Fiscal Policy

Fiscus (in Latin) refers to a purse and ‘fisc’ (in English) is a royal or state treasury. Thus, ‘fiscal policy’ is that
under which the government uses its revenue and expenditure programs to produce desirable effects on
national income, production and economy. It is thus used as a balancing device in the economy. Two major
elements of fiscal policy are taxation and public expenditure.
ECONOMICS
Economics can be broadly classified as: (A) Microeconomics and (B) Macroeconomics. These
have different objectives that are required to be achieved the instruments for achieving these
objectives, i.e., policies that can be classified as: fiscal, monetary, income and foreign exchange.
The first points to the operation of the government treasury, its two major elements being public
expenditure and taxation. The second points the total supply of money in the economy. The
supply of currency jointly with bank deposits has a direct effect on rates of interest investment
and, in turn, on the total output, besides influencing the level of employment and prices. The third
aims at controlling prices thus fixing the way national income is shared by various groups of the
society. These policies also have effects on employment and economic growth. The fourth policy
works through licensing, quotas, import duties, export bounties etc., thus determining the
exchange rate and maintaining exim steadiness. All these policies aim at carrying desired
changes in foreign trade and payments on foreign accounts.

Objectives of fiscal policy

The role of fiscal policy in developed economies is to maintain full employment and stabilize
growth. In contrast, in developing countries, fiscal policy is used to create an environment for
rapid economic growth. The various aspects of this are:

1. Mobilisationm of resources: Developing economies are characterized by low levels of income

and investment, which are linked in a vicious circle. This can be successfully broken by mobilizing
resources for investment energetically.

2. Acceleration of economic growth: The government has not only to mobilize more resources for
investment, but also to direct the resources to those channels where the yield is higher and the
goods produced are socially acceptable.

3. Minimization of the inequalities of income and wealth: Fiscal tools can be used to bring about
the redistribution of income in favor of the poor by spending revenue so raised on social welfare
activities.

4. Increasing employment opportunities: Fiscal incentives, in the form of tax-rebates and

concessions, can be used to promote the growth of those industries that have high employment-
generation potential.

5. Price stability: Fiscal tools can be employed to contain inflationary and deflationary tendencies
in the economy.

The limitations of Fiscal Policy

Fiscal policy has been a great success in developed countries but only partially so in developing
countries. The tax structure in the developing countries is rigid and narrow. Thus, conditions
conducive to the growth of well-knit and integrated tax policies are absent and sorely missed.
Following are some of the reasons that are hindrances for its implementation in developing
countries:

1. A sizeable portion of most developing economies is non-monetized, rendering fiscal measures

of the government ineffective and self-defeating.

2. Lack of statistical information as regards the income, expenditure, savings, investment,

employment etc. makes it difficult for the public authorities to formulate a rational and effective
fiscal policy.
3. Fiscal policy cannot succeed unless people understand its implications and cooperate with the
government in its implication. This is due to the fact that, in developing countries, a majority of the
people are illiterate.

4. Large-scale tax evasion, by people who are not conscious of their roles in development, has an
impact on fiscal policy.

5. Fiscal policy requires efficient administrative machinery to be successful. Most developing

economies have corrupt and inefficient administrations that fail to implement the requisite
measures vis-à-vis the implementation of fiscal policy.

Among the various tools of fiscal policy, the following are the most important:

Reflationary Fiscal Policy

It may be used to boost the level of economic activity during periods of recession or deceleration
in economic activity. This is done by lowering taxes or increasing government expenditure.

Deflationary Fiscal Policy

During a boom, i.e., when the economy is growing beyond its capacity, inflation and balance of
payment problems might result. This can be achieved by increasing taxes or by reducing
government expenditure.

It would perhaps be too simplistic to conclude that fiscal policy is the most important tool of
financial correction and consolidation, especially that undertaken by the government. However,
there is no reason to neglect this very powerful tool that is in the hands of governments and
central banks the world over. Used properly, fiscal policy can determine the broad direction the
economy of a given country is going to take.
Fiscal policy
WHEN the government makes use of its revenue and expenditure programmes (to achieve the
above mentioned goals) and affects the aggregate level of demand for goods and services in the
economy, then this action is essentially known as fiscal policy. Related to fiscal policy are deficits
and surpluses. When the government’s expenditure exceeds its revenue, then there is a fiscal
deficit and the opposite of this is known is fiscal surplus.
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What is the difference between fiscal and monetary policies?
Renowned economist Keynes believed that taxes and expenditure decisions, that is fiscal policy,
should be used to stabilize the economy. According to him, government should cut taxes and
increase spending to bring the economy out of a slump, this kind of a policy action is known is
expansionary fiscal policy. On the other hand, government should increase taxes and cut
expenditure to bring the economy out of inflationary pressure, that is, it should follow a
contractionary fiscal policy. The classical economists however believed that the government can
affect the level of output, overall price level and interest rates by determining the level of money
supply in the economy. When the central bank uses tools like CRR and repo rate to control the
level of money supply to stabilize the economy then it is known as the monetary policy.
How does a fiscal policy affect the economy?
Aggregate demand, which is the total demand for goods and services in the economy, depends
on three main variables- consumption, private investment and government spending. When the
government increases its expenditure then it spurs the aggregate demand in the economy. A
higher aggregate demand in turn will stimulate output, growth and employment. Whereas if the
government lowers it’s spending then it decreases the aggregate demand and hence slows down
the growth of the economy.