Tax and Fiscal Policy

Fiscal Policy

Taxes and Government Spending

Fiscal policy describes two governmental actions by the government. The first is taxation. By levying taxes the government receives revenue from the populace. Taxes come in many varieties and serve different specific purposes, but the key concept is that taxation is a transfer of assets from the people to the government. The second action is government spending. This may take the form of wages to government employees, social security benefits, smooth roads, or fancy weapons. When the government spends, it transfers assets from itself to the public (although in the case of weaponry, it is not always so obvious that the population holds the assets). Since taxation and government spending represent reversed asset flows, we can think of them as opposite policies.

In the first macroeconomic SparkNote on measuring the economy we learned that output, or national income, can be described by the equation Y = C + I + G + NX where Y is output, or national income, C is consumption spending, I is investment spending, G is government spending, and NX is net exports. This equation can be expanded to represent taxes by the equation Y = C(Y - T) + I + G + NX. In this case, C(Y - T) captures the idea that consumption spending is based on both income and taxes. Disposable income is the amount of money that can be spent on consumption after taxes are removed from total income. The new form of the output, or national income, equation reflects both elements of fiscal policy and is most useful for analysis of the effects of fiscal policy changes. 

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