Fiscal policy is comprised of the actions taken by the government that set tax rates and government spending levels. How much tax we pay and how much healthcare is subsidised are important and immediate concerns, but the main influence of government is to set incentives. Government policy sets the broad framework of the economy. For example having higher taxes on consumption than income is an incentive for people to earn more and spend less. These incentives dictate the long term evolution of economic growth.
What drives fiscal policy?
The government has two main fiscal levers, tax revenue and public spending. Tax revenue is collected by the government and is distributed through providing public services. Fiscal policy is all about balancing these two factors. It is desirable to increase spending and reduce revenue in the near term as it will boost economic growth. However, one cannot indefinitely spend more than income, as this will require ever greater amounts of borrowing and debt.
Fiscal policy affects us all
Everyone is impacted by the decisions of government, as fiscal policy is difficult to avoid. Taxes are paid on the weekly wages and GST on a new pair of shoes. Tax collected is then used to fund public services, such as education and healthcare. The government also ensures those in need get sufficient help through welfare payments. Essential services that keep us safe such as law enforcement would not be possible without taxation. The diagram shows how the budget is spent on providing public services.
How can we measure fiscal policy?
As the government taxes many things and spends on many areas, it is difficult to tell if they are adding or subtracting from economic growth. The government’s operating balance is the difference between its revenue and expenditure. If the operating balance is increasing, it means the government is saving money or taking money out of the economy. If the operating balance is getting smaller (or a deficit getting larger) then the government is injecting money into the economy.
It may seem that reducing the operating balance will lead to economic growth. This is only true in the short term. If the government is persistently running deficits, that is spending more than it earns, it will have to borrow money to meet the shortfall. Accumulating more and more debt is not sustainable, as the government can become insolvent!
To find out more of what is happening with fiscal policy visit the Treasury website: www.treasury.govt.nz
The main publication of fiscal policy decisions is Treasury’s annual Budget (in May) and mid year Fiscal and Economic update (in December).