Fiscal Policy

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FISCAL POLICY

Fiscal Policy



Fiscal Policy

Fiscal Policy

Fiscal policy refers to the government's use of spending and tax policies to influence the economy. When the government increases its spending for defense purposes or raises personal income tax rates, it affects the total level of spending in the economy and, hence, will affect the overall macroeconomic activity of a nation measured by such factors as gross domestic product (GDP), employment, and inflation. This is true for almost any change in spending or taxes. Any change in government spending or taxes will also affect the government's budget deficit. An increase (decrease) in spending or a decrease (increase) in taxes will increase (decrease) the government's budget deficit for a given state of the rest of the economy. Because the government must borrow by selling U.S. Treasury securities to finance its deficits, any increase or decrease in the government's deficit will affect the market for loanable funds and interest rates, which then feeds back on GDP, employment, and inflation (Seidman, 2001, pp. 17).

Federal Government Spending

Economists categorize government spending in two types. First, there are government purchases of goods and services. Government purchases of food, military goods, and other goods needed for consumption purchases, as well as purchases of investment goods, such as buildings and the building of bridges, are included. On the other hand, the government also spends on social insurance programs, such as Food Stamps and Medicare, which are primarily transfers of income from taxpayers to needy citizens. These are referred to as transfer payments. Federal, state, and local governments all purchase goods and services and have the potential to affect economic activity. According to the 2008 Economic Report of the President, over the past 46 years, total government spending on goods and services, as well as federal spending by itself, has fallen as a percentage of GDP while state and local spending has increased as a percentage of GDP. Total government spending was approximately 19.1% of GDP in 2007: Federal spending was 7.1% of GDP while state and local spending was 12.2%. This compares with total government spending of 21.2% of GDP in 1960, when federal spending was 12.2% of GDP and state and local spending was 9.0% (Blinder, 1997, pp. 115).

Federal Tax Revenue

The federal government has several tax revenue streams, including individual income taxes, corporate income taxes, social insurance taxes (to fund programs intended to protect households from economic hardship), excise taxes (taxes ...
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