Fiscal Policy

Fiscal Policy

 

Introduction

Fiscal policy deals with everything regarding the government’s income and spending. From budgeting to taxation, measures of fiscal policy deal with the most important areas of the economy. In India, fiscal policy is divided into three parts. Government receipts, Government expenditures, and Public Debt. The fiscal policy is set by the Ministry of Finance with assistance from NITI Ayog.

 

What is a Fiscal Policy?

  • The use of taxation and spending by the government to affect the economy is referred to as fiscal policy.
  • It is a crucial instrument for governments to use in achieving macroeconomic objectives including job growth, inflation control, and unemployment reduction.
  • Fiscal policy works by changing the economy’s total demand, which therefore has an impact on the level of economic activity.
  • To accomplish its desired economic results, the government can either raise or decrease spending and/or change tax rates.This is accomplished via a range of policy tools, such as adjustments to transfer payments, tax rates, and government spending. The timing of implementation, the scope of the policy response, and the health of the economy are only a few of the variables that affect how effective fiscal policy is.
  • Fiscal policy is based on the principles of Keynesian economics, which basically states that governments can influence macroeconomic productivity levels by increasing or decreasing tax levels and public spending.

 

Meaning of Fiscal Policy

  • Government strategy for managing its budget to influence the economy.
  • Balances taxation and government spending to achieve economic goals.

 

What are the fiscal policy objectives?

A government has several fiscal policy objectives in mind when making decisions. Some governments may favour an objective over the other one. Below are the five main objectives of the fiscal policy.

  • Economic growth– As an economy develops, its citizens become flourishing on the whole. Also, the economy’s government should be careful, as a violent fiscal policy may turn destructive in the long run.
  •  Full employment– It is the primary objective of a government to get people into work. Not only do the higher taxes benefit the governments, but also the lower expenditures on social security. Although, an expansionary policy may invest in infrastructure to create employment opportunities in future. Likewise, it may also minimize taxes to supply more money to consumers to stimulate employment indirectly from purchases.
  •  Control debt– Operating a budget deficit is not a harm. It creates more and more debt over time. If the tax receipts and economic growth do not increase its line, a nation witnesses an unsustainable debt. Thus, a rational fiscal policy tends to control to avoid drastic action.
  • Redistribution– The transfer of wealth from rich to poor is another government’s objective. High taxes may result in high tax receipts, but not always. Although avoidance and evasion may occur, small incremental increases may not be impactful in the short term.
  •    Control Inflation– When an economy develops strongly, it may witness inflation depending on the monetary policy. Although inflation is a monetary phenomenon, the government still takes necessary steps to stem such a situation. Nevertheless, governments take steps by increasing taxes to minimize disposable incomes and consumption.

 

Tools of Fiscal Policy

Public Expenditure

  • It consists of subsidies, transfer payments including welfare packages, public works projects and government salaries. By increasing or lowering its spending, the government can at once affect economic interest. For example, more government spending can increase demand, leading to better output and employment.

Taxation

  • The government can have an impact on economic interest through its taxation policy. By reducing taxes, the government leaves people and agencies with greater profits to spend and invest, which could boost economic growth. Conversely, growing taxes can assist cool down an overheated financial system through reducing the amount of disposable earnings to be had.

Public Borrowing

  • Public borrowing refers to the method with the aid of which governments finance their fees that exceed tax sales. Under it, the government increases money from the home population or from abroad via units which include bonds, NSC, Kisan Vikas Patra, etc. Public borrowing is a not unusual practice used to fund public services, infrastructure initiatives, welfare programs, and to control the country’s fiscal policy.

Other Measures

  • Rationing and price control
  • Regulation of wages
  • Increase the manufacturing of goods and services.

 

Types of Fiscal Policy

  • Neutral Policy: The first type of fiscal policy is a neutral policy, which is also known as a balanced budget. This is where the government brings in enough taxation to pay for its expenditures. In other words, government spending equals taxation.
  • Expansionary Fiscal Policy: Expansionary fiscal policy is where the government spends more than it takes in through taxes. This may involve a reduction in taxes, an increase in spending, or a mixture of both. In turn, it creates what is known as a budget or fiscal deficit.
  • Contractionary Fiscal Policy: Contractionary fiscal policy is where the government collects more in taxes than it spends. A government may wish to do this for several reasons. Primarily, it is used to help stem inflation. For example, the more government tax, the less disposable income consumers have. In turn, this reduces aggregate demand which may seem like a bad thing, but it helps reduce inflation.

 

Examples of Fiscal Policy

There are several examples of fiscal policy including:

  • Transfer Payments: When times are tough economically, governments may raise transfer payments like unemployment benefits to help households. This can keep consumers from cutting back on their spending and keep the economy from getting worse.
  • Deficit Spending: The government may occasionally participate in deficit spending, which is when it spends more money than it brings in through taxes. The economy may benefit from this, but it may also result in an increase in government debt, which could have long-term repercussions.
  • Tax Incentives: To promote investment and the creation of jobs, governments may provide tax incentives, such as tax reductions for companies that invest in R&D.
  • Increased Government Spending: The government may raise its spending on public works initiatives, such as infrastructure repairs, to stimulate the economy during a recession in order to generate jobs and increase consumer confidence.
  • Tax Cuts: The government may lower tax rates in times of weak economic development in an effort to boost investment and consumer spending. This in turn may encourage economic expansion.

 

Why is Fiscal Policy Necessary?

  • Governments need a fiscal policy because it gives them the power to affect the level of economic activity in a nation. It is one of the key strategies employed by governments to maintain economic stability and achieve their goals. There are several reasons why fiscal policy is necessary:
    • In periods of recession or poor growth, fiscal policy can be utilized to boost the economy. To encourage consumer spending and investment, for instance, a government can raise spending or lower taxes. This can assist in boosting economic activity and rescuing a struggling economy.
    • Inflation can be decreased by fiscal policy. Prices can increase quickly if an economy is expanding too quickly and there is an excessive amount of demand for goods and services. A government may raise taxes or cut spending in order to slow down economic growth and lower inflation.
    • It enables governments to pay for the services and programs they offer their populations. Governments rely on tax money to pay for things like infrastructure, healthcare, and education. Governments can make sure they have the funds available to deliver these services by altering their budgetary policies.

What is the difference between fiscal policy and monetary policy?

  • The government uses both monetary and fiscal policy to meet the county’s economic objectives.
  •  The central bank of a country mainly administers monetary policy. In India, the Monetary Policy is under the Reserve Bank of India or RBI.
  • Monetary policy majorly deals with money, currency, and interest rates. On the other hand, under the fiscal policy, the government deals with taxation and spending by the Centre.

 

Importance of Fiscal Policy in India:

  • In a country like India, fiscal policy plays a key role in elevating the rate of capital formation both in the public and private sectors.
  • Through taxation, the fiscal policy helps mobilize a considerable amount of resources for financing its numerous projects.
  • Fiscal policy also helps in providing stimulus to elevate the savings rate.
  • The fiscal policy gives adequate incentives to the private sector to expand its activities.
  • Fiscal policy aims to minimize the imbalance in the dispersal of income and wealth.
  • Fiscal policy, in a nation like India, is critical in increasing capital formation in both the private and public sectors.
  • The fiscal policy is intended to mobilize a significant amount of resources towards financing its varied programmes through taxes.
  • Fiscal policy also contributes to raising the savings rate by providing stimulation.
  • Fiscal policy strives to reduce the imbalance in the distribution of income and wealth by providing enough incentives to the private sector to grow its operations.

 

Conclusion

  •  Fiscal policy has a huge role in determining the trajectory of the macro and microeconomic progress of the country. It plays a crucial role in resource allocation, reducing income disparity, ensuring growth, and so on. Reduced taxes and/or increased government expenditure are used in a fiscal expansion to boost aggregate demand and growth.
  •  On the other hand, fiscal policy contraction reduces aggregate demand and output by cutting government expenditure and/or raising taxes. It is also a feature of fiscal policy that it tends to impact the demand directly and quickly when compared to monetary policy, the impact of which is even uncertain.