SCHOOL OF LAW

GURU GHASIDAS VISHWAVIDYALAYA, BILASPUR (C.G.)

(A Central University)

SESSION 2019-2020

PROJECT ON

FISCAL POLICY

SUBMITED BY.

HEMU BHARDWAJ

STUDENT OF B.A. LLB, 5TH SEMESTER

ROLL NO. 17001251

UNDER THE GUIDANCE OF

PROF ANKITA TIWARI

SUBJECT:- ECONOMICS

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 ACKNOWLEDGEMENT

I would like to express my deepest and earnest gratitude to, PROF. ANKITA
TIWARI faculty for ECONOMICS, School of Law, for giving me this opportunity to
do a project on such a valuable topic of FISCAL POLICY I am grateful for the
assistance, guidance, and support that were extended during the course of excellent
research. I am also thankful to the college administration for providing the resources
necessary for thee research work. I thank my parents and friends their moral support
and love throughout my research work and project preparation. Above all I thank the
God almighty for blessing me with the health and the vitality to complete this project.

HEMU BHARDWAJ
ROLL NO- 17001251
B.A.LLB
5TH SEMESTER

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 CERTIFICATE

I am glad to submit this project report on FISCAL POLICY as a part of my

academic assignment. The project is based on research methodology and further
discusses the interview method. I think this would be significant for academic
purposes as well as prove information to all the readers. Here though I declare that
this paper is an original piece of research and the borrowed text and ideas have been
duly acknowledged.

HEMU BHARDWAJ FACULTY SIGN

ROLLNO.-17001251
B.A.LLB 5TH SEMESTER

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 DECLRATION

I, HEMU BHARDWAJ, Roll No.17001251, B.A.LLB 5TH Semester of the

GURU GHASIDAS UNIVERSITY do hereby declare that, this project is my
original work and I have not copied this project or any part thereof from any source
without acknowledgement. I am highly indebted to the authors of the books that I
have referred in my project as well as all the writers of all the articles and the owners
of the information taken from the website for it. It is only because of their
contribution and proper guidance of my faculty advisor PROF. ANKITA TIWARI
that I was able to gather light on the subject.

HEMU BHARDWAJ

Roll. No.-17001251
B.A,LL.B.
5TH SEMESTER

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 MEANING OF FISCAL POLICY

Fiscal policy is the means by which government adjusts spending level and tax rate to
monitor and influence nation’s economy. The budgetary instruments of government
policy are known as fiscal policy. It is the policy relating to change in a government
expenditure and tax payment. According to Arhur Smithies, fiscal policy means “a
policy under which the government uses its expenditure and revenue programmes to '
produce desirable effects and to avoid undesirable effects on the national income,
production and employment.” During the depression days, Keynes spoke about the
overwhelming importance of government policy in macroeconomics. Monetary policy
was looked upon as a spoiled child, and the affection shifted on to fiscal policy. Fiscal
policy or government policy is highly aggregative. Fiscal policy influences
employment, output and income mainly through taxation, government spending and
borrowing.

INSTRUMENTS OF FISCAL POLICY

There are so many measures or instruments in fiscal policy which are used by the
state to influence the general level of economic activity. They are: Government
expenditure, borrowing or debt, taxation, budget, etc., There are different types of
budgets annually balanced budget, and fully managed compensatory budget.
Budgetary Policy. Budgeting is an important instrument of fiscal policy. It is used to
improve the operation of economic system and to fight both inflation and deflation.
The Annually Balanced Budget. The classical economists propounded the principle
of annually balanced budget. There were some reasons to accept this principle. First,
the classical economists maintained that, there should be balance in income and
expenditure of the government. Secondly, they felt that balanced budget will not lead
to a boom or depression. Thirdly, balanced budget is necessary to check the excessive
expenditure of the politicians. Fourthly, this type of budget is desirable because it will
create the situation of‘ full employment without inflation. This principle requires that
the state should increase the taxes to get more money and reduce expenditures to
bring the budget into balance.

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Cyclically Balanced Budget. This budget has a stabilizing effect on the economic
system. This policy maintains the basic character of a balanced budget. It can stabilize
the level of business activity.
Fully Managed Compensatory Budget. This policy implies a deliberate change in
tax, expenditure, revenues and borrowings with the aim of achieving full employment
without inflation. It seems to secure the stability in economic system. With the help of
this policy, the growth of public debt and the problems of interest and principal
payments are avoided. In a word, this approach is called ‘functional finance'.
Taxation. Taxation is an important instruments of fiscal policy. Inequalities in the
distribution of income are greater in underdeveloped countries. The rich people spend
lavishly on luxury goods which is not favorable for economic growth. Hence, taxation
on higher income groups will provide funds for economic development. There are
many kinds of taxes. A government should adopt the appropriate tax policy which is
suitable for that country. The tax structure should be based on the principle of
mobilization of resources. The tax policy is used for controlling inflationary pressure
in the economy.
Public expenditure. In an underdeveloped country, a properly planned expenditure
policy is required to increase income, output and employment. There are two types of
public expenditures -(i) Pump priming, and (ii) Compensatory spending. Pump
priming helps to initiate and revive economic activity in an economy from depression.
The objective of this policy is to stimulate private investment. Compensatory
spending involves relief expenditure, social insurance payments, public works and
subsidies. The compensatory spending raises the levels of income, output and
employment through its multiplier and acceleration effects.
Public Debt. It involves public borrowing and the repayment. This policy is adopted
to fight inflation and to bring full employment in the economy. The public debt or
borrowing can be of many forms:
(1) Borrowings from the Banks.
(2) Borrowings from the Treasury.
(3) Borrowings from Non-Bank Public.
(4) Printing of Money.
During depression, the government may borrow from the banking institutions. The
government may borrow from the treasury at the time of deficit. The government can
borrow money by selling bonds to the non bank public. This policy has non-

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inflationary effect on the economy. This policy has great advantage in an inflationary
period.

TYPES OF FISCAL POLICY

There are two types of fiscal policy are:

1. Expansionary fiscal policy
2. Confectionary fiscal policy.

Expansionary fiscal policy designated to stimulate the economy, mainly used during
recession, time of high unemployment, lower period of business cycle. It entails
government spending more money , lowering taxes or both.
Confectionary fiscal policy used to stop economy, such as inflation is growing too
rapidly. The opposite of expansionary fiscal policy, confectionary fiscal policy raises
taxes and cuts spending.
There are two tools of fiscal policy
Taxes and Spending
Taxes influences economy by determining that how much money government should
spend in certain areas and how much money individual should spend .
Spending is used as a tool of fiscal policy to drive government money to certain
sectors needs economical boost.

OBJECTIVES OF FISCAL POLICY

Objectives of fiscal policy are:

1. Full employment

2. Price stability

3. Accelerating the rate of economic development

4. Optimum allocation of resources

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5. Equitable distribution of income and wealth

6. Economic stability

1. Full Employment:
The first and foremost objective of fiscal policy in a developing economy is to
achieve and maintain full employment in an economy. In such countries, even if full
employment is not achieved, the main motto is to avoid unemployment and to achieve
a state of near full employment. Therefore, to reduce unemployment and under-
employment, the state should spend sufficiently on social and economic overheads.
These expenditures would help to create more employment opportunities and increase
the productive efficiency of the economy. In this way, public expenditure and public
sector investment have a special role to play in a modern state. A properly planned
investment will not only expand income, output and employment but will also step up
effective demand through multiplier process and the economy will march
automatically towards full employment. Besides public investment, private
investment can also be encouraged through tax holidays, concessions, cheap loans,
subsidies etc. In the rural areas attempts can be made to encourage domestic industries
by providing them training, cheap finance, equipment and marketing facilities.
Expenditure on all these measures will help in eradicating unemployment and under-
employment.

In this context, Prof. Keynes made the following recommendations to achieve full
employment in an economy:
(a) To capture the excessive purchasing power and to curb private spending:

(b) Compensate the deficiency in private investment through public investment.

(c) Cheap money policy or lower interest rates to attract more and more private
entrepreneurs.

2. Price Stability:
There is a general agreement that economic growth and stability are joint objectives
for underdeveloped countries. In a developing country, economic instability is
manifested in the form of inflation. Prof. Nurkse believed that “inflationary pressures

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are inherent in the process of investment but the way to stop them is not to stop
investment. They can be controlled by various other ways of which the chief is the
powerful method of fiscal policy.” Therefore, in developing economies, inflation is a
permanent phenomena where there is a tendency to the rise in prices due to expanding
trend of public expenditure. As a result of rise in income, aggregate demand exceeds
aggregate supply. Capital goods and consumer goods fail to keep pace with rising
income. Thus, these result in inflationary gap. The price rise generated by demand
pull reinforced by cost push inflation leads to further widening the gap. The rise in
prices raises demand for more wages. This further gives rise to repeated wage-price
spirals. If this situation is not effectively controlled, it may turn into hyper inflation.
In short, fiscal policy should try to remove the bottlenecks and structural rigidities
which cause imbalance in various sectors of the economy. Moreover, it should
strengthen physical controls of essential commodities, granting of concessions,
subsidies and protection in the economy. In short, fiscal measures as well as monetary
measures go side by side to achieve the objectives of economic growth and stability.

3.To Accelerate the Rate of Economic Growth:

Primarily, fiscal policy in a developing economy, should aim at achieving an
accelerated rate of economic growth. But a high rate of economic growth cannot be
achieved and maintained without stability in the economy. Therefore, fiscal measures
such as taxation, public borrowing and deficit financing etc. should be used properly
so that production, consumption and distribution may not adversely affect. It should
promote the economy as a whole which in turn helps to raise national income and per
capita income. In this connection it is significant to quote the views of Mrs. Hicks,
who observed, “now that fiscal policy has been developed as an established economic
function of a government, every country is anxious to gear its public finance in
pursuit of the twin aims of stability and growth, but their relative importance is very
differently regarded from one country to another… A steady rate of expansion will
tend to reduce the violence of such fluctuations as may occur; a successful full
employment policy will provide an atmosphere which is congenial for growth.”

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3.Optimum Allocation of Resources:
Fiscal measures like taxation and public expenditure programmes, can greatly affect
the allocation of resources in various occupations and sectors. As it is true, the
national income and per capita income of underdeveloped countries is very low. In
order to gear the economy, the government can push the growth of social
infrastructure through fiscal measures. Public expenditure, subsidies and incentives
can favorably influence the allocation of resources in the desired channels. Tax
exemptions and tax concessions may help a lot in attracting resources towards the
favored industries. On the contrary, high taxation may draw away resources in a
specific sector. Above all, direct curtailment of consumption and socially
unproductive investment may be helpful in mobilization of resources and the further
check of the inflationary trends in the economy. Sometimes, the policy of protection
is a useful tool for the growth of some socially desired industries in an under-
developed country.

Prof. R.N. Tripathi suggests the following steps to raise the saving ratio which
provides the required finance for developmental schemes:
(i) Direct physical control.

(ii) Increasing the rate of existing taxes.

(iii) Introduction of new taxes,

(iv) Public borrowing of non-inflationary nature,

(v) Deficit financing.

5. Equitable Distribution of Income and Wealth:

It is needless to emphasize the significance of equitable distribution of income and
wealth in a growing economy. Generally, inequality in wealth persists in such
countries as in the early stages of growth, it concentrates in few hands. It is also
because private ownership dominates the entire structure of the economy. Besides,
extreme inequalities create political and social discontentment which further generate
economic instability. For this, suitable fiscal policy of the government can be devised
to bridge the gap between the incomes of the different sections of the society. To

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reduce inequalities and to do distributive justice, the government should invest in
those productive channels which incur benefit to low income groups and are helpful
in raising their productivity and technology. Therefore, redistributive expenditure
should help economic development and economic development should help
redistribution. Thus, well-planned fiscal programme, public expenditure can help
development of human capital which in turn possesses positive effects on income
distribution. Regional disparities can also be removed by providing incentives to
backward regions. A redistributive tax policy should be highly progressive and aim at
imposing heavy taxation on the richer and exempting poorer sections of the
community. Similarly, luxurious items, which are consumed by the higher section,
may be subject to heavy taxation.

6. Economic Stability:
Fiscal measures, to a larger extent, promote economic stability in the face of short-run
international cyclical fluctuations. These fluctuations cause variations in terms of
trade, making the most favorable to the developed and unfavorable to the developing
economies. So, for the purpose of bringing economic stability, fiscal methods should
incorporate built-in-flexibility in the budgetary system so that income and expenditure
of the government may automatically provide compensatory effect on the rise or fall
of the nation’s income. Therefore, fiscal policy plays a leading role in maintaining
economic stability in the face of internal and external forces. The instability caused by
external forces is corrected by a policy, popularly known as ‘tariff policy’ rather than
aggregative fiscal policy. In the period of boom, export and import duties should be
imposed to minimize the impact of international cyclical fluctuations. To curb the use
of additional purchasing power, heavy import duty on consumer goods and luxury
import restrictions are essential. During the period of recession, government should
undertake public works programmes through deficit financing. In nut shell, fiscal
policy should be viewed from a larger perspective keeping in view the balanced
growth of various sectors of the economy.

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 MAIN FUNCTIONS OF FISCAL POLICY

Prof. Musgrave outlines the three main functions of a fiscal policy’:

1. Allocation of resources.
2. Distribution of income and wealth.

3. stabilisation -checking inflation and correcting other disturbing forces.

We may add another important function, i.e.,
4. Capital formation and economic growth.

1.Allocation of Resources.
Fiscal policy with the help of its instruments like taxation and public expenditure
programmes, can affect the allocation of resources through factor mobility in various
occupations, industries and sectors. Fiscal policy, by helping the growth of social and
economic infrastructure. and by expenditure, subsidy and incentives can favourably
influence the allocation of resources in the desired channels. Tax exemptions and tax
concessions may go a long way in attracting resources towards the favoured industries
and sectors; whereas high taxation in a particular sector or industry may draw away
resources elsewhere. The policy of protection is generally utilised for the growth of
some desired industries in a developing economy. When allocation of resources to
some industries is no longer desired, protection is withdrawn. Allocation of resources
to different sectors and industries is facilitated by removing bottlenecks,
discontinuities and diseconomies in production through proper fiscal measures. A
large part of the economies required for allocation of resources can be created by
fiscal policy.

2.Distribution of Income and Wealth.

Distribution of wealth and income can similarly be influenced by fiscal measures. For
this, suitable tax structure can be devised. A progressive taxation on wealth and
property may be very helpful in reducing inequalities and in altering the distribution
of income and wealth. A high taxation on property and unearned' increment, or, on
large income, accompanied by a policy of expenditure towards the upliftment of the
poor section of the community, will bring about an equal income distribution as
between the poor and the rich. For affecting income distribution, fiscal , policy may

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change the institutional environment through which distribution generally occurs. The
policy may also aim at altering the resultant distribution pattern. For instance, land
taxes may help to alter the distribution of land ownership; investment on human
capital and skill formation can suitably upgrade the workers to earn more income and
can also help to bridge the gap between the earnings of skilled and unskilled workers
in the economy as a whole. Taxes and subsidies can change the degree of competition
among the various sectors of the economy. Distribution of property of the landed
aristocrats beyond a certain ceiling, among the landless farmers, will alter the
distribution pattern of land. Income distribution can also be effected by changing the
terms of trade between the sectors or by a proper change in the relative price level of
luxury and necessary articles of consumption. A socially desirable pattern of income
distribution may be considerably helped by raising the prices of the luxury articles
pari passu with lowering the price of the necessary commodities.

3.Stabilisation.
Economic disturbances in the form of inflation and depression can be checked by
proper compensatory fiscal measures. Inflation may be checked by financing
government expenditure through higher taxation. Government spending may be
lowered relative to taxes. Fiscal policy may also resort to budgetary surplus, public
borrowing or overvaluing the currency. For the purpose of economic stabilization,
fiscal policy should incorporate built in flexibility in the budgetary system so that the
government income and expenditure policy ma y automatically provide compensatory
effects on the rise or fall in the general income level of the country. While depression
as such is not likely to be a serious problem in underdeveloped countries, some
disturbing forces and pressure spots may generate during the process of development,
which may give rise to serious instability. Such distorting forces may be corrected by
compensatory taxation, spending, pump priming, budgetary flexibility and proper debt
management policies. Fiscal policy should aim at taking out sufficient money from
the economy during inflation, and injecting sufficient money into the economy during
depressionary periods.

4.Capital Formation and Growth.

Fiscal policy may be tailored effectively to maintain a steady rate of growth of output
overtime. When growth is allowed for, however, fiscal policy has a double role to

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play. On the one hand, it ensures the sale of the growing volume of output resulting
from the full use of capacity and on the other hand it may change the rate of growth of
capacity itself. Investment expenditures work in two directions: (i) increasing capacity
creation so that, as investment takes place, more and more goods and services can be
turned out in the economy, (ii) increasing income generation so that the increased
output may be purchased. In order to ensure the purchase of the growing volume of
output, investment must increase by larger and larger absolute amount. Fiscal policy
by wholly directing private and public investment and by influencing private
investment to some extent, can determine the extent of required investment and can
mobilise resources for this purpose, from a number of sources such as taxation, public
and private savings, domestic surplus, deficit financing or borrowing from abroad.
Fiscal policy can be influential in changing demand directly. In full employment,
fiscal policy may be designed to alter the ratio between the pool of income funds and
the pool of capital funds. A given growth rate can be sought to be attained by the
fiscal policy through the means of expanding investible funds. For maintaining a
particular growth rate, government revenue must rise along with the government
expenditure. Each level of taxation and government expenditure is uniquely
associated with a growth rate. An egalitarian tax structure requires a relatively larger
government surplus to achieve a particular rate of growth. The influence of fiscal
policy on growth rate will depend upon the character and volume of taxation and of
expenditure. As expectations concerning taxes change in the long run, the level of
consumption and, therefore, the rate of growth, become more amenable to influence
through the fiscal mechanism. However, the merit of fiscal policy lies in its ability to
accumulate social surplus for economic development. Capital formation can be
facilitated by personal business and by government savings.“ Government saving may
be augmented by increasing the surplus over its expenditure. Hence, an economy
drive towards reducing expenditure may be quite helpful. the fiscal mechanism can
directly or indirectly help to mobilise savings for capital formation. Fiscal policy
should aim at mopping up maximum savings and mobilizing them towards the most
productive channels for capital formation. Taxation should be so framed that the
incentive to save is not destroyed. Tax parameter, by enforcing collective savings in
the society, can redirect resources towards capital formation.

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 LIMITATION OF FISCAL POLICY

1.Fiscal system may be in conflict with the objectives of price stability and full
employment.

2.An expansionary fiscal policy in the matter of allocation of resources may be self-
defeating. The tendency of interest rate to fall would set in motion some corrective
forces which may ultimately raise it again.

3.In an economy as liquid as in U.S.A., growth rate may be hampered by a sudden

increase in taxation. Any growth rate takes the theoretical assumption of particular
consumer behaviour. This is actually not so in a
dynamic economy.

4.Fiscal instruments have limited efficacy.

5.Fiscal policy, for its effectiveness, requires correct forecasting of economic trends
and efficient administrative machinery. These cannot be in backward countries.

6.Political pressure and structural problems also put hindrance to the effective
utilisation of fiscal machinery.

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 CONCLUSION

Fiscal policy, if properly planned and coordinated, may be very helpful in the process
of economic development. The main sources of finance for capital formation are
fairly amenable to fiscal measures Prof. Musgrave has pointed out that fiscal policy
now has its day" But fiscal policy has cells in limitations, and by itself it is
incomplete. However, fiscal mechanism can more effectively play its role in
economic development, if it is supplemented by a suitable monetary policy. In the
case one can get rid of the disadvantages of fiscal policy and at the same can hope to
achieve the best of both the policies.

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 BIBLIOGRAPHY

Websites

1. https://www.toppr.com/guides/general-awareness/public-finance-

and-budget/fiscal-policy/

2.https://www.wallstreetmojo.com/fiscal-policy/

Books

Indian economy by S.N. Mishra

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