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Essay on Fiscal Policy
Essay Contents:
- Essay on the Meaning of Fiscal Policy
- Essay on the Kinds of Fiscal Policy
- Essay on the Importance of Fiscal Policy
- Essay on the Tools of Fiscal Policy
- Essay on Fiscal Policy Vs. Monetary Policy
- Essay on the Fiscal Policy in India
Essay # 1. Meaning of Fiscal Policy:
Fiscal policy today is largely a direct result of Keynesian beliefs. The economy does not always work smoothly. Keynes argued for intervention by the government to cure depression and inflation by adopting appropriate tools of macroeconomic policy.
Stabilising the economy at a higher level of employment and national output is not the only goal of macroeconomic policy. Macroeconomic policy can play a useful role in raising the rate of saving and investment and therefore ensure rapid economic growth.
Three important policy of macro-economic policy are:
(a) Economic stability at a high level of output and employment;
(b) Price stability; and
(c) Economic growth.
Since the beginning of 2000s, the role of fiscal and monetary policy has started to become more active. Another aspect of fiscal and monetary policy interaction explored at the meeting was the impact of fiscal policy on interest rates. In theory, the impact depends on whether the private sector is Ricardian or non- Ricardian. In a Ricardian world, fiscal deficits and debt have no consequences for interest rates, as the private sector saves the full extent of discounted tax liability implied by a rise in the fiscal deficit.
The economic crisis that started in 2007 has led to a rapid deterioration of public finances in most advanced economies. In many of the countries where fiscal deficits were large before the crisis began, deficits have reached or approached double-digit levels, raising concerns about the sustainability of public finances. In some countries (Greece, Ireland and Portugal being the most prominent examples), this development has not only contributed to significantly increased risk premia, but also accentuated the sustainability problem and made stabilisation policy measures less effective.
The performance of the Indian economy in recent years has attracted increasing international interest. An interesting feature of the record of economic growth in India is that it has experienced a sustained slow acceleration in growth since independence. Growth has been accelerating gradually since the 1950s, except for an interregnum between 1965 and 1980. Comprehensive economic reforms have been undertaken on a continuous basis since the crisis year of 1991-92.
The sustained acceleration in real GDP growth of the Indian economy has been associated with a secular up trend in domestic savings and investment over the decades. The sustained reform process in the macro economy has been accompanied by gradual reforms in the financial sector through the whole period since the early 1990s’.
The word ‘fisc’ means ‘state treasury’ and ‘fiscal policy’ refers to policy concerning the use of ‘state treasury’ or the government finances to achieve the macroeconomic goals. Arthur Smithies defined fiscal policy as “a policy under which government uses its expenditure and revenue programs to produce desirable effects and avoid undesirable effects on the national income, production and employment.”
G.K. Shaw defines fiscal policy as “any decision to change the level, composition or timing of government expenditure or to vary the burden, structure or frequency of the tax payment.” According to Samuelson and Nordhaus, fiscal policy means “the process of shaping taxation and public expenditure to help dampen the swings of the business cycle and contribute to the maintenance of a growing, high employment economy, free from high or volatile inflation.”
‘Fiscal policy is how the government manages its budget. It collects revenue via taxation that it then spends on various programs. Elected officials guide fiscal policy, redirecting funds from one sector of the population to another. The purpose of fiscal policy is to create healthy economic growth and increase the public good for the long-term benefit of all’.
‘It means government spending policies that influence macroeconomic conditions. Through fiscal policy, regulators attempt to improve unemployment rates, control inflation, stabilize business cycles and influence interest rates in an effort to control the economy. Fiscal policy is largely based on the ideas of British economist John Maynard Keynes (1883—1946), who believed governments could change economic performance by adjusting tax rates and government spending.
Fiscal policy is of two types:
i. Discretionary fiscal policy and
ii. Non-discretionary fiscal policy of automatic stabilisers.
Essay # 2. Kinds of Fiscal Policy:
Fiscal policy actions are generally classified as:
(a) Automatic stabilisation fiscal policy;
(b) Compensatory fiscal policy; and
(c) Discretionary fiscal policy.
The automatic fiscal policy means adopting a fiscal system with build-in-flexibility of tax revenue and government spending. Build-in-flexibility means automatic adjustment in the government expenditure and tax revenue in response to rise and fall in GNP.
The compensatory fiscal policy is a deliberate budgetary action taken by the government to compensate for the deficiency in or excess of aggregate demand. The compensatory action is taken by the government in the form of surplus budgeting or deficit budgeting.
Discretionary fiscal policy in ad hoc changes is made in the government expenditure and taxation system and tax rates at the discretion of the government.
In this policy government makes deliberate changes in:
(a) The size and composition of public debt,
(b) The size and pattern of expenditure; and
(c) The level and pattern of taxation.
Essay # 3. Importance of Fiscal Policy:
Fiscal policy is an important instrument to stabilise the economy, i.e. to overcome recession and inflation. It is the government programme of making discretionary changes in the pattern and level of its expenditure, taxation and borrowing in order to achieve intended economic growth, employment, income equality, and stabilisation of the economy on a growth path.
The essence of fiscal policy lies in the budgetary operations of the government. The two sides of the government budget are receipts and expenditure. The government expenditure consists of payments for goods and services, interests and loan repayments, subsidies, pensions and grants-in-aid.
Government uses expansionary fiscal policy to stimulate the economy and create more growth. This is most critical at the contraction phase of the business cycle, when voters are clamoring for relief from a recession. The government spends more, or cuts taxes or both if it can. The idea is to put more money into consumers’ hands, so they spend more.
Advocates of demand-side economics say additional spending, such as public works projects, unemployment benefits, and food stamps, goes directly into the pockets of consumers, who go right out and buy the things businesses produce. The purpose of contractionary fiscal policy is to slow down economic growth.
The tools of contractionary fiscal policy are used in reverse:
i. Taxes are increased, and
ii. Spending is cut.
These two policies are used in various combinations to direct a country’s economic goals. Here we look at how fiscal policy works, how it must be monitored and how its implementation may affect different people in an economy.
Maintaining full employment in the developed countries and creation of employment opportunities for millions of unemployed persons in the less developed countries has been one of the main objectives of fiscal policy. According to the Keynesian theory of employment, all fiscal measures that accelerate the pace of economic growth promote employment also. Where resource mobilisation through tax measures prove inadequate, the governments resort to borrowings to finance the growth projects.
To fight depression the government needs to increase its spending and cut down its taxation. For a discretionary fiscal policy to cure depression, the increase in Government expenditure is an important tool. Government expenditure can be increase by spending money on infrastructure, construction, irrigation etc. It will affect the economy directly or indirectly. Directly means people will get employment and supply of various raw materials. Indirect effect occurs by multiplier. Deficit spending through deficit financing are results in net injection into the economy.
This results in an increase in aggregate demand and rise in the general price level. Fiscal policy also changes the composition of aggregate demand. When the government runs a deficit, it meets some of its expenses by issuing bonds. In doing so, it competes with private borrowers for money loaned by savers. Holding other things constant, a fiscal expansion will raise interest rate and “crowd-out” some private investment, thus reducing the fraction of output composed of private investment.
Essay # 4. Tools of Fiscal Policy:
The first tool is taxation, whether of income, capital gains from investments, property, sales or just about anything else. Taxes provide the major revenue source that funds government. The downside of taxes is that whatever or whoever is taxed has less income to spend themselves. The second tool is spending. The government provides subsidies, transfer payments, contract to perform all kinds of public works and of course salaries to government employee.
Fiscal policy instruments include:
(a) Budgetary surplus and deficit;
(b) Government expenditure;
(c) Taxation;
(d) Public debt; and
(e) Deficit financing.
Keeping budget in balance, in surplus or in deficit is in itself a fiscal instrument. When government keeps its total expenditure equal to its revenue, then it is known as balanced budget policy. When the government spends more than its expected revenue, then it is called as deficit budget policy, and when government keeps expenditure lower than the revenue, than it is called as surplus budget policy.
The government expenditure is an injection into the economy. The government expenditure includes total public spending on purchase of goods and services, payment of wages and salaries of public servants, public investment, and transfer payments.
A tax is a non-quid pro quo payment by the people to the government. Taxes are classified as direct taxes and indirect taxes. Direct taxes include taxes on personal incomes, corporate incomes, wealth and property. Indirect tax includes taxes on production and sale of the goods and services. Public borrowing includes both internal and external borrowing.
Internal borrowing is of two types:
(a) Borrowing from the public by means of government bonds and treasury bills; and
(b) Borrowing from the central bank.
External borrowing includes borrowing from:
(a) Foreign governments;
(b) International organisations; and
(c) Market borrowing.
Essay # 5. Fiscal Policy Vs. Monetary Policy:
Monetary policy is a term used to refer to the actions of central banks to achieve macroeconomic policy objectives such as price stability, full employment, and stable economic growth. Fiscal policy is a broad term used to refer to the tax and spending policies of the federal government. Fiscal policy decisions are determined by the Congress and the Administration; the Federal Reserve plays no role in determining fiscal policy.
Fiscal policy relates to government spending and revenue collection. For example, when demand is low in the economy, the government can step in and increase its spending to stimulate demand. Or it can lower taxes to increase disposable income for people as well as corporations. Monetary policy relates to the supply of money, which is controlled via factors such as interest rates and reserve requirements for banks. For example, to control high inflation, policy-makers (usually an independent central bank) can raise interest rates thereby reducing money supply.
Essay # 6. Fiscal Policy in India:
Fiscal policy deals with the taxation and expenditure decisions of the government. Monetary policy, deals with the supply of money in the economy and the rate of interest. These include, tax policy, expenditure policy, investment or disinvestment strategies and debt or surplus management.
Fiscal policy is an important constituent of the overall economic framework of a country and is therefore intimately linked with its general economic policy strategy. Fiscal policy feeds into economic trends and influences monetary policy. When the government receives more than it spends, it has a surplus. If the government spends more than it receives it runs a deficit.
Broadly, during the first 30 years of independence, between 1950 and 1980, the fiscal deficits of both the central and the state governments were not excessive. This was a period of revenue surplus in general. However, automatic monetisation of government deficit by the RBI, which started as an exception during the mid 1950s, became a regular practice thereafter.
There was a significant deterioration in the fiscal situation in the 1980s, accompanied by large and automatic monetisation of government deficits. The large fiscal deficit and its monetisation had some spill-over effect on the external sector, which reflected in the widening current account deficit in the late 1980s and early 1990s.
Due to the global economic crisis, the fiscal deficit increased in 2009-10 to 9.3 per cent. India faced a severe macroeconomic crisis in 1991. A series of economic reforms, implemented in response, have, arguably, supported higher growth and a more secure external payments situation. However, growth only marginally accelerated in the 1990s compared to the previous decade.
India’s current fiscal situation is potentially grave, and could lead to an economic crisis (fiscal, monetary and/or external) with severe short-term losses of output and even political turmoil, or, alternatively and more subtly, many years of continued under-performance of the economy. A loose fiscal policy in India may lead to inflation, crowding out, and debt unsustainability, which may ultimately hamper economic growth.
When a loose fiscal policy tries to finance its deficit by printing money, inflation can occur. When a government borrows to finance a looser fiscal position, the greater demand for loanable funds can reduce private investment by raising interest rates. Under a floating exchange rate, a higher interest rate tends to attract foreign capital, leading to an appreciation of the exchange rate, which also crowds out export.
‘The Reserve Bank of India has done significant research on the role of fiscal policy in reviving the Indian economy (RBI 2001)’. Research shows that an attempt to raise public consumption to revive aggregate demand will crowd out both private consumption and private investment with no long-run positive impact on output growth.
Further, public investment in manufacturing appears to adversely affect private investment. However, government expenditure on infrastructure crowds in private investment. In addition, the level of fiscal deficit is also important because the positive impact of public sector infrastructure.
As the fiscal imbalances continue to exist and debt level is rising, the reforms mainly aimed to enhance government revenues are critical. There is ample room for improving the structure of indirect taxes, in particular, improved tax administration and enforcement remains one of the most critical areas for reform. Tax reform is an essential step towards increasing government revenue, as well as reducing microeconomic distortions.
The fiscal policy assumes centre stage in policy deliberations as the continuous fiscal imbalances and rising levels of public debt pose risks to the prospects for macroeconomic stability, and accelerating and sustaining growth. The rise in government consumption compensated for the fall in private consumption and investment, and contributed to the quick recovery. An expanding fiscal deficit made this possible. Countercyclical movement in deficits is compatible with overall fiscal consolidation.
Conclusion:
Fiscal policy is the use of government revenue collection and expenditure to influence the economy, or else it involves the government changing the levels of taxation and government spending in order to influence aggregate demand and the level of economic activity. The two main instruments are changes in the level and composition of taxation and government spending in various sectors.
Governments use fiscal policy to influence the level of aggregate demand in the economy, in an effort to achieve economic objectives of price stability, full employment, and economic growth.
Governments can use a budget surplus to do two things:
i. To slow the pace of strong economic growth and
ii. To stabilize prices when inflation is too high.
When the government decides on the goods and services it purchases, the transfer payments it distributes, or the taxes it collects, it is engaging in fiscal policy. The primary economic impact of any change in the government budget is felt by particular groups—a tax cut for families with children, for example, raises their disposable income.