The basic function of government fiscal policy is to control the money supply and interest rates. Through changes in taxes and its expenditure, the government seeks to stabilize the ups and downs of the national economy and tries to increase overall output and income. In doing so, fiscal policy generates a surplus (if total revenue exceeds total expenditure) or a surplus budget (if total expenditure exceeds total revenue). However, sometimes the government has to resort to means that have a significant adverse effect on revenue generation. Such measures include inflation and excessive deficits.
A surplus budget, by definition, implies that government earns more income from the revenue it raises than it spends. A deficit on the other hand, implies that the government spends more than it earns. This difference between surplus and deficit is often referred to as the capital structure. When the gap between surplus and deficit is large enough to warrant concern, there is a potential threat to financial liquidity and creditworthiness. Interest rates are also likely to be affected if the government goes into deficit.
In order to counter this potentially problematic scenario, the United States government implements several policies. One of these is called the automatic budget reconciliation procedure. As the name suggests, this system involves reconciliation of the government’s financial records to identify any areas where actual expenditure exceeds revenue. Once this is identified, a government may choose to adopt the revenue-spending restraint or the revenue-loading restraint to counter the potential for future outflows.
Another policy that the government implements is the revenue efficiency policies. These policies aim to provide incentives for the government to earn more revenue by improving tax collection efficiency. For instance, if a company is able to reduce its tax bill by $1 million in a given year (the so-called “burden share”), the government is likely to adopt measures that will further reduce the company’s expenditure and increase revenue generation.
One way to improve tax collection efficiency is to improve internal accounting systems. In this regard, the government implements a policy that requires publicly traded corporations to itemize their tax liabilities. The itemization is done on an International Accounting Standards Board basis. This is an important measure because accounting systems that are able to properly document and account for the itemized tax liabilities of a corporation (even if such accounting systems do not directly represent the government) can help provide accurate medium for tax reporting to the government. Internal controls can also ensure that government revenue collected does not exceed the maximum amount allowed by the tax expenditure caps established by Congress.
The government can implement fiscal policy by increasing the tax credit available to low and middle-income households, reducing the rate at which income taxes are levied, reducing the corporate tax rate, and encouraging entrepreneurship. These measures, taken together, are expected to raise government revenues enough to support the government’s welfare programs and social programs. Another way to raise government revenues is to reinstate the earned income tax credit (EITC). Both these policies are designed to boost economic activity and increase government revenue.
In addition to its direct effects on government finances, a government policy that encourages entrepreneurship also has indirect effects on other economic variables. The more economically efficient a country is, the greater its ability to attract capital and hire workers. For instance, a business that has a strong system of commercial law and that enjoys stable exchange rates is more likely to succeed than one that is still developing and in need of certain procedural safeguards. This form of policy therefore indirectly boosts economic output through the creation of jobs, improved infrastructure, and a more favorable environment for start-ups. However, because a higher share of capital income goes to high-income families, a reduction in the corporate tax rate can affect employment levels, thereby reducing the scope for economic volatility.
As fiscal policy continues to evolve, researchers have continually searched for methods to better understand the relationship between fiscal policy and economic development. They have developed a set of guidelines called the Basel III rules, which were established to assist international banking institutions in providing independent judgments about whether countries are in a position to meet their debt and GDP needs. In addition to helping policy makers determine the safety of their national debt, the Basel III guidelines have also helped policy makers to determine the appropriate mix of publicly and privately provided credit, as well as the amount and frequency with which governments should draw on external financing resources to finance their activities. It is unclear whether the current efforts by governments to reform their fiscal policies will achieve all of the goals that they have set forth. Nevertheless, it is likely that they will at least introduce some measures to help increase sustainable economic growth.