Fiscal Policy and the Effects on Unemployment

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  • 0:01 Intro to Fiscal Policy
  • 0:46 Review of Fiscal Policy Basics
  • 2:47 Taxation and Unemployment
  • 5:22 Government Spending…
  • 6:43 Government Debt and…
  • 7:54 Lesson Summary
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Lesson Transcript
Instructor: Aaron Hill

Aaron has worked in the financial industry for 14 years and has Accounting & Economics degree and masters in Business Administration. He is an accredited wealth manager.

Review what fiscal policy is and how the two key components of fiscal policy can be used to influence unemployment. Find out when and how fiscal policy can be used and why it is so important.

Intro to Fiscal Policy

Take a look at your next paycheck stub or last income tax return. Consider how easy or hard it has been for you and your friends or family to find jobs. Why do we ask you to think about this? The answer is because fiscal policy has an effect on the taxes you pay, your ability to find a job, and the overall financial health of the economy.

The federal government creates regulations and policies to protect or benefit American families, many of which may have economic impacts, such as creating new jobs. Many of these policies revolve around fiscal policy and improving unemployment, which we will now explore further.

Review of Fiscal Policy Basics

Before we dive into how fiscal policy effects unemployment, let's first review the basics. Fiscal policy is best described as taxation and spending policies that the government pursues in an effort to influence the overall state of the economy. Its roots come from the British economist John Maynard Keynes. A few of the primary goals of fiscal policy are to reduce unemployment, control inflation, and encourage economic growth.

Have you ever spent more money in a month than you made? Maybe you needed a big down payment for a new car, needed to buy a new computer for school or work, or simply had repairs on your apartment or house. You may have gotten a loan from the bank, used excess cash reserves, or put those expenses on a credit card. Much like your own personal situation, government fiscal policy can be described in a similar way. Sometimes the government has a loose or expansionary fiscal policy strategy, which is when spending is higher than revenue coming in, known as a deficit. Other times, it is said to be tight or contractionary when revenue/taxes coming in are higher than spending, also known as a surplus.

One of the most recent and publicized fiscal policy examples came in 2012 when Americans were worried that the fiscal cliff, a simultaneous increase in tax rates and cuts in government spending, would send the U.S. economy back to recession. The U.S. Congress avoided this problem by passing the American Taxpayer Relief Act of 2012 on Jan. 1, 2013. This act addressed issues, such as income tax rates, payroll tax rates, tax credits for low-income families, and tax breaks for businesses.

Now that we have reviewed the basics and seen a recent example, let's see how fiscal policy can affect unemployment.

Taxation and Unemployment

Why does the government work so hard to control unemployment? The answer is largely based on self-preservation. Unemployment negatively impacts the federal government's ability to generate income and also tends to reduce economic activity. When unemployment is high, fewer people are paying taxes to the government to help it run.

Additionally, unemployment results in fewer people with income to spend on goods and services. When less people have money to go out to eat, buy gifts, or shop at the local stores, this lowers spending. This in turn makes it more difficult for businesses to profit and expand, which can result in lower job growth and lower overall economic growth.

So how does the tax side of fiscal policy affect unemployment? Taxation is one of the primary fiscal policy tools the government has at its disposal to reduce unemployment. When unemployment is high or the economy needs a boost out of a recession, the government can lower the tax rates on businesses and individuals, ultimately putting more money into the hands of consumers. In general, as consumers spend or demand more goods and services, businesses make more money and need to hire more people to keep up with increased demand. This in turn can result in more people paying taxes into the government and generating revenue.

For example, if you owned a local coffee shop and residents now had more money to spend, they may come visit you more often to indulge in that special treat or experience you offer. When they demand more baked goods and coffee, you may need to hire an additional employee to keep up so that you can maximize your revenue. As this happens across several different businesses and local economies, it can have a largely positive effect on employment.

On the other hand, if employment was full and the economy was thriving at peak capacity, the government could raise taxes to cool things off a little and try to avoid high inflation, which is an overall increase in the price of goods. Higher taxes mean consumers now have less disposable income to buy your coffee and baked goods. When consumers buy less, your business takes in less revenue, and ultimately, you are less likely to hire new workers. You may even lay off workers to reduce costs.

Now that you understand how the tax component of fiscal policy works, let's discuss the spending side of things.

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