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Fiscal Policy

  A fiscal policy (from Latin fiscus, ‘rush basket’ or ‘purse’) refers to the changes in federal government spending and taxation in order to affect the general level of economic activity. Such policy was urged by John Maynard Keynes, the British economist, in the early 1930s when it appeared that monetary policy would not bring the UK or the US out of deep depression. The US Employment Act of 1946 adopted fiscal policy as a means of fighting unemployment.

In order to manage public expenditure and raise the revenue to pay for it, governments have to decide on forms of taxation and the volume of spending. Taxation can influence spending and working behaviour, and the distribution of income in a society. So governments choose a balance between direct and indirect taxation (for example, income tax versus value added tax); progressive or regressive taxation; taxing companies or individuals; the balance between earned and unearned income. Fiscal policy aims to plug loopholes, and must constantly adapt to new tax dodges. In addition, one eye has to be kept on other countries\' policy, as more favourable taxation policy elsewhere may lure away tax revenue producing multinational companies.

In addition to taxation, governments choose the volume of their spending. Spending is divided between current (pens, textbooks, salaries) and capital items, (roads, hospitals, sewers). Bids to cut spending usually focus on capital spending which can be cut more quickly and easily than current. It is easier to scrap a planned project then someone\'s salary. The drawback is that capital spending, as investment, may have a bigger multiplier effect on total spending; also, the infrastructure must be maintained and if neglected will collapse and cause further economic turmoil.

To slow an ‘overheated’ economy, fiscal policy would reduce government spending and/or raise taxes. Governments find either policy very difficult to adopt. Either action is likely to lose votes and financial support for legislators. Even when people agree generally that belt-tightening is required each of us prefers that it be someone else\'s belt. TF

See also deficit spending.



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