Which of the Following Does Fiscal Policy Strive to Balance?

Fiscal policy plays a key role in shaping a country’s economic stability and growth. It involves government decisions on taxation, spending, and borrowing to influence demand, employment, and inflation. Striking the right balance ensures development without excessive debt or instability.

Governments must manage revenue collection and public expenditures while addressing inflation, unemployment, and national debt. Achieving this balance requires strategic planning to promote growth while maintaining financial responsibility.

Government Revenue Strategies

Governments rely on multiple revenue sources, with taxation being the most significant. Income taxes, corporate taxes, and consumption-based levies like value-added tax (VAT) or sales tax generate substantial funds. In the United States, individual income taxes accounted for about 50% of total federal receipts in 2023, followed by payroll and corporate income taxes. Countries with progressive tax systems impose higher rates on higher earners, while others, like Estonia, use a flat tax model where all individuals pay the same percentage.

Beyond taxation, governments generate revenue through fees, fines, and licenses. Vehicle registration fees, business permits, and environmental compliance charges contribute to public funds. Excise taxes on goods such as tobacco, alcohol, and fuel serve both as revenue sources and regulatory tools. The UK levies a fuel duty of 52.95 pence per liter on petrol and diesel, significantly affecting transportation costs.

Sovereign wealth funds and state-owned enterprises also supplement government revenue. Countries rich in natural resources, such as Norway, invest surplus oil revenues into sovereign wealth funds, which had assets exceeding $1.4 trillion in 2024. Singapore’s Temasek Holdings manages government investments in telecommunications, banking, and real estate, generating returns that bolster public finances.

Public Expenditure Priorities

Governments allocate public funds to infrastructure, healthcare, education, defense, and social welfare. Infrastructure investments improve roads, bridges, and public transportation, supporting economic activity. The U.S. Infrastructure Investment and Jobs Act of 2021 allocated $1.2 trillion to modernize highways, upgrade rail networks, and expand broadband access, aiming to reduce transportation costs and attract investment.

Healthcare funding ensures access to medical services and supports a productive workforce. Countries with universal healthcare, such as Canada, allocate substantial public funds to ensure citizens receive medical care without financial hardship. In the U.S., Medicare and Medicaid accounted for about 25% of federal spending in 2023. Preventive care and medical research help reduce long-term healthcare costs by addressing health issues early.

Education spending supports workforce development. Public funding covers primary and secondary schools, vocational training, and universities. Germany emphasizes vocational education, funding apprenticeship programs that equip students with specialized skills for high-demand industries. In the U.S., federal and state governments provide grants and subsidized loans to increase access to higher education, though rising tuition costs remain a concern.

Defense expenditures cover military personnel, equipment, cybersecurity, and intelligence operations. The U.S. defense budget exceeded $800 billion in 2023, reflecting commitments to global security and technological advancements. European countries have increased military spending in response to geopolitical tensions, balancing security needs with other public services.

Social welfare programs provide financial assistance to low-income individuals, retirees, and people with disabilities. Public pension systems, such as Social Security in the U.S. and the UK’s State Pension, ensure income stability for older populations. Unemployment benefits and food assistance programs help mitigate economic hardship during downturns. Aging populations in many countries are increasing pressure on pension and healthcare systems, requiring sustainable funding mechanisms.

Budget Deficit and Surplus Interplay

Governments adjust fiscal policies to manage the balance between revenue and spending, leading to either a budget deficit or surplus. A deficit occurs when expenditures exceed revenue, requiring borrowing to cover the shortfall. This often results in the issuance of government bonds, which investors purchase in exchange for periodic interest payments. The U.S. issues Treasury securities such as T-bills, notes, and bonds to finance deficits, with the national debt surpassing $34 trillion in early 2024. Persistent deficits increase debt servicing costs, diverting funds from other priorities.

A surplus arises when government revenue exceeds spending, allowing for debt reduction, investment in long-term projects, or the creation of reserve funds. Norway’s Government Pension Fund Global, built from surplus oil revenues, illustrates how disciplined fiscal management can create financial stability. While surpluses provide flexibility, maintaining them for extended periods may indicate excessive taxation or underinvestment in public services, potentially slowing economic growth.

Cyclical factors influence whether a country runs a deficit or surplus. During economic downturns, governments often increase spending on stimulus programs while tax revenues decline, leading to temporary deficits. Conversely, strong economic periods generate higher tax receipts, sometimes resulting in surpluses. The COVID-19 pandemic underscored this dynamic, as many nations expanded fiscal stimulus measures, significantly increasing deficits to support businesses and individuals.

Addressing Inflation Concerns

Governments use fiscal policy to manage inflation by influencing aggregate demand through spending adjustments and taxation policies. When inflation rises beyond target levels, reducing discretionary expenditures and limiting subsidies can help temper excessive demand. Scaling back non-essential programs or delaying infrastructure projects can ease pressure on supply chains and prevent overheating in sectors experiencing price surges. In 2022, several European nations reduced energy subsidies after inflationary pressures intensified, aiming to curb excessive consumer spending.

Taxation policies also influence inflation. Increasing direct taxes, such as higher marginal rates on personal income or corporate profits, can reduce disposable income and slow demand-driven inflation. Adjustments to indirect taxes, like VAT or excise duties, affect consumption behavior. The UK temporarily reduced VAT on hospitality services during the pandemic to stimulate demand but later reinstated standard rates as inflation accelerated. Targeted tax measures can either dampen or stimulate specific sectors, depending on economic conditions.

Employment Objectives

Fiscal policy influences labor market conditions by shaping job creation and economic activity. Public sector hiring, infrastructure investments, and targeted subsidies for businesses help generate employment opportunities, particularly in industries facing downturns. The U.S. CHIPS and Science Act, passed in 2022, allocated $52 billion to boost domestic semiconductor manufacturing, creating thousands of high-tech jobs and reducing reliance on foreign supply chains.

Tax incentives and direct subsidies encourage businesses to expand their workforce. Hiring credits, such as the U.S. Work Opportunity Tax Credit, provide financial benefits to companies employing individuals from disadvantaged backgrounds, including veterans and long-term unemployed workers. Wage subsidies, commonly used in countries like Australia, help businesses retain employees during economic slowdowns, preventing mass layoffs. These measures stabilize employment levels and prevent prolonged economic stagnation.

Debt Servicing Approaches

Managing national debt requires balancing repayment obligations with economic growth. Governments employ various strategies to ensure debt remains sustainable while maintaining fiscal flexibility. Refinancing existing obligations by issuing new bonds at lower interest rates helps reduce borrowing costs. Countries with strong credit ratings, such as Germany, benefit from lower yields on government securities, making debt servicing more manageable. Nations with higher risk premiums, like Argentina, face steeper borrowing costs, limiting their ability to refinance efficiently.

Inflation-linked bonds and extended maturity structures provide additional tools for managing debt burdens. Issuing long-term debt instruments spreads repayment obligations over decades, reducing short-term fiscal pressure. The UK issues gilts with maturities exceeding 50 years, allowing governments to lock in favorable interest rates for extended periods. Some nations use inflation-indexed bonds, such as U.S. Treasury Inflation-Protected Securities (TIPS), to align debt servicing costs with economic conditions, ensuring real repayment values remain stable over time.