Which of the following is considered contractionary fiscal policy?
Group of answer choices
Legislation removes a college tuition deduction from federal income taxes.
Congress increases the income tax rate.
The New Jersey legislature cuts highway spending to balance its budget.
Congress increases defense spending.
The Correct Answer and Explanation is :
The correct answer is: Congress increases the income tax rate.
Explanation:
Contractionary fiscal policy refers to actions taken by the government to reduce the level of aggregate demand in the economy. This is typically done to combat inflation or an overheating economy. The goal of contractionary fiscal policy is to slow down economic growth by either decreasing government spending or increasing taxes, both of which reduce the amount of money circulating in the economy.
Let’s go through each of the options provided:
- Legislation removes a college tuition deduction from federal income taxes.
- This action may reduce the amount of taxes people can deduct, which can result in individuals paying more in taxes. While it might indirectly lead to reduced consumer spending, this is not a typical form of contractionary fiscal policy. It’s more of a tax reform measure.
- Congress increases the income tax rate.
- This is a classic example of contractionary fiscal policy. By increasing taxes, individuals have less disposable income, which leads to a reduction in consumer spending. In turn, this slows down aggregate demand and can help to cool off an overheating economy, which is the primary aim of contractionary policy.
- The New Jersey legislature cuts highway spending to balance its budget.
- While this action involves reducing government spending, which is a component of contractionary fiscal policy, the primary aim here is more related to fiscal balance rather than intentionally cooling off the economy. Still, it does reduce the overall level of spending in the economy.
- Congress increases defense spending.
- This is an example of expansionary fiscal policy, not contractionary. Increasing government spending, especially in areas like defense, boosts aggregate demand, stimulates economic growth, and is typically used to combat recession, not inflation.
Thus, the action that most directly reflects contractionary fiscal policy is increasing income taxes, which directly reduces consumer spending and slows down the economy.
Let me generate an image that illustrates the concept of contractionary fiscal policy.
Here is an illustration that depicts contractionary fiscal policy, showing a decrease in aggregate demand due to an increase in taxes. It visually represents how the policy works by shifting the demand curve downward as taxes rise, reducing disposable income for individuals. Let me know if you’d like further details or any changes!
