Introduction to Fiscal Policy

Economics: IB Diploma, topic 2.5.1

Fiscal Policy

Fiscal policy is one of the two tools for managing the economy (the other is monetary policy).

While policymakers at the Federal Reserve make monetary policy, Congress and the President make fiscal policy.
Fiscal policy refers to how the federal government manipulates taxation and spending to achieve macroeconomic goals, such as full employment.

Government spending covers a range of services that the federal, state and local governments provide.
National defense, Social Security, healthcare and interest payments account for roughly 73% of all federal spending in recent years.
Federal taxes, the government's revenue source, come from individual income taxes (due every year on April 15 and by far the largest single source), payroll tax (social insurance and retirement receipts), and finally corporate income or profits tax.

The federal income tax is progressive which means the marginal rate of tax increases as income increases.
For example, income below $9,700 (for a single taxpayer) is taxed at 10% but income earned between this and $39,475 is taxed at 12% (2019 tax brackets).
Regressive income taxes see the marginal rate fall as income rises.
The Social Security payroll tax is proportional up to the wage limit, but above that level, it becomes a regressive tax, meaning people with higher incomes pay a smaller share of their income in tax.

The government spending multiplier is always higher than the tax multiplier.
This is because the government directly demands goods and services and tends to obtain them domestically. The initial government spend is a component of AD.
In contrast, tax cuts go into the pockets of households and businesses and can be spent in many different ways, if at all. If the extra income is kept under a mattress then there will be no impact on AD.

Why do governments implement fiscal policies?
Which of the following is NOT one of the main areas of federal government spending?
Which of the following is NOT a tool of fiscal policy?