Fiscal policies refer to economic policies adopted by the government to regulate and control economic activities, as well as stimulating economic growth and development through manipulation of government expenditures and taxation. Fiscal policies are implemented to influence aggregate demand and supply within the economy. Hansen (2010) defines fiscal policies as taxation and spending policies adopted by the government to manipulate the macroeconomy. Fiscal policies usually affect government budgets by increasing or decreasing expenditures and taxes of the government. Thus, a fiscal policy contains two major instruments, namely government expenditures and taxation.
The government collects revenue through taxation to fund expenditures such as provision of education and healthcare facilities to the citizens. When the government expenditures exceed revenues, the resultant is a budget deficit, while an excess of revenues over expenditures leads to budget surplus. According to Taylor (2009), budget deficits and surpluses are harmful to the economy and thus require adequate fiscal policies to correct and regulate such budgeting challenges.
Implementation of Expansionary Fiscal Policies in Government Expenditures and Taxation. An expansionary fiscal policy is a form of economic policy, which aims at increasing government expenditure, transfer payments and reducing taxation. Expansionary fiscal policies are used by governments during economic recessions to stimulate the economy.The use of expansionary fiscal policies requires a government to reduce its taxation and increase total government expenditures.Expansionary fiscal policies aim at increasing the amount of money supplied to the economy so as to encourage economic activities and curb price increases.In my opinion, expansionary fiscal policies are used to encourage economic growth during recessions.
According to Taylor (2009), Frenkel and Razin (2008), an increase in purchases by the government and transfer payments, such as retirement pensions and unemployment benefits, would result into increased aggregate expenditures. Consequently, the government budget grows larger, and budget surplus reduces. For effective implementation of expansionary fiscal policies, the government increases spending and purchases of final goods and services such as provision of national security and defense. Government purchases form a large part of gross domestic product. Expansionary fiscal policies can also be implemented through increased funding of state agencies and corporations. This results into increased productivity in the economy as well as creation of more employment opportunities.
Similarly, the government may reduce taxes levied on personal incomes, business returns and corporate profits. Hansen (2010) defines taxes as involuntary payments made to the government by citizens and businesses that may be levied on income, wealth, profits and consumption expenditures such as value added tax (VAT). The government uses revenue generated through taxation to provide public goods such as infrastructure and other government functions.
In my view, expansionary fiscal policies thus involve decreasing taxes from individuals. A reduction in taxes often provides households with additional disposable income. This consequently leads to increase in consumption expenditures.
Additionally, when the government increases transfer payments, the disposable income of households also increases. Consequently, aggregate consumption and production are stimulated as well as creation of employment opportunities. This finally results into increased income to the citizens.
However, Keynesians warn that the government can only increase expenditures by a small percentage due to the multiplier effect of aggregate expenditures on aggregate demand.
Implementation of Contractionary Fiscal Policy in Government Expenditures and Taxation. A contractionary fiscal policy refers to a form of economic policy that involves reduction in the government expenditures and transfer payments, which is accompanied by an increase in taxation. According to McConnell and Brue (2011), economic policy makers and governments use contractionary fiscal policies to regulate inflationary problems.Contractionary fiscal policies usually involve a decrease in government spending or expenditures and transfer payments. This eventually leads to a reduction in disposable income for households; hence decline in demand for goods and services.Just like expansionary fiscal policies, contractionary fiscal policies also entail regulation of the two sides of the government budget; the expenditures side and revenue or taxation side.
For effective implementation of contractionary fiscal policies, the government must reduce its expenditures or spending on goods and services and transfer payments as well as reduce funding of government agencies. This results into a decrease in aggregate consumption and production, disposable income available to households and low rates of inflation.
An increase in taxation also deprives households their disposable income that they may use for consumption expenditures. Taylor (2009) asserts that reduced transfer payments also lead to a decline in disposable income for households. These result into reduced demands for consumer goods and services hence decline in production. Consequently, inflationary pressure on the economy is reduced.
In conclusion, both expansionary and contractionary fiscal policies are usually adopted by governments to induce economic stability.