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INTRODUCTION
It is now widely recognized that the state has a sine qua non in the regulation of economic activity along the desired lines. Fiscal policy is traditionally concerned with the determination of state income and expenditure policy. However, in recent times, public borrowing and deficit budgeting have also become a part of fiscal policy.Thus all the budgetary instruments like taxes, public spending, borrowing and debt management constitute the fiscal policy. Fiscal policy tries to achieve its objectives by regulating the working of the market mechanism while retaining the mechanism itself.
Meaning and objectives of Fiscal Policy
In simple words, fiscal policy refers to the instruments by which a government tries to regulate or modify the economic affairs of the economy keeping in view certain objectives.The concept of fiscal policy has been defined by different economists as follows:
Harvey and Johnson define fiscal policy as "changes in government expenditure and taxation designed to influence the pattern and level of activity."
According to G.K. Shaw, "We define fiscal policy to include any design to change the price level, composition or timing of government expenditure or to vary the burden, structure or frequency of the tax payment."
Must see- Fiscal-policy-and-crowding-out-effect
Objectives of Fiscal Policy
Fiscal policy in under-developed countries has a different objective to that in advanced countries.The objective of fiscal policy in developed economies is to maintain the condition of full employment, economic stability and stabilise the rate of growth.For an under-developed economy, the main purpose of fiscal policy is to accelerate the rate of capital formation and investment.
To achieve economic stability in developed countries, functional finance by regulating the volume of public expenditure go a long way but this device is not relevant to solve the problem of under-developed countries at length because lack of resource mobilisation is the major hindrance in such economies. Thus the technique of "Activating Finance" i.e. mobilisation of resources through taxation, borrowing and deficit financing is advocated to achieve the economic growth and stability.
Following are the main objectives of a fiscal policy in a developing economy :
1. Full employment.
2. Price stability
3. Accelerating the rate of economic development
4. Optimum allocation of resources
5. Equitable distribution of income and wealth.
6. Economic stability
7. Capital formation and growth
8. Encouraging investment.
The nature of economic fluctuations in under-developed countries is different from those in the developed economies.
It follows that in under-developed countries stability cannot be separated from economic growth. Growth and stability present more challenging problem than a merely compensatory fiscal policy. Thus, Government has to follow a policy of 'Activating Finance' and try to increase resources for economic development. The objectives of fiscal policy in under-developed countries are :
(i) To maximise the rate of capital formation and to lead the economy on the path of rapid economic progress.
(ii) To make available the maximum flow of human and material resources consistent with current consumption requirements.
(iii) To guide the allocation of existing resources into socially necessary lines of development.
(iv) To reduce the extreme inequalities in wealth, income and consumption standards which undermine productive efficiency, offend justice and endanger political stability.
(v) To mop up the excess purchasing power so as to mobilise savings for investment.
(vi) To eliminate as far as possible sectorial imbalances in the economy.
Instruments of Fiscal Policy
Contra-cyclical fiscal policy occupies the centre place for maintaining full employment without inflationary and deflationary forces. Thus, the various instruments or measures which influence the economic stability of an economy are :
(i) Budget :- The budget of a nation is a useful instrument to assess the fluctuations in an economy. Different budgetary principles like annual budget,cyclical budget and fully managed compensatory budget have been formulated by the economists.
(ii) Taxation :- Taxation is a powerful instrument of fiscal policy in the hands of public authorities which greatly affect the changes in disposable income,consumption and investment.
(iii) Public Expenditure :- The active participation of the government in economic activity has brought public spending to the front line among the fiscal tools. The appropriate variation in public expenditure as compared to taxes have more direct effect upon the level of economic activity. The increased public spending will have a multiple effect upon income, output and employment exactly in the same way as of increased investment has its effect on them. Similarly, a reduction in public spending, can reduce the level of economic activity through the reverse operation of the government expenditure multiplier.
(iv) Public Works :- Keynes has highlighted public works programme as the most significant anti-depression device because:
(i) they absorb hitherto to unemployed workers.
(ii) they help to create economically and socially useful capital assets as roads, canals, power.
(iii) they increase the purchasing power of the community and thereby stimulate the demand for consumption goods.
(v) Public Debt :- Public debt is a sound weapon to fight against inflation and deflation. It brings about economic stability and full employment in an economy. The government borrowing may assume any of the following forms:
(a) Borrowing from Non-Bank Public
(b) Borrowing from banking system
(c) Drawing from treasury
(d) Printing of currency notes (i.e. Deficit Financing).
Fiscal Policy and Full Employment
When the economy suffers from involuntary unemployment, i.e.unemployment of idle resources and manpower, three alternative fiscal policies measures may be used to attain full employment which are -
(i) Deficit Spending i.e. increased government expenditure without increase in taxation.
(ii) Deficit without spending i.e. decreased taxation without increase in government expenditure and
(iii) Balanced Budget Multiplier i.e. spending without deficit.
Deficit Spending :
When the sum of private consumption, private investment, government consumption and government investment is less than full employment income and as such there is a deflationary gap in the economy causing unemployment, the government may increase its expenditure either on consumption or on investment without an increase in taxation and thereby incur a deficit in the budget, the deficit being covered either by the creation of new money or by government borrowing. For example, marginal propensity to spend is 3/4 in the society and, hence, multiplier is 4, a deficit government expenditure of Rs. 1000 which is invested and spent in total will generate a national income of Rs. 4000 i.e., by multiplier times the initial injection of money into economy. This point has been shown with the help of diagram 1.
Deficit without Spending :
The second device by which the government can remedy the problem of unemployment is by the reduction of taxation without any increase in government expenditure and thereby creating a budget deficit. When taxation is decreased, the
disposable income of the people is increased. This will result in an ultimate increase in national income through successive doses of private expenditure. This is shown in Diagram 2, where a tax reduction of amount AB raises the consumption - investment function, and income, as a result, rises by BC which will generate additional employment.
Balanced Budget Multiplier
The third alternative expansionary fiscal policy measures is the balanced budget multiplier. Here an increase in government expenditure is matched by an equal increase in taxes but still there is net increase in the national income, if we assume that the marginal propensity to spend is same for both the tax payers and the people who receive the money spent by government. An increase in government expenditure financed by an equal increase in taxes leads to a net increase in the national income and hence in employment and output.
Fiscal Policy and Economic Development
Economic growth implies a long-period expansion of the gross national product in real terms. Economic growth does not end with achievement of full employment.Level of full employment varies in different countries. Production capacity can be increased in many ways and, thus, every economy aims at higher rates of growth.Thus deficit financing becomes an essential fiscal instrument in raising the level of full-capacity output as a long-run policy. Long-run growth depends on many factors like volume of employment, technical skill, physical capacity etc., all these will be fully exploited. The physical capacity is higher in developed countries than in under-developed ones. In the former, labour is generally fully utilised with production capacity left unutilised while in the under-developed countries, labour can not be fully employed because of shortage of capital formation. Thus fiscal policy in developed countries is more concerned with increase of labour employment, but in backward economies, it is basically devoted to development of infrastructure which helps to generate capital formation.
Fiscal Policy and Inflation
To meet the chronical situation of inflation and deflation, compensatory fiscal policy is adopted. Compensatory fiscal policy refers to those fiscal actions that are directed to compensate for this undesireable development in the private economy so that a high level of employment can be maintained without inflation or deflation.When there are inflationary tendencies, the government should take steps to reduce its expenditure by having a surplus budget and raising taxes in order to stabilise the economy. In deflationary situation the government should adopt methods to raise expenditure through reducing taxes, public borrowings and deficit budgets.Since the stabilisation function of government budget is to maintain full employment with price level stability, compensatory fiscal policy becomes the main instrument of achieving this objective.
Musgrave describes the basic logic of compensatory fiscal policy in three rules,
(a) If involuntary unemployment prevails, increase the level of demand so as to adjust aggregate expenditures upward to the value of output produced at full employment.
(b) If inflation prevails, reduce the level of demand so as to adjust aggregate expenditures upward to the value of output measured in current, rather than rising prices.
(c) If full employment and price-level stability prevail, maintain the aggregate level of money expenditures to prevent unemployment and inflation.The effect of compensatory fiscal policy in relation to inflation and deflation on the economy is created by three principal means, viz., (i) changes in the amount of government expenditure, (ii) changes in the amounts of taxes and transfer payments and (iii) changes in the amount of budget deficit and budget surplus. To cure the economy of inflation and deflation, a combination of these fiscal instruments is generally used.
Anti-Inflationary Fiscal Policy
Inflationary phase of trade cycle is the reverse order of unemployment and deflationary situation. Under inflationary situation, private expenditure go on increasing even after full employment is reached. Since there do not remain unutilised capacity and idle resources or manpower, the increase in aggregate expenditure cannot add to production but only raises the price level. However, due to increased incomes in society, government revenues would rise and would lead to budget surplus. But this surplus is often not sufficient to counter the inflationary pressure of over-investment. The normal budget surplus that could be created due to automatic rise in revenues and fall in deflation - oriented public expenditure is no likely to be anywhere near the excessive rise in private expenditure. Therefore a deliberate budget policy and fiscal action must be evolved to meet the situation. The alternative fiscal remedies are :
(i) reduce effective demand to a level where aggregate expenditures become equal to the value of output at stable prices.
(ii) reduce private consumption by imposing new taxes or raising rates of taxes.
(iii) curtail all non-development expenditure of government.
(iv) combine tax-expenditure measures. If economy suffers from acute inflation, decrease in government expenditure should be combined with increase in tax rates and imposition of new taxes.Thus Budget surplus is the main instrument to check inflation. But the creation of budget surplus is not always feasible, when inflation arises due to war expenditures or compulsions of public expenditure for economic development in under-developed countries. Hence in such cases the revenue side has to provide the main fiscal measures. Taxation as an anti-inflationary fiscal device has also serious limitations.The fiscal policies must be supplemented by monetary and debt policy.
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