Taxation As A Tool Of Fiscal Policy
Taxation plays a major role in managing the fiscal policy of a state. Tax can be defined as a person’s share, contribution and obligation of the cost for the maintenance of socio-economic order and governance, and to enjoy the sovereign rights, privileges and powers of a state.
In other words, tax is a sum of money paid by a person in whatever form to the state which is backed by law. There are two types of tax; these are direct tax and indirect tax. Direct taxes include income tax, corporate tax, tolls and rates. Also, indirect taxes include Value Added Tax (VAT), excise duties, and import and export duties.
Fiscal policy is the use of taxes and government spending to control the economic activity of a country. It is classified into two; expansionary fiscal policy and contractionary fiscal policy. These have to do with increasing and reducing taxation, subsidies and government expenditure or spending, respectively. The various economic conditions that could affect the economic stability of a state include; aggregate demand, balance of payment, unemployment, inflation, deflation, etc.

The most immediate effect of fiscal policy is to change aggregate demand for goods and services. A fiscal expansion, for example, raises aggregate demand through one of the two channels. First, if the government increases its purchases but keeps taxes constant, it increases demand directly.
Secondary, if the government cuts taxes or increases transfer payment, households’ disposable incomes rises and they will spend more on consumption. This rise in consumption will in turn raise aggregate demand.
Moreover, fiscal policy may be employed to manage aggregate demand so as to control the price level. If there is a need to increase aggregate demand we may reduce taxation, increase subsidies or increase government expenditure. When direct taxes are reduced workers disposable income rise and this may lead to increase in effective demand.