Fiscal Policy

Meaning: Fiscal policy deals with the taxation & expenditure of the government. It is a type of
economic policy which controls & regulates tax system, expenditure and public debt management
within a country. The main focus of this policy is on the flow of money in a particular economy.
The role of Fiscal policy is differs according to the requirements of a country. Developed countries
use this policy as a tool to increase the employment & maintain economic stability.
According to Buehler: “By fiscal policy means the use of public finance or expenditure, taxes
borrowing and financial administration to further our national economy objectives”.
Arthur Smithies defines fiscal policy as “a policy under which the government uses its
expenditure and revenue programmes to produce desirable effects and avoid undesirable effects on
the national income, production and employment.”
Objectives of Fiscal Policy:-
1. Development by effective Mobilization of Resources: The principal objective of fiscal policy
is to ensure rapid economic growth and development. This objective of economic growth and
development can be achieved by Mobilization of Financial Resources. The central and state
governments in India have used fiscal policy to mobilize resources.
2. Taxation: Through effective fiscal policies, the government aims to mobilize resources by way
of direct taxes as well as indirect taxes because most important source of resource mobilization
in India is taxation.
3. Public Savings: The resources can be mobilized through public savings by reducing
government expenditure and increasing surpluses of public sector enterprises.
4. Private Savings: Through effective fiscal measures like tax benefits, the government can raise
resources from private sector & households. Resources can be mobilized through government
borrowings by ways of treasury bills, government bonds, etc., loans from domestic and foreign
parties and by deficit financing.
5. Reduction in inequalities of Income & Wealth: It aims at achieving equity or social justice by
reducing income inequalities among different sections of the society. The direct taxes like
income tax are charged more on the rich people as compared to poor people. Indirect taxes are
also more on luxury items which are mostly consumed by the upper middle class & the upper
class. The government invests a significant proportion of its tax revenue in the implementation
of Poverty Alleviation Programmes to improve the conditions of poor people in society.
6. Price Stability & Control of Inflation: Another objective of fiscal policy is to control inflation
& stabilize price. Therefore, the government always aims to control the inflation by reducing
fiscal deficits, introducing tax savings schemes, productive use of financial resources, etc.
7. Employment Generation: The government is making possible effort to increase employment in
the country through effective fiscal measures. Investment in infrastructure has resulted in direct
and indirect employment. Lower taxes and duties on small-scale industrial (SSI) units encourage
more investment and consequently generate more employment. Various rural employment
programmes have been undertaken by the Government of India to solve problems in rural areas.
8. Balanced Regional Development: there are various projects like building up dams on rivers,
electricity, schools, roads, industrial projects etc run by the government to mitigate the regional
imbalances in the country. This is done with the help of public expenditure.
9. Reducing the Deficit in the Balance of Payment: Some time government gives export
incentives to the exporters to boost up the export from the country. In the same way import
curbing measures are also adopted to check import. Hence the combine impact of these
measures is improvement in the balance of payment of the country.
10. Increases National Income: It’s the strength of the fiscal policy that is brings out the desired
results in the economy. When the government wants to increase the income of the country then
it increases the direct and indirect taxes rates in the country. There are some other measures
like: reduction in tax rate so that more peoples get motivated to deposit actual tax.
11. Development of Infrastructure: When the government of the country spends money on the
projects like railways, schools, dams, electricity, roads etc to increase the welfare of the
citizens, it improves the infrastructure of the country. An improved infrastructure is the key to
further speed up the economic growth of the country.
12. Foreign Exchange Earnings: When the central government gives incentives like, exemption
in custom duty, concession in excise duty while producing things in the domestic markets, it
motivates the foreign investors to increase the investment in the domestic country.
Instruments of Fiscal Policy
1. Taxation Policy: The tax rate structure has to be varied in the context of conditions prevailing
in an economy. Taxes determine the size of disposable income in the hands of general public
and therefore, the quantum of inflationary and deflationary gaps. During depression tax policy
has to be such as to encourage private consumption and investment; while during inflation, tax
policy must curtail consumption and investment.
2. Public Debt: A sound programme of public borrowing & debt repayment is a strong weapon to
fight inflation & deflation. It can be in the form of borrowing from non-bank financial
intermediaries, borrowing from commercial banking system, drawings from the central bank or
printing of new money. Borrowing from the public through the sale of bonds and securities
which curtails consumption and private investment is anti-inflationary in effect. Borrowing from
banking system is effective during depression if banks have got excess cash reserves.
3. Public Expenditure: Public expenditure can be used to stimulate production, income and
employment. Government expenditure highly significant part of the total expenditure in the
economy. A reduction or expansion in it causes significant variations in the total income. It can
be instrumental in adjusting consumption and investment to achieve full employment. During
inflation, the best policy is to reduce government expenditure in order to control inflation by
giving up such schemes as are justified only during deflation. While expenditures are reduced,
attempts are made to increase public revenues to generate a budget surplus.
Significance of Fiscal Policy
1. To Mobilize Resources: The aim of fiscal policy in underdeveloped countries is to mobilize
resources in the private & public sectors. The national income & per capita income is very low
due to low rate of savings. Therefore, the governments of such countries forced savings push the
rate of investment & capital formation which accelerates the rate of economic development.
2. Accelerate Growth Rate: It helps to accelerate the rate of economic growth by raising the rate
of investment in public & private sectors. The various tools of fiscal policy as taxation, public
borrowing, & deficit financing of public enterprises should be used in a combined manner so
that they may not adversely affect the consumption, production and distribution of wealth.
3. To Encourage Optimal Investment: Fiscal policy encourages the investment into those
channels which are considered socially economically & desirable. It means optimal investment
which promotes economic development & avoids wasteful & unproductive investment.
4. Employment Opportunities: In less developed countries, population grows very fast rate, the
aim of fiscal policy in such countries is to make high doses of expenditures which are helpful to
raise employment opportunities. Under developed economies suffer from unemployment.
5. Economic Stability: Still another role played by the fiscal policy in developing countries is of
maintaining reasonable internal and external economic stability. Generally, a developing country
is prone to the efforts of international cyclical fluctuations. Such countries mainly export
primary products and import manufactured and capital goods.
6. To Check Inflationary Tendencies: Inflationary tendencies are the main problems of
developing countries as these countries make heavy doses of investment for their development
activities. Thus, there is always an imbalance between demand and supply of real resources.
7. Subsidies in Consumption & Production: This Policy is used in underdeveloped economies
to provide food & production inputs. Government programmes like public distribution system,
procurement of food grains, marketing facilities, input supply schemes, etc. are all directed to
help the poorer sections to enable them to be more productive so that the income level is raised.
8. Incentive to Production: Increase in production & productivity can be influenced by fiscal
policy. Through grant of tax concessions relating to output produced from desirable lines of
production, the industrial activity can be enhanced. On the other hand, discriminatory fiscal
policy against the output on undesirable lines of business activity will help more essential
commodities to grow because the resources will be released for their use in such production.
Limitations of fiscal policy:
1. Existence of Barter Economy: In Under Developed Countries, there exists non-monetized
sector i.e. barter system prevails in the economy. This sector remains unaffected by the fiscal
policy.
2. Lack of Elasticity: Taxation system in underdeveloped countries is not modern, rational and
elastic. Tax evasion leads to the generation of black market. It becomes difficult to earn
sufficient revenue by the way of taxes which hinders the development activities.
3. Inadequate Data: Generally, in less developed countries, there is inadequate statistical data. In
the absence of accurate data, the scope of fiscal policy is minimized.
4. Illiteracy: Lack of knowledge and proper understanding on account of illiteracy, the scope of
fiscal policy becomes limited. The common people are unable to recognize the significance of
fiscal policy.
5. Lack of co-operation: In Under Developed Countries lack of confidence and non-cooperative
attitude among people hinders the significance of fiscal policy.