FISCAL POLICY

Fiscal policy is the part of governmental economics which

deals with taxation, expenditure, borrowing and the
management of public debt in an economy. It is an instrument of
modern public finance.
According to Paul Samuetson “fiscal policy
means public expenditure and tax policy.”
According to buehler “by fiscal policy is meant the
use of public finance or expenditure, taxes, borrowing and
financial administration to further our national economic
objective.”
Thus fiscal policy operates through the control of
government expenditures and tax receipts. It encompasses two
separate but related decisions, public expenditures, and the level
and structure of taxes. The amount of public outlay, the
incidence and effects of taxation, and the relation between
expenditure and revenue exert a significant impact upon the free
enterprise economy.

OBJECTIVES OF FISCAL POLICY

 FULL EMPLOUMENT:- Every government aims at

maintaining full employment situation in the country. To achieve
this objective and to increase aggregate demand, the government
increases public expenditure and reduces taxes so that private
sector is induced to spend more. Increase in aggregate demand will
lead to more production and employment.

 PRICE STABILITY: - Another important objective of fiscal

policy is to achieve price stability. In the case of rising prices or
inflation, fiscal policy seeks to reduce aggregate demand by
reducing public expenditure and increasing direct and indirect
taxes. These measures bring down the purchasing power the
purchasing power of the people. In the event of falling prices or
deflation, fiscal policy seeks to increase aggregate demand by
increasing public expenditure and lowering the rates of taxation.

 REDUCTION IN ECONOMIC INEQUALITY; - In

democratic countries, economic inequalities are sought to be

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removed through appropriate fiscal measures. To achieve these
objective, progressive direct taxes, like income tax wealth tax,
death duties etc. are levied. The incidence of these taxes is more on
the rich.

 ECONOMIC DEVELOPMENT: - In pursuance of the

objective of economic development, fiscal policy seeks to increase
the rate of capital formation. In an underdeveloped economy,
increase in the rate of capital formation is the sole determining
factor to increase output and employment.

TOOLS OR METHODS OF FISCAL POLICY:-

 Taxation Policy: - Government collects large funds from the
public by way of taxes. Aggregate demand can be influenced
through taxes. There are various kinds of taxes. These are broadly
classified as direct taxes and indirect taxes. As a result of taxes
either the monetary income of the people is diminished or prices of
goods increase. In other words, real income of the people is
diminished and so also their aggregate demand. Effect of taxes on
aggregate demand depends on taxation multiplier. Value of
taxation multiplier can be known with the help of the following
formula;

KT = ∆Y/∆T = -C/1-C

(Here KT = Taxation multiplier; ∆y = change

in income; ∆t = change in taxation; C =
Marginal propensity to consume.)

Value of taxation multiplier is negative. It

means that change in taxation has an inverse effect on national
income fall in taxation increases national income and rise in taxation
decreases national income.

 Government Expenditure Policy: - Aggregate demand is

influenced by government expenditure. On account of increase in
public expenditure there is increase in aggregate goods and
services. It has a direct effect on aggregate demand and vice versa.
Public expenditure can be two types: (1) public expenditure

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incurred to buy goods and services. It has a direct effect on
aggregate demand. The quantum of its effect depends on public
expenditure multiplier, which can be known with the help of the
following formula;

KG =∆Y/∆G =1/1-C
(Here KG =public expenditure multiplier; ∆Y =
Change
http://img543.imageshack.us/img543/2299/tfn8.
gifin income; ∆G = Change in public
expenditure; C = marginal propensity to
consume)

(2) Public expenditure can also be incurred without buying goods and
services; e.g. expenditure made in pensions, scholarship,
education, medical facilities, etc. By the government .such
expenditure is called transfer payments. Transfer payments have an
indirect effect on aggregate demand. Aggregate demand does
increase when there is an increase in transfer payments.

 Public Debt Policy: - Aggregate demand is also influenced by

public debt policy. Public debt is of two kinds; (1) Internal Debt
and (2) External; Debt. The effect of public debt on aggregate
demand depends on many factors. If due to public debt; demand of
the private sector does not fall, then by spending the amount
collected through public debt, government can increase aggregate
demand. If on the contrary, private expenditure goes down due to
public debt then its effect on aggregate demand becomes doubtful.

 Deficit Financing: - It refers to the financing of the deficit of

government’s budget. When the government meets its budgetary
deficit by borrowing from the central bank, it is called deficit
financing. As a result of deficit financing, income of the people
goes up and alongwith it aggregate demand also goes up. All
governments make an increasing use of deficit financing these
days. There is always an apprehension of rise in prices due to
deficit financing.

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Income % expenditure %
• Taxation 45 Public expenditure 10
0
• Public finance
50
• Fiscal deficit
(Balancing
figure) 5

Total 10 total 10
0 0

According to above table, Govt. collects money from

different sources, which are income for govt. But before
income Govt. has fixed, what will be the expenditure. If
expenditure is higher than the income sources then govt
can raise money to make fiscal deficit and govt. can
direct to the central bank to print new currency in same
amount of balancing figure.

by: –
• Manish Singh
• Sushil Singh
Regional Institute of Management & Technology
Gobindgarh (Punjab)

Email: mrmanishsingh@yahoo.in
rimtsushil@gmail.com