Fiscal Policies mean changes by the government in the TAX rate or public-sector government spending in order to influence business activity.
The government first collects TAX revenue, in addition to other sources of revenue from sales of public land or privatization of state-owned businesses. Then, the government spends the money on public projects including social security payments, healthcare system, public education, public transportation, infrastructure such as new roads, bridges and airports, and so on.
There are two types of Fiscal Policies.
- Inflationary fiscal policy. This expansionary policy is used to boost business activity to get the economy out of a recession and to reduce unemployment. TAXes will be decreased while government spending will be increased to speed up economic growth.
- Deflationary fiscal policy. This constraining policy is used to slow down business activity to cool the economic growth and lower inflation. TAXes will be increased while government spending will be decreased to slow down economic growth.
Different types of TAXes: Direct TAXes
Direct TAXes are paid directly by employees and businesses to the government.
1. Individual Income TAX. Paid by employees from their Income Before TAX, or Gross Income. The specific amount of TAX charged depends on the amount of income. It can be fixed (everyone pays the same TAX rate regardless of income), or progressive (lower TAX rate applies to low earners while higher TAX rate applies to high earners).
The higher the Individual Income TAX, the less money people have to spend and save.
The lower the Individual Income TAX, the more disposable income individuals have.
2. Corporate TAX. Paid by companies from Net Profits Before TAX. The specific amount of TAX charged depends on the profit that the company made in the last fiscal year – usually between April 1 and March 31.
The higher the Corporate TAX, the less money to reinvest back into the business for future growth, and less money for shareholders to be paid as dividends.
The lower the Corporate TAX, the more money the business will have for reinvestment, and more people will be willing to invest in the business as they will get paid higher dividends.
Different types of TAXes: Indirect TAXes
Indirect TAXes are added to prices of products and paid by customers when they make the purchase.
1. Consumption TAX (VAT, GST, IPI, or Sales TAX). Customers pay this TAX when they purchase goods and services from businesses. Consumption TAX is added to final prices. There will be different rates of Consumption TAX depending on the type of item sold. Usually, for essential items like food, basic clothes and water, Consumption TAX will be quite low. Some products may even have 0% Consumption TAX.
The higher the Consumption TAX, the higher the prices of goods in the shops would be. Therefore, overall demand for products will decrease.
The lower the Consumption TAX, the lower the prices of goods in the shops would be. Therefore, overall demand for products will increase.
2. Import Tariffs and Quotas. Import Tariffs are special TAXes added on imported products. This duty is calculated as a percentage of the value of goods being brought into the country from abroad. Usually, there are different tariffs for different classes of goods. Quotas are physical limits on the quantity of goods that can be imported into a country. While an embargo is a complete ban on importing a certain product.
These restrictions have several purposes. First, the government can control imports to protect local businesses against foreign competition that may lead to lower demand, hence loss of sales. Domestic companies will benefit as imported goods will be more expensive. Second, the government can also raise additional money to boost the national budget.
However, Import Tariffs and Quotas may increase the cost of production (Cost of Goods Sold (COGS)) for domestic firms that rely on imported raw materials and components for making their goods. For businesses that bring finished goods from abroad to resell in the country, the costs will also increase. Therefore, Gross Profit Margin (GPM) will decrease.
In the worst-case scenario, other countries may retaliate by taking similar, the same, or even worse actions. Therefore, local businesses that export products will face trading difficulties that may lead to lower demand, hence loss of sales, in those foreign markets.
