Experience has shown that private consumption expenditure and private investment expenditure, if left uncontrolled, cannot be relied upon for maintaining a level of expenditure which is appropriate to a state of full employment. In a depression, the policy should be to substitute public spending for deficient private spending and to reduce taxation to encourage private spending.
During boom conditions a maximum of taxation is necessary to defend the economy against price inflation.
The general purpose of counter-cyclical taxation is to encourage private consumption and investment when national income is below the full employment level and to break consumption and investment when full employment has been reached and further spending can result only in inflation.
2. It is held that the government should maintain a state of full employment by means of what is called compensatory spending.
When prices go on falling and depression sets in, 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 flow of spending.
When prices go on rising and inflationary conditions appear, the government should reduce public expenditure to contain inflation. At this stage the government should have surplus budgets in order to stave off inflation.
The main purpose of compensatory spending is to fill up the gap between full employment expenditure and actual expenditure.
If private consumption and investment expenditures are not appropriate for full employment, the government should spend huge sums of money to make good the deficiency in total spending.