By changing taxes and expenses, the state pursues a fiscal policy. It aims to regulate the level of activity in the economy and manage aggregate demand. If the same measures are related to legislative ones, the state pursues a discretionary fiscal policy. The government, as a rule, reports officially about it. Discretionary fiscal policy is accompanied by changes in tax rates, transfer payments, and public procurement. A sufficient reason for such a move can serve as fluctuations in investment. As part of total costs, this is the most unstable part of them, which destabilizes the situation as a whole. Changes in investments entail changes in employment, in the volume of production. By reducing or increasing taxes and spending, the government is trying to counteract this effect. Such a tool at one time used the government of T. Roosevelt in America.
It is known that tax cuts do not have such a strong effect as cost increases. This happens because consumer income is growing, but not fully utilized. Some of them remain, since the maximum tendency to spend does not reach unity. This phenomenon is known as a balanced budget multiplier. Simple calculations make it possible to see that it is 1. And this means that an increase in production and income corresponds to an increase in government spending. This pattern can be used by the government. When it wants to stop inflation, it is enough to reduce government spending and raise taxes, or do the opposite if the economy needs to be expanded. It seems to be very easy to do. But in practice, discretionary fiscal policy has some difficulties in use. These are problems of volume and time. The first includes the amount of regulation by the state and what kind of force there will be a possible effect. The second problem is that it is impossible to predict how long the time lags will last.
World practice shows that discretionary fiscal policy is often carried out on the basis of not very accurate statistics, as a result of which a destabilizing effect occurs instead of a stabilizing effect.
In order to somehow improve the current economic situation in the country, the following fiscal policy tools are used:
- Change those programs that are associated with costs. During the period of depression that swept the country, the government first of all begins with the implementation of those public investment projects aimed at overcoming unemployment. Often they are ineffective, as they are compiled in a hurry, ill-conceived, if only to provide faster employment for the population.
- Change of redistribution type waste programs. The growth of transfers increases aggregate demand. This is because increasing social benefits also increases household incomes. If other conditions are the same, consumer spending is also rising. Also, increases in subsidies to firms allow expansion of production. A decrease in transfer payments, on the contrary, leads to a drop in aggregate demand.
- Periodic fluctuations in the level of taxes. This tool acts in a different direction. Raising taxes leads to lower investment costs and consumer spending. Consequently, aggregate demand is falling. And, accordingly, a reduction in taxes leads to its growth and to the growth of real GNP.
In special situations, for example, in conditions when the country is experiencing an economic crisis, the state introduces a stimulating fiscal policy. In this case, the government should support supply and aggregate demand (or at least one of these parameters). To this end, the state increases the volume of services and goods it purchases, reduces taxes, and increases transfers as much as possible. Even the smallest of these changes will lead to the fact that the total output will increase, which means that the aggregate demand will automatically increase. The use of stimulating fiscal policy in most cases leads to this result.