OBJECTIVES AND TOOLS OF FISCAL POLICY

OBJECTIVES:
1. Efficient allocation of Financial Resources

2. Reduction in inequalities of Income and Wealth

3. Economic stability 4. Employment Generation 5. Balanced Regional Development 6. Reducing the Deficit in the Balance of Payment 7. Capital Formation

FISCAL TOOLS

ECONOMIC STABILITY

FULL EMPLOYMENT AGGREGATE SUPPLY=EFFECTIVE DEMAND NEITHER INFLATION NOR DEFLATION

1) Discretionary Control: Deals with the deliberate changes in taxation and government spending by the central authority for the purpose of offsetting the economic instability.E.g COMPENSATORY SPENDING. 2) Non Discretionary Control: Fiscal tools that automatically work in order to correct economics instability.E.g PROGRESSIVE INCOME TAX.

INFLATION
BOOM PERIOD: RISE IN:
PRICES PROFITS DISPOSABLE INCOME INVESTMENTS

PURCHASING POWER

CONSUMPTION

EFFECTIVE DEMAND>AGGREGATE SUPPLY

DEFLATION
RECESSION TIMES:

FALL IN:
PRICES INCOME PROFITS INVESTMENTS DISPOSABLE

PURCHASING POWER

CONSUMPTION

EXPENDITURE

AGGREGATE SUPPLY>EFFECTIVE DEMAND

DISCRETIONARY POLICIES
1) TAXATION
A) ANTI DEFLATIONARY TAX POLICY

Measure against deflation

Tax is a withdrawal of funds from the private hands
>deflationary effect

A tax reduction leaves large funds with community for

consumption and investment purposes>inflationary effect.
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AS THE NATIONAL INCOME INCREASES:TAX BASE ALSO INCREASES A HIGHLY PROGRESSIVE TAX SYSTEM WILL INCREASE THE TAX BURDEN MORE THAN PROPORTIONATELY TO THE RISE IN THE LEVAL OF ECONOMY.

A) ANTI DEFLATIONARY TAX MEASURE:WILL: A TAX REDUCTION

Rise in effective demand and reduce deflationary gap. In this respect govt should reduce commodity taxes like excise duty, sales tax and import duty.

Hansen and Musgrave have emphasized on the reduction of corporate and personal income tax to overcome deflationary pressure.

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b) ANTI INFLATIONARY TAX POLICY

MEASURE TO REMOVE THE INFLATIONARY GAP

EXISTING TAX RATE SHOULD BE RETAINED AND NEW TAXES SHOULD BE LEVIED EXCISE DUTIES, PROGRESSIVE INCOME TAX ARE ANTI INFLATIONARY

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 AS A GENERAL PROPOSITION:

DURING INFLATION TAX SHOULD BE INCREASED

DURING DEFLATION TAX SHOULD BE REDUCED

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ANTI 2) BORROWINGS- DEFLATIONARY TOOL

GOVERNMENT BORROWINGS CAN BE OF THE FOLLOWING FORMS: BORROWINGS FROM NON BANK PUBLIC
BORROWINGS FROM BANKS DRAWING FROM THE TREASURY
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A) BORROWINGS FROM NON BANK PUBLIC:

GOVT CAN BORROW FROM THE PUBLIC THROUGH THE SALE OF BONDS. IN THAT CASE MONEY WILL FLOW OUT OF THEIR

1)CONSUMPTION
2)SAVINGS 3)HOARDING

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BORROWINGS FROM BANKS ARE HIGHLY EFFECTIVE IN REMOVING DEPRESSION.

B) BORROWINGS FROM THE BANKING SYSTEM

DURING DEPRESSION BANKS HAVE EXCESS CASH BECAUSE PRIVATE INVESTORS WILL BORROW LESS FROM THEM SINCE IT IS CONSIDERED UNPROFITABLE.
WHEN UNUSED CASH IS LENT TO THE GOVT IT CAUSES INCREASE IN EMPLOYMENT AND INCOME.
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C)BORROWINGS FROM THE TREASURY

IT COVERS THE DEFLATIONARY GAP.

IT ATEMPTS TO DISHOARDING IT CAUSES A NET ADDITION TO THE SUPPLY OF MONEY IT IS INFLATIONARY IN NATURE AND HENCE FOLLOWED DURING DEPRESSION

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3)PUBLIC EXPENDITURE
PUBLIC EXPENDITURE IS INCURRED FOR:

1. GENERAL FUNCTIONS OF THE GOVERNMENT 2. ECONOMIC STABILIZATION.

INCREASED PUBLIC SPENDING WILL HAVE MULTIPLE EFFECTS ON INCOME, OUTPUT AND EMPLOYMENT IN SAME MANNER INCREASED INVESTMENTS HAVE ON THEM
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PUBLIC EXPENDITURE DURING INFLATION:

PUBLIC POLICY SHOULD AIM TO REDUCE

GOVT SPENDING

PRODUCTIVE GOVERNMENT EXPENDITURE

SHOULD BE INCREASED

UNPRODUCTIVE GOVERNMENT SPENDING SHOULD BE REDUCED

PUBLIC EXPENDITURE DURING DEFLATION: HELPFUL TO LIFT UP THE ECONOMY OUT

OF STAGNATION
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4)TRANSFER PAYMENTS
ANTI DEFLATIONARY TOOL
DURING INFLATIONARY SITUATIONS GOVT REFRAINS FROM GIVING BONUSES TO EMPLOYEES AND THUS REDUCES THE AGGREGATE SPENDING DURING DEFLATIONARY SITUATIONS GOVT RELEASES BONUSES TO ITS EMPLOYEES THERE BY INCREASING THEIR PURCHASING POWER.

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4)PUMP PRIMING

IT REFERS TO THE INCREASE IN PRIVATE INVESTMENT THROUGH INJECTION OF FRESH PURCHASING POWER IN THE FORM OF INCREASED PUBLIC EXPENDITURE OPTIMISTIC APPROACH ONCE THE GOVT SPENDS MONEY, THE ECONOMY WILL CONTINUE SMOOTHLY.
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COMPENSATORY EXPENDITURE

Compensatory spending means that deficit financing can be used for compensating and neutralizing tendencies towards over-saving and over-investment.

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NON DISCRETIONARY POLICY[pPOLICIES

DEMAND SIDE POLICY
DURING RECESSION THE GOAL IS TO RAISE AGGREGATE DEMAND TO FULL EMPLOYMENT LEVEL THIS MAY BE ACHIEVED BY INCREASING GOVT SPENDING (G) DECREASE IN TAX REVENUE(T) OPPOSITE OF THIS IS FOLLOWED DURING INFLATION

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SUPPLY SIDE POLICY

WHEN FIRMS EXPERIENCE INCREASE IN RESOURCE COST DUE TO SHARP RISE IN WORLD PRICES OF RAW MATERIALS IT CAUSES A FALL IN AGGREGATE SUPPLY. THIS CREATES DEFLATIONARY GAP THEREFORE, AN EXPANSIONARY POLICY IS TO REDUCE CORPORATE INCOME TAX.

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1)PROGRESSIVE INCOME TAX

PERSONAL INCOME TAX IS THE LARGEST SOURCE OF REVENUE TO THE GOVT WHEN THE DISPOSABLE INCOME INCREASES IN A BOOM THE HIGH TAX RATE WILL REDUCE: DISPOSABLE INCOME CONSUMPTION

AGGREGATE DEMAND

THEREFORE IT IS AN ANTI INFLATIONARY TOOL

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2) Farm aid programs:

Farm aid programs also stabilize against the price fluctuations.

When the prices of the agricultural products are falling and the economy is threatened with depression, government purchases the surplus products of the farmers at the set prices.

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)UNEMPLOYMENT COMPENSATION

FOLLOWED IN ADVANCED COUNTRIES PEOPLE RECEIVE UNEMPLOYMENT COMPENSATION WHEN THEY ARE OUT OF JOBS. HELPFUL IN TIMES OF RECESSIONS.

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4) CORPORATE SAVINGS

THE CORPORATE AND WISE FAMILY MEMBERS WITHHOLD A PART OF THEIR DIVIDEND OF THE BOOM PERIOD TO PAYU IN THE DEPRESSION TIMES HOLDING BACK OF MONEY DURING BOOM PERIOD: CONTRACTS THE MONEY SUPPLY IN GOOD YEARS AND RELEASES THE MONEY SUPPLY IN THE RECESSION TIME

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FUNCTIONAL FINANCE

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INTRODUCTION

AGAINST THE CLASSICAL THOUGHT
KEYNES AND LERNER> MODERN CONCEPT GOVERNMENT NEEDS TO PLAY A POSITIVE ROLE SO AS TO REGULATE AND CONTROL THE ECONOMY BY THE MEANS OF TAXES AND PUBLIC EXPENDITUREPRINCIPLE OF FUNCTIONAL FINANCE

RULE 1
REGULATE PUBLIC SPENDING INFLATION = SPEND LESS DEFLATION = SPEND MORE

5 ELEMENTS TO SPENDING CONSUMPTION AND INVESTMENT BY INDIVIDUALS( 2) CONSUMPTION AND INVESTMENT BY GOVERNMENT( 2)

INVESTMENT BY BUSINESSMAN (1).

WHEN VOLUME OF SPENDING IS LESS ELEMENTS DEFLATION ANY ONE OF THE 5

GOVT SPENDING TRANSFER PAYMENTS PUBLIC WORKS TAX RATE, ROI.

= POLICY OF DEFICIT BUDGET

*OPPOSITE IS FOLLOWED WHEN VOLUME OF SPENDING IS MORE

OLE OF FUNCTIONAL FINANCE IN INFLATION

1. Spending less. 2. New taxes and raise existing tax rates. 3. Government may borrow money to prevent

private expenditure from increasing.

4. Government may increase bank rate.
5. The government may sell the goods at a

higher price.

ROLE OF FUNCTIONAL FINANCE IN DEFLATION

1. Tax rates may be reduced

2. Government may increase its social security schemes

3. Government may reduce the rate of interest 4. It may repay its debts borrowed from the public

RULE 2

PUBLIC BORROWINGS IN MAINTAING STABILITY

INFLATION PEOPLE SHOULD BUY BONDS AND HOLD LESS MONEY DEFLATION PEOPLE SHOULD SELL BONDS AND HOLD MORE MONEY.

RULE 3
REGARDING TAXATION

INFLATION
VOLUME AND RATE OF TAXATION SHOULD INCREASE

DEFLATION

VOLUME AND RATE OF TAXATION SHOULD FALL

RULE 4
CONTROL CYCLICAL FLUCTUATIONS

BUDGET DEFICIT DEFICIT FINANCING/ PRINTING MORE

NOTES

SURPLUS BUDGET HOARDING AND DESTRUCTION OF MONEY