Fiscal Policy

Financial Dictionary -> General Finance -> Fiscal Policy

Tax and expenditure changes can be a very effective way of influencing demand. In effect this is what Fiscal Policy is; a government policy that keeps the economy and inflation in check by altering tax. Governments across the world have different stances on fiscal policy. Some like to keep it neutral, some like to alter it for growth and others pay little attention to it.

A tax increase effectively reduces the spending power of the taxpayers because it reduces their disposable income. The opposite works for a tax decrease. It can be used selectively to target particular groups of people or specific types of spending, meaning fiscal policy doesn't affect all people in the same way, which often causes controversy among those highly affected.

Depending on the current status of the economy the government will have different fiscal policy objectives. For example:

To increase the amount of new businesses the government could cut corporation tax for small firms. To cut consumer spending sales tax (in the UK VAT, in Canada GST) can be increased. To improve the wealth of the poor the government could increase the amount in higher band of income tax, whilst reducing the amount in the lower band, or cutting the starting rate so the poor need to earn more before tax is paid.

It is not just tax that is used as part of fiscal policy, but also various forms of government spending. For example if in general the government just cut government spending then there would be less money in the economy, which can have numerous outcomes.
Fiscal policy is closely related to other government policies, most notably Monetary Policy, which controls the money supply in the country.