Fiscal Functions - An Ove1view 39

Chapter 3
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 40
Fiscal Func tio ns - An Overview

3.1 INTRDDUCTIDN
. h t· ' ties involved in the nmnin g of an economy for the purpose
Government operations are t ose ac 1v1 . . . .
. . p blic administrat10n 1s a ve hicl e for express ing the values
of producing value for the c1t1zens . u
. . . ·res and society as a whole . Som e of these values and
and preference s ot c1t1zens , commum 1
prefere nces are constant, ot h ers c h ange as societies evolve.
. 1 m· ·nfluencing the economic direction of an economy. Wh e n
Fiscal Policy plays an important roe 1 . .
• h ent generally is refernng to two maJor gove rnmental
speak:ina of fiscal policy, t e govemm . . .
~ . . . • d d . g The budget is the ma1or instrument through which the
econormc actlvttles; taxation an spen m · .
government determines . h .r- ·ts energy and resources to devote to these two ma1or
how muc 01 I . .
• •• • · th
actw1ties. Time and agam e govemmen t deems it necessary to .intervene m order to. check the
· ·
progress and functlomng of govemmen t policies · Such intervention by government
. .1s based on
·
the belief that the objective of economic system an d th e role of govemmen t 1s to 1m prove t he
welfare of individuals and households.

3.2 THE RDll Of GOVERNMENT IN AN ECONOMIC SYSTEM

The Allocation Function The Distribution Function

ROLE OF GOVERNMENT IN
AN ECONOMIC SYSTEM

The Stabilization Function The Development Function

Figure 3.2(a) Role of Government in an Economic System

Before discussing the role of government towards economy and its development let us first discuss
the basic problems surrounding an economy. The fundamental economic problem is related to
the issue of scarcity. Because of limited resources and infinite demands , society needs to
determine and answer how to produce and distribute these relatively scarce resources . The
modem society, in general, offers three alternate economic systems through which the decisions
of resource reallocation may be made namely, the market, the government and a mixed system
where both markets and governments simultaneously determine resource allocation . The
development of a fiscal policy generally has four primary purposes or functions , which are
discussed in the following sections .

3.3 THE AllOCATION FUNCTION

Resource allocation refers to the way in which the available factors of production are allocated
among the various uses to which they might be put . It is helpful in determining how muc h the
various kinds of goods and services will actually be produced in an economy. The first major
function of fiscal policy is to determine exactly how funds will be allocate d . This is closely related
to the issues of taxation and spending, because the allocation of funds depends upon the
collection of taxes and the government using that revenue for specific purposes. The national
budget determines how funds are allocated. This means that a specific amount of funds is set
aside for purposes specifically laid out by the government . This has a direct economic impact on
the country. Efficient allocation of resources is assumed to take place only in perfectly competitive

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fis cal Functions - An ~vervi~"." 41
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markets .. n re ity, ~arkets are never perfectly competitive. Market failures which are responsible
.
for inefficient allocation or re sources occur mamly due to following reasons:
•
•
Monopoly Powers of varied ct egree and imperfect competition·
• Markets generally fail to p ·ct 1 • .
rovi e co lective goods which • common b Y all th e
are 'consumed m
people;
· ·
. . of. factors causi·n g pro blems of meffic1ency
• Immobility and unemployment;
Inequalities m the distribution of income and wealth·
• Externalities_ occurring in an economy when the pro~uction or consumption of a specific good
impacts a th ird Party that is not directly related to the production or consumption;
• Imperfect information

It is necessary for the government to intervene in the market to bring about improvement in social
welfare. In absence of appropriate government intervention market failures may occur and the
resources are likely to be misallocated by over-production 0 ; under-production. There are variety
of instruments available by which government stimuli resource allocation in the economy. E .g.
• Government may directly produce the economic good like electricity, public transportation
services, etc.;
• Government may influence private allocation through incentives and disincentives. E.g. tax
concessions and subsidies for the production of those goods that promote social welfare;
• Government may influence allocation through its Competition Policies and Merger Policies;
• Dilatory /Regulatory activities by Government such as licensing controls, minimum wages etc.;
• Setting up of legal and administrative frameworks by government

3.4 THE DISTRIBUTION FUNCTION

The distributive function of budget is related to the basic question, 'For whom should an economy
produce goods and services?'. The Distribution Function provides the specific explanation of what
allocation was intended for in the first place. Whereas, allocation determines how much will be
set aside and for what purpose, the distribution function of fiscal policy is to determine more
specifically how those funds will be distributed throughout each segment of the economy. Over
the past decades there has been a tremendous expansion in economic activities which resulted
in generation of enormous increase in aggregate output and wealth. However, the outcomes of
this growth have not spread evenly acros~ the households . So, the major function of government
involved changing the pattern of distribution of income .
The distribution function of the Government aims at:
• Redistribution of income for achieving an equitable distribution of output among households;
• Extending the well-being to the members of the so~~ty who are suffering from deprivations;
Providing equality in income, wealth and o~portumtles;
• Providing security for people facing hardships; ..
• Ensuring that everyone enjoys a minimum standard of living
Few examples of the redistribution function performed by the Government are:

• Taxation policies of the Government; ~~-tf'l,,. .

• Proceeds from progressive taxes to be used for l:laee: fof financmg public services especially
those benefiting low income households;
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 ,~1~n1l F'll11 C' lion i" ,\n Ovt'rvkw 42

• Emplo yment re se rva tions ;

• Regula tion of the manuf acture and sale of certain specifi c produ . h h alth d
cts ensun ng t e e an
well -be ing of consu mers;
• Specia l schem es for backw ard region s

3.5 THE STIBIUZATION FUNCTION

·
Sta bilizat ion of the econo my 1s one of the go al s th a t gove rnmen ts attem pt to . achiev e throug.h
m a nipula tion of fiscal and f!10netary policie s. Witho ut son:ie rest_ra ints
on spend1.~1g, the econo mic
growth of the nation could becom e unstab le, result ing m penod s
of unreS t ramed grow:1h and
contra ction . The cyclical nature of the marke t means that unrest rained
growt h ~ann_o t contin ue for
an i1tdefinite period . When growth period s end, they are follow ed by
contra ction m the forn:1 of
recess ions or prolon ged recess ions known as depres sions. In
the absen ce of ~ppro pnate
correc tive interv ention by the govern ment the instab ilities that occur
in the econo my m the form
of recess ions , inflati on etc. may be prolon ged for longer period causin
g enorm ous hards hips to
people especi ally the poor sectio ns of the society . The stabili zation
issue also becom es more
compl ex as the increa sed intern ationa l interd epend ence cause s forces
of instab ility to get easily
transm itted from one countr y to other countr ies. This is also known
as 'Conta gion Effect' . The
stabili zation functio n is conce rned with the perfor mance of the follow
ing:
• Emplo yment of labor and .optim um utiliza tion of capita l;
• Overal l outpu t and incom e level;
• Gener al price levels;
• Balanc e of payme nts;
• Rate of econom ic growth
Gover nment s fiscal policy has two major compo nents which are
crucia l for stabili zing the
econom y. The workin g of this mecha nism is partly autom atic and partly
the result of delibe rate
action s by the monet ary author ities in each countr y.

3.6 THE DEVHOPMENT FUNCTION

The fourth major functi on of fiscal policy is that of develo pment . Devel
opmen t seems to indica te
econo mic growth , and that is, in fact, its overal l purpo se. Howev
er, fiscal policy is far more
compl icated than determ ining how much the govern ment will tax citizen
s and then determ ining
how that money will be spent. True econo mic growth occurs when
variou s projec ts are financ ed
and carrie d out using borrow ed funds. This stems from the belief that
the privat e sector canno t
grow the econo my by itself. Instea d, some govern ment input and influe
nce are neede d.
3.7 CONCLUSION
Now when we have discus sed the need for and ration ale of gover nment
interv ention s for impro ving
social welfar e by enhan cing welfar e for impro ving social welfar e by
enhan cing stabili ty efficie ncy
and fairne ss, it is also necess ary to under stand that when we say
that the marke t genera ted
alloca tion of resour ces is imperf ect, it does not necess arily mean that
the gover nment is alway s
and at all times capab le of correc ting the failure s of the marke
t. It is throug h an optim um
combi nation of Gover nment and Privat e Player s, econo mic develo
pment by maxim izing social
benefi ts can be resort ed to.

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43

PIICTICE QUESTIINS
• Briefly explain the role of government in a market economy.
• Write short notes on:
0 The Allocation Function
0 The Development Function
• Briefly explain the reason behind the Redistribution Function of Government.
• Give a few examples of Allocation and Stabilization Function.
• Fiscal policy plays an important role in influencing the economic direction of an Economy.
Comment.

Notes

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<D CS Adi ti Pan1