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How fiscal policy impacts business

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Last editedMay 20212 min read

The government’s fiscal policies of spending and taxation have an impact on every UK business, so it’s important to understand how it works. Keep reading to learn more about what fiscal policy entails and what it could mean for your business.

What is fiscal policy?

Fiscal policy refers to government actions, including new taxation and spending policies, designed to influence the economy through aggregate demand. There are numerous objectives involved, including stabilising economic growth, keeping inflation low, and stimulating growth during recessions. Depending on the objective, governments can pursue expansionary and contractionary fiscal policy.

  • Expansionary fiscal policy means higher government spending and lower taxes, designed to encourage consumer spending. It increases aggregate demand, but requires more government borrowing.

  • Contractionary fiscal policy means cutting government spending and raising taxes to reduce aggregate demand. With higher taxes, consumer spending reduces. Yet at the same time, a contractionary fiscal policy helps repair the government budget deficit through tax revenue.

We can see how fiscal policy has played out in the UK over the past decade. In 2009, the government cut VAT to boost consumer spending as part of an expansionary fiscal policy. As a result, government borrowing rose. Swinging back from this in 2010, the government reduced government borrowing with spending cuts, ushering in austerity measures.

These practices have a direct impact on businesses, since they determine VAT and your corporate tax bill. Fiscal policy also trickles down into the wider economy by impacting how much money consumers can afford to spend on goods and services.

Fiscal vs monetary policy

Fiscal policy is often used in conjunction with monetary policy, so it’s helpful to understand the difference between the two. Here are the primary differences when looking at fiscal vs monetary policy:

  • Monetary policy is concerned with changes to the money supply in circulation. It uses interest rates and is managed by a government’s central bank. The Bank of England has controlled monetary policy within the UK since 1997, determining interest rates to manage inflation and economic growth.

  • Fiscal policy is controlled by the government rather than the banks, and addresses both government spending and taxation.

While monetary and fiscal policy differ, they work together to achieve the same objectives of economic management.

Fiscal policy toolkit

As we’ve outlined above, there are two primary components of fiscal policy, including government spending and taxation. Here’s what is included in those actions, as well as how they have an effect on business.

1. Government spending

In the UK, government spending covers a wide range of different programs from the NHS to Education. Government spending typically breaks down into the following categories:

  • Infrastructure spending including hospitals, prisons, and roads

  • Current spending on state-provided services like health and education

  • Transfer payments for state pensions and other welfare payments

When the government spends more on welfare payments and infrastructure with an expansionary policy, it boosts consumer confidence. Increased government spending also increases government jobs, which translates to wider spending. Improvements to infrastructure require the use of independent contractors, further stimulating the economy and boosting aggregate demand. All of this is good news for businesses, who can enjoy greater demand for goods and services.

2. Taxation

The second component of fiscal policy is taxation, which is used by the government for purposes including the following:

  • Raising revenue to pay for increased government spending

  • Managing income and wealth distribution

  • Correct problems within the market

During an expansionary period of fiscal policy, taxes are reduced, which can boost business profits. On the other hand, contractionary fiscal policy calls for higher taxes and reduced spending. This has a direct impact on a business’s bottom line.

Overall, monetary and fiscal policy both affect small businesses along with the wider economy. Tighter fiscal policy causes the economy to contract, with reduced spending and demand. As a business owner, you must plan for these periods by tightening up your own budget accordingly.

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