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Fiscal Policy

Concerns about Fiscal Policy

Fiscal policy is highly susceptible to political and ideological influence because it is set by governments and elected officials.

There are several concerns and criticisms regarding the theories and implications of fiscal policies (policies a government uses to attempt to influence the economy). Federal, state, and local governments set fiscal policy, with most of the power to influence the economy being held within the federal government. All fiscal policymaking is subject not only to the considerations of economic theories, but also of political realities. Lawmakers want to enact policies that please their constituencies to ensure that they are re-elected to office. A positive result of this is that policymakers are forced to take measures to improve the immediate, day-to-day situations of their constituents. A negative effect is that policymakers risk being tugged this way and that by public demand or the news cycle. Additionally, lobbyists and corporations plead their cases to lawmakers to benefit industries they are advocating for. Furthermore, the policies that economic theory recommends may be politically unviable. This is especially the case with contractionary fiscal policies. Benefit cuts combined with tax increases are unpopular in almost all cases, even though they might be the required steps necessary to deal with an overheating economy.

Political pressure can tie the hands of lawmakers in other ways. Local governments in the United States, as well as member states of the European Union, have recently found their policy options limited by legislation requiring those governments to achieve balanced budgets. A balanced budget occurs when government expenditures and revenue are equal. Balanced budget requirements limit those governments' ability to enact expansionary policies, and leave them only with contractionary policy options. Policies such as this tend to arise from value judgments regarding fiscal conservatism (the belief that the government should spend little money) and size of government. This makes dealing with recessions and slow growth more difficult on the local level. In addition, when the general public sees government institutions only cutting staff, wages, and services, their trust in those bodies erodes, which can increase the complications for fiscal policies in the future.

Tax cuts reduce government revenue, money the government receives from taxes and other measures, which increases the national debt (total money a government owes to banks or foreign governments). If those tax cuts spur economic expansion, then decreases in government revenue might be offset by the ensuing growth. Or, once the tax cuts expire and new tax receipts come in, they may be sufficient to pay down the government debt, the total funds owed by a government. However, political circumstances may interfere. Tax cuts are popular; tax increases are not. In the modern American economy, enormous political pressure exists to drive taxes downward, despite what economic theory suggests.

As with monetary policy, the problem of lag, the delay between the enactment of a policy and that policy's outcomes, affects fiscal policies. The main lag affecting fiscal policy is the speed of the political process. Legislative lag is the time it takes to get a bill passed. Implementation lag is the time it takes to get a project started. In contrast, monetary policy does not encounter these latter types of lag, because central banks have the power to set policy as their boards see fit. The fiscal policy process moves more slowly. Legislative bodies debate, revise, and sometimes dismantle fiscal policy.