Taxation and Government Spending
As with monetary policy and as discussed in the overview of fiscal policy, legislators have the option to enact an expansionary or a contractionary policy, meaning the nation will either tax lightly and spend heavily or maintain high tax levels alongside a budget surplus (or decreasing deficit). Per political norm, these choices have loose party associations as well as optimal implementation periods in times of economic downturn or over-inflation. While America’s course of action certainly depends on elements such as recent economic events and incumbent president or congressional majority, the various aspects of congress’s choices deserve analysis, including effects on the American public, current and future economic impact, and indicators on global economic well-being.
Congress first must choose whether expansionary or contractionary policy better fits the current economic climate by considering recent economic growth and inflation. John Maynard Keynes, the father of fiscal policy, promoted expansionary policy in order to stimulate consumer demand thereby bolstering economic growth. Despite Keynes’s support, congress may face uncertainty in choosing to follow devout expansionism due to the inflationary problems, as well as the partisan issues regarding government spending and taxation.
The first of two methods for employing expansionary fiscal policy comes in the form of raising government spending to encourage infrastructure growth while putting more money into the hands of consumers. Increased spending on infrastructure would create jobs in the construction and manufacturing industries, thereby lowering the unemployment rate and pushing government money to the public. Alternatively, the government can more directly allocate its money to individuals by increasing transfer payments and subsidizing social welfare. Transfer payments include systems like unemployment benefits and welfare, whereas farm and technology subsidies attempt to stimulate the economy by bolstering production of large corporations, who often proceed to increase their workers’ compensations. Drastic spending increases and budget deficits experience opposition from many classical economists, among other schools of thought, making a perpetually increasing deficit a difficult measure to consistently push through congress.
Congress can also follow an expansionary fiscal policy by maintaining current levels of government spending while decreasing the tax rate at all levels. Lower income tax gives the public more disposable income which will increase consumption at all income levels, whereas a decreased consumption tax will lower the price of all taxable goods, making their consumption more likely and frequent. As discussed, greater consumption generally encourages economic growth, but an effective universal increase in income could simply increase the cost of living, negating the benefits of more consumption. Further, the general income tax rate begins to encroach upon politically partisan issues as opposed to strictly economic considerations; the politically liberal tend to advocate for a varied tax structure with low tax levels for low earners and high levels for high earners, whereas politically conservative tend to argue for lower taxes on the rich to promote increased spending and a “trickle-down” system of wealth. An excessively low-rate tax system could also have a negative impact on general government function since they may receive little funding. Proponents of higher taxation often use this argument to support their contractionary stance.
Generally, congress only employs contractionary policy to control the inflation rate when it begins to spiral upwards. However, prominent Nobel Prize winning economist Milton Friedman argued that expansionary policy would only promote instability and inflationary trouble, therefore leaning toward a contractionary stance. Friedman, alongside other proponents of contraction, values a stable growth rate and an optimal inflation rate over bullish economic growth, which represents a conservative and traditional perspective defined by a balanced budget and ample taxation.
Contractionary policy believes a balanced budget, if not a small surplus, will optimally control both the economy’s and the inflation rate’s long-term growth. By spending little on social programs and infrastructure, the government keeps more money in its own hands, thereby maintaining control over the money supply; this control allows the government to effectively control the average consumer’s demand, thereby giving it control over the average cost of living and inflation rate. While a constant and optimal inflation rate proves valuable in the long term, it also sacrifices current consumption and growth by forcing money from the hands of consumers. The government’s large role in contractionary policy makes it aversive to most republicans, while the lack of funding for social programs conflicts many democrats; these politically motivated factors make debt decreasing propositions infrequent and unpopular in Congress.
As an alternative method of putting more money into the government’s hands, congress could also vote to raise income and consumption taxes. This measure would reduce consumption due to the decrease in disposable income, while also providing the government with more leverage over the cost of living and inflation rate (similar to decreased spending). Many economists hold similar hesitancies to decreased spending on economic growth grounds, but the American population also interjects regarding this issue as a politician running on a platform of drastic tax increases will seldom get elected. The public opposition of higher taxes organically makes this form of contractionary policy largely unemployed, with tax hikes of over five percentage points (~15% of current tax rate) not witnessed since 1993.
Currently, Congress chooses to practice an expansionary style with an increasing budget deficit and a relatively stable tax rate, with a small decrease (two percentage points) for the highest bracket under President Trump. In the future, the congresspeople citizens elect will determine whether the economy could see drastic growth alongside a spiraling inflation rate, or steady growth with a stable inflation rate. This makes determining whether you prefer lower taxes and an increasing deficit or higher taxes with a more stable deficit, as the macro-scale preference of the public will determine the direction of the economy for the foreseeable future.
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