FISCAL POLICY

Definition of Fiscal Policy

It refers to the activities of the state regarding deliberate changes in
income, expenditure and debt is being increasingly used in modern
times as an important instrument of economic policy for achieving
economic stability and growth throughout the world. To mate Fiscal
Policy more effective, it is supplemented by a monetary policy.

What is Fiscal Policy?

Fiscal policy is the means by which a government adjusts its levels of
spending in order to monitor and influence a nation's economy. It is the
sister strategy to monetary policy with which a central bank influences
a nation's money supply. These two policies are used in various
combinations in an effort to direct a country's economic goals. Here we
take a look at how fiscal policy works, how it must be monitored and
how its implementation may affect different people in an economy

For example:
Before the Great Depression in the United States, the government's approach to
the economy was laissez faire. But following the Second World War, it was
determined that the government had to take a proactive role in the economy to
regulate unemployment, business cycles, inflation and the cost of money. By
using a mixture of both monetary and fiscal policies (depending on the
political orientations and the philosophies of those in power at a particular time,
one policy may dominate over another), governments are able to control
economic phenomena.
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How fiscal policy work for growth and stabilization

The issue of how fiscal policy affects a country’s development is a controversial

one. Some experts worry that taxes discourage growth and should be kept to a
minimum, while others see fiscal policy as a countercyclical tool to stabilize swings
in prices and unemployment. But it is time to acknowledge a third possibility: that
fiscal policy can not only foster economic growth, but also contribute to other
development goals, such as combating poverty, preventing social exclusion and
providing more equal opportunities.

Public expenditure, for instance, should aim to provide high-quality public goods
and services for all; if this is achieved, fiscal spending should have a positive
impact on reducing poverty, inequality and exclusion, all of which are obstacles to
development. The same applies to public revenues: if tax collection systems are
fair and broad-based, as well as adapted to the specific nature of the economy,
they can raise the funds needed for publicly-provided goods and services
sustainably and efficiently.

To understand better how Fiscal Policy works let us take an

example of LATIN AMERICA

At Latin America’s fiscal performance – particularly set alongside the experience of

OECD countries – illustrates the magnitude of the work to be done. Public spending
is still much lower than in OECD countries, and the quality of vital goods and
services such as education is poor. Generation of government revenue is limited
and regressive – the rate of tax decreases as income increases, so the poorer
taxpayers are proportionally hardest hit. At the same time, although public debt
management has improved, deficits remain high, the maturity in domestic bond
markets is short, and sovereign-bond markets remain too sensitive to political
cycles. Latin American governments are falling short in their use of fiscal
policy as a development tool that can boost growth, reduce poverty and
inequality, and provide high quality public goods and services.
 One of the main problems is the sensitivity of Latin American sovereign-bond
markets to political cycles, which is much greater than in most OECD countries. On
average, investment banks start to downgrade sovereign bonds issued by Latin
American countries three months ahead of presidential elections. Capital markets
where public debt is traded, meanwhile, are particularly sensitive to the effect of
Latin American democratic elections on fiscal management. Investors worry that
incumbent political parties will be especially prone to expand spending to
encourage political support, and they are furthermore uncertain about candidates
who espouse populist fiscal rhetoric, a common feature in Latin American political
processes.

Figure Tax revenue in Latin America and the OECD

To reduce the taxes, Unemployment, price stability, economic

development the Government started following the objectives
of Fiscal policy which are following:

Objectives of Fiscal Policy

 1) Economic Development: An under developed country is a
poor country due to which it caught by various circle of
poverty. People have high prosperity to consume, whatever
income comes in their hand, they spend it on buying
consumption goods due to which a very little money is left for
saving and as result is low saving causes low rate of capital
formation.

Thus, the first objective of fiscal policy is to bring off the

Economic Development. Economic development is the steady
process if increasing the productivity of the country and hence
increasing real income. The main aim of the Fiscal policy is to
increase the rate of saving restraining actual and potential
consumption. The increases in the saving & investment lead to
increase in the economic development.

2) Price Stability or Control of Inflationary Pressure: - In the

process of economic due to price huge investment expenditure is
incurred an as such the prices are bound to increase. This would
increase inflationary pressure in the country unless the inflationary
pressure is controlled, the work of planned development cannot run
smoothly. Thus second Objective of fiscal policy is to control
inflationary pressure.

3) Social Justice: - Under the growth of socialistic ideas, people

now want equality in distribution of income and wealth. Social justice
demands the following:
 i) Equality in income and wealth.

ii) Reducing exploitation of the poor by rich and fixing

minimum wages for workers and providing reasonable standard
of living to all the people.

Thus the 3rd objective of fiscal policy is to provide social justice.

4) Reduction and Under-Employment:- An underdeveloped country is

a poor country; masses suffer from poverty and hunger. Poverty in these
countries is due to large scale unemployment and underemployment.
Therefore, the basic object of fiscal policy is to reduce the poverty and
underemployment.

5) To tap additional sources of Revenue: - A developing

economy requires huge monetary resources to undertake and run
various development projects. Thus the fiscal policy in under developed
country must tap additional resources through taxes, etc. It aims at:

i) It should rise of investment by restraining actual and potential

consumption. This implies that it should aim at increasing the flow
of resources investment.

ii) It should aim at diverting the flow of investment into these

industries which are considered useful society.

iii) It should aim at reducing the inequalities in the distribution of

income and wealth.
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For achieving the objectives of fiscal policy, it has different tools or

instruments from which it controls taxation, public expenditure, public
debt and deficit financing. Following Instruments are:

1) Taxation: - In developing countries taxes fulfill the major objective of

fiscal policy i.e to restrain consumption and to encourage saving and
investment. In developing countries the masses have high prosperity to
consume. Therefore, money raised from increase taxation comes largely
from consumption expenditure and so taxes will curb consumption and
increase saving and investment. But increase in indirect taxes is likely to
affect the indirect investment in the private investment.

It is also possible that taxes may not confirm strictly to the principle of
equity. However, there must be some limit to taxation beyond which taxes
cannot be increased otherwise the productive capacity of the country will be
impaired.

Taxation is also regarded as the best method of reducing inequalities of

income and wealth. Indirect taxes can also be used for reducing inequalities of
income if they are imposed on commodities exclusively used by rich people.

2) Public Expenditure:- Public expenditure is a poverty tool for

accelerating into two types:-

i) Direct Investment on projects like, power, irrigation, transport ect.

ii) Making a grant or subsidy to encourage production of some raw

material or community.

The role of public expenditure on the provision of social and economic

overheads like means of transport, communication, power, water, technical
education and training etc, has been assuming great significance in
developing countries. But once the government provided these social and
economical developments, the new industries will take them for granted and
 private investment will be the new industries will take them for granted and
private investment will be stimulated.

3) Public Debt: - As already said the main problem of the developing

countries is lack of resources for financing, the developing countries are
lack in resources for financing and the development programs. Since the
people in these countries are poor, taxation alone cannot be sufficient
source of saving and capital formation. It is here that the importance of
public Debt lies. The government can raise loans inside the country and
finance development plans.

Who Does Fiscal Policy Affect?

Unfortunately, the effects of any fiscal policy are not the same on
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.
What are Balancing Acts?

The idea, however, is to find a balance in exercising these influences.

For example, stimulating a stagnant economy runs the risk of rising
inflation. This is because an increase in the supply of money followed
by an increase in consumer demand can result in a decrease in the
value of money - meaning that it will take more money to buy
something that has not changed in value.

Let's say that an economy has slowed down. Unemployment levels are
up, consumer spending is down and businesses are not making any
money. A government thus decides to fuel the economy's engine by
decreasing taxation, giving consumers more spending money while
increasing government spending in the form of buying services from
the market (such as building roads or schools). By paying for such
services, the government creates jobs and wages that are in turn
pumped into the economy. Pumping money into the economy is also
known as "pump priming". In the meantime, overall unemployment
levels will fall.

Continued in next page

With more money in the economy and less taxes to pay, consumer
demand for goods and services increases. This in turn rekindles
businesses and turns the cycle around from stagnant to active.

If, however, there are no reins on this process, the increase in

economic productivity can cross over a very fine line and lead to too
much money in the market. This excess in supply decreases the value
of money, while pushing up prices (because of the increase in demand
for consumer products). Hence, inflation occurs. Or this reason, fine
tuning the economy through fiscal policy alone can be a difficult, if not
improbable, means to reach economic goals. If not closely monitored,
the line between an economy that is productive and one that is
infected by inflation can be easily blurred

Conclusion
In my point of view Fiscal Policy is one of the
main instrument that’s helps Government to
control the economy by using the instruments so
that they can take decision correctly.
But some time one of the biggest obstacles
facing policymakers is deciding how much
involvement the government should have in the
economy. Indeed, there have been various
degrees of interference by the government over
the years. But for the most part, it is accepted
that a degree of government involvement is
necessary to sustain a vibrant economy, on which
the economic well being of the population
depends.

Sources:
1. Internet

2. Word Web

3. Economic Notes

4. Microsoft Word 2007