The best tax base for purposes of contra-cyclical taxation is perhaps personal income tax. If there is a depression, the remedy is to give relief to business with the hope of stimulating investment towards the later stage of the boom; the principal problem is to arrest inflationary price movements.
This can best be controlled by putting a brake on consumption and on anti-cyclical tax policy requires imposition of relatively high taxes on smaller incomes during the boom phase.
2. Compensatory Spending:
When prices go on falling and the depression goes on deepening, it is necessary for the government to go on injecting more and more money in order to offset the increasing disappearance of private funds from the circular flow of spending.
In other words, the Government must undo the deflationary effects of an increasing propensity to hoard on the part of private individuals. This task involves increasing government expenditure.
When prices go on rising, contra-cyclical spending leads to diminishing public expenditure. As the volume of private consumption and investment expenditure goes on increasing, there should be a gradual tapering off of public expenditure.
When the economy reaches a state of full employment the government should not only retire from compensatory spending but might also make compensatory spending negative. At this stage, the government should have a surplus budget in order to stave off inflationary expansion of the boom.
3. Monetary Policy:
The central bank through its bank rate policy, open market policy and through variations in reserve ratio can increase or decrease the money supply and hence can control the wide fluctuations in business activities.