Fiscal policy is a crucial part of modern economies and it is operated by the government through budget and policies. The government uses fiscal and monetary policies to achieve stability and growth by influencing and regulating the behavior of spenders, consumers, and investors.
In this article, we will learn what is fiscal policy, its types, its objectives, how it affects the national economy, what is budget, and what are the tools and instruments of fiscal planning.
► What is Fiscal Policy?
Fiscal policy is a part of government policy that is concerned with raising revenue through taxation and other means and deciding the level of expenditure.
It is a tool that helps the government decide how much money it should spend in different economic sectors to support economic growth, and how much taxes it should levy to earn revenue so it keeps the economy of the country on track.
◉ Fiscal Policy Meaning
Fiscal policy means the use of government expenditure and tax policies to influence economic conditions, especially the macroeconomic condition of the country.
◉ Definition of Fiscal Policy
Fiscal policy is defined as the use of government spending and taxation policy to influence the aggregate demand and supply of goods and services, promote economic growth, and generate employment.
► Types of Fiscal Policy
There are three types of Fiscal policies
- Expansionary Policy
- Contractionary Policy
- Neutral Policy
✔ 1. Expansionary Fiscal Policy
Expansionary policy occurs when government spending is lower than tax revenue and is usually undertaken to pay down government debt.
- Government expenditure is more than taxes receipts.
- Reduces unemployment, Increases in Inflation
Action | Effect |
Lower Taxes | Increasing tax savings increases available funds for spending, so consumers and businesses purchase more, and AD is increased. |
Increase Government Spending | Increasing government spending provides the funds needed for consumers and businesses to purchase goods and services. Ad is increased. |
✔ 2. Contradictory Fiscal Policy
The contradictory policy involves government spending exceeding tax revenue and is usually undertaken during recessions.
- Government expenditure is less than the taxes and revenues received.
- Reduces inflation, Increase Unemployment
Action | Effect |
Raise Taxes | Increasing tax expenditures decreases money available for spending, so consumers and businesses spend less. AD is decreased. |
Decrease Government Spending | Decreasing government spending reduces the funds needed for consumers and businesses to purchase goods and services. AD is decreased. |
✔ 3. Neutral Fiscal Policy
It is usually undertaken when an economy is in equilibrium. Government sending is fully funded by tax revenue and overall the budget outcome has a neutral effect on the level of economic activity.
- A Neutral stance results in a large tax revenue government.
- Spending is fully funded by tax revenue and the overall budget has a neutral effect on the level of economic activity.
► Fiscal Policy in India
In India, fiscal policy operates through the budget. The budget is an estimate of government revenue and expenditure for an ensuing financial year.
The budget is presented in parliament by the finance minister. Article 112 of the Indian constitution deals with the budget.
Under Article 112, the Government is required to present an Annual financial statement (AFS) before both houses of the Parliament. The budget contains an Appropriation Bill which deals with the expenditure Side and Finance Bill which deals with the receipts side.
The budget policy has served the following purpose.
- Accelerate the pace of economic development by allocating resources to a different sector.
- Effective improvement in income distribution
- Promote exports and encourage import substitution
- Achieve economic stability
- Effective improvement in the production of goods and services.
Also Read : What is Budget? (in detail)
► Objectives of Fiscal Policy
- Increase revenue and promote progressive tax
- Price stability
- Economic stability
- Encourage Investment
- Promote Employment opportunities
- To reduce income inequality
✔ Increase Revenue and Promote Progressive Tax
One of the primary objectives of fiscal policy is to generate sufficient revenue to meet government expenditures. To protect from fiscal deficit government use a progressive taxation policy.
✔ Price Stability
Inflation is a very big problem in developing countries, in which the price of commodities rises extremely high, so the government uses its fiscal tools like control over commodities, granting concessions and subsidies with the objective to achieve price stability and economic growth.
✔ Economic stability
The fiscal policy promotes economic activity, it provides protection against internal and external economic shocks. It also strengthens the microeconomic and macroeconomic framework.
The government uses effective tariff policy and EXIM policy as tools to provide long-term economic stability and balanced growth of various sectors of the economy.
✔ Encourage Investment
The aim of the fiscal plan is to accelerate economic growth so it encourages investment in both the private sector and the public sector which are considered vital importance from the social economic viewpoint of society.
✔ Promote Employment opportunities
One of the main goals of fiscal policies is to create full employment in the economy. The government provides special grants, and tax cuts to accelerate economic growth.
✔ To Reduce income inequality
Accumulation of wealth among a few people hand not only creates income equality but also creates social and political inequality which may be caused a threat to economic instability.
Fiscal policy increases the public expenditure on the development of human capital and progressive tax policy help in reducing income disparity.
Also Read : What is Monetary Policy?
► Tools of Fiscal Policy
Government predominantly uses two major tools to influence the economy.
- Spending Tools or Expenditure Tools
- Capital expenditure
- Revenue expenditure
- Transfer of payment
2. Revenue Tools or Taxation Tools
- Direct Taxes
- Indirect Taxes
◉ 1. Spending Tools or Expenditure Tools
✔ Capital Expenditure
Capital Expenditure (Capex) funds are used by a company to acquire, upgrade and maintain physical assets such as property, plants, buildings, technology, or equipment.
✔ Revenue Expenditure
Revenue Expenditure is a routine expenditure incurred in the normal course of business and includes the cost of sales and maintenance of fixed assets.
✔ Transfer of Payment
Transfer of Payment Transfer payments are payments from tax revenue that are received by certain members of the community.
Payments tend to transfer income from those able to work and pay taxes to those unable to work or in need of assistance.
Examples include; Old age pensions, Housing allowances, Child benefits, Unemployment benefits, and Food Security Schemes.
◉ 2. Revenue Tools or Taxation Tools
✔ Direct Tax
The person on whom the tax is levied is identifiable. The burden of paying the tax falls on the same person or entity and cannot be shifted. Eg: Income tax, Corporate tax, Wealth tax, etc.
✔ Indirect Tax
The person on whom the tax is levied is not identifiable. The burden can be shifted. E.g.: GST, Excise duty, customs duty, Service tax, etc.
