Tax lever of fiscal policy

In the last blog I explained about monetary and fiscal policy. Here, in the Khan Academy, it explains some more about taxes as they pertain to fiscal policy. In the last example, under fiscal policy, taxes remained constant and spending went up. To do that, the government has to take on more debt. So the formula looks like this:

⬆️ GDP = C + I + G ⬆️ – NX

Where C = private consumption, I = mostly business investments, G = government expenses, and NX is net exports.     C and I remain constant, government expense goes up, so GDP goes up.

If taxes go down and government spending remains constant, private consumption and business investments will go up, so GDP will also go up. It is another way government can influence GDP:

⬆️ GDP = ⬆️ C + ⬆️ I + G – NX

Another way show it is in diagram format:

Govt. spending constant

As I stated in my last blog, the difference (for the most part) between the two parties, Democrats and Republicans, is that the Democrats, usually tend to want to increase taxes and the Republicans want to decrease, or at least not increase, taxes. In both cases National Debt takes the brunt. The Republicans want to see business investments increase, and consumption along with it. Fiscal policy, as desired by the Democrats, is a more direct government influence, so they see quicker results than the Republicans. Again, this is just a very generalized point of view, and depends very much on the market conditions.

The question remains: How much more debt can the government take on?

One thought on “Tax lever of fiscal policy

  1. The United States is a special case when it comes to national debt because the U.S. dollar is primary used world wide as a reserved currency. Many countries over the years have defaulted on their debt. Russia, Mexico and of course Greece just to name a few.

    Back in 1998, Canada came close to defaulting when our dollar when down to $0.62 to the U.S. dollar. No one wanted to buy our bonds, so the government had no choice but to cut spending and increase taxes.

    Zero interest rates for the past 9 years has allowed the U.S. to postpone dealing with future debt problems. U.S. national debt will continue to grow as long as countries and investors are willing to buy U.S. treasuries.

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