Question

How can expansionary and contractionary tax policies be used to manage the economy? Provide your answer in two to three sentences.

Answer 1

Expansionary tax policy—cutting income or corporate taxes or increasing transfers—raises households’ and firms’ disposable income, boosting consumption and investment to raise aggregate demand and help close a recessionary gap. Contractionary tax policy—raising taxes or reducing transfers—lowers disposable income and demand to cool an overheating economy and help bring inflation down, though it can slow growth and must be used carefully.