Is government policy towards its raising of revenue and its level of (public) spending. The task of setting fiscal policy is undertaken by the Chancellor of the Exchequer . It is arrived at in the following order:
1. establish government economic objectives
2. decide on the correct balance between government revenue and government spending (known as the fiscal or budgetary balance)
3. make the individual decisions that are compatible with 1 and 2 and maximise political advantage. Such decisions may include increasing the tax on petrol or cutting government spending on the National Health Service.
In the circular flow of national income, taxes represent a withdrawal that is balanced by government expenditure on such items as pensions, unemployment benefit and so on. If the government takes in more than it spends, consumer spending power is reduced and demand falls, thus slowing down the economy. If it spends more than it takes in, then it increases demand and therefore increases economic activity. Because of the impact on demand, fiscal policy is often called ‘demand management’, as opposed to monetary policy, which attempts to control the economy through the money supply and interest rates.
From a government’s point of view, fiscal policy has the following advantages and disadvantages:
• government spending injected into the economy has a multiplier effect as it moves through the economy. For instance, if an unemployed person gets a job helping to build a new road, some of his or her wages will be spent on things which previously could not be afforded, such as new clothes. This creates demand in the clothing industry, so more people are employed to make clothes, which creates more income and so on. If the clothes are made abroad, however, it is the overseas economy and workforce that benefits
• revenue can be raised either through direct taxation, e.g. income tax and corporation tax , or through indirect taxation, e.g. VAT . Governments can alter the mix of the two for policy reasons, such as reducing direct taxation, which some believe has an important impact upon people’s incentives to work .
• the timing of government intervention is crucial, yet extremely difficult to judge
• many large-scale projects take a long time to have any effect on the economy. For instance, if a new motorway is to be built, it may take years of planning before the first contractor moves on to the site, by which time the economy may have recovered
• some economists believe that government spending has a ‘crowding out’ effect, meaning that any boost to the economy from the public sector is at the cost of the private sector