This paper examines the two primary fiscal policy tools governments use to combat economic recession: tax reduction and increased government spending. It begins by explaining how economic contractions reduce consumer demand, leading to unemployment and declining business activity. The paper then analyzes how lowering taxes reduces the fiscal burden on businesses, freeing capital for investment and expansion. It also explores how government spending on infrastructure and construction projects creates employment, raises aggregate demand, and generates new revenue opportunities for private firms. Both approaches are evaluated for their role in raising the marginal propensity to consume and restoring broader economic activity.
Economic contraction produces a decrease in demand driven by declining purchasing power among consumers. As demand falls, businesses contract their operations, which in turn increases unemployment — firms require less labor when sales and revenues shrink. This self-reinforcing cycle of reduced demand, declining business activity, and rising unemployment defines the core challenge governments face during a recession.
Traditionally, fiscal policy is designed to restart the economy following a recession. Restarting the economy means encouraging businesses to return to pre-recession levels of production, create jobs, and boost employment. With this goal in mind, fiscal policy aims to establish the necessary conditions for businesses to operate and grow within a difficult economic environment shaped by prior contraction.
There are two main, broadly accepted fiscal approaches a government can apply to encourage economic growth: lowering taxes or increasing government spending. Increasing government spending creates new projects that employ individuals and thereby reduce unemployment. This paper examines how each of these fiscal policies functions from an economic perspective and what impact each has on the broader economy.
The first fiscal method is to lower taxes. Lowering taxes reduces the fiscal burden on businesses, meaning that the total sum a firm must pay to government and local authorities decreases. In practical terms, after subtracting expenses from revenues and accounting for other fees and interest payments, the company retains a greater net sum available for investment and profit redistribution. This additional capital allows companies to expand their operations even within a difficult macroeconomic environment, stimulating the economy at an aggregate level.
Tax reductions therefore act as a supply-side stimulus: by allowing businesses to keep more of their earnings, the policy incentivizes investment, hiring, and expansion. This mechanism is a central argument behind supply-side economics, which holds that reducing the tax burden on producers ultimately generates broader economic benefits.
The second fiscal approach is increased government spending. Government spending involves directing public funds into projects such as infrastructure or construction. There are several reasons why this strategy can prove effective during an economic recession. Most directly, it creates new work opportunities, thereby reducing unemployment. A reduction in unemployment raises the aggregate purchasing power of the population, which in turn increases overall consumer demand and creates more opportunities for businesses operating in the market.
Beyond direct employment, government projects generate demand for the goods and services of private businesses. Firms that previously had little work find themselves facing increased demand for their services. Greater demand produces more revenue, and as revenues recover, companies become able to resume hiring. This beneficial process compounds across the economy, spreading the initial public investment into wider private-sector activity. The concept of the fiscal multiplier captures this dynamic, describing how an initial injection of government spending generates a proportionally larger increase in economic output.
Infrastructure investment in particular has long-term productivity benefits in addition to its short-term stimulus effects. By improving roads, bridges, and public systems, governments simultaneously reduce unemployment in the present and lower the cost of doing business in the future, supporting sustained economic recovery.
"Both tools aim to revive consumer spending and MPC"
You’re 84% through this paper. Sign up to read the remaining 1 section.
Sign Up Now — Instant Access Already a member? Log inAlways verify citation format against your institution’s current style guide requirements.