Question

What are the main sources of government revenues? Describe in detail the main expansionary fiscal policy tools that the government can use to expand an economy during a recession period.

Answer 1

The federal government collects taxes from income tax, payroll tax, and corporate tax.

State and local governments receive the major portion of their tax revenue from the property taxes and sales and gross receipts taxes. The tax basket is also made of corporate income tax, individual income tax, motor vehicle license tax.

There are both efficiency and equity arguments which suggests that it is quite better to have different tax jurisdictions on the basis of different tax bases. This logic is based on the argument that the federal government has better efficiency in collecting taxes from income as it is quite difficult for the individuals to hide the income by shifting it to across the national borders in comparison to state borders.

The equity argument is based on the fact that the redistribution of funds can be done efficiency by the Fed government from high income to low-income states.

Expansionary (or loose) Fiscal Policy

This mainly deals with increasing the aggregate demand and this is accomplished by the government by increasing the spending and facilitating the tax cuts. There will be the advantage to the customers by tax cuts as they will have excess money to spend and it will boost the AD. The main disadvantage of this policy is that the government will face the budget deficit and thus the government has to increase borrowings from the market.

expansionary fiscal policy mainly involves the reduction of tax rates in the economy in order to boost the consumption. This can be seen as one of the best strategies to be adopted during the great depression. As we know that during the depression, most of the people do not want to consume products and services as they have very limited money in hand and they want to save it for the unpredictable future. When the expansionary fiscal policy is employed and tax rates are relaxed, it facilitates the more money in the hand of the consumers, and with this excessive money, customer tends to buy the products and service. This boosts the demand in the economy resulting in greater production. This will require more employed to be employed and these unemployed people will start receiving salaries and thus the demand will be further boosted. In a way, a cycle of demand and production will help the economy to recover from the recession. Thus the expansionary fiscal policy is effective during the depression.

As there will be greater advantages in the form of improved demand, lower unemployment and so on by having an expansionary fiscal policy than paying for the debts, thus I would suggest that expansionary fiscal policy should be favored.