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Fiscal PolicyThe most important instrument of government intervention in the economy is fiscal or budgetary policy. fiscal policy is essential in the matter of

Overcoming Recession or Inflation Promoting and Accelerating Economic Growth.

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‘Fisc’ means State Treasury

Fiscal policyFiscal policy  

Fiscal policy is the government programme of making discretionary Fiscal policy is the government programme of making discretionary

changes in changes in The pattern and level of its expenditure, The pattern and level of its expenditure, TaxationTaxation BorrowingsBorrowings

To Achieve To Achieve Intended Economic Growth, Employment, Income Equality

and Stabilization of the Economy on a Growing Path.

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Fiscal policy is also called Budgetary Policy The essence of fiscal policy lies in the budgetary operations of the The essence of fiscal policy lies in the budgetary operations of the

Govt.Govt.

Two sides of the Govt budget are – Two sides of the Govt budget are – Receipt and ExpenditureReceipt and Expenditure Receipts - inflow ( flow of money from private sector to Govt.sector) Tax revenue Non tax revenue Borrowings including Deficit Payment

Expenditures Payments/outflow – flow of money from Govt to Private

Sector Payment for goods and services Interest and loan payments Subsidies Pensions grand in –aid and so on.

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Govt using its statutory power to change the magnitude and composition of inflows and outflows

magnitude and composition can be altered by – Making changes in taxation– Govt spending– Borrowing

Fiscal Instruments

Fiscal Instruments are the variables that government changes it. Fiscal policy is implemented through instruments.

Target Variables

Variables that are intended to be changed to achieve the intended results

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Fiscal Policy Instruments

  Budgetary surplus and deficit Govt expenditure Taxation – direct and indirect Public debt Deficit financing

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Budgetary Balance Policy Balanced budget – expenses = revenue

Deficit budget – Govt.spending> expected revenue

Surplus budget - Govt.spending> expected

revenue

Balanced, Deficit, Surplus budgets affect the economy

in different ways and in different directions.

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Govt. Expenditures Govt. expenditures means the sum of public spending on purchase of

goods and services, public investment, transfer payments

Size and composition of GE is a matter of Govt. direction

GE is an injection into the economy

It adds to the AD (C + I)

Effect GE depends on Way of Govt. financing Multiplier effect of the GE.

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Taxation Direct –

• taxes on personal income

• Corporate income

• Wealth and property

Indirect tax –

• on production

• Sale of the goods and services

  

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Public Borrowings Borrowings include both internal and external

To finance their budget deficit

Internal Borrowing- Borrowing from public by means of bonds & treasury ( transfer of

purchasing power from the public to the Govt)- From central bank (straightaway an injection into the economy)

External Borrowing- Borrowing from foreign Govt- International organization i.e. IMF and WB- Market borrowing

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Target Variables Disposable income

Aggregate Consumption expenditure

Savings and investment

Imports and exports

Level and structure of prices

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Fiscal Policy and Macroeconomic Goals

Fiscal policy for economic growth

Fiscal policy for Employment

Fiscal policy for Stabilization

Fiscal policy for economic equality

Fiscal policy for external balances

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Fiscal Policy and Economic Growth

Given the Manpower

Technology

Natural Resources

The growth rate of a country depends on the

Rate of Savings

Investment.

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Therefore fiscal policy in this regard is To create conditions for increase in private savings

and investment

To enhance investment in the public sector.

To promote savings

reducing rate income tax

giving tax incentives for savings

giving incentives to promote private savings

giving concessions to promote private investment

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Incentives/concessions may be one of the following

Tax holiday

High depreciation allowance

Rebate for capacity expansion

Investment subsidies

Exception of import duties on capital imports

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These measures often prove to be inadequate to promote savings and investment due to,

Low level of per capita income and high rate of

MPC

A small fraction of population with taxable income

Inadequate growth infrastructure and social

overhead Capital

Because of these reasons savings and investment may

inadequate.

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The Government is required, under these conditions to

play the role of a prime mover

This requires Expansion of the public sector and Enhancement of the public sector investment.

To accomplish these things huge amount of resources

is need.

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Tax is a suitable means of source of income.

progressive taxation of personal and cooperate income

taxation of all kinds of consumer goods

taxation of luxury goods at a prohibitive rate

imposition of extraordinary high duty on imports of

consumer goods.

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Fiscal policy for Employment

According to Keynesian theory of employment

All fiscal measures that accelerate the pace of

economic growth promote employment but

This proposition does not hold under all conditions.

Developed countries try to maintain full employment

Developing countries try to create more

employment opportunities.

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Fiscal measures should accelerateFiscal measures should accelerate Economic growth Promote employment

Some conditions not increase economic growth Capital intensive or labour saving technology does

not increase employment

In this situation Govt. intervene through fiscal policy

as follows Govt should discourage use of labour – saving

Technology Encourage the use of labour absorbing technology

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In this case Govt may take following fiscal measures

heavy taxation on capital – intensive good

giving subsidization for labour intensive goods

heavy duty on imports of capital intensive

technology

Concessions in customs for the import of input for

labour intensive products

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Fiscal Policy for stabilizationFiscal policy for stabilization can take any of the two forms of

fiscal policy

automatic stabilization policy discretionary policy

Automatic stabilization policy means adopting a fiscal system with built – in flexibility of tax revenue and government spending.

Built – in flexibility means automatic adjustment in the

government expenditure and tax revenue in response to rise

and fall in GNP.

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Automatic Stabilization Policy

If GNP increases tax revenue also increases because household income increases no need to government expenditure

If GNP decreases tax revenue also decreases Because household income decreases So Govt. will increase its expenditures

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Discretionary Fiscal PolicyIt means ad hoc changes – happening when necessary

and not planned in advance

So, here Govt. make changes in the

level and pattern of taxation

size and pattern of govt. expenditures

size and composition of public debt

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Fiscal policy for Economic Equity

Economic Disparity beyond a level is socially,

economically and politically undesirable.

Both taxation and expenditure measures are

used to reduce income and wealth gap between the rich and poor……

 

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Fiscal Policy – Tax Measures Taxation on personal income

corporate income at progressive rate

Imposition of wealth and property tax

Taxation of high price and luxury goods at

higher rate

 

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Fiscal Policy – Govt. Expenditures

Spending on projects which increase the earning

capacity of the lower income people

Ex: Free Education , Medical Facilities

Reallocating capital expenditures to enhance employment opportunities for unemployed and under employed people.

 

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Fiscal Policy – Govt. Expenditures

Financial aid for unemployed people for their self – employment

Giving unemployed relief and unemployment insurance.

 

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Tax and expenditure measures make two – way attack on

economic disparity.

Tax measures limit the growth of incomes in th high – income groups and transfer a part of rich people’s income to the Govt. treasury

Which enhances government resources to help poor

Expenditures increase incomes in low-income groups

 

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Fiscal policy for External Balances External imbalances arise - when external

payment obligations exceed the foreign exchange

earnings.

This gap arises mainly due to decreasing trade

balance or current account deficits

Current account deficit increase mainly due to he widening gap between imports and exports

 

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Tax policy can be used as an effective tool of

resorting the external balance.

Imposition of heavy import duty – especially on the import of consumer goods

Subsidization of exports These measures work efficiently only when

both imports and exports are price – elastic In the absence of a high – price elasticity,

these measures may not work

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Kinds of Fiscal Policy

Variety of fiscal policies have been suggested by the

economists and used by the policy makers in different

countries under different circumstances to achieve

specific macroeconomic goals.

Automatic Stabilization Fiscal policy Compensatory Fiscal Policy Discretionary Fiscal Policy

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Automatic Stabilization Fiscal policy

Automatic stabilization policy means adopting a fiscal

system with built – in flexibility of tax revenue and

government spending.

Built – in flexibility means automatic adjustment in

the government expenditure and tax revenue in

response to rise and fall in GNP.

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Tax revenue increases and government expenditure decreases automatically, with an increase in GNP

Tax revenue decreases and government

expenditure increases automatically, with an

decrease in GNP

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Compensatory Fiscal Policy Compensatory Fiscal Policy is deliberate

budgetary action taken by the government to compensate for the deficiency in aggregate demand and excess of aggregate demand.

During the period of depression – the Govt is

required to boost up the aggregate demand The government compensatory fiscal actions may

be – reduction in tax and increase in

Govt.expenditure.

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This kind of fiscal action (Deficit budgeting)

increases AD

AD leads first to the rise in price level It adds to the producer’s profit without any

increase in costs. This creates an optimistic environment So opportunity and incentives to invest increases This push up the level of employment and output

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During the period of high rate of inflation surplus budgeting policy is adopted.

Inflation is caused by excessive demand So Govt. lowers the expenditure level Increase the tax level Higher taxes reduces the disposable income as

result aggregate demand decreases Further, cut in the Govt. expenditure reduces the

AD Therefore, two side attack on the AD helps

reducing the demand pressure and thereby, the inflation.

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Discretionary Fiscal Policy Ad hoc changes in the Govt. expenditure and

taxation System In Discretionary Fiscal Policy, the Govt. makes

deliberate changes in

Level and pattern of taxation

Size and pattern of its expenditure

Size and composition of public debt. The discretionary changes in these fiscal instruments

are made with the view to achieving certain specific

objectives.

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During recession/depression period Fiscal Policy helps to

increase demand Govt increase its expenditures Spending more on public works to increase employment Increase subsidies to producers of consumer goods Lowering tax to stimulate consumption and investment

During period of inflation Fiscal Policy helps to

Reduce demand Govt reduce its own expenditures Reducing private investment by imposing tax –

consumption or investment.