Fiscal Policy Introduction & Meaning

Every government seeks to control and give direction to economic activities. For this purpose, it has at its disposal a number of instruments. Among these, the most important is the fiscal policy or what is also known as the budgetary policy.

• The fiscal policy, or budgetary policy, operates through the financial operations of the government. Every government performs a large number of functions to carry out its responsibilities. The functions that government has to carry and perform has been continually rising. In this Unit, you will learn about the meaning and instruments of fiscal policy, public revenue, tax, public expenditure and public debt. you will be further familiarised with government budget and its components.

Meaning and instruments of Fiscal Policy

Fiscal policy is concerned with the finance of government, i.e., with the revenue and expenditure of government. Studied earlier, a government mobilizes financial resources through different means that include taxation and various non-tax sources. In addition, a government can and does raise financial resources by way of loan and printing of new currency.

• Likewise, a government undertakes various functions that involve expenditure. By bringing out changes in structure of taxation, borrowing, etc., and by changing the size and pattern of public expenditure, government can see to bring about desired change in the economy. Thus, (i) public revenue, (ii) public expenditure and (iii) public debt form important instrument of fiscal policy.
• All the instruments of fiscal policy operate simultaneously. Changes in public revenue, expenditure and debt implement each other.
• Fiscal policy is defined as the policy under which a government uses the instruments of taxation, public expenditure and public borrowing to achieve various objectives of economic policy.

The Fiscal Policy is useful to achieve the following objectives:

Full Employment

• Full Employment is the common objective of fiscal policy in both developed and developing countries. Public expenditure on social overheads help to create employment opportunities. In India, public expenditure on rural employment programmes like MGNREGS is aimed at employment generation.

Price Stability

• Price instability is caused by mismatch between aggregate demand and aggregate supply. Inflation is due to excess demand for goods. If excess demand is caused by Government expenditure in excess of real output, the most effective measure is to cut down public expenditure. Taxation reduces disposable income and so aggregate demand.
• To fight depression, the Government needs to increase its spending and reduce taxation.

Economic Growth

• Fiscal Policy is used to increase the productive capacity of the economy. Tax is to be used as an instrument for encouraging investment. Tax holidays and tax rebates for new industries stimulate investment. Public sector investments are to be increased to fill the gap left by private investment. When resource mobilization through tax measures is inadequate, the Government resorts to borrowing both from internal and external sources to finance growth projects.

Equitable distribution

• Progressive rates in taxation help to reduce the gap between the rich and the poor. Similarly progressive rates in public expenditure through welfare schemes such as free education, noon meal for school children and subsidies promote the living standard of poor people.

Exchange Stability

• Fluctuations in international trade cause movements in exchange rate. Tax concessions and subsidy to export oriented units help to boost exports. Customs duties on import of non-essential items help to cut import bill. The reduction in import duty on import of raw material and machinery enables reduction in cost and make the exports competitive.

Capital formation

• Capital formation is essential for rapid economic development. Tax relief helps to increase disposable income, savings and thereby capital formation. Government expenditure on infrastructure development like power and transport encourages private investment.

Regional balance

• Fiscal incentives for industries in the backward regions help to narrow down regional imbalances. Public expenditure may be used to start industrial estates so that industrial activity is stimulated in backward regions.

Public Finance

In Modern times, the subject ‘Public Finance’ includes five major sub-divisions, viz., Public Revenue, Public Expenditure, Public Debt, Financial Administration and Fiscal Policy.

Definitions

• “Public finance is one of those subjects that lie on the border line between Economics and Politics. It is concerned with income and expenditure of public authorities and with the adjustment of one to the other”. – Huge Dalton
• “Public finance is an investigation into the nature and principles of the state revenue and expenditure”. – Adam Smith

Fiscal Policy – Taxes, subsidies, public debt and public expenditure are the instruments of fiscal policy. Public Revenue – Public revenue deals with the methods of raising public revenue such as tax and non-tax, the principles of taxation, rates of taxation, impact, incidence and shifting of taxes and their effects. Public Debt – Public debt deals with the methods of raising loans from internal and external sources. The burden, effects and redemption of public debt fall under this head. Public Expenditure – This part studies the fundamental principles that govern the Government expenditure, effects of public expenditure and control of public expenditure. Financial Administration – This part deals with the study of the different aspects of public budget. The budget is the Annual master financial plan of the Government. The various objectives and steps in preparing a public budget, passing or sanctioning, allocation evaluation and auditing fall within financial administration.

Public Revenue

The responsibilities of a government all over the world have been steadily increasing. Government is responsible for the national defence and also for maintenance of law and order. Besides, government is also responsible for promoting social and economic welfare of the people. All these responsibilities imply that a government has to discharge large number of functions. These require money. A government has to mobilize more and more money in order to finance its function and the money mobilized by the government is called public revenue.

The various sources of public revenue can be broadly presented as shown