Fiscal policy is a broad term, describing the policies enacted around government revenue and expenditure in order to influence the economy. Governments can increase their revenue by increasing taxes, or increase their expenditure by spending money on programs.
Expansionary fiscal policies are usually implemented during recessions because they attempt to increase economic demand, and as a result, increase economic output which is reduced during a recession. Expansionary fiscal policies involve reducing taxes or increasing government expenditure.
Remember that government revenue is based on collected taxes. When taxes exceed government spending, the government is characterized as having a surplus. When taxes equal government expenditures, the government has a balanced budget. When the government spends more than the revenue it collects, it has a deficit. Increasing government spending, creating a budget deficit, and financing the shortfall through debt issuance are typical policy actions in an expansionary fiscal policy scenario.
Due to the funding process of expansionary policy, there is a lack of consensus among economists with respect to the merits of fiscal stimulus. The discord mostly centers on crowding out, defined as government borrowing leading to higher interest rates that in turn may offset the stimulative impact of government spending. When the government runs a budget deficit, funds will need to come from public or foreign borrowing. As a result, the government issues bonds. This raises interest rates across the economy because government borrowing increases demand for credit in the financial markets. This may in turn reduce aggregate demand for goods and services, which defeats the purpose of a fiscal stimulus.
Fiscal stimulus is implemented with the view that tax relief through a reduction in tax rate and or direct government spending through investment (infrastructure, repair, construction) will provide stimulus to increase economic growth by directly influencing consumption or the government expenditure component of GDP .
Fiscal policy: Taxes
Taxes have not only been a way to initiate fiscal policy intervention, but have also been used to solidify popular approval. In the picture above former President George W. Bush is signing into effect the Tax Relief Reconciliation Act of 2001.