Which of these is a contractionary fiscal policy?
a. The federal government builds a new medical research center at a prestigious state university.
b. The President and Congress pass a new two-cent-per-gallon gasoline tax.
c. The federal government sends taxpayers up to $300 each in the form of an income tax rebate.
d. The sales tax on clothing is lifted for one week before the school year begins.
The correct answer and explanation is:
The correct answer is b. The President and Congress pass a new two-cent-per-gallon gasoline tax.
A contractionary fiscal policy is aimed at reducing aggregate demand in the economy to control inflation or prevent an overheated economy. This is achieved through measures that reduce government spending or increase taxes. The goal is to decrease overall economic activity, which can cool down inflationary pressures or curb excessive growth.
Option b represents a tax increase, which is a classic tool of contractionary fiscal policy. By raising taxes, the government reduces disposable income for consumers and businesses, leading to lower consumption and investment. Specifically, a gasoline tax would raise the cost of fuel, leading to higher transportation and production costs, which in turn can reduce consumer spending on goods and services.
In contrast, the other options are expansionary fiscal policies, which aim to stimulate economic activity:
- Option a (building a medical research center) involves increased government spending, which would boost economic activity by creating jobs and supporting research and development.
- Option c (income tax rebate) is a direct transfer of money to taxpayers, which increases disposable income and encourages spending, thus boosting demand in the economy.
- Option d (lifting the sales tax on clothing for a week) lowers the cost of goods, encouraging consumers to spend more, which also stimulates demand.
Therefore, option b is the only measure that reduces economic activity, making it a contractionary fiscal policy. The aim of such a policy is typically to prevent inflation or reduce budget deficits by slowing down economic growth.