Explain how the Federal Government can use fiscal policy to

promote economic growth, redistribute income and assist

external stability?
Fiscal policy refers to the use of the Commonwealth Budget (ie: government
expenditure and taxation measures) to achieve the government economic objectives.
The Federal Government can use fiscal policy to promote economic growth,
redistribute income and assist external stability.
Economic growth refers to an increase in the quantity of goods and services produced
in the economy over a period time. It is measured by the percentage annual increase in
real Gross Domestic Product (GDP).
Fiscal policy influences economic growth by influencing the level of aggregate
demand (C+I+G+X-M).
The impact of the budget on the level of economic activity is determined by changes
in the size of the budget outcome. There are three possible budget outcomes: Budget
surplus (where taxation revenue exceeds government expenditure); budget deficit
(where government expenditure exceeds taxation revenue); or balanced budget (where
government expenditure = taxation revenue).
In the 2005-06 Budget, the government has budgeted for a surplus (measured in terms
of the underlying cash outcome) of $8.9 billon or 1.1% of GDP. Now, the fact that this
years Budget surplus ($8.2 billion) is lower than last years surplus ($9.2 billion)
indicates the budget will have a slightly expansionary effect on economic activity. A
lower budget surplus implies that the government has increased government
expenditure and/or reduced taxation compared to the previous year. (In fact, most of
the stimulus in this years budget comes from reduced taxation ie: cuts in income
tax). The effects of lower taxes and increased government spending is to stimulate
aggregate demand (C+I+G+X-M) and lead to an increase in the level of production
and income.
In assessing the impact of the budget on the level of economic activity, economists
suggest that it is important to distinguish between the cyclical and structural
components of the budget outcome. The cyclical component of the budget outcome
refer to that part of the budget outcome that results from the influence of automatic
stabilisers, such as progressive income tax and unemployment benefits. The structural
component of the budget outcome refers to that part of the budget outcome that results
from deliberate, discretionary government decisions.
In 2005-06, it is expected that cyclical factors will act to increase the size of the
budget surplus. In particular, it is expected that continued growth in the economy will
help to boost taxation revenue and reduce government expenditure. Increased tax
revenue combined with lower spending means a bigger surplus.
The fact this years budget surplus is actually lower than last years surplus is sue to
deliberate (discretionary) government decisions to increase spending and more
importantly, reduce taxation. (It is estimated that discretionary decisions have reduced

the budget surplus by around $9 billion. On this basis, it can be concluded that the
fiscal stance is expansionary.
The government has adopted a slightly expansionary fiscal stance in order to pursue
its goal of maximising sustainable economic growth.
The budget has an important impact on the distribution of income. In general, the
government uses the progressive income tax system, combined with its social welfare
expenditure, to redistribute income from higher income earners to lower income
earners.
The 2005-06 Budget includes a number of measures which have significant
implications for the distribution of income. For example
the cuts in personal income tax tend to favour higher income earners, thus
increasing inequality
reductions in the surcharge (extra tax) on the superannuation contributions of
high-income earners also tends to increase inequality
the government has tightened the mutual obligation requirements for single
parents and the disabled. This means that single parents and disabled persons
who do not make serious efforts to obtain work will receive unemployment
benefits rather than the relevant pension.
In recent years, a central focus of fiscal policy has been to promote external stability
(ie: reduce the CAD and foreign debt. In order to achieve external stability, the
government has set itself the target of achieving fiscal balance over the course of the
economic cycle.
The significance of maintaining a balanced budget (or even a surplus budget) is that a
balanced budget reduces the governments call on domestic savings. Because the
governments call on domestic savings is lower, there will be more savings available
for domestic firms to finance their investment. The greater the availability of domestic
savings means that domestic firms will not need to borrow as much money overseas.
A reduction in foreign borrowing implies a reduction in the capital and financial
account surplus, which, under a floating exchange rate, also means a smaller CAD.