Tax and Fiscal Policy

Summary

Taxes are an integral part of your life as an American. Each April you spend countless hours pouring over records and receipts, or paying an accountant to do this, in preparation for income taxes. Similarly, in most states whenever you purchase something, like clothing or a car, you are required to pay sales tax. These are just two of the most common taxes faced by the American people. Others include luxury tax, inheritance tax, and corporate income tax. What is all of this tax money used for? Why does the amount of tax change from place to place and from year to year? These are all questions for this SparkNote.

Tax revenues are used to support government spending. Health care, defense, social security, and politicians' salaries are all government expenses. From an economic standpoint, it is reasonable to think of the American government as one large company. The total amount of government spending is dictated by the governmental budget, just as the spending of a company is dictated by the budget.

Through taxes and government spending, the American government has a direct hand in the workings of the economy. By changing either taxes or government spending, the government affects the amount of money available to the public. Changes in taxation and in government spending are called fiscal policy. The government actively uses fiscal policy to steer the American economy. In this SparkNote, you will learn both how and why the government utilizes fiscal policy.

But fiscal policy is not the only means that the government possesses to steer the economy. Through monetary policy, the Fed is able to affect output. The key factor that the Fed uses to affect the economy is the interest rate. Because the growth of the economy is dependent upon the interest rate, by manipulating this variable the Fed can effect an increase or decreases in output to help maintain stable growth and low inflation. The workings of monetary policy will also be revealed in this SparkNote. Together, monetary policy and fiscal policy work together as reigns to steer the mighty horse of the economy in the right direction.