United States Fiscal Policy: Structure, Evolution, and Economic Impact Research Paper

Introduction

The U.S. fiscal system is three-tiered, and taxation operates at the federal, state, and local levels. However, Congress essentially controls the spending and tax system in the United States. The executive branch of government significantly influences the fiscal policy pursued by a given administration. There are two types of expenses: discretionary and mandatory.

The former is allowed through annual appropriations, which are included in the annual budget. Most of the national programs and activities function at the expense of appropriations. Discretionary spending is governed by rules and processes established by Congress to ensure funds are distributed as appropriated. It is the easiest way to increase spending, as it does not require a particular vote. U.S. fiscal policy stimulates the economy created by Congress and involves increasing spending and reducing taxes.

The Laissez-Faire Economic Tradition in U.S. State Governments

Up to the Great Depression of the 1930s, the United States state governments had an extensive laissez-faire approach to economic policy. The government has historically tried to avoid interfering in economic affairs. The government’s representatives hoped it could keep a balanced budget (Bricker, 1944). Nonetheless, there were economic downturns before the Great Depression. However, the laissez-faire approach to the economy tended to succeed because the economy tended to self-correct.

The New Deal and the Evolution of Federal Budgetary Policy

Under the New Deal, President Roosevelt first instituted new budgetary principles in the U.S. (Bricker, 1944). Early attempts were not very successful, although this was also because company expectations had already been severely reduced by the Great Depression. Currently, the U.S. government is highly decentralized. Hence, state and federal taxes are both applicable and are entirely separate. Each level provides its authority to collect taxes. Therefore, the federal government cannot interfere with the state’s taxation system.

The Structure of State and Local Taxation in the United States

Every state has a unique tax structure distinct from other states’ tax structures. Some local governments in the state also charge taxes (Financial Report of the United States Government – Executive Summary – an Unsustainable Fiscal Path, n.d.). For instance, counties or localities may impose taxes in addition to state taxes. The parallelism concept also applies in the United States, allowing the taxation of the same income at the federal, state, and municipal levels. Except for Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming, which don’t have a state income tax, the majority of the 50 states impose a personal income tax (Financial Report of the United States Government – Executive Summary – an Unsustainable Fiscal Path, n.d.). Only a few states impose income taxes at rates that exceed 10%. However, in state tax revenues, this tax makes up about 40% (Financial Report of the United States Government – Executive Summary – an Unsustainable Fiscal Path, n.d.). Naturally, state taxes are significantly lower than the federal tax rate. Most states and some municipalities levy income tax on individuals who work or reside within their jurisdiction.

Fiscal and Monetary Policy: Tools for Economic Influence

Politicians try to affect the economy by enacting fiscal and monetary measures. With modifications to interest rates, bank reserve requirements, purchases and sales of government securities, and foreign exchange, central banks can indirectly target activity by modifying the money supply (Horton & El-Ganainy, 2022). Governments affect the economy by altering tax rates and kinds, expenditure amounts and structures, and borrowing amounts and types.

GDP and Government’s Role in Aggregate Demand

Governments have a direct or indirect impact on how the economy uses resources. It is explained by the basic accounting equation for national income, which compares an economy’s output (or GDP) to its spending: GDP = C + I + G + N.X. (Horton & El-Ganainy, 2022). The GDP indicator on the left represents the value of all final goods and services generated in the economy. The sources of total demand or spending are shown on the right.

This equation is crucial to fiscal policy and shows that governments impact the economy (GDP). Hence, G may likewise be controlled by altering taxes, transfers, and spending. Expansionist or “loose” fiscal policy is described as increasing aggregate demand directly through more government expenditure (Horton & El-Ganainy, 2022). Fiscal policy, on the other hand, is frequently regarded as contractionary or “tight” if it lowers demand through decreased expenditure.

Short-Term and Long-Term Goals of Fiscal Policy

Beyond the supply of goods and services, the objectives of government fiscal policy include public safety, roadways, and elementary education. Governments may concentrate on macroeconomic stabilization shortly. Examples include tax reductions or increases meant to boost a flagging economy and spending reductions or increases intended to control inflation or lessen external vulnerabilities.

The long-term goal is to encourage sustainable growth or decrease poverty by improving infrastructure and education through supply-side impacts. Despite the similar aims, their relative importance differs based on the country’s conditions. Short-term priorities are influenced mainly by the business cycle, the response to a natural disaster, or a rise in the price of food or fuel worldwide.

Long-term motivators include the state of development, population trends, or the availability of natural resources (Reports Explore Fiscal Challenges Facing U.S. State and Local Governments, 2010). In a prosperous economy like the U.S., pension changes may focus on long-term expenditures associated with an aging population. In contrast, fiscal measures to eliminate poverty may push a low-income country to direct spending on primary healthcare.

Taxation of Non-Resident Businesses and International Treaties

The amount of financial room the government has for further spending programs or tax reductions heavily influences the precise reaction to the problem. Since their prospective creditors feared that increased expenditure and borrowing would put too much pressure on inflation or foreign reserves, several governments could not respond with stimulus. Lenders may doubt a government’s capacity to manage its financial resources properly or rescind recently implemented incentives. Based on the action of stabilizers, more onerous budgetary restrictions for certain governments entail expenditure reductions when revenues fall.

Fiscal stimulus is likely ineffective or undesirable for a country with high inflation or an external current account deficit. For instance, in the U.S., non-resident businesses’ income taxation is based on their interactions with the government (Britannica, 2019). The degree and level of presence, the availability of offices and staff, and storage facilities are often assessed. The withholding tax applies to some non-business income from U.S. sources, such as interest, dividends, and royalties. It is calculated on a gross basis at the rate. The United States has signed tax treaties with more than 50 nations to avoid double taxation and deter tax evasion.

The government adjusts its budgetary allotments for public expenditure to implement U.S. fiscal policy to ensure that local essential goods and services are offered to residents. By altering the quantity of money in circulation, infrastructure expenditure, for instance, improves access to new roads and aids job creation by promoting economic development (Britannica, 2019). On the other hand, lowering income or value-added taxes impacts the rise in disposable income.

Raising income taxes, however, decreases disposable income while expanding the tax base for public spending. The U.S. government employs powerful fiscal policy instruments to fight poverty and raise neighborhood standards of life. Increased government expenditure guarantees the general public access to essential public goods and services (Britannica, 2019). Such a method promotes economic expansion, job opportunities, and sustained growth and development.

The U.S. government’s fiscal policy is highly successful and efficient at the state level. For instance, tax reductions and cash transfers enhance disposable income and redistribute resources within society from the wealthy to people in need (Horton & El-Ganainy, 2022). Fiscal policy aids in shielding the populace from labor market turbulence that may result from rivalry or economic efficiency and harm regular people. The majority of states and certain municipalities in the U.S. impose sales and use taxes, but there is no federal consumption tax.

Each state determines its tax rate and guidelines for how purchases are taxed. In the Wayfair case, the U.S. Supreme Court overruled prior court rulings on June 21, 2018, prohibiting states from requiring merchants to pay sales and use taxes unless they have a physical presence (Horton & El-Ganainy, 2022). While there are still many unsolved issues, the overall Wayfair case ruling is anticipated to expand the number of states requiring merchant corporations to collect and remit sales and use taxes.

Conclusion

In conclusion, a stable fiscal policy is considered a public debt to a gross domestic product that is stable or declining over the long term. Up to the 1930s Great Depression, the American government’s fiscal policy was laissez-faire. The government made its fair share of taxes and expenditures throughout this time, but there was no deliberate policy influence on the economy.

The Great Depression and the election of President Franklin D. Roosevelt brought about a radical transformation in everything. Income, labor, sales, property, dividends, imports, and different levies are all subject to taxation. The aim, which includes battling inflation, taming the economy’s cyclical oscillations, and lowering unemployment, determines fiscal policy. The state controls real national income and aggregate demand via taxation, expenditure on the general government, and transfer payments.

References

Bricker, J. W. (1944). Federal and state fiscal policies local government essential to federal system. Vital Speeches of the Day.

Britannica. (2019). Fiscal policy. In Encyclop忙dia Britannica. Web.

Financial Report of the United States Government – Executive Summary – An Unsustainable Fiscal Path. (n.d.). Fiscal.treasury.gov. Web.

Horton, M., & El-Ganainy, A. (2022). Fiscal policy: Taking and giving away. IMF. Web.

Reports Explore Fiscal Challenges Facing U.S. State and Local Governments. (2010). PR Newswire Association LLC.