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CONCEPT OF FISCAL POLICY

Functions Of Fiscal Policy

  • In macroeconomics, fiscal policy refers to the efforts by the government to use taxes
  •   The government uses these tools to try to prevent high unemployment and high inflation
  • If the economy faces a recession, the government is supposed to cut taxes and increase spending.
  • This will lead to more jobs for people who make those goods and services.
  • A government can use fiscal policies to reduce the demand for goods and services.

There are 4 major functions of Fiscal Policy:

1.Allocation

The first major function of fiscal policy is to determine exactly how funds will be allocated. 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.

2.Distribution

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.

HOW DOES FISCAL POLICY HELP CONTROL INFLATION?

  • Inflation is a sustained increase in the general price level of goods and services in an economy over a period of time.
  • When the price level rises, each unit of currency buys fewer goods and services.
  • Consequently, inflation reflects a reduction in the purchasing power per unit of money.

What causes inflation?

When the demand is more than the supply. Hence inflation can basically be controlled by increasing supply.

KEY POINTS

There are three types of fiscal policy: neutral policy, expansionary policy, and contractionary policy.

  • In expansionary fiscal policy, the government spends more money than it collects through taxes. This type of policy is used during recessions to build a foundation for strong economic growth and nudge the economy toward full employment.
  • In contractionary fiscal policy, the government collects more money through taxes than it spends. This policy works best in times of economic booms. It slows the pace of strong economic growth and puts a check on inflation.
  • Fiscal neutrality occurs when taxes and government spending are neutral, with neither having an effect on demand. Fiscal neutrality creates a condition where demand is neither stimulated nor diminished by taxation and government spending.
  • Agriculture:
  • Rs. 25,000 crore for Rural Infrastructure Development Bank.
  • Rs. 5,300 crore to support Micro Irrigation Programme.
  • Farmers credit - target of 8.5 lakh crore.

INTRODUCTION

Fiscal policy is the means by which a government adjusts its spending levels and tax rates to monitor and influence a nation's economy. It is the sister strategy to monetary policy through which a central bank influences a nation's money supply.

Union Budget 2015

  • No change in the Income Tax slabs of individuals.
  • Wealth Tax was abolished
  • Service Tax was raised from 12.36% to 14%
  • Swacch Bharat Cess was announced, under which 2% will be added on select services
  • Excise duty:
  • On cigarettes was increased by 25%
  • On cut tobacco was increased from Rs.60 to Rs.70 per Kg.
  • On plastic bags was increased from 12% to 18%
  • On soft drinks and packaged water was increased from 12% to 18%
  • On cement, from Rs.900 per tonne to Rs.1000 pes tonne.
  • On locally manufactured mobile phones, LED/LCD panels was reduced
  • On imported commercial vehicles was increased from 10% to 40%

Fiscal measures: highly controlling govt spending, personal consumption expenditure and private and public investments.

OBJECTIVES OF FISCAL POLICY

  • FULL EMPLOYMENT
  • PRICE STABILITY
  • TO ACCELERATE THE RATE OF ECONOMIC GROWTH
  • OPTIMUM ALLOCATION OF RESOURCES
  • EQUITABLE DISTRIBUTION OF WEALTH AND INCOME
  • ECONOMIC STABILITY
  • CAPITAL FORMATION AND GROWTH
  • TO ENCOURAGE INVESTMENT
  • Reduce unnecessary expenditure - prioritize the spending, cut down on non-essential expenditure. Less money is equal to less subsidy for farmers.
  • Increase in taxes - to reduce personal consumption expenditure. There could be a marginal increase in taxes but not so high so as to discourage savings , investments and production. Eg: cigarettes
  • Penalise tax evaders and holders by imposing heavy fine.
  • Increase in savings - By providing attractive schemes for investments and thus resulting in reduction of disposable income.
  • Creating surplus budget - Collecting more revenue and spending less
  • Encourage Increase in production of essential commodities. Eg: Toor dal

OBJECTIVES OF FISCAL POLICY IN INDIA

  • DEVELOPMENT BY EFFECTIVE MOBILIZATION OF RESOURCES
  • EFFICIENT ALLOCATION OF FINANCIAL RESOURCES
  • REDUCTION IN INEQUALITY OF INCOME AND WEALTH
  • PRICE STABILITY AND CONTROL INFLATION
  • EMPLOYMENT GENERATION
  • BALANCED REGIONAL DEVELOPMENT
  • REDUCING DEFICIT IN BALANCE OF PAYMENTS
  • CAPITAL FORMATION AND INCREASE IN NATIONAL INCOME

IMPACT OF FISCAL POLICY

  • Automatic stabilizers have emerged as key elements of fiscal policy
  • Automatic stabilizers of fiscal policy tend to increase GDP when it is falling
  • Changes in Business Taxes-
  • An investment tax credit allows a firm to reduce its tax liability by a percentage of the investment it undertakes during a particular period
  • Changes in Income Taxes-
  • Income taxes affect the consumption component of aggregate demand. An increase in income taxes reduces disposable personal income and thus reduces consumption
  • Changes in Transfer Payments-
  • Changes in transfer payments, like changes in income taxes, alter the disposable personal income of households and thus affect their consumption

3. Stabilization

Stabilization is another important function of fiscal policy in that the purpose of budgeting is to provide stable economic growth ,without some restraints on spending , the economic growth of the nation could become unstable, resulting in period of unrestrained growth and contraction

IMPACT OF FISCAL POLICY

4.Development

The fourth major function of fiscal policy is that of development. Development seems to indicate economic growth, and that is, in fact, its overall purpose.  Borrowing funds for this economic growth is one way in which the government brings about development.

  • Aggregate demand and the level of economic activity

  • The pattern of resource allocation

  • The distribution of income

  • A neutral stance of fiscal policy implies a balanced economy

  • An expansionary stance of fiscal policy involves government spending exceeding tax revenue

  • A contractionary fiscal policy occurs when government spending is lower than tax revenue

THANK YOU

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