Question

Explain the differences between typical demand side fiscal policy and supply side fiscal policy. For each of the following fiscal policy proposals, determine whether the primary focus is on aggregate demand or aggregate supply or both. A 10% reduction in all tax rates both for businesses and individuals

Answer 1

The first difference is the focus of the fiscal policy. The demand side fiscal policy is intended to stimulate the aggregate demand and for this it is the household sector that is supported with the help of government policy. In contrast to it, supply side fiscal policy focuses upon firms and businesses with its policy initiatives so that production increases and benefits are transferred to the people. The second difference is the principle of economics to be considered. Demand side fiscal policy believes that demand creates its own supply, whereas supply side fiscal policy still thinks that it is supply that creates its demand. The third difference is the policy choice. The demand side fiscal policy uses direct government spending or change in income tax rates to stimulate the demand. The supply side fiscal policy uses business taxes as well as stimulus packages in terms of subsidies or other benefits to the firms.

Primary focus for the demand side fiscal policy is to stimulate or regulate household consumption and AD so that output is manipulated. Though, the secondary  focus is also to help supply gets demand to be catered and new jobs are created. But, supply side policies focus primarily on firms and expects that benefits passed to the firms, will be transferred to the consumers or households as a trickle down theory. But, it does not happen.

A 10% reduction in tax for individuals as a part of demand side fiscal policy, will cause spending to increase on the basis of increase in disposable income and tax multiplier applies to increase the AD. When 10% reduction in corporate tax happens as a part of supply side fiscal policy, then firms have to pay less tax and increase their profit level. But, this reduction does not translate into higher wages or lower price of the products. It makes no contribution in AD and later on firms keep beating the drum that demand is not there in the economy.