Fiscal policy is changes in the taxing and spending of the federal government for purposes of expanding or contracting the level of aggregate demand....

Fiscal policy is changes in the taxing and spending of the federal government for purposes of expanding or contracting the level of aggregate demand. [ In a recession, an expansionary fiscal policy involves lowering taxes and increasing government spending. In an overheated expansion, a contractionary fiscal policy requires higher taxes and reduced spending. According to Keynes, a recession requires deficit spending while an overheated expansion requires a budget surplus. 1) Discretionary Fiscal Policy. The first way this can be done is through the federal budget process. However, this process takes so long - 12 to 18 months - that it is difficult to match discretionary fiscal policy with the business cycle. The expansionary Kennedy tax cut of 1964 and later the contractionary Ford tax increase of 1974 hit the economy just when the opposite contracyclical policy was needed. As a result, the federal government will only use discretionary fiscal policy in a severe recession, such as 1981-82 and 2008-09. In both cases, the federal government resorted to a large fiscal stimulus ? tax cuts in 1981-82 and increased spending in 2008-09. Both policies created large deficits, which is the appropriate stabilization policy during a severe downturn. 2) Automatic Stabilizers. A second type of fiscal policy is built into the structure of federal taxes and spending. This is referred to as "nondiscretionary fiscal policy" or more commonly as "automatic stabilizers". The progressive income tax (the major source of federal revenue) and the welfare system both act to increase aggregate demand in recessions, and to decrease aggregate demand in overheated expansions. These automatic changes in spending and taxes will generate a deficit in recessions and a surplus in overheated expansions. The size of these automatic changes can be quite large.