Fiscal Policy

Fiscal policy is the deliberate alteration of government spendingor taxation to help achieve desirable macro-economic objectives by changing the level and composition of aggregate demand (AD).

Types of fiscal policy

There are two types of fiscal policy, discretionary and automatic.

• Discretionary policy refers to policies which are decided, and implemented, by one-off policy changes.

Automatic stabilisation, where the economy can be stabilised by processes called fiscal drag and fiscal boost. If direct tax rates are progressive, which means that the % of income, then a rapid increase in national income will be slowed down automatically. Fiscal drag means that, as incomes rise, the impact of rising incomes for the better off is reduced as they pay proportionately higher taxes, and the impact of rising incomes on the poor and unemployed is reduced as they come off benefits, and start to pay tax. The effect is that the increase in disposable income is moderated.

Fiscal boost

Similarly, a potentially rapid and deep decrease in national income would be prevented by fiscal boost. Fiscal boost means as incomes fall in a recession the impact of falling incomes for the better off is softened as they pay proportionately lower taxes, and retain more post-tax income.
The impact of falling income is to increase unemployment, but rather than experience a complete collapse in personal income, the unemployed, and the poor, receive benefits, and spend more than they would have without such benefits. Hence, a downturn in the economy is also ‘moderated’.

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