Paper on Economics

Fiscal Policy as defined by Investopedia is government spending policies that influence macroeconomic conditions. These policies affect tax rates, interest rates and government spending, in an effort to control the economy. Fiscal Policy is generally controlled by the Legislative and Executive branches of government. There are two primary components of Fiscal Policy, government expenditures and taxes. Government expenditures are anything the government spends money on this includes all government consumption and investment but excludes transfer payments made by a state. By imposing taxes the government receives revenue from the population. Taxes come in many varieties and serve different specific purposes, but the key concept is that taxation is a transfer of assets from the people to the government. . There are two main types of fiscal policy, expansionary fiscal policy and contractionary fiscal policy. Expansionary fiscal policy is designed to stimulate the economy during or in anticipation of a business cycle contraction. This is achieved by increasing aggregate expenditure and aggregate demand through an increase in government spending or a decrease in taxes. Expansionary policy generally leads to a larger budget deficit or a smaller budget surplus. Contractionary fiscal policy is designed to restrain the economy during or in anticipation of an inflation-inducing business cycle expansion. This is accomplished by decreasing aggregate demand and aggregate expenditure through a decrease in government spending or an increase in taxation. Thus contractionary fiscal policy will lead to a smaller budget deficit or a larger budget surplus. When discussing fiscal policy there are typically three tools available; government purchases, taxes, and transfer payments.

Government Purchases

Government purchases are expenditures by the government sector, on purchases of final goods and services. Things that fall in this category are teacher’s salaries, office supplies, military equipment and road development to name a few. In an expansionary fiscal policy environment, the government will increase the funding throughout different agencies and encourage increased spending in different areas, the idea is to boost aggregate production, increase income and promote higher levels of employment. On the other end of the spectrum a contractionary fiscal policy environment will involve a decrease in funding to these agencies, which in turn will reduce the spending of each agency. This is in hopes of accomplishing reduced aggregate production, income and overall the decreasing the rate of inflation.

Taxes

The more preferred tool of fiscal policy are taxes, with taxes there is a more immediate affect than there is with government purchases. Generally personal income taxes imposed by the federal government are implied in this category. The federal income tax system which is administered by the IRS involves a set of tax rates that are applied towards the income a taxpayer collects. Expansionary fiscal policy will involve either a decrease in a taxpayer’s tax rate or a one-time rebate for taxes already paid. The idea behind this is that with more money to spend the taxpayer will go out and spend money on the economy thereby boosting economic growth. An example of this is when Former President Bush put into effect tax cuts for the year 2000; the end result was taxpayers received a rebate check in the mail. The less popular contractionary fiscal policy tool in regards to taxes are used less than the above mentioned method, but has been used. Typically with this method the government will either increase the tax rate for taxpayers or induce a one –time surcharge. The increase in taxes provides a household with less disposable income for consumption expenditures which will decrease the aggregate production and employment that lead to a further decrease in income, therefore reducing inflationary pressure.

Transfer Payments

The third fiscal policy tool is transfer payments. Transfer payments are payments made to households with no expectation of productive activity in return. This includes Social Security, Unemployment benefit and welfare payments for the poor. In regard to expansionary fiscal policy the government will increase the amount of payments to these households with intent to increase their disposable income, thus to be used for consumption expenditures which will increase the aggregate production leading to higher employment and increased income. In a contractionary situation, the government will reduce the amount of payments given to each household in hopes of reducing the deficit.

When government expenditures exceed government tax revenues in a given year, the government is running a budget deficit for that particular year. The budget deficit, which is the difference of government expenditures and tax revenues, is financed by government borrowing; the government will issue long term, interest bearing bonds and use the proceeds to finance the deficit. The total amount of government bonds and interest payments outstanding, past and present is what is known as the national debt. When government expenditures are less than tax revenues in a given year, the government is running a budget surplus for that year. Revenues from a budget surplus are typically used to reduce the national debt. When government expenditures are exactly equal to tax revenues this is known as a balanced budget. Both methods of fiscal policy are effective at different times of an economic struggle, although expansionary fiscal policy is probably the more popular of the two, we as a nation have seen what too much stimulus will do to a government’s budget.

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Works Cited
Chen, Judy. "Fiscal Policy and the AD/AS Model - Welker 's Wikinomics Page." Welcome to Welker 's Wikinomics Page - Welker 's Wikinomics Page. N.p., 28 Mar. 2008. Web. 8 Dec. 2012. .
Heakal, Reem. " What Is Fiscal Policy?." Investopedia – Educating the world about finance. N.p., 16 Feb. 2009. Web. 5 Dec. 2012. .
Horton, Mark, and Asmaa El-Ganainy. "Fiscal Policy: Taking and Giving Away - Back to Basics: Finance & Development." IMF -- International Monetary Fund Home Page. N.p., 7 June 2001. Web. 6 Dec. 2012. .

Cited: Chen, Judy. "Fiscal Policy and the AD/AS Model - Welker 's Wikinomics Page." Welcome to Welker 's Wikinomics Page - Welker 's Wikinomics Page. N.p., 28 Mar. 2008. Web. 8 Dec. 2012. . Heakal, Reem. " What Is Fiscal Policy?." Investopedia – Educating the world about finance. N.p., 16 Feb. 2009. Web. 5 Dec. 2012. . Horton, Mark, and Asmaa El-Ganainy. "Fiscal Policy: Taking and Giving Away - Back to Basics: Finance & Development." IMF -- International Monetary Fund Home Page. N.p., 7 June 2001. Web. 6 Dec. 2012. .