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What Is the Relationship between Fiscal Policy and Government Spending?

John Lister
John Lister

Fiscal policy and government spending are closely-related concepts: the latter is a key component of the former. Fiscal policy covers the actions taken by a government involving spending and taxation. This contrasts with the other main type of central economic control, monetary policy, which involves the availability and cost of money and credit. Fiscal policy and government spending can be used for both economic and political means.

At heart, fiscal policy is the government's budgeting process. It involves deciding how much to spend on public services such as infrastructure, the military or welfare payments. It also involves deciding how much to raise in taxes. In both cases, fiscal policy includes the total amounts spent or raised, and the specific amounts spent or raised from individual programs. Some policies may have specific measures, for example using a tax to influence behavior such as high sales tax on tobacco.

Government decisions and actions affect fiscal policies.
Government decisions and actions affect fiscal policies.

It's important to distinguish between the overall amounts spent and raised, and the balance between the two. Both of these have economic and political components. For example, a government may decide it wants to promote high public spending and raise high enough tax revenues to pay for it. Alternatively a government may decide that taxes should be low, and thus reduce public spending accordingly.

The balance between spending and revenue is also an important policy decision. Some governments aim for the two to be as close to identical as possible. Other governments argue for an expansionary policy, meaning if only temporarily, the government spends more than it receives. The argument is usually that this will benefit the country in the long-run and help increase future tax revenues. Some governments argue for a contractionary policy meaning spending is intentionally lower than tax revenue; the argument is usually that this will pay off past debts or build up a reserve.

Fiscal policy and government spending debates are sometimes confused by economic cycles. This is because year-to-year figures may be influenced by economic events. A government that doesn't change its overall policy may find welfare payments rise and tax revenues fall in unemployment increases, and vice-versa.

Technically there is a third strand to fiscal policy, namely borrowing. In one sense this is simply a logical conclusion of the other two: if spending exceeds taxation, borrowing is seemingly inevitable. In practice a government can make decisions about how to fund these shortfalls. As well as borrowing, for example by issuing bonds, it can use existing reserves built up when taxation exceeded spending, or it can sell off government-owned assets. The prospect of taking these measures may influence the decisions made in wider fiscal policy and government spending.

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    • Government decisions and actions affect fiscal policies.
      By: Simfalex
      Government decisions and actions affect fiscal policies.