Fiscal Policy And Its Instruments

Fiscal Policy-Meaning

Fisc - state treasury Fiscal policy package of governments economic measures to influence the direction of nations economy by using its financial and regulatory powers.

The expenditure a government undertakes to provide goods and services and the way in which the government finances these expenditures.

Objectives of Fiscal Policy

It has 2 major objectives:

GENERAL - aimed at achieving macroeconomic goals

i.

ii. SPECIFIC - relating to any particular problem of the economy

Fiscal Policy And Macroeconomic Goals

Economic Growth - by creating conditions for increase in savings & investment. Employment Reduce sectoral and regional imbalances. Economic Equality Price stability

Functioning of fiscal policy

Aim is to increase Aggregate Demand

Govt. buys more goods and services

Decrease tax on 1.Households 2. Corporate world

Increase transfer payments

Instruments of Fiscal Policy

Powerful tool for creating demand stimulus. Budgetary surplus and deficit Government expenditure Taxation- direct and indirect Public debt

Budgetary surplus and deficit

A budget is a detailed plan of operations for a specific future period Keeping budget balanced (R=E) or deficit (R<E) or surplus (R>E) as a matter of policy is itself a fiscal instrument.

Government Expenditure

It includes : Government spending on current purchase of goods & services govt. consumption. Payment of wages and salaries of government servants Investment intended for future benefits. Transfer payments no purchases but just transfer of money.

Public debt

1.

Internal borrowings
Borrowings from the public by means of treasury bills and govt. bonds Borrowings from the central bank (monetization of debt)

2.

1.

2.

External borrowings Foreign investments From international organizations World Bank & IMF

Taxation

Non quid pro quo transfer of private income to public coffers for the purpose of generating
revenues for public expenditure.

Classified into 1. Direct taxes- Corporate tax, Personal Income Tax,

Fringe Benefit tax, Banking Cash Transaction Tax

2. Indirect taxes- Central Sales Tax, Service Tax, Excise duty.

TAXATION AS A FISCAL POLICY

What is taxation?
Means by which government raises revenue under the authority of the law, to promote welfare and protection for its citizens.

What is tax ? Characteristics of Tax

Forced contribution Non quid pro quo Levied for public purposes domestic, external Levied on person or property

Why to tax ?
Three R

Revenue Redistribution Reorientation of pattern and level of demand

How to tax ?

Should it be progressive? Should it be regressive?

Should it be proportional?

How to tax ? Basic Principles of a Sound Tax System

Fiscal adequacy - revenue should be capable of expanding or contracting in response to changes in public expenditure luxury items Equality - taxes levied must be based upon the paying ability of the bearer. Administrative feasibility - tax should be clear to taxpayers, enforcement should be easy and convenient. Compatible with economic goals eg. sectoral boost, R&D.

Where to tax ? Direct Vs Indirect taxation

Direct tax levied on income, wealth and profit. Indirect tax on expenditure (spending on goods and services), such as excise duties, VAT.

Why indirect taxes not recommended?

Many are regressive in nature do not follow equity principle. Raising indirect taxes leads to cost push inflation. Less revenue when consumer demand is low.