Fiscal Policy, Objectives, Importance

 

What is Fiscal Policy

Fiscal policy plays a crucial role in managing a nation's economy through government spending and taxation policy. When a government increases spending or cuts taxes to boost economic activity, it implements what is known as a fiscal stimulus. However, these actions can sometimes lead to a fiscal deficit, especially when expenditures exceed revenues. If this gap continues over time, it contributes to a growing budget deficit, which can impact long-term public finance stability. It is a policy of revenue and expenditure programs by the government to produce sound effects and avoid harmful effects on national income, output, and employment.

According to Prof Dalton

"Public finance deals with government revenue and its expenditure. Moreover, it deals with the measures which adjust revenue and expenditures".

According to Charles G. Lipsay

"Government revenue raising and revenue spending activities are called the fiscal policy".

Objectives of Fiscal Policy 

The government uses it to achieve economic objectives such as controlling inflation, reducing unemployment, and promoting economic growth.

Economic Growth:

Fiscal policy is used to maintain the level of economic growth in developed countries. It promotes long-term economic growth by investing in public goods like infrastructure, education, and healthcare, which enhances productivity. Such a policy is also followed in developed countries to increase economic development by taking fiscal measures like deficit financing and a deficit budget, which are generally helpful in promoting economic growth.

Stabilization of General Price Level:

Fiscal policy helps stabilize the country's general price level. When prices of goods and services begin to rise, the government adopts the contracting fiscal policy, and when they start to fall, the expansionary fiscal policy is used.

Fair Distribution of Income:

Economic development is always accompanied by inequalities in the distribution of wealth. A small group of people is richer and more powerful, while the majority becomes poorer and poorer.

Economic Stability:

Fiscal policy aims to reduce volatility in the business cycle by ensuring steady growth. In case of recession, the government may use expansionary fiscal policy, while during periods of rapid growth, contractionary fiscal policy is applied to avoid inflation.

Control Money Supply:

Sometimes changes in the money supply may cause instability in the economy. The government reduces its expenditure during inflation to stabilize the value of money. In case of deflation, the government increases its expenditure and encourages private expenditure by lowering taxes.

 Resource Allocation:

Fiscal policy helps to allocate resources efficiently by prioritizing government spending sectors that benefit the public, such as healthcare, education, and infrastructure development. 

Balance of Payment Stability:

Fiscal measures can influence a country's foreign trade and current account balance; they also reduce domestic demand for imports through taxation or boost exports through subsidies to help stabilize the balance of payment.

Achieve Full Employment:

The achievement of the whole employment level is another objective of fiscal policy. Due to unemployment, national income decreases, and demand for goods and services, saving, and investment levels become low. In this case, the government gives incentives to the investors by lowering taxes, offering tax concessions, tax holidays, or increasing tax slabs, etc.

Monetary Policy vs Fiscal Policy

Fiscal policy is distinguished from monetary policy; fiscal policy is about the government's revenue and its spending, and is often administered by government authorities. It directly affects the economy by influencing the demand, employment, and production through the government's budget. While monetary policy deals with interest rates and money supply to influence inflation, employment, and economic stability, which is controlled by the country's central bank.

The purpose of fiscal policy is to manage economic growth, reduce unemployment, and ensure public welfare through budgetary allocations. It is often used to stimulate demand or control inflation through direct spending or tax adjustments. But the main purpose of monetary policy is to target price stability ( inflation control), stabilize the currency, and manage long-term interest rates. The goal is to maintain economic stability and moderate inflation or deflation.

Instruments of Fiscal Policy

The government uses various fiscal tools to actively promote full employment in an economy without inflation and deflation.

A. The built-in Stabilizers

Taxation

Taxation is the most effective instrument of fiscal policy to reduce the concentration of wealth through a progressive taxation system on gifts, inheritances, and wealth. Both direct and indirect taxes are levied to raise revenue. Taxes can encourage investment and redirect private investment through tax concessions, tax rebates, tax holidays, etc. The consumption pattern is affected by changing indirect taxes like VAT or excise duties.

Unemployment Allowance

The developed countries provide unemployment allowance to unemployed workers to maintain the aggregate demand for goods and services during a depression. However, there is a decrease of stopped such allowances in the boom, even though the workers contribute towards the unemployment fund.

Farm Aid Programs

The objective of this tool is to bring stability to the country's general price level. In LDCs, when the prices of agricultural products are falling, and the economy is faced with depression, the government purchases farm produce at higher prices and keeps it in store. In a better situation, the government can bring a stock of goods to keep the prices stable.

B. Discretionary Fiscal Policy

Public Expenditure

Public expenditure plays an essential role in the economic development of a country. An increase in public spending during the Depression increased the aggregate demand for goods and services, which led to the restoration of economic activities. During inflation, a reduction in public expenditure also reduces the aggregate demand as well as the national income. Thus, inflationary and deflationary pressures can be controlled in this way.

The role of public expenditure is highly significant in developing countries concerning poverty alleviation and reducing income inequalities. The efficient expenditure management effectively curtailed the overall expenditures during the current fiscal policy.

Change in Public Revenue

The government can restrict the increased demand for goods and services during the inflationary period by raising taxes. As a result, people's consumption decreased. The government can reduce tax rates during deflationary periods.

Public Debt

The government may issue bonds to finance deficits or buy back bonds to reduce debt. This method of managing debt can influence interest rates and investor confidence.

Government Grants

The government provides financial support for certain industries (e.g., agriculture, renewable energy) to lower costs and increase production. Funds are allocated for specific purposes like research, education, or healthcare.