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• Fiscal Policy is the main part of Economic Policy and Fiscal Policy's first word

Fiscal is taken from French word Fisc it means treasure of Govt. So we can
define fiscal policy as the revenue and expenditure policy of Govt. of India .It
is prime duty of Government to make fiscal policy. By making this policy ,
Govt. collects money from his different resources and utilize it in different
expenditure . Thus fiscal policy is related to development policy . All welfare
projects are completed under this policy

Fiscal Policy-Meaning The word fisc means ‘ state treasury ’ and fiscal policy refers to
policy concerning the use of ‘state treasury’ or the govt. finances to achieve the
macroeconomic goals. “ any decision to change the level, composition or timing of
govt. expenditure or to vary the burden ,the structure or frequency of the tax payment is
fiscal policy.” - G.K. Shaw
The fiscal policy is concerned with the raising of government revenue and incurring of
government expenditure.

“Fiscal policy is concerned with all those activities which are adopted by the
government to collect revenues and make the expenditures so that economic
stability could be attained without inflation and deflation”
Fiscal policy has to decide on the size and pattern of flow of
expenditure from the government to the economy and from the
economy back to the government. So, in broad term fiscal policy
refers to "that segment of national economic policy which is primarily
concerned with the receipts and expenditure of central government."
In other words, fiscal policy refers to the policy of the government
with regard to taxation, public expenditure and public borrowings.
The importance of fiscal policy is high in underdeveloped countries.
The state has to play active and important role. In a democratic
society direct methods are not approved. So, the government has to
depend on indirect methods of regulations. In this way, fiscal policy
is a powerful weapon in the hands of government by means of which
it can achieve the objectives of development.
1. Development by effective Mobilisation 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
Mobilisation of Financial Resources.
The central and the state governments in India have used fiscal policy to mobilise resources.
The financial resources can be mobilised by :-
Taxation : Through effective fiscal policies, the government aims to mobilise resources by
way of direct taxes as well as indirect taxes because most important source of resource
mobilisation in India is taxation.
Public Savings : The resources can be mobilised through public savings by reducing
government expenditure and increasing surpluses of public sector enterprises.
Private Savings : Through effective fiscal measures such as tax benefits, the government
can raise resources from private sector and households. Resources can be mobilised through
government borrowings by ways of treasury bills, issue of government bonds, etc., loans
from domestic and foreign parties and by deficit financing.
2. Efficient allocation of Financial Resources

The central and state governments have tried to make efficient allocation of financial resources. These
resources are allocated for Development Activities which includes expenditure on railways, infrastructure,
etc. While Non-development Activities includes expenditure on defence, interest payments, subsidies, etc.
But generally the fiscal policy should ensure that the resources are allocated for generation of goods and
services which are socially desirable. Therefore, India's fiscal policy is designed in such a manner so as to
encourage production of desirable goods and discourage those goods which are socially undesirable.

3. Reduction in inequalities of Income and Wealth

Fiscal policy aims at achieving equity or social justice by reducing income inequalities among different
sections of the society. The direct taxes such as income tax are charged more on the rich people as
compared to lower income groups. Indirect taxes are also more in the case of semi-luxury and luxury items,
which are mostly consumed by the upper middle class and 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.

4. Price Stability and Control of Inflation

One of the main objective of fiscal policy is to control inflation and 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
5. Employment Generation

The government is making every possible effort to increase employment in the country through effective fiscal
measure. 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 generates more
employment. Various rural employment programmes have been undertaken by the Government of India to
solve problems in rural areas. Similarly, self employment scheme is taken to provide employment to
technically qualified persons in the urban areas.

6. Balanced Regional Development

Another main objective of the fiscal policy is to bring about a balanced regional development. There are
various incentives from the government for setting up projects in backward areas such as Cash subsidy,
Concession in taxes and duties in the form of tax holidays, Finance at concessional interest rates, etc.

7. Reducing the Deficit in the Balance of Payment

Fiscal policy attempts to encourage more exports by way of fiscal measures like Exemption of income tax on
export earnings, Exemption of central excise duties and customs, Exemption of sales tax and octroi, etc.
The foreign exchange is also conserved by Providing fiscal benefits to import substitute industries, Imposing
customs duties on imports, etc.
The foreign exchange earned by way of exports and saved by way of import substitutes helps to solve balance
of payments problem. In this way adverse balance of payment can be corrected either by imposing duties on
imports or by giving subsidies to export.
8. Capital Formation

The objective of fiscal policy in India is also to increase the rate of capital formation
so as to accelerate the rate of economic growth. An underdeveloped country is
trapped in vicious (danger) circle of poverty mainly on account of capital deficiency.
In order to increase the rate of capital formation, the fiscal policy must be efficiently
designed to encourage savings and discourage and reduce spending.

9. Increasing National Income

The fiscal policy aims to increase the national income of a country. This is because
fiscal policy facilitates the capital formation. This results in economic growth, which in
turn increases the GDP, per capita income and national income of the country.

10. Development of Infrastructure

Government has placed emphasis on the infrastructure development for the purpose
of achieving economic growth. The fiscal policy measure such as taxation generates
revenue to the government. A part of the government's revenue is invested in the
infrastructure development. Due to this, all sectors of the economy get a boost.
Fiscal policy is the policy under which the government of a
country uses fiscal measures (or instruments) to correct
excess demand and deficient demand and to achieve other
desirable objectives. There are mainly three types of fiscal
measures, viz.
a. Taxes
b. Public expenditure
c. Public borrowing

And one more which is d) Debt financing


(a) Taxes/ Taxation Policies

These are involuntary payments from the household sector to the government
sector. Taxes are the primary source of revenue used by government to finance
government spending. Taxes affect the amount of disposable income available for
consumption and saving. As such, any change in taxes indirectly affects
aggregate expenditures and the macro economy through consumption
expenditures and investment expenditures (via saving).

Excess of aggregate demand over aggregates supply is caused due to the excess
amount of money income is the hands of the people in relation to the available
output in the country. In order to correct such situation personal disposable in
such case should be reduced. Therefore, government should increase the rate of
personal income tax, and corporate income tax so that people will have less
money in their hands and aggregates demand will fall.
On the other hand, deficient demand is caused due to low level of personal
disposable income. Therefore, government of a country should reduce the rate of
direct taxes such as personal income tax, and corporate tax.
(b) Public expenditure / Government Expenditure Policy

It refers to government expenditure on public or final goods and services.


Public expenditure is an important component of aggregate demand.
Therefore, excess demand can be corrected by reducing government
expenditure. Reduction in government expenditure also leads to a
decline in the volume of national income due to the backward operation
of investment multiplier. Reduction in national income leads to a decline
in aggregate demand and fall in the price level.
On the other hand, government should increase expenditure on public
works programmes such as the construction of roads, expansion of
railways, setting up of power projects, construction of irrigation projects,
schools and colleges, hospitals and parks and so on. Besides,
government should also enhance expenditure on social security
measures, like old age pensions, unemployment allowances, sickness
benefits etc. As a result, national income would rise due to the operation
of multiplier and aggregate demand for goods would expand.
c) Public borrowing:
Like tax and public expenditure, public borrowing is also an important anti –
inflationary instrument. Government of a country should resort to borrowing from
the non-bank public to keep less money in their hands for correcting the state of
excess demand and inflationary situation. On the other hand, to correct deficient
demand, government should reduce borrowing from the general public so that
purchasing power in the hands of the people is not reduced. Rather,
government should repay the past loans to the people to increase their
disposable income.

d) Deficit financing
Besides the above fiscal measures, government should resort to deficit
financing to correct deficient demand. Deficit financing is a technique of
financing a deficit budget by (i) printing notes, & (ii) borrowing from the central
bank or drawing down the cash balances on part of the government from the
central bank. In any case, deficit financing makes an addition to the total money
supply of the country and can correct deficient demand. However, deficit
financing beyond a limit may produced inflationary situation in a country.
Therefore, deficit financing must be kept within a limit and should be used with
caution and care.
The three possible stances of fiscal policy are neutral,
expansionary and contractionary. The simplest definitions
of these stances are as follows:
• A neutral stance of fiscal policy implies a balanced
economy. This results in a large tax revenue.
Government spending is fully funded by tax revenue and
overall the budget outcome has a neutral effect on the
level of economic activity.( Government Spending = Tax
Revenue)
• An expansionary stance of fiscal policy involves
government spending exceeding tax revenue. ( G > T)
• A contractionary fiscal policy occurs when government
spending is lower than tax revenue. ( G < T)
Expansionary Fiscal Policy: The recommended fiscal policy to correct the
problems of a business-cycle contraction is expansionary fiscal policy.
Expansionary fiscal policy includes any combination of an increase government
purchases, a decrease in taxes, or an increase in transfer payments. This fiscal
policy alternative is intended to stimulate the economy by increasing aggregate
expenditures and aggregate demand. It is primarily aimed at reducing
unemployment.

Deficient demand is caused due to low level of personal disposable income.


Therefore, government of a country should reduce the rate of direct taxes such as
personal income tax, and corporate tax.
Government should increase expenditure on public works programmes such as
the construction of roads, expansion of railways, setting up of power projects,
construction of irrigation projects, schools and colleges, hospitals and parks and
so on. Besides, government should also enhance expenditure on social security
measures, like old age pensions, unemployment allowances, sickness benefits
etc. As a result, national income would rise due to the operation of multiplier and
aggregate demand for goods would expand.

To correct deficient demand, government should reduce borrowing from the general public
so that purchasing power in the hands of the people is not reduced. Rather, government
should repay the past loans to the people to increase their disposable income.
Contractionary Fiscal Policy:

The recommended fiscal policy to correct the inflationary problems of a


business-cycle expansion is contractionary fiscal policy. Contractionary fiscal
policy includes any combination of a decrease government purchases, an
increase in taxes, or a decrease in transfer payments. This fiscal policy
alternative is intended to restrain the economy by decreasing aggregate
expenditures and aggregate demand. It is primarily aimed at reducing
inflation.
Excess of aggregate demand over aggregates supply is caused due to the excess
amount of money income is the hands of the people in relation to the available output in
the country. In order to correct such situation personal disposable in such case should
be reduced. Therefore, government should increase the rate of personal income tax,
and corporate income tax so that people will have less money in their hands and
aggregates demand will fall.
Reduction in government expenditure also leads to a decline in the volume of national
income due to the backward operation of investment multiplier. Reduction in national
income leads to a decline in aggregate demand and fall in the price level.

Government of a country should resort to borrowing from the non-bank public to keep
less money in their hands for correcting the state of excess demand and inflationary
situation.
BUDGET ( IN BRIEF) (Detailed Notes done in the class)

A budget is a statement of expenditures and receipts. If expenditures exceed


receipts, then a budget deficit occurs. If receipts exceed expenditures, then a budget
surplus occurs. While households, businesses, and other entities have budgets, fiscal
policy is most concerned with government budgets. In particular, fiscal policy,
especially that undertaken by the federal government, is commonly evaluated in
terms of budget deficits and surpluses.

With expansionary fiscal policy--through an increase in government spending,


either purchases or transfer payments, or a decrease in taxes--then the budget
moves in the direction of a deficit or at the very least a smaller surplus.

With contractionary fiscal policy--through a decrease in government spending,


either purchases or transfer payments, or an increase in taxes--then the budget
moves in the direction of a surplus or at the very least a smaller deficit.
• A government’s budget deficit is the difference between
what it spends (G) and what it collects in taxes (T) in a
given period:
Budget deficit  G  T

• With Expansionary fiscal policy


• With Contractionary fiscal policy
A FISCAL DEFICIT IS OFTEN
FUNDED BY ISSUING BONDS
LIKE TREASURY BILLS.
A FISCAL SURPLUS IS OFTEN
SAVED FOR FUTURE LOCAL
FINANCIAL INSTRUMENTS
UNTILL NEEDED.
FULL EMPLOYMENT GAPS

Fiscal policy is used to address business-cycle instability that gives rise to the
problems of unemployment and inflation, that is, to close recessionary gaps and
inflationary gaps.

Recessionary Gap: A recessionary gap exists if the existing level of aggregate


production is less than what would be produced with the full employment of
resources. This gap arises during a business-cycle contraction and typically
gives rise to higher rates of unemployment.

Inflationary Gap: An inflationary gap exists if the existing level of aggregate


production is greater than what would be produced with the full employment of
resources. This gap typically arises during the latter stages a business-cycle
expansion and typically gives rise to higher rates of inflation