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Fiscal policy Definition Fiscal policy is that part of government policy which is concerned with raising revenue through

taxation and other means and deciding on the level and pattern of expenditure with a view to correct the situations of excess demand or deficient demand in the economy Instruments of fiscal policy Instruments related to government expenditure Fiscal instruments related to government revenue Measures of fiscal policy 1. In case of deficient demand or deflationary gap a. Decrease in taxes b. Increase in public expenditure c. Increase in deficit financing d. Reduce public borrowing 2. In case of excessive demand or inflationary gap a. Increase taxes b. Decrease government expenditure c. Reduce deficit financing d. Increase public borrowing Role of fiscal policy in development of economy Fiscal policy means the use of taxation, public borrowing and expenditure by the government for purpose of stabilization or development Role of fiscal policy in development of economy 1. 2. 3. 4. 5. 6. 7. 8. 9. Capital formation Increase the rate of investment Encourage socially optimal investment Increase employment opportunity Economic stability in face of international instability Counteract inflation Flow of investment in socially desirable channels Check imbalance in various sectors Reduce inequality of income and wealth

Budget annual statement of the estimated receipt and expenditure of the government over the fiscal year

Two kinds of budget Revenue budget consist of revenue receipt and the expenditure met from such revenues Revenue receipt a. Tax revenue a. Indirect tax b. Direct tax b. Non tax revenue a. Commercial revenue b. Interest and dividend revenue c. Administrative revenue i. Fees ii. Fines and penalties iii. License fees iv. Escheat v. Forfeiture Capital budget consist of capital receipt and capital expenditure Capital receipt a. Loans raised by the government from the public b. Borrowings by the government from the sale of RBI and other parties through sale of treasury bills c. Loans received from foreign government and bodies d. Recoveries of loans granted to state and union territory government and other parties e. Small savings and deposits in public provident funds Capital expenditure expenditure on acquisition of assets and loans and advances

The growth of government since the 1930s has been accompanied by steady increases in government spending. In 1930, the federal government accounted for just 3.3 percent of the nation's gross domestic product, or total output of goods and services excluding imports and exports. That figure rose to almost 44 percent of GDP in 1944, at the height of World War II, before falling back to 11.6 percent in 1948. But government spending generally rose as a share of GDP in subsequent years, reaching almost 24 percent in 1983 before falling back somewhat. In 1999 it stood at about 21 percent.

The development of fiscal policy is an elaborate process. Each year, the president proposes a budget, or spending plan, to Congress. Lawmakers consider the president's proposals in several steps. First, they

decide on the overall level of spending and taxes. Next, they divide that overall figure into separate categories -- for national defense, health and human services, and transportation, for instance. Finally, Congress considers individual appropriations bills spelling out exactly how the money in each category will be spent. Each appropriations bill ultimately must be signed by the president in order to take effect. This budget process often takes an entire session of Congress; the president presents his proposals in early February, and Congress often does not finish its work on appropriations bills until September (and sometimes even later). Fiscal Policy and Budget Outcomes

This tutorial was written by Ken Edge Head Teacher Social Science Cardiff High School

Outcomes Overview Content Review exercises More Outcomes

HSC Topic Four: Economic Polices and Management is described in the Board of Studies NSW Stage 6 Economics Syllabus (1999) on pages 40 to 42. The specific outcomes from the syllabus for this tutorial are listed below.

A student:H1 H2

demonstrates understanding of economic terms, concepts and relationships

analyses the economic role of individuals, firms, institutions and governments

H5 discusses alternative policy options for dealing with problems and issues in contemporary and hypothetical contexts

H6

analyses the impact of economic polices in theoretical and contemporary Australian contexts

H7 evaluates the consequences of contemporary economic problems and issues on individuals, firms and governments.

Being up to date and aware of contemporary issues

Students of Economics need to be aware of what is happening in the Australian Economy today and should, for instance, have looked at the most recent Federal Budget. There is an excellent web link to notes on the most recent budget at the bottom of this page in the section 'MORE'. Overview

Fiscal policy involves the Commonwealth Government changing expenditure and revenue patterns to achieve a range of economic objectives. The estimated revenue and expenditure for the next year and future years of the government is known as the Commonwealth Budget and is the main instrument of fiscal policy.

Deliberate or discretionary changes to the structure of revenue and expenditure components of the Budget can be used to alter the level of economic growth, inflation, unemployment and external stability. For example, a budget surplus can be used to slow down an overheated economy and reduce inflation, whilst a budget deficit can be used to stimulate economic recovery from recession.

Changes in the methods of revenue collection and expenditure can also affect the distribution of income and the pattern of resource allocation in the economy.

The major objective of the federal government is to achieve a fiscal balance over the length of the business cycle.

Content The Commonwealth Governments budget

The Budget is delivered in May of each year and is a statement of the governments estimated expenditure (G) and revenue (T) for the next fiscal year. However, economic conditions can change and alter the budget estimates. Revisions of the budget estimates occur in December or January, when the government issues an assessment of economic conditions. This is referred to as the Mid-Year Economic and Fiscal Outlook (MYEFO).

There are three possible budget outcomes: a balanced budget where government expenditure equals revenue (G=T) a deficit budget where government expenditure is more than revenue (G>T) a surplus budget where government expenditure is less than revenue (G<T).

Measuring the budget outcome

Table 1 Commonwealth budget aggregates

The main methods used by the government to calculate the budget outcome are:

The headline cash balance includes all sources of government revenue and expenditure.

headline cash balance = total outlays less total revenue

This method of calculating the budget outcome uses the cash accounting system where the government records transactions when payments are made and income is received.

The underlying cash balance removes "one-off" effects such as the partial privatisation of Telstra in 199798, 199899 and the sale of Sydney Airport Corporation Limited in 200102 from the headline budget outcome.

underlying cash balance = headline cash balance less net advances

(net advances include the purchase and sale of assets, and debt transfers between the state and federal governments)

This method of calculating the budget outcome gives a good indication of the overall impact of the budget on the economy. The Treasurer refers to this measure of determining the budget outcome in his or her Budget speech.

An underlying cash surplus is available to the government to purchase assets or pay off debts. Successive surpluses were used by the Australian Government up until the 2008/9 Budget which reduced debt to virtually zero and allowed the accumulation of savings to be used in the future for investment and economic downturns.

An underlying cash deficit needs to be financed by the sale of government financial assets or by drawing on cash reserves from other sectors of the economy. The underlying cash deficit for 2009-2010 of $3.6 billion was incurred because of a shortfall in tax collections due to low economic growth, and to pay for cash and infrastructure stimulus spending. The projected budget deficits and cash deficits are expected to be very large for the foreseeable future as the Government is intending to spend more in the community to offset the impact of the GFC and associated downturn.

The fiscal balance is similar to the underlying cash balance but is calculated using an accrual accounting system. Using this system, transactions are recorded as they occur, not as they are received or paid (cash accounting system). The Treasury first introduced the fiscal balance in the 19992000 budget.

fiscal balance = net operating balance minus net capital investment

The fiscal balance is also adjusted for one-off purchases and sales of non- financial assets by the government (net capital investment).

The fiscal balance is important because it measures the balance between government savings and investment. For example, a fiscal surplus enables the government to increase national savings and reduce debt. A fiscal deficit means that the government has to borrow funds from other sectors of the economy, potentially affecting the balance of payments and the current account.

Changes in the budget outcome

One important observation from Table 1 is that, the amount of revenues, expenditures as well as budget outcomes change each year. There are two main reasons for these variations: Discretionary changes in fiscal policy

Discretionary changes are deliberate changes inrevenue and expenditure levels by the government. For example, in the 200910 Budget, the government anounced a $22billion infrastructure investment. Such deliberate changes in fiscal stance alter the structural component of the budget, and are used to stabilise the economy in the medium-term. Cyclical or non-discretionary changes in fiscal policy

Adjustments in levels of revenue and expenditure can result from changes in the level of economic activity (booms and recessions). These adjustments are beyond the control of the government and are known as automatic stabilisers. There are two main automatic stabilizers:

Unemployment benefits

In a recession, the level of economic activity falls and the unemployment rate increases. As a result, government expenditures on unemployment benefits and Job Search allowances automatically increase. This increase in government expenditure reduces the budget surplus or increases the deficit. As unemployment increases in the recession then spending on unemployment will rise, increasing the spending of unemployed people. This acts to offset the recession and increase spending in the community.

The opposite occurs during an upturn in economic activity. In this situation, jobs are created and the government spends less on unemployment benefits, which increases the budget surplus or reduces the deficit.

The PAYG income tax system

During times of economic growth, employment levels and incomes rise. Workers move into higher income brackets automatically increasing government taxation revenue. This process is known as fiscal drag or bracket creep. During a downswing in economic activity or recession, taxation revenue is reduced, increasing the deficit or reducing the surplus.

The automatic stabilisers in the budget therefore play a counter-cyclical role, in that they tend to smooth out the effects of booms and recessions on the economy. In booms, demand is automatically checked through higher tax revenue and reduced government expenditure. In a recession, increases in government expenditure (unemployment benefits) help stimulate the economy and raise aggregate demand.

Between 2002 and 2008 the mining boom and increased consumption of raw materials by China is estimated to have added $334 billion to corporate taxes paid by business to the Australian Government. This large increase in revenues allowed the government to deliver budget surpluses, tax cuts and save funds in national infrastructure funds all at the same time.

Fiscal stance

The fiscal stance refers to the intended overall impact of the Budget on the level of economic activity in the coming and future years. There are three possible fiscal stances: A neutral stance is where G=T, with little or no impact on the level of economic activity.

Expansionary fiscal policy is associated with budget deficits, where injections are greater than withdrawals or G>T. The government borrows money to inject

Contractionary fiscal policy is associated with surplus budgets, where injections are less than withdrawals or G<T. In this situation, government expenditure is less than revenue, thereby reducing the level of aggregate demand and economic activity.

In determining fiscal stance the government must also consider the impact of changes in spending and revenue on: resource reallocation and production in the economy the redistribution of income that could occur.

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