Fiscal Policy

INTRODUCTIONo One major function of government is to

stabilize the economy(prevent unemployment or inflation)

o Stabilization can be achieved in parts by manipulating the public budget - government spending and tax collection - to increase output and employment or to reduce inflation.

Fiscal policy is defined as the government’s programme of taxation, expenditure and other financial operations to achieve certain national goals.

DEFINITION

Government

Income Expenditure

Tax Policy Public Expenditure

o Fiscal Policy is a vital instrument in modern times.

o Fiscal Policy means relating to taxation and public expenditre.When these policies are used to achieve balanced economic development of any country its called as Fiscal Policy.

o Since the economic, political and social conditions of the nation vary, the aspiration of people and, therefore the objectives of fiscal policy may be different.

MEANING & COMPREHENSION

Full Employment Price Stability Deduction in Economic

Inequality Economic Development

OBJECTIVES OF FISCAL POLICY

TOOLS OF FISCAL POLICY

Taxation PolicyGovernment Expenditure

Public Debt Policy

Deficit Financing

Fiscal Policy

TAXATION

Rise in tax = Rise in costFall in tax = Fall in cost

Effect of change in

Tax

Spend Save

Example:For Company ABC –

Profit – 100Prevailing Tax Rate – 30%

Today – Profit – 100 less Tax – 30 Balance — 70Suppose Tax Rate ↑ :- New Rate – 50%

Profit – 100 less Tax – 50 Balance— 50 If, Tax Rate ↓ :-

New Rate – 20 % Profit – 100

less Tax – 20 Balance— 80

Over Heating of Economy

INTEREST RATE

COST

SALES

FUNCTIONS1.Revenue Function – The Revenue earned from taxes is spent by the government for various public activities.2. Regulatory Function – o Reducing disparities in income & wealth

distributiono Restraining consumer demand to contain

inflationo Promoting savings and investmentso Shifting investment from non-essential to

priority sectors

LEGAL CHANGESExamples –1. The creation of a National Minimum Wage

which has recently been extended to under 18s.

2. The requirement for business to cater for disabled people, by building ramps into offices, shops, etc.

3. Providing increasingly tighter protection for consumers to protect them against unscrupulous business practices.

4. Creating tighter rules on what constitutes fair competition between businesses.

Public expenditure is incurred by Central and State Governments on various activities for welfare of people and for economic development of the country.

PUBLIC EXPENDITURE

• Promote rapid economic and rural development

• Promote trade and commerce• To exploit and develop

mineral resources• Maximizing social welfare• Ensuring an equitable

distribution of income

SIGNIFICANCE OF PUBLIC EXPENDITURE

1. Administration of law, order and justice.

2. Maintenance of defence and police force.

3. Public administration.4. Servicing of public debt.5. Provision for public health.6. Creation of social goods.

OBJECTIVES

1. Capital and Revenue expenditure2. Development and Non-

Developmental expenditure3. Transfer and Non- Transfer

expenditure4. Plan and Non Plan expenditure5. Other classification

TYPES OF PUBLIC EXPENDITURE

Public expenditure increases flow of funds in the economy. It increases private incomes and private expenditure.

Counter Cyclical fiscal policy is based on the relationship of public expenditure to the national income i.e.GNP = Value of final goods and services produced during a period

+ income earned abroad by nationals - income earned locally by foreigners.

HOW IT AFFECTS BUSINESS?

PUBLIC EXPENDITURE

Increases

PRIVATE INCOME PRIVATE EXPENDITURE

Public Expenditure

GNP

Business Income

&Business

Profit

Household Income

Consumption of

Goods & Services

Govt.’s Tax &

Revenue

1. Automatic changes

2. Discretionary changes

COUNTER CYCLICALFISCAL POLICY

HEFA23 % of

CSR

Funds flow out of company

into the economy

Schools constructed, infrastructur

eMore

teachers employed

Skill training,More trainees employable

More stationery required

Generates employmen

t

Benefits Companies

More CSR

Education and skill training

CYCLE OF GOVT.

EXPENDITURE

• Growing population• Defence expenditure• Interest payments• Subsidies• Administration• Rise in national income

CAUSES OF GROWTH IN

PUBLIC EXPENDITURE

o Capital Formationo Resource Mobilisationo Incentives to Private Sectoro Encourages Savingso Poverty alleviation and

Employment Generationo Reduction in Inequality of Income and Wealth o Export Promotion

ADVANTAGES OF FISCAL POLICY

• Lack of Elasticity• Non Monetized Sector• Inadequate Statistics• Illiteracy• Limited Sector• Delay to Decision• Limitation regarding Full

Employment

LIMITATIONS OF FISCAL POLICY

The only good budget is a balanced budget.

--Adam Smith

CONCLUSION