Final answer:
In a recession, government tax revenue decreases due to lower incomes, despite constant tax rates, while spending on unemployment welfare increases. Economist Arthur Laffer suggested lower tax rates could sometimes increase revenue by stimulating economic growth. Fiscal policy is crucial in addressing these challenges but must be managed to avoid long-term fiscal issues.
Step-by-step explanation:
During a recession, the government usually experiences a decrease in tax revenue even if the tax rates remain unchanged. This is primarily because, in a recession, there is an overall decline in economic activity, which means individuals and businesses earn less income. As such, the income that is subject to taxation is reduced, leading to lower tax collections.
Furthermore, with unemployment rising during a recession, more people qualify for and receive unemployment benefits, increasing government spending that does not generate revenue. Economist Arthur Laffer noted that paradoxically, reducing tax rates can sometimes increase tax revenue. This could happen because lower taxes may spur economic growth, thereby increasing the overall tax base. However, during a recession when the government uses fiscal policy tools like tax cuts or increased spending to stimulate the economy, this often leads to increased government budget deficits and national debt.
The fiscal policy plays a critical role in managing the economy during these times. A balance needs to be struck between stimulating economic growth and managing the government's finances effectively to prevent long-term fiscal problems.