Effect of Taxes on the Economy 1. Expansionary fiscal policy 2. contractionary fiscal policy 3. supply side fiscal policy To close Recessionary gap using net taxes - net taxes goes down ==> AD to go up ==> real GDP to up ==> prices to go up. it's called expansionary fiscal policy To close expansionary gap using net taxes - net taxes goes up ==> AD to go down ==> real GDP to go down ==> prices go down . it's called contractionary fiscal policy supply side of using net taxes - lower business/corporate and sales taxes to close recessionary gap.
Fiscal policy can affect the Supply-Side of the economy by providing incentives to work and investment. The main measures of fiscal policy are Taxation and Government Expenditure. The fiscal authorities can employ a number of taxation measures to control Aggregate Demand or spending: Direct Taxes on individuals (Income Tax) and companies (Corporation Tax) can be increased if spending needs to be reduced, for example, to control inflation; i.e. an increase in income tax reduces people's disposable income, and similarly an increase in corporation tax leaves companies with less profit available to pay dividends and to reinvest. Alternatively, spending can be reduced by increasing Indirect Taxes: an increase in Value Added Tax on products in general, or an increase in Excise Duties on particular products such as petrol and cigarettes, will, by increasing their price, lead to a reduction in purchasing power. Taxation and government expenditure are linked together in terms of the government's overall fiscal or Budget position: total spending in the economy is reduced by the twin effects of increased taxation and expenditure cuts with the government running a budget surplus. If the objective is to increase spending, then the government operates a budget deficit, reducing taxation and increasing its expenditure. A decrease in government spending and an increase in taxes (a withdrawal from the circular flow of national income) reduce aggregate demand and, through the multiplier process, serve to reduce inflationary pressures when the economy is ‘over-heating’. By contrast, an increase in government spending and/or decrease in taxes (an injection into the circular flow of national income) stimulate aggregate demand and, via the multiplier effect, create additional jobs to counteract unemployment. In practice, the application of fiscal policy as a short-term stabilization technique encounters a number of problems that reduce its effectiveness. Taxation rate changes, particularly alterations to income tax, are administratively cumbersome to initiate and take time to implement. Also, changes in taxes or expenditure produce ‘multiplier’ effects (i.e. some initial change in spending is magnified and transmitted around the economy) but to an indeterminate extent.
Lower business taxes or lower sales tax=Increase in AS
Supply side
Tax cuts are more favorable by the public, can be implemented for a short time then be re imposed, tax changes can be implemented faster than government spending, however, government spending has a bigger impact.
Dr. Stephanie Powers, "Fiscal policy", Intro to Macroeconomics.(Lecture, Donald School of Business, Red Deer Alberta, Winter 2012)
1. Expansionary fiscal policy
2. contractionary fiscal policy
3. supply side fiscal policy
To close Recessionary gap using net taxes - net taxes goes down ==> AD to go up ==> real GDP to up ==> prices to go up. it's called expansionary fiscal policy
To close expansionary gap using net taxes - net taxes goes up ==> AD to go down ==> real GDP to go down ==> prices go down . it's called contractionary fiscal policy
supply side of using net taxes - lower business/corporate and sales taxes to close recessionary gap.
Fiscal policy can affect the Supply-Side of the economy by providing incentives to work and investment. The main measures of fiscal policy are Taxation and Government Expenditure.
The fiscal authorities can employ a number of taxation measures to control Aggregate Demand or spending: Direct Taxes on individuals (Income Tax) and companies (Corporation Tax) can be increased if spending needs to be reduced, for example, to control inflation; i.e. an increase in income tax reduces people's disposable income, and similarly an increase in corporation tax leaves companies with less profit available to pay dividends and to reinvest. Alternatively, spending can be reduced by increasing Indirect Taxes: an increase in Value Added Tax on products in general, or an increase in Excise Duties on particular products such as petrol and cigarettes, will, by increasing their price, lead to a reduction in purchasing power.
Taxation and government expenditure are linked together in terms of the government's overall fiscal or Budget position: total spending in the economy is reduced by the twin effects of increased taxation and expenditure cuts with the government running a budget surplus. If the objective is to increase spending, then the government operates a budget deficit, reducing taxation and increasing its expenditure.
A decrease in government spending and an increase in taxes (a withdrawal from the circular flow of national income) reduce aggregate demand and, through the multiplier process, serve to reduce inflationary pressures when the economy is ‘over-heating’. By contrast, an increase in government spending and/or decrease in taxes (an injection into the circular flow of national income) stimulate aggregate demand and, via the multiplier effect, create additional jobs to counteract unemployment.
In practice, the application of fiscal policy as a short-term stabilization technique encounters a number of problems that reduce its effectiveness. Taxation rate changes, particularly alterations to income tax, are administratively cumbersome to initiate and take time to implement. Also, changes in taxes or expenditure produce ‘multiplier’ effects (i.e. some initial change in spending is magnified and transmitted around the economy) but to an indeterminate extent.
Collins Dictionary of Economics, s.v. "fiscal policy," accessed April 13, 2012, http://www.credoreference.com.ezproxy.ardc.talonline.ca/entry/collinsecon/fiscal_policy
lower taxes=AD increase
- expansionary fiscal policy
increase taxes -AD decrease- contractionary fiscal policy
Lower business taxes or lower sales tax=Increase in AS- Supply side
Tax cuts are more favorable by the public, can be implemented for a short time then be re imposed, tax changes can be implemented faster than government spending, however, government spending has a bigger impact.Dr. Stephanie Powers, "Fiscal policy", Intro to Macroeconomics.(Lecture, Donald School of Business, Red Deer Alberta, Winter 2012)