Governments only have an indirect control over the economy. Direct control, speaking generally, is in the hands of banks, foreign investors and corporations. This does not mean that government is powerless. Fiscal policy is the means of a government to influence the economy. It revolves around two words: tax and spend.
The basic features of a government's fiscal policy are the ability to extract resources from the economy and to spend these resources on areas in its interest. In general terms, one important modern view of fiscal policy is the ability of government to adapt to the business cycle of "boom and bust." This view holds that government spending should increase during the "bust" cycle, while it should contract during the "boom" cycle. This means that the state can act to stabilize the economy in bad times.
The concept of a boom and bust economy puts certain basic obligations on fiscal policy. To increase spending in bad economic times means to put money into the economy that the bust cycle will not do on its own. This includes unemployment insurance and other human services during times of unemployment and other economic dislocations. When times are good, the government can pull its spending back and enjoy the higher tax revenues good economic times usually brings.
Fiscal policies can create or alter the structure of economic expenses. To tax something is to almost automatically reduce demand for that item. To spend money to subsidize a behavior will cause a rush on that specific behavior. For example, if the state does not like smoking because of the health risks, it can tax cigarettes so as to provide more incentive to quit. If the government subsidizes college educations for the poor, this means that more people will shift their resources to education, since they are receiving government help.
When governments spend beyond their means, they create debt. Debt can be carried to the extent economic growth will always cover interest payments and any credit problems. If a country, such as the United States, is a global market, then debt can be carried since that market is essential for the global economy. For example, China and Russia own a great degree of American debt. But since the Chinese economy is based largely around exports to the U.S., that debt will just have to be carried by the Chinese for the sake of its own economic health. Therefore, the strength of the domestic market is determinate of the amount of debt a state's fiscal policy can carry.
Ultimately, fiscal policy is about the distribution of wealth. One group is taxed in order for another group to benefit. When a state taxes a part of the population, such as the middle class or cigarette smokers, it seeks to benefit at the expense of someone else. Therefore, any government's fiscal policy is really based on the state's coercive power to remove money from the economy and to spend it where it will.
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