Question

We have been discussing the policies of the U.S. Government. If you were to advise the government, what directions would you give to the federal government regarding fiscal policy?

Support your opinion within an economic framework.

Answer 1

Before we look at the possible fiscal policy, the following points about the economy is important to note -

Point 1 - The US government debt stands at $22 trillion and is over 100% of GDP. The swelling debt has been as a result of sustained fiscal deficits.

Point 2 - For the US economy and for any economy in the world, the government sector is a relatively static sector of the economy. The dynamic sectors (growth triggering) are the private sector and household sector. Therefore, anything that negatively impacts the dynamic sectors is bad for the economy.

Coming to the policy action. I would recommend the following -

1. Since economic growth is healthy, the government needs to curb spending and ensure that budget deficits are minimized. High government debt and sustained deficits results in crowding out of investments from the private sector. This will translate into weak economic growth. Therefore, the first priority is to cut spending.

2. Further, since economic growth is robust, it makes sense to increase taxation on the rich. Since US is a consumption driven economy, higher taxes for the middle-class would negatively impact growth. However, taxing the rich can help in reducing budget deficits in addition to curbing government spending.

3. Another key measure would be to create conducive policies for the private sector to encourage local investment. This can potentially include providing tax breaks for local manufacturing units, among others. However, the key objective should be to trigger higher growth in specific industries in the private sector.

Overall, the objective should be to have a smaller government with role that is limited to oversight and conducive policy creation that helps the dynamic sectors flourish.