FISCAL POLICY

Final Project

Submitted to: Maam Neha

Submitted by: Mehran Fayyaz
Registration no: 2153001
Contents
Introduction: ....................................................................................................................................... 2
Definition ............................................................................................................................................ 2
Objectives of policy in Pakistan fiscal ................................................................................................. 2
Price stability:...................................................................................................................................... 2
To accelerate the economic growth ................................................................................................... 3
Optimum Allocation of Resources: ..................................................................................................... 3
Economic Stability: .............................................................................................................................. 3
To Encourage Investment: .................................................................................................................. 4
How Does Fiscal Policy works? ........................................................................................................... 4
Who Does Fiscal Policy Affect? ........................................................................................................... 4
Types of Fiscal Policy:.......................................................................................................................... 5
The 3 possible stances of fiscal policy................................................................................................. 5
Methods of Raising Funds:.................................................................................................................. 5
Types of Taxes ..................................................................................................................................... 6
Direct:.................................................................................................................................................. 7
Indirect: ............................................................................................................................................... 7
Pakistan face large revenue gap: ........................................................................................................ 8
Principles of Tax Policy ........................................................................................................................ 9
Why Pakistan is facing budget shortfall? .......................................................................................... 11
Fiscal Policy and Macroeconomic objectives .................................................................................... 12
How Pakistan can avoid Surge in Fiscal Deficit? ............................................................................... 12
Conclusion ......................................................................................................................................... 13

1|Page
Introduction:
The term fiscal policy refers to the expenditure a government undertakes to provide goods and
services and to the way in which the government finances these expenditures.

Definition
What is a Fiscal Policy?
According to Samuelson,
Fiscal Policy is concerned with all those arrangements which are adopted by the Government
to collect the revenue and make the expenditures so that economic stability could be
attained/maintained without inflation and deflation´

According to Lee, fiscal policy considers:

• Imposition of taxes
• Government expenditures
• Public Debt
• Management of Public debt

Objectives of policy in Pakistan fiscal

Price stability:
There is a general agreement that economic growth and stability are joint objectives for
underdeveloped countries. In a developing country, economic instability is manifested in the
form of inflation. Prof. Nurkse believed that “inflationary pressures are inherent in the process
of investment but the way to stop them is not to stop investment. They can be controlled by
various other ways of which the chief is the powerful method of fiscal policy.”

Therefore, in developing economies, inflation is a permanent phenomenon where there is a

tendency to the rise in prices due to expanding trend of public expenditure. Because of rise in
income, aggregate demand exceeds aggregate supply. Capital goods and consumer goods fail
to keep pace with rising income.

2|Page
Thus, these result in inflationary gap. The price rise generated by demand pull reinforced by
cost push inflation leads to further widening the gap. The rise in prices raises demand for more
wages. This further gives rise to repeated wage-price spirals. If this situation is not effectively
controlled, it may turn into hyper inflation.

In short, fiscal policy should try to remove the bottlenecks and structural rigidities which cause
imbalance in various sectors of the economy. Moreover, it should strengthen physical controls
of essential commodities, granting of concessions, subsidies and protection in the economy. In
short, fiscal measures as well as monetary measures go side by side to achieve the objectives
of economic growth and stability.

To accelerate the economic growth

Primarily, fiscal policy in a developing economy, should aim at achieving an accelerated rate
of economic growth. But a high rate of economic growth cannot be achieved and maintained
without stability in the economy. Therefore, fiscal measures such as taxation, public borrowing
and deficit financing etc. should be used properly so that production, consumption and
distribution may not adversely affect. It should promote the economy which in turn helps to
raise national income and per capita income.

In this connection it is significant to quote the views of Mrs. Hicks, who observed, “now that
fiscal policy has been developed as an established economic function of a government, every
country is anxious to gear its public finance in pursuit of the twin aims of stability and growth,
but their relative importance is very differently regarded from one country to another… A
steady rate of expansion will tend to reduce the violence of such fluctuations as may occur; a
successful full employment policy will provide an atmosphere which is congenial for growth.”

Optimum Allocation of Resources:

Fiscal measures like taxation and public expenditure programmes, can greatly affect the
allocation of resources in various occupations and sectors. As it is true, the national income
and per capita income of underdeveloped countries is very low. To gear the economy, the
government can push the growth of social infrastructure through fiscal measures. Public
expenditure, subsidies and incentives can favourably influence the allocation of resources in
the desired channels.

Tax exemptions and tax concessions may help a lot in attracting resources towards the favoured
industries. On the contrary, high taxation may draw away resources in a specific sector. Above
all, direct curtailment of consumption and socially unproductive investment may be helpful in
mobilization of resources and the further check of the inflationary trends in the economy.
Sometimes, the policy of protection is a useful tool for the growth of some socially desired
industries in an under-developed country.

Economic Stability:
3|Page
Fiscal measures, to a larger extent, promote economic stability in the face of short-run
international cyclical fluctuations. These fluctuations cause variations in terms of trade, making
the most favourable to the developed and unfavourable to the developing economies. So, for
the purpose of bringing economic stability, fiscal methods should incorporate built-in-
flexibility in the budgetary system so that income and expenditure of the government may
automatically provide compensatory effect on the rise or fall of the nation’s income. Therefore,
fiscal policy plays a leading role in maintaining economic stability in the face of internal and
external forces. The instability caused by external forces is corrected by a policy, popularly
known as ‘tariff policy’ rather than aggregative fiscal policy. In the period of boom, export and
import duties should be imposed to minimize the impact of international cyclical fluctuations.

To curb the use of additional purchasing power, heavy import duty on consumer goods and
luxury import restrictions are essential. During the period of recession, government should
undertake public works programmes through deficit financing. In nut shell, fiscal policy should
be viewed from a larger perspective keeping in view the balanced growth of various sectors of
the economy.

To Encourage Investment:
Fiscal policy aims at the acceleration of the rate of investment in the public as well as in private
sectors of the economy. Fiscal policy, in the first instance, should encourage investment in
public sector which in turn effect to increase the volume of investment in private sector. In
other words, fiscal policy should aim at rapid economic development and must encourage
investment in those channels which are considered most desirable from the point of view of
society.

It should aim at curtailing conspicuous consumption and investment in unproductive channels.

In the early stages of economic development, the government must try to build up economic
and social overheads such like transport and communication, irrigation, flood control, power,
ports, technical training, education, hospital and school facilities, so that they may provide
external economies to induce investment in industrial and agricultural sectors of the economy.
These economies will be helpful for widening the size of the market, reducing the cost of
production and increasing the social marginal productivity of investment. Here it must be
remembered that projects of social marginal productivity should wisely be selected keeping in
view its practical implication.

How Does Fiscal Policy works?

Fiscal policy is how a government adjusts its spending levels and tax rates to monitor and
influence a nation's economy. It is the sister strategy to monetary policy through which a central
bank influences a nation's money supply. 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.

Who Does Fiscal Policy Affect?

4|Page
Unfortunately, the effects of any fiscal policy are not the same for everyone. Depending on the
political orientations and goals of the policymakers, a tax cut could affect only the middle class,
which is typically the largest economic group. In times of economic decline and rising taxation,
it is this same group that may have to pay more taxes than the wealthier upper class.

Similarly, when a government decides to adjust its spending, its policy may affect only a
specific group of people. A decision to build a new bridge, for example, will give work and
more income to hundreds of construction workers. A decision to spend money on building a
new space shuttle, on the other hand, benefits only a small, specialized pool of experts, which
would not do much to increase aggregate employment levels.

Types of Fiscal Policy:

1. Expansionary:

An increase in government purchases of goods and services, a decrease in net taxes, or some
combination of two for the purpose of increasing aggregate demand and expanding real output.

2. Contractionary:
A decrease in government purchases of goods and services, an increase in net taxes, or some
combination of the two for the purpose of decreasing aggregate demand and thus controlling
inflation.

The 3 possible stances of fiscal policy

1. Neutral fiscal policy is usually undertaken when an economy is in

equilibrium. Government spending is fully funded by tax revenue and over all the
budget outcome has a neutral effect on the level of economic activity.

2. Expansionary fiscal policy involves government spending exceeding tax revenue and
is usually undertaken during recessions.

3. Contractionary fiscal policy occurs when government spending is lower than tax
revenue and is usually undertaken to pay down government debt.

Methods of Raising Funds:

5|Page
 1. Taxation
Taxation directly takes money from the pockets of citizens and puts it into the hands of the
government. It’s important to remember that households and businesses can never do
anything remotely similar to taxation–you cannot compel your employer to pay you more,
and you cannot compel customers to buy your goods and services. It should also be noted
that taxation has serious consequences for morality and justice, but those are beyond the
scope of today’s post. Today we are focusing only on how taxation affects the government’s
budget and economic performance, not on the ways it affects the distribution of wealth or
opportunity.

2. Borrowing

At the end of the taxation post, we left the government in a sticky situation–how should it
raise money when the economy is depressed, such that any money it seizes through taxation
will further depress consumption or investment? One great way to deal with this problem
is borrowing. If the government gives consumers or investors bonds in exchange for their
money, the money they hand the government becomes an investment that pays them a
return.

3. Foreign aid

Foreign aid is money that one country voluntarily transfers to another, which can take the
form of a gift, a grant or a loan. In the United States, the term usually refers only to military
and economic assistance the federal government provides to other governments. Broader
definitions of aid include money transferred across borders by religious organizations,
nongovernment organizations (NGOs) and foundations. Some have argued that remissions
should be included, but they are rarely assumed to constitute aid.

4. Bonds

A government bond is a debt security issued by a government to support government

spending. Federal government bonds in the United States include savings bonds, Treasury
bonds and Treasury inflation-protected securities (TIPS). Before investing in government
bonds, investors need to assess several risks associated with the country, such as country
risk, political risk, inflation risk and interest rate risk, although the government usually has
low credit risk.

Types of Taxes
1. Direct tax

6|Page
 2. Indirect tax

Direct:
Direct taxis the one paid directly to the government by the persons on whom it is imposed.

 Income tax

An income tax is a tax imposed on individuals or entities (taxpayers) that varies with
respective income or profits (taxable income). Income tax generally is computed as the
product of a tax rate times taxable income. Taxation rates may vary by type or
characteristics of the taxpayer. The tax rate may increase as taxable income increases

 Corporate tax
A corporate tax, also called corporation tax or company tax, is a direct tax imposed by
a jurisdiction on the income or capital of corporations. Many countries impose such
taxes at the national level, and a similar tax may be imposed at state or local levels. The
taxes may also be referred to as income tax or capital tax.

 Property tax
Property tax is the annual amount paid by a land owner to the local government or the
municipal corporation of his area. The property includes all tangible real estate
property, his house, office building and the property he has rented to others.

 Capital value tax

The Capital Value Tax is applicable in urban areas for residential property exceeding
an area of one kanal and in case of commercial properties without any threshold of land
area or size of the property.

Indirect:
Taxation on an individual or entity, which is ultimately paid for by another person.
Some indirect taxes are also referred to as consumption taxes such as:

7|Page
  Sales tax
A sales tax is a tax paid to a governing body for the sales of certain goods and services.
Usually laws allow (or require) the seller to collect funds for the tax from the consumer
at the point of purchase.

 Value added tax

A value-added tax (VAT), known in some countries as a goods and services tax (GST),
is a type of tax that is assessed incrementally, based on the increase in value of a product
or service at each stage of production or distribution. VAT essentially compensates for
the shared services and infrastructure provided in a certain locality by a state and funded
by its taxpayers that were used in the elaboration of that product or service.

 Federal excise duty

An excise or excise tax is any duty on manufactured goods which is levied at the
moment of manufacture, rather than at sale.

Pakistan face large revenue gap:

Government of Pakistan collect taxes from its people in order to spend the collection
on the welfare of its people which includes national defenced servicing and other
welfare related issues. While designing the tax policy a country should account the
equity and justice for its people because a system is most effective when it is designed
on the bases of equal and fair treatment of each tax-payer. But in case of Pakistan the
situation is bit different, as a nation we are in debt by the foreign and domestic lenders
which is due to our extra expenses incurred due to recent war on terror, our habit of
corruption at national and international level and we are also tax averse society in which
we don’t feel ourselves responsible to pay taxes. Our current tax collection system is
very weak which comprises of loopholes in the system accompanied by the corruption
of Federal Board of Revenue (FBR) officers which speaks about the justice and equity
of our government officials for their people. After analysing the height of corruption,
special favour given to government officials or their friends, (Their Detail of Corruption
will be discussed later with their names). Our undocumented economy and failure to
increase tax net it has become necessary for any lender to set the target in order to
continue the money lending and to make sure that their borrowed money can be repaid
by the borrower.
Initially the foreign lenders did not set any targets for us because they somehow
believed in our commitments and also felt that we will pay them back their money as
per the signed agreement but after the several failures of debt servicing, lenders started
to analyze the root cause of this issue in which they found our tax collection system
complied with old methodology of taxation i.e. General Sales Tax (GST) in which all
the tax collected at the last stage which makes them aware of the fact that as a corrupt

8|Page
 nation and low tax net economy it will become more difficult for them to collect their
lent amount from us which lead IMF to set targets for us.

Principles of Tax Policy

 Widening the tax base
Widening of tax base means covering maximum people under tax net and it has two
aspects in its fold.

1. It can fetch maximum revenue for the government for its expenditure.

2. Govt can consider lowering of tax rate on collection of higher revenue due to widening
of tax.

 Lowering tax rates

When the economy is weak, for example, the Federal Reserve tries to boost consumer
and business demand by cutting interest rates or purchasing financial securities.
Congress, for its part, can boost demand by increasing spending and cutting taxes. Tax
cuts increase household demand by increasing workers' take-home pay.

 Taxing all value additions including services, not just

manufacturing sector
A value-added tax (VAT), known in some countries as a goods and services tax (GST),
is a type of tax that is assessed incrementally, based on the increase in value of a product
or service at each stage of production or distribution. value added refers to "extra"
feature(s) of an item of interest (product, service, person etc.) that go beyond the
standard expectations and provide something "more", even if the cost is higher to the
client or purchaser.

 Establish an effective and efficient tax system

1. Focus resources on improved auditing, processes, and tools

9|Page
 Fast-moving growth creates opportunities for tax evasion and may encourage a culture
of noncompliance. Auditing can not only detect and penalize evasion attempts but also
signal a tax administration’s intention to prioritize more aggressive enforcement.

2. Use simple segmentation to identify larger collection opportunities

Most rapidly developing economies lack the advanced analytic tools and databases
necessary to flag and follow up on suspicious taxpayer behaviour automatically.
Nonetheless, simply segmenting taxpayers according to attributes such as size, sector,
and past behaviour can help tax authorities quickly perform a risk analysis identifying
discrepancies between an individual taxpayer’s behaviour.

3. Ensure regular updates to the taxpayer registry

In many rapidly growing markets, it can be difficult to maintain an accurate central

taxpayer registry, as much of the economy is made up of “informal” and small-scale
businesses, and tax authorities lack the external controls necessary to ensure that such
entities stay within the system. To counteract this, registration should be made more
rigorous and feedback systems introduced to ensure that taxpayers regularly update
their information.

4. Introduce account managers to oversee large taxpayers

In most countries, a very small number of taxpayers account for the majority of tax
revenue. Although tax administrations usually have large-taxpayer units, these LTUs
often use the same processes, rules, and resources as general tax offices. LTU “account
managers,” supported by a back office devoted to their needs, can provide large
taxpayers with differentiated and improved services that will ensure increased
revenues.

5. Use electronic channels for simple transactions

In many rapidly developing economies, mobile and Internet penetration are

comparatively high. Tax administrations can therefore introduce electronic channels
such as Internet portals, mobile-payment options, and ATMs. By using these channels
for simple taxpayer transactions (such as declarations and payments), a tax
administration can increase the level of voluntary payments while conveying a strong
sense of its public purpose. Such approaches reduce the length of queues at tax offices
while also removing a barrier to compliance.

6. Analyze opportunities to close tax loopholes

With input from senior tax officials, tax administrations can perform a top-down,
granular analysis of each type of tax to establish whether there are opportunities to close

10 | P a g e
 sector-specific tax loopholes quickly. The analysis should establish whether there are
any significant gaps between the expected and the effective tax rates.

 Overcome the culture of tax avoidance and evasion

1. The rapid introduction of multilateral automatic tax information exchange between tax
agencies in every single jurisdiction. This would ensure money illegally held offshore
was easily identified and accounted for.

2. The introduction of new levels of financial transparency requiring the public disclosure
of the ultimate human beneficiaries of companies, trusts and foundations. This is
needed to prevent the further subversion of countries' tax bases whether by high net
worth individuals, businesses, corrupt politicians, criminals or terrorists. It is also
required to restore faith in the rule of law and the democratic process as the current non-
disclosure of beneficial ownership is corruption's best friend.

3. The global introduction of country-by-country reporting so that every company has to

publicly state financial details relating to its turnover, profits, costs, employees and
taxes in every jurisdiction.

Why Pakistan is facing budget shortfall?

1. Too many factories are closed or in partial production for want of power and
gas

In the era of 2011 we all know that a huge investor shift from Pakistan to
Bangladesh just because of energy crises. Bangladesh create a free tax zone and
because of energy crisis most of the Pakistan investor shift from Pakistan to
Bangladesh.

2. Tax Evasion by well performing industries

The Federal Board of Revenue (FBR) has blacklisted QMobile manufacturer, Digicom

Electronics for tax evasion of millions of rupees. An Urdu daily, claimed that the company

paid around Rs300 million to Indian actors for working in the advertisement of his cell

phones but avoided paying taxes in Pakistan. The latest investigations conducted by the

11 | P a g e
 FBR revealed that the company has evaded Rs520 million taxes, it added. The company

paid Rs100 million each to Indian actresses Kareena Kapoor Khan and Jacqueline

Fernandez, while the same was given to Arjun Singh, Shahid Kapoor and Ranvir Singh,

3. Stock Exchange and Real Estate pay minimal tax.

Investor in Pakistan hide their assets because of high tax rate big investor is not
willing to pay tax.

4. Corruption by Tax Officials

Corruption in Pakistan is widespread, particularly in the government and lower levels

of police forces. Pakistan's prime minister Nawaz Sharif was declared ineligible to hold
office for life by Supreme Court of Pakistan after charges of corruption were filed
against him. Transparency International's 2017 Corruption Perception Index ranks the
country 117th place out of 180 countries.

Fiscal Policy and Macroeconomic objectives

Fiscal policy is concerned with govt. spending and taxation.

 If govt. spending is increased, there will be an increase in the amount of injections;
expenditure in an economy will rise so national income would rise.
 If taxation is increased, there will be an increase in the withdrawals from the economy,
expenditure and national income will fall.

How Pakistan can avoid Surge in Fiscal Deficit?

 Central Board of Revenue should impose new taxes

 Increase the price of utilities

12 | P a g e
  Decrease in development spending

Conclusion
As we know about the Pakistan tax policy system that is very weak., as a nation we are in
debt by the foreign and domestic lenders which is due to our extra expenses incurred due
to recent war on terror, our habit of corruption at national and international level and we
are also tax averse society in which we don’t feel ourselves responsible to pay taxes. Our
current tax collection system is very weak which comprises of loopholes in the system.
Pakistan fiscal position worsened because of unexpected events occurred on domestic and
external scene. High proportion of revenues being spent on defense and interest payments.
Lower industrial productivity leads to lower tax collection because of high interest rates.
Pakistan needs to increase tax base by imposing tax on agriculture and capital gain to
increase revenue. By taking bold steps and making tax policies stricter we can stabilize our
country. We can make our policies strict by following some actions which includes
Widening the tax base, lowering tax rate, by controlling tax evasion, establish a strict tax
system etc.

13 | P a g e
Reference
https://www.thebalance.com/what-is-fiscal-policy-types-objectives-and-tools-
3305844
https://www.economicshelp.org/macroeconomics/fiscal-policy/fiscal_policy/
http://www.finance.gov.pk/publications/FPS_2017_18.pdf
https://businessjargons.com/fiscal-policy.html
https://www.finpipe.com/fiscal-policy-definition/
https://www.economicshelp.org/macroeconomics/fiscal-policy/fiscal_policy/
https://en.wikipedia.org/wiki/Fiscal_policy
https://sites.google.com/site/maeconomicsku/home/fiscal-policy-in-pakistan
https://www.regjeringen.no/en/aktuelt/conference-the-impact-of-fiscal-policy-
on-the-economy/id2522585/

14 | P a g e