Tax and Spend

Posted by Irwan

February 9, 2008

Today we are going to talk about government and economy. Sounds like history lessons right? hehe

Okay, we don’t know much about how the whole system of government works but we know two things about them; they tax and they spend.

Sounds like a bad guy right? Not really. In fact, those are the most influential things that government can do in our economy. I going to talk more about US government as they have longer history and we might get something from it.

Before our time, government and economy were not as related as today. Government left the matter to market players such as firms, investors and customers. They played nice with each other and live happily ever after except they were not. The former is correct that they played nice with each other, perfectly followed the theory of Microeconomic( supply vs demand theory). However the second part, which applies to everything in reality, is not true.

Then come the Great Depression. People started questioning why depressions happen. According to supply and demand theory, this is not possible. Along come the Macroeconomists that try to explain three most important thing that micro can’t explain

Inflation
Aggregate Growth
Unemployment

Government role in economy started to increase as microeconomists suggested that government should play a role as a buffer. Here are two main action that government has to take accordingly:

Expansionary: Reduce tax and increase spending to get the economy from slumber/recession

Contractionary: Increase tax and reduce spending to slow overgrowth economy (to reduce inflation).

But what happen if economy is in recession and inflation in a rise? That question is the beauty of macroeconomy where people are trying to explain the reality that’s not suppose to exist in theory.

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