, although changing expectations can impact consumers instantly.

Spending on longer projects can be a disadvantage to fiscal policy due to the time it takes to complete them. This longer duration will mean that their impact on the economy will be delayed. This type of spending is beneficial in the long run and will contribute to the sustainability of economic growth. There are factors that make fiscal policy ineffective. Fiscal policy cannot fully stabilize average demand, because difficulties in its application cannot be completely eradicated.

First, politicians don't have enough data on how the economy works. it may take policymakers months to realize that the economy is slowing because the data is available with a time lag, and even then the data must be revised. This is called recognition delay and has been likened to the difficulty of using a rearview mirror to drive. Then, when the final decision to change the policy is made, it can take many months to implement it. This is called action delay. If the government decides to increase spending on capital projects, for example to stimulate the labor market and wages, it may take several months to plan and implement. After all, the ultimate goal of these economic efforts will take a long time to become apparent; this is known as impact delay. These various types of policy lag also occur in the case of discretionary monetary policy.

Another aspect of timing in this connection is when economic agents are uncertain about future economic outcomes regardless of policy changes. For example, stimulus may occur at the same time as a sudden increase in investment or demand for national exports, just as discretionary government spending begins to rise. Macroeconomic determination models have not performed very well in terms of historical data, and therefore they are not given much importance in political decision making. Also, when discretionary fiscal adjustments are communicated to the public (or are already in place), it can influence private sector behavior, leading to increased consumption and investment, which amplifies the impact of increased public spending, and this will make it difficult to calibrate the necessary fiscal adjustment for job security.

When employment is high and inflation is high, fiscal policy can be cut or tightened by cutting government spending or raising taxes.


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