Fiscal Policy

Meaning of Fiscal Policy ↓

The fiscal policy is concerned with the raising of government revenue and incurring of government expenditure. To generate revenue and to incur expenditure, the government frames a policy called budgetary policy or fiscal policy. So, the fiscal policy is concerned with government expenditure and government revenue.

Fiscal policy has to decide on the size and pattern of flow of expenditure from the government to the economy and from the economy back to the government. So, in broad term fiscal policy refers to "that segment of national economic policy which is primarily concerned with the receipts and expenditure of central government." In other words, fiscal policy refers to the policy of the government with regard to taxation, public expenditure and public borrowings.
The importance of fiscal policy is high in underdeveloped countries. The state has to play active and important role. In a democratic society direct methods are not approved. So, the government has to depend on indirect methods of regulations. In this way, fiscal policy is a powerful weapon in the hands of government by means of which it can achieve the objectives of development.

Main Objectives of Fiscal Policy In India ↓

The fiscal policy is designed to achive certain objectives as follows :-

1. Development by effective Mobilisation of Resources

The principal objective of fiscal policy is to ensure rapid economic growth and development. This objective of economic growth and development can be achieved by Mobilisation of Financial Resources.
The central and the state governments in India have used fiscal policy to mobilise resources.
The financial resources can be mobilised by :-

1. Taxation : Through effective fiscal policies, the government aims to mobilise resources by way of direct taxes as well as indirect taxes because most important source of resource mobilisation in India is taxation.
2. Public Savings : The resources can be mobilised through public savings by reducing government expenditure and increasing surpluses of public sector enterprises.
3. Private Savings : Through effective fiscal measures such as tax benefits, the government can raise resources from private sector and households. Resources can be mobilised through government borrowings by ways of treasury bills, issue of government bonds, etc., loans from domestic and foreign parties and by deficit financing.

2. Efficient allocation of Financial Resources

The central and state governments have tried to make efficient allocation of financial resources. These resources are allocated for Development Activities which includes expenditure on railways, infrastructure, etc. While Non-development Activities includes expenditure on defence, interest payments, subsidies, etc.
But generally the fiscal policy should ensure that the resources are allocated for generation of goods and services which are socially desirable. Therefore, India's fiscal policy is designed in such a manner so as to encourage production of desirable goods and discourage those goods which are socially undesirable.

3. Reduction in inequalities of Income and Wealth

Fiscal policy aims at achieving equity or social justice by reducing income inequalities among different sections of the society. The direct taxes such as income tax are charged more on the rich people as compared to lower income groups. Indirect taxes are also more in the case of semi-luxury and luxury items, which are mostly consumed by the upper middle class and the upper class. The government invests a significant proportion of its tax revenue in the implementation of Poverty Alleviation Programmes to improve the conditions of poor people in society.

4. Price Stability and Control of Inflation

One of the main objective of fiscal policy is to control inflation and stabilize price. Therefore, the government always aims to control the inflation by Reducing fiscal deficits, introducing tax savings schemes, Productive use of financial resources, etc.

5. Employment Generation

The government is making every possible effort to increase employment in the country through effective fiscal measure. Investment in infrastructure has resulted in direct and indirect employment. Lower taxes and duties on small-scale industrial (SSI) units encourage more investment and consequently generates more employment. Various rural employment programmes have been undertaken by the Government of India to solve problems in rural areas. Similarly, self employment scheme is taken to provide employment to technically qualified persons in the urban areas.

6. Balanced Regional Development

Another main objective of the fiscal policy is to bring about a balanced regional development. There are various incentives from the government for setting up projects in backward areas such as Cash subsidy, Concession in taxes and duties in the form of tax holidays, Finance at concessional interest rates, etc.

7. Reducing the Deficit in the Balance of Payment

Fiscal policy attempts to encourage more exports by way of fiscal measures like Exemption of income tax on export earnings, Exemption of central excise duties and customs, Exemption of sales tax and octroi, etc.
The foreign exchange is also conserved by Providing fiscal benefits to import substitute industries, Imposing customs duties on imports, etc.
The foreign exchange earned by way of exports and saved by way of import substitutes helps to solve balance of payments problem. In this way adverse balance of payment can be corrected either by imposing duties on imports or by giving subsidies to export.

8. Capital Formation

The objective of fiscal policy in India is also to increase the rate of capital formation so as to accelerate the rate of economic growth. An underdeveloped country is trapped in vicious (danger) circle of poverty mainly on account of capital deficiency. In order to increase the rate of capital formation, the fiscal policy must be efficiently designed to encourage savings and discourage and reduce spending.

9. Increasing National Income

The fiscal policy aims to increase the national income of a country. This is because fiscal policy facilitates the capital formation. This results in economic growth, which in turn increases the GDP, per capita income and national income of the country.

10. Development of Infrastructure

Government has placed emphasis on the infrastructure development for the purpose of achieving economic growth. The fiscal policy measure such as taxation generates revenue to the government. A part of the government's revenue is invested in the infrastructure development. Due to this, all sectors of the economy get a boost.

11. Foreign Exchange Earnings

Fiscal policy attempts to encourage more exports by way of Fiscal Measures like, exemption of income tax on export earnings, exemption of sales tax and octroi, etc. Foreign exchange provides fiscal benefits to import substitute industries. The foreign exchange earned by way of exports and saved by way of import substitutes helps to solve balance of payments problem.

Fiscal policy uses the government's powers of taxation and spending to influence the amount of employment and output across the economy. The legislative and executive branches of government control this type of economic policy. In the United States, for example, Congress and the president make fiscal policy decisions. There are two basic types of fiscal policy, which each having different objectives.

1. Types of Fiscal Policies

   Fiscal policy is one of the main ways in which government tries to influence overall economic performance in the United States. The two main types of fiscal policy are expansionary and contractionary policy. Both involve the use of the government's budget and its ability to levy taxes.
   

   Expansionary Fiscal Policy

   Expansionary fiscal policy uses increased government spending, reduced taxes or a combination of the two. The chief objective of a fiscal expansion is to increase aggregate demand for goods and services across the economy, as well as to reduce unemployment. Governments often enact expansionary measures during an economic recession, when unemployment rises and output decreases. By boosting its own purchases of goods and services, government tries to stimulate the economy. During the 1930s, the U.S. government used expansionary fiscal policy to combat the effects of the Great Depression.
   
   
   

   Expert Insight

   Expansionary fiscal policy has a multiplier effect, in which each dollar spent by government generates additional demand across the economy, according to Professor Gregory Mankiw, a Harvard economist and former White House adviser. For example, if the Defense Department orders additional parts and equipment from a defense contractor, those purchases raise production and employment at the contractor. The firm's employees increase their spending on consumer goods, illustrating the multiplier effect resulting from a fiscal expansion.
   

   Contractionary Fiscal Policy

   When government policy-makers cut spending or increase taxes, they engage in contractionary fiscal policy. Governments may enact contractionary measures to slow an economic expansion and prevent inflation. In addition, governments may enact contractionary policy for ideological reasons. These include reducing the overall size and scope of government activity or lowering budget deficits, in which the government spends more money than it collects. The economics department at Harper College in Illinois points out that contractionary policy reduces aggregate demand in the economy, lowering inflation. But it may also lead to higher unemployment.
   

   Considerations

   Economic fluctuations independent of policy actions by government often affect the level of tax revenues, forcing elected officials to alter fiscal policy. For example, economic recessions reduce output and employment, resulting in reduced revenue for government coffers. This often forces policy makers to consider contractionary measures, such as increasing revenues by raising taxes or cutting government spending.

Conclusion On Fiscal Policy ↓

The objectives of fiscal policy such as economic development, price stability, social justice, etc. can be achieved only if the tools of policy like Public Expenditure, Taxation, Borrowing and deficit financing are effectively used.
Though there are gaps in India's fiscal policy, there is also an urgent need for making India's fiscal policy a rationalised and growth oriented one.
The success of fiscal policy depends upon taking timely measures and their effective administration during implementation.