A government affects the economy in many ways, including through fiscal
policy, the way the government taxes its population and spends its
resources, and through monetary policy and regulation, which is covered later. All
governments require money to operate, so they raise money through taxation. Often
governments augment the income generated through taxation by borrowing money. Most
governments tax and spend using myriad methods, including spending, borrowing, and
running deficits, all of which strongly affect the economy.
THREE STRATEGIES USED BY GOVERNMENTS TO IMPROVE THE
ECONOMY
|
Fiscal Policy
|
Monetary Policy
|
Regulation
|
| Governments create tax policies and budgets that allow them
to allocate resources the most efficiently. | Governments control the amount of money circulating in the
economy to control inflation, borrowing, and spending in order to
stabilize the economy. | Governments establish economic rules to protect consumers,
balance labor and capital, and foster an atmosphere of fair
trade. |
Taxes
Taxes are seldom neutral. Most tax systems produce winners and losers
because governments frequently use their tax policies to encourage—or
discourage—certain types of behavior. If a government wants to reward
investment, for example, it might cut taxes on capital gains (income earned from
selling investments). Alternatively, if a government wishes to discourage
drinking alcohol, it might tax liquor at a high rate.
In addition to various taxes on goods and services, most governments rely
on one, some, or all of three types of income taxes: progressive, regressive,
and flat. Progressive and regressive taxes directly affect income distribution.
Regardless of which tax system is used, governments shape people’s behavior
through the taxes they levy on citizens.
