Fiscal Policy Tools and the Macroeconomy

Consider a government program to purchase influenza vaccines for the elderly population every year. Which spending category do you think this program best falls into?

Incorrect. Although this is only for one group of individuals (the elderly), it is not a transfer of income.

Correct. This program would be current government spending because it regularly purchases goods and services.

Incorrect. Influenza vaccines do not add to the physical capital stock of the economy. Once consumed, they are used up.

One tax proposal being implemented in the European Union is a tax on some types of financial transactions. Which taxation category do you think this best falls into?

Incorrect. Since this is a tax on the sale of financial instruments, it is best categorized as an indirect tax

Correct. Since this is a tax on the sale of financial instruments, it is best categorized as an indirect tax.

Economists generally prefer taxes to be fair, efficient, simple, and sufficient. A fair tax system taxes people of the same income at the same rates and people of higher income at higher rates. A tax system is more efficient the less it changes people's behavior. A simple tax system makes it easy to comply with and enforce. A sufficient tax system raises adequate revenues. Many times, these desired traits conflict with one another. Consider, for example, a head tax. A head tax is a type of tax that is a fixed amount paid by all individuals (for example, if every citizen were required to pay USD 2,000 in tax). Why do you suppose most countries have abandoned this type of tax?

Incorrect. There is probably no tax simpler than a head tax. It is relatively easy to comply with and relatively easy to enforce.

Correct. Head taxes are simple and efficient (there's nothing that can be done to avoid them, so they don't change behavior). Although fairness is subjective, many saw a head tax as unfair. This is because it taxes low income individuals the same amount as high income individuals. Most countries have abandoned head taxes for this reason, despite their simplicity and efficiency.

Incorrect. A head tax is very efficient. Because there is no way to avoid paying it, it changes people's behavior relatively little.

In summary: [[summary]]

A government's fiscal policy tool set comprises its spending tools and revenue tools. Just as a hammer and a screwdriver have different uses in a physical tool set, different fiscal policy tools have different uses. Government spending tools roughly fall into three categories: __Transfer payments__ are a type of spending where the government effectively transfers income from one individual to another individual in the economy. Examples of transfer payments include welfare payments to poor individuals or state pensions for the elderly. __Current government spending__ is when the government purchases goods and services, usually on a regular basis. Examples include spending on education or military spending. __Capital expenditures__ are when the government buys items that add to an economy's stock of physical capital. Examples include spending on highway systems or physical university buildings.

There are many reasons a government may want to spend money. It may want to provide equal access to some services for all. It may want to redistribute wealth or income. It may want to boost its country's economic growth prospects. It may want to stabilize the business cycle through aggregate demand management. Or, it may want to encourage the development of risky new sectors of the economy, like green energy or biotech.

Governments implement taxes to raise revenues, redistribute income and wealth, and discourage some activities (like smoking). A government's revenue tools fall roughly into two categories: __Direct taxes__ are taxes on income and wealth. Examples include labor income taxes, capital gains taxes, taxes on corporate profits, or property taxes. __Indirect taxes__ are taxes on the sales of goods and services. Examples include excises taxes on specific goods (like cigarettes or gasoline), sales taxes, and value-added taxes.

Transfer payments

Current government spending

Capital expenditures

Direct taxes

Indirect taxes

It is not simple

It is not fair

It is not efficient

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