Contractionary fiscal policy reduces aggregate demand

Steps:

• Increased direct taxes reduce disposable income, lowering consumer spending.
• Lower government spending directly cuts public expenditure.
• Both actions decrease aggregate demand in the economy.
• Reduced aggregate demand leads to lower output and higher unemployment.

Why D is correct:

• Contractionary fiscal policy shifts AD leftward, creating a recessionary gap and increasing cyclical unemployment per Okun's law.

Why the others are wrong:

• A: Reduces imports via lower income, improving the balance of payments.
• B: Higher tax revenue and lower spending decrease the budget deficit.
• C: Slower demand growth reduces inflationary pressures.

Final answer: D