Business success often depends on the economy. Companies are more likely to thrive when the economy is strong than when it is not. Fiscal policy influences the direction of the economy by shaping how governments raise and spend money. If companies are deciding whether to expand or cut back, fiscal policy changes like increases in tax rates or decreases in government spending can influence their decisions. When governments use fiscal policy to stimulate or slow the economy, businesses usually adapt accordingly.
British economist John Maynard Keynes formulated the theory that governments influence economies by changing tax rates and spending levels through fiscal policy. The economy then impacts the business cycle, affecting factors like inflation, employment and consumer spending. The U.S. government assumed control of the nation’s fiscal policy after the Great Depression in the 1920s.
While the federal government’s fiscal policy has the greatest impact on the national economy, the decisions of local and state governments also can affect the business cycle. Executive and legislative branches often form fiscal policy based on how the economy affects their constituencies. Leaders combine monetary policy, which determines the money supply, with fiscal policy to meet economic goals.
Taxes and spending are the primary levers in fiscal policy. Governments raise money by levying taxes on income, investment gains, sales and property, for example. They then spend their revenue on expenses like infrastructure projects, social programs and government salaries. Governments can spend more if they collect more in taxes. But they collect taxes from consumers and businesses, which means companies and their employees may have less to spend.
A government may implement an expansionary fiscal policy to stimulate the economy such as during a recession. This means that it will lower taxes so that businesses and consumers will have more money to spend. But the government also may spend more of its revenue by increasing unemployment benefits or buying goods and services from businesses. This can give businesses and their employees more to spend, further stimulating the economy.
If an economy is too strong, the value of money may decrease through inflation, meaning businesses and consumers might have to pay more to acquire goods and services. When prices rise too high, governments may implement a contractionary fiscal policy to slow economic growth. They commonly will do so by increasing taxes or decreasing government spending so that businesses and consumers have less money to spend. Higher prices and less revenue can cause profits to decrease, which means that businesses could hire fewer workers or delay expansion plans.
Governments strive to balance taxing and spending so that the economy remains strong for a long time. If an economy grows too quickly, inflation can set in, thus prompting a government to implement a contractionary policy. But if economic growth is too slow, or recedes or stops altogether, then the government may have to implement an expansionary policy instead. Businesses can plan best and prosper most in steady economies without booms and busts.