Introduction

The most important instrument of government intervention in the

country is that of Fiscal or Budgetary policy. Fiscal policy refers to the
taxation, expenditure and borrowing by the government. The
economists now hold the government intervention through Fiscal policy
is essential in the matter of overcoming recession or inflation as well as
of promoting and accelerating economic growth,
which monetary policy will not hold alone. There is no doubt that the
government budgetary or fiscal policy must be sound, keeping in view
the needs and requirements of a developing economy. In short we can
say that, it is a part of government policy, which is concerned with
raising revenue through taxation and other means and deciding on the
level and pattern of expenditure. The main problem faced by the
capitalist economies instability prevailing in them. This instability is
reflected in the periodic occurrence of trade cycles, which are a
general phenomenon in the free market capitalist economies. During a
recession or depression fiscal policy should help in increasing demand.

Objectives of Fiscal Policy in Developing Countries

In developing countries, taxation, the government expenditure,
taxation and borrowing have to play a very important role in
accelerating economic development. Fiscal policy is a powerful
instrument in the hands of the government by means of which it can
achieve the objectives of development. There are several peculiar
characteristics of a developing country, which necessitate the adoption
of a specific fiscal policy, which ensures a rapid economic growth.
There are vast and diverse resources human and
material, which are lying underutilized. Such countries have weak
infrastructure, i.e. they lack adequate means of transport and
communications, road ports, highway, irrigation and power and
technical know-how. Their population increasing at an explosive rate,
which necessitates rapid economic development to, met the
requirements of the rapidly- growing population. In order to overcome
these handicaps, a suitable fiscal and taxation policy is called.

The principal objectives of fiscal policy in a

developing economy are.
To mobilize resources for economic growth, especially for the public
sector.
To promote economic growth in the private sector by providing
incentives to save and invest.
To restrain inflationary forces in the economic in order to ensure
price stability.
To ensure equitable distribution of income and wealth so that fruits
of economic growth are fairly dist
ROLE OF FISCAL POLICY
In recent weeks, a number of signs have appeared suggesting that the
recovery of the U.S. economy from the recent recession is on a bumpy
path. During the second quarter of 2002, real GDP grew at an anemic
annual rate of barely over 1%, well below market expectations.
Unemployment, after rising throughout 2001, has leveled off but has
yet to show signs of declining. Adding some
gloom to the general outlook, the stock market continued to drop
through most of July and has remained volatile. This sluggish economic
performance comes despite substantial stimulus from both monetary
and fiscal policy. Since January 2001, the Federal Reserve has reduced
its benchmark policy interest rate, the federal funds rate, from 6.52%
in September 2000 to a current level of 1.75%. Fiscal policy also has
become more expansionary. The federal government budget has
swung from a surplus of $236 billion in 2000 (2.5% of GDP) to a
projected 2002 deficit of $157 billion (1.5% of GDP) as the government
has increased expenditures and reduced taxes. This active use of fiscal
policy during a recession is somewhat unusual. During the last U.S.
recession, in 1990, then President George H.W. Bush resisted attempts
to use fiscal policy to stimulate the economy. In fact, his Council of
Economic Advisers, in their February 1992 report, argued that
increases in fiscal expenditures or reductions in taxes might hamper
the economy’s recovery. In contrast, during the current recession, both
Congress and the President have supported increases in expenditures
and tax cuts as ways to stimulate economic growth, culminating in the
passage of the Economic Recovery Act in March 2002.The current
recession and the 1990–1991 recession offer contrasting examples of
the use of fiscal policy, and theyalso highlight some elements of the
longstanding debate in economics over whether fiscal policy can play a
useful role in combating business cycle downturns. This Economic
Letter discusses some of the issues involved in using fiscal policy to
help stabilize short-run fluctuations in the economy. In developing
economies, the government has to play a very active role in promoting
economic
development and fiscal policy is the instrument that the state must
see. Hence the great importance of public finance in underdeveloped
countries desirous of rapid economic development. In a democratic
society, there is an inherent dislike for direct control regulation by the
state. The entrepreneur would not like to be ordered about to produce
this or that, how much to produce or where to produce. Fiscal
incentives in the form of tax concessions, rebates or subside are,
therefore, preferable. Similarly, the consumers would not like to be told
directly to curtail their consumptions or to consume this and not to
consume that. Taxation of articles whose consumptions is to be
discouraged is therefore preferable.Hence, a democratic state must
rely on indirect methods of control and regulation and this is doing
through fiscal and monetary policies. Thus in democratic countries,
fiscal policy is a powerful and least undesirable weapon on which the
states can rely for promoting economic development.

INSTRUMENTS OF FISCAL POLICY

I. BUDGET:-
Keeping budget in balance, in surplus or deficit, is in itself a fiscal
instrument. When the government keeps its total expenditure equal to
its revenue, as a matter of policy, it means it has adopted a balanced
budget policy. When the government spends more than its expected
revenue, as a matter of policy, it is pursuing a deficit-budget policy.
And when the government follows a policy of
keeping its expenditure substantially below its current revenue, it is
following a surplus budget policy.

II.TAXATION
A tax is a non quid pro quo payment by the people to the government.
By this definition, taxation means non quid pro quo transfer of private
income to public coffers by means of taxes. Taxation takes many forms
in the developed countries including taxation of personal and corporate
income, so-called value added taxation and the collection of royalties
or taxes on specific sets of goods. Government may want to smooth
out the nation's income in order to minimize the pejorative effects of
the business cycle or they may want to take steps designed to increase
the national income. They may also want to take steps intended to
achieve specific social objectives deemed to be appropriate by the
political or legal process. Sound tax system, with moderate rates and a
broad base, is an integral part of the prudent fiscal policy. The
expansion in the tax base is sought to be achieved through expansion
in the scope of taxes, specifically service tax, removal of exemptions
and improvement in tax administration. With a decline in non-tax
revenue receipts as a proportion of overall revenue receipts, the
burden of fiscal corrections is expected to be mainly on tax revenues.
However, the measures to increase the tax-GDP ratio must be
harmonized with the overall growth objective. The strategy seeks to
increase tax compliance, improve the efficiency of tax administration
and with intense focus on recovery of arrears of tax revenues and
prevent further build-up of such arrears. Agricultural taxation: This
economic surplus mainly goes to rich farmers, landlords, intermediaries
in the absence of suitable taxation on agriculture. It has potential
surplus & to achieve maximum utilization of land through devising a
system of land taxation which would penalize poor use of good land.

III.PUBLIC EXPENDITURE

Suppose the government spends more on an electricity project for

which the contract is given to a PSU like BHEL. Then the money that
the government spends comes back to it in the form of BHEL's
earnings. Similarly, suppose that the government spends on food-for-
work programmers, and then a significant part of the expenditure
allocation would consist of food grain from
the Public Distribution System which would account for part of the
wages of workers employed in such schemes. This in turn means that
the losses of the Food Corporation of India (which also includes the
cost of holding stocks) would go down and hence the money would find
its way back to the government. In both cases, the increased
expenditure has further multiplier effects because of the subsequent
spending of those whose incomes go up because of the initial
expenditure. The overall rise in economic activity in turn means that
the government’s tax revenues also increase. Therefore there is no
increase in the fiscal deficit in such cases.
IV. GOVERNMENT BORROWING:
Government borrowing is another fiscal Method by which savings of
the community may be mobilized for economic development. In
developing economies, the government resort to borrowing in order to
finances schemes of economic development. Government or what is
also called public borrowing becomes necessary because taxation
alone cannot provide sufficient funds for economic development.
Besides, too heavy taxation has an adverse effect on private saving
and investment.

. Fiscal Policy Can Be Divided In Two Types.

I) DISCRETIONARY FISCAL POLICY FOR STABILISATION
Fiscal policy is an important instrument to stabilize the economy, that
is, to overcome recession and control inflation in the economy. By
discretionary policy we mean deliberate change in the Government
expenditure and taxes to influence the level of national output and
prices. Fiscal policy generally aims at managing aggregate demand for
goods and services.
II) NON_DISCRETIONARY FISCAL POLICY: AUTOMATIC
STABILIZERS
There is an alternative to use of discretionary fiscal policy, which
generally involves the problem of, large in recognizing the problem of
recession or inflation and large of the taking appropriate action to
tackle the problem. In this Non-discretionary fiscal policy, the tax
structure and expenditure are so designed that taxes and government
spending vary automatically inappropriate direction with the changes
in National Income. That is, these taxes and expenditure pattern
without any special deliberate action by the government and
parliament automatically raise aggregate demand in times of recession
and reduce aggregate demand in times of boom and inflation and
there by help in insuring economic stability. These fiscal measures are
therefore called automatic stabilizers or built-in stabilizers. Since these
automatic stabilizers do not require any fresh deliberate policy action
or legislation by the government, they represent non-discretionary
fiscal policy. Built-in-stability of tax revenue and government
expenditure of transfer payment of subsidies is created because they
vary with national income. These taxes and expenditure automatically
bring about appropriate change in aggregate demand and reduce the
impact to recession and inflation that might occur in an economy at
sometimes. This means that because of existence of this automatic or
built-in-stabilizers recession andinflation will be shorter and less
intense than otherwise is the case. Important automatic fiscal
stabilizes compensation, welfare benefits corporate dividends.

Limitations of fiscal policy

1. Formulation of an appropriate fiscal policy requires reliable
forecasting of the target variables, like GNP, consumption, investment
and its determinants, technological changes, and so on. But no one has
yet discovered a foolproof method of economic forecasting.’
2. The Overall effect of changes in the policy instruments, like, changes
in government spending and taxation is determined by the rate of
dynamic multiplier. Forecasting the multiplier is in itself an extremely
difficult task and a time consuming process. Therefore, by the time the
full impact of one policy change is realized, economic conditions
change necessitating another
change in the fiscal policy.
3. A decision and execution lag in case of discretionary fiscal policy
makes both working andefficacy of fiscal policy shrouded with
uncertainty.
4. Working and effectiveness of fiscal policy in underdeveloped
countries is severely limited by a) low levels of income, b) small
proportion of population in taxable income groups, c) existence of large
non - monetized sector, d) all pervasive corruption and inefficiency in
administration,especially in tax collection machinery.
5. Countries which are excessively dependent on fiscal policy for their
economic management, the governments are often forced to have
recourse to internal and external borrowings and deficit financing.
Excessive borrowings take such countries close to debt trap and deficit
financing beyond the absorption capacity of the economy accelerates
the pace of inflation,which further creates other control problems.