Other Issues in Fiscal Policy

A second type of fiscal policy is built into the structure of government taxes and spending. This is referred to as “ non-discretionary fiscal policy” or more commonly as “automatic stabilizers”or“built-in stabilizers ”.

When the economy contracts, tax receipts automatically decrease (because incomes decrease). The effect is magnified by progressive taxation, (when the system is applying higher tax rates to higher incomes). Workers who are laid off automatically fall into a lower tax bracket. Their lower taxes will partially offset the effect of their lost income. Similarly, when incomes rise, particularly during inflation, bracket creep* pushes people into higher tax brackets. The higher taxes they pay take money out of their pockets – money they can no longer use to bid prices up even higher.

Another aspect of non-discretionary fiscal policy is welfare system which is government financial aid provided to individuals in need. The payment of unemployment benefits is a typical example of non-discretionary fiscal policy. The payments necessarily increase when the number of unemployed increases, and that is during an economic slow down. The payments necessarily decrease when the unemployed return to work with an economic recovery. The progressive income tax (the major source of federal revenue) and the welfare system both act to increase aggregate demand in recessions, and to decrease aggregate demand in overheated expansions. Fiscal policy exerts an automatic stabilizing effect on the economy, even when the government makes no explicit changes in its tax or spending plans.

Another issue in fiscal policy is multiplier effect or spending multiplier. It is the idea that an initial amount of spending (usually by the government) leads to increased consumption spending and so results in an increase in national income greater than the initial amount of spending. The multiplier effect has been used as an argument for the efficacy of government spending or taxation relief to stimulate aggregate demand.

Finally, like the multiplier, the propensities to spend and to save are at work. If the government reduces taxes to stimulate consumption, but households save money rather than to spend it, consumption will not rise, nor will investment. If people save the money, they are “sitting on their wallets” and consumption remains low. If consumption is low, businesses won’t invest. This has been a problem in the application of fiscal stimulus in Japan, where people tend to save increases in income.

Note: *bracket creep – переход в группу населения с доходами, подлежащими обложению налогами по более высоким ставкам

Ex. 1. Match the following Russian word combinations with their English equivalents:

Ex. 2. Based on your understanding of the text, are the following TRUE or FALSE?

1. Fiscal policy exerts an automatic stabilizing effect on the economy, even when the government makes no explicit changes in its tax or spending plans.

2. When the economy contracts, tax receipts automatically increase.

3. When the economy expands government spending for unemployment compensation, welfare, and other transfer payments increases.

4. Workers who are laid off automatically fall into a higher tax bracket.

5. The multiplier will boost the effect of an increase or reduction in taxes or spending.

6. If the government reduces taxes to stimulate consumption, but households save money rather than to spend it, consumption will not rise, nor will investment.

7. If people save the money, they are “sitting on their wallets” and consumption increases.

Ex. 3. Find information in the text to answer the following questions.

1. What are automatic stabilizers?

2. How does the multiplier effect work?

3. How can you account for the term ‘propensity to consume or to save’?

Text 3

While reading the text complete the gaps with the following words:

Should the Government Intervene in the Business Cycle?