Advantages and Disadvantages of Fiscal Policy

11 May

Fiscal Policy is a use of taxes and subsidies, or government expenditure to control aggregated demand. Increase in taxes causes left shift on aggregated demand because tax on certain good will increase the price of the good. In addition, increase in income tax will decrease the amount of available income which leads to the decrease in aggregated demand. Subsidies on the other side, encourages people to purchase by reducing the price. Subsidies and Taxes uses law of demand in order to control aggregated demand.

Advantages of using fiscal policy is that it can significantly impact the national income and therefore have immediate effect on the economy. In addition, taxes on negative externalities decreases consumption of negative externalities or demerit goods. Similarly, subsidizing merit goods or public goods will increase the consumption. Another advantage is that tax cuts on wages encourages people to work and therefore, shift the long run aggregated supply curve to the right. Lastly, different rate of taxes on different levels of income reduces gap between the rich and the poor. Not only controlling aggregated demand, fiscal policy in long term can benefit the society in many different ways.

However, there are some disadvantages of fiscal policy. One of them is its inflexibility. Changes in direct taxes or government spending may take considerable time because of both political and moral reasons. For example, taxing rich people more than the others might be unfair for them. Another disadvantage of fiscal policy is that another problem can rise when solving the other. For example, stimulating aggregated demand to decrease the demand-deficient unemployment may worsen inflation because right shift in aggregated demand will cause rise in price level. Reversely, decreasing aggregated demand in order to decrease inflation will cause demand-deficinet unemployment.

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One Response to “Advantages and Disadvantages of Fiscal Policy”

  1. 12hsuela May 13, 2011 at 2:35 am #

    Good points. Old people would complain if inflation increased as a result of increase in AD and increased spending would worsen debt at least in short term.

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