The following points highlight the three major tools used by government to influence private economic activity. The tools are: 1. Taxes 2. Government Expenditures 3. Regulation and Control.
Government Policy: Tool # 1.
Taxes reduce income of individuals and companies and thus reduce private expenditures (on motor cars, television sets, or liquor). However, the basic object of taxes is to provide resources for public expenditures (on roads, highways, public schools, colleges, hospitals or even parks and playgrounds).
The tax system is not just a revenue- raising instrument, it is also used to exercise control over the private sector.
It is often used to encourage the purchase and consumption of certain useful articles which are lightly taxed or are not taxed at all (such as low-cost owner-occupied housing meant for medium and low-income groups) and, at the same time, to discourage the consumption of certain articles which are heavily taxed (such as luxury cars or cigarettes).
Government Policy: Tool # 2.
The government is also a major buyer of goods and services produced by the private sector. So government expenditure on medicines, food, cars, etc. increases income of the private sector.
At the same time government transfer expenditures (payment) such as unemployment compensation or pension provide income to individuals. Such payments are called welfare payments and because of such payments a modern mixed economy is also called the welfare state.
Thus while government expenditure is expansionary in its impact (because it creates jobs and incomes), taxes are contractionary. The net result of the government’s combined expenditure and tax programmes may be expansionary or contractionary depending on the nature of government expenditures and the types of taxes used to finance such expenditures.
In fact, some taxes (like income tax) are more contractionary than others (such as wealth tax or capital gains tax).
The government’s revenue and expenditure programmes are announced in the budget which is a tool of government control. Apart from performing its revenue and expenditure functions the government uses the budget to exercise control over the private sector.
Government Policy: Tool # 3.
Regulation and Control:
The government is also a regulatory agency. One of the objectives of the government is to regulate and control the private sector. Such regulation and control serve a very useful purpose—they direct people either to perform certain economic (and non-economic) activities or to refrain from performing certain other (such) activities.
For example, the government can pass rules relating the extent to which firms can pollute. Similarly, the government can regulate working conditions in farms and factories. In some countries there are rules requiring nutritional information on food packaging or on safety.