Fiscal policy

Fiscal policy Fiscal policy is controlled and implemented by the U.S. Congress (the House of Representatives and Senate) and the President. This type of economic policy focuses on how the federal government collects money (revenue) and how it spends that money. Most government revenue comes from taxes. You’re probably most familiar with income taxes. The Internal Revenue Service (IRS) collected roughly $2.0 trillion in 2025. That’s a large amount, but the government spent even more than it collected, which is known as deficit spending. Fiscal policy determines how much tax is collected, how taxes are assessed on individuals and businesses, and how government spending is directed.

Sidenote

The Internal Revenue Service (IRS) The IRS is a well-known government institution. Millions of Americans file taxes each year and may owe money to the IRS. The IRS carries out these roles on behalf of the federal government:

Collecting taxes

Providing assistance to taxpayers

Investigating instances of tax fraud

Investors pay close attention to the IRS because most investment returns are subject to taxation. Broker-dealers report these returns directly to the IRS on various tax forms. The investor then confirms that information when filing their own tax return. If an investor doesn’t file properly, they may be audited (investigated) and could face IRS enforcement actions. A lien is a legal claim the IRS places on property to secure payment of a tax debt. A levy is the legal seizure of property to satisfy that debt. For example, if an investor doesn’t pay capital gains taxes, the IRS may place a levy on the investor’s paycheck. This can result in part or all of the investor’s earnings being collected until the tax is paid. The IRS is an agency of the U.S. Department of Treasury, the same organization responsible for issuing U.S. government debt securities.

Sidenote

Progressive vs regressive taxes The IRS enforces a progressive tax system for personal income taxes. People with higher income levels pay higher tax rates on their income. You don’t need to memorize the details, but the lowest federal income tax bracket is 10% (for those with low reported income), while the highest bracket is 37% (for those with high reported income). Estate and gift taxes are also progressive. An estate refers to assets owned by a deceased person that are eventually distributed to heirs and beneficiaries. For tax year 2026, the federal government taxes estates above $15 million and gifts above $19,000. In a progressive system, smaller amounts generally result in lower tax obligations. A regressive tax system applies the same tax rate regardless of income level or the amount of money involved. Sales tax is a common example. Whether you’re a billionaire or have no reported income, you pay the same percentage tax on items you buy at the store. Excise tax, a tax on a specific good (e.g., cigarette taxes), is also regressive.

Keynesian (demand-side) theory

A modern approach to fiscal policy called Keynesian (demand-side) theory was developed by British economist John Maynard Keynes during the Great Depression era. The core idea is that increased government spending can drive economic growth. In a recession, Keynes argued that the government should spend large amounts of money. That spending increases demand for goods and services and can raise employment. For example, the American Recovery and Reinvestment Act of 2009 was enacted during the Great Recession of 2008. The bill led to more than $800 billion in spending on infrastructure, healthcare, education, and social programs during the most severe economic collapse since the Great Depression. More than a decade later, many economists agree the legislation reduced unemployment and encouraged economic growth. If the private (non-government) sector isn’t hiring or spending enough to keep the economy growing, the government can increase spending, including through deficit spending. Keynesian policy also works in the opposite direction. When inflation rises because the economy is “overheating,” the government can reduce spending to help stabilize prices. Keynes also argued that tax rates can be used to influence the economy:

In a recession, tax rates should fall to encourage individuals and businesses to spend more, supporting economic growth. In an inflationary environment, the government should raise taxes to help stabilize prices.

Supply-side theory

In many ways, supply-side theory is the opposite of Keynesian theory. As the name suggests, supply-side theorists focus on increasing the supply of goods and services across the economy, often through reduced taxation and reduced government spending. A recent example is the Tax Cuts and Jobs Act of 2017, which resulted in significant cuts to individual income, corporate, estate, and portfolio (investment) income tax rates. When comparing supply-side and demand-side (Keynesian) theory, the key difference is what each view treats as the main driver of economic activity:

Demand-side proponents emphasize demand for goods and services, including demand created by government spending. Supply-side proponents emphasize the supply of goods and services produced by the private (business) sector.

Summary of fiscal vs. monetary policy

Both fiscal and monetary policy are used by the government to influence the economy. You’ll want to know how they differ, who controls them, and the main tools each policy uses.

Fiscal policy

Controlled by Congress and the President

Keynesian (demand-side) theory

Increased gov’t spending benefits the economy

Supply-side theory

Decreased gov’t spending benefits the economy

Monetary policy

Controlled by the Federal Reserve

In a recession

Increase (loosen) money supply

Bring interest rates down

In an inflationary environment

Decrease (tighten) money supply

Bring interest rates up

Key points

Fiscal policy

Relates to taxation and gov’t spending

Controlled by Congress and the President

Internal Revenue Service (IRS)

Government agency responsible for:

Collecting taxes

Providing assistance to taxpayers

Investigating instances of tax fraud

Progressive tax systems

Higher taxes if more money involved

Examples:

Income taxes

Estate taxes

Gift taxes

Regressive tax systems

Flat tax rates

Examples:

Sales taxes

Excise taxes

Keynesian (demand-side) theory

Gov’t spending and taxation influence the economy

In a recession:

Gov’t spending increases

Tax rates fall

In an inflationary environment:

Gov’t spending decreases

Tax rates rise

Supply-side theory

Reduced gov’t spending and taxation stimulate the economy