Fiscal Policy in Action : Uses of Fiscal Policy – Economics Notes Class12

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Uses of Fiscal Policy:

   Fiscal policy can be used to control inflation and to achieve economic stability, growth and equity.

 

  Fiscal Policy to Control Inflation  :

Fiscal policy is often used to control inflation.
 
  Contractionary fiscal policy can be used to reduce aggregate demand and hence to control demand pull inflation.
 
    “Contractionary fiscal policy is the policy of reducing government expenditure and increasing government revenues.”
 
   There are several tools to operate contractionary fiscal policy – some are as follows :
 
   1. Taxation : 
  • Taxation is an important tool of contractionary fiscal policy.
 
  •  To control inflation tax burden is to be increased by increasing tax rates and imposing new taxes.
 
  • Direct taxes like income tax, corporate tax etc., reduce the disposable income of the taxpayers and hence reduce their expenditure. 
 
  •  In this procedure tax system should be so evolved that promote saving habits of people and also induces them to undertake productive investments.
 
  2. Public Expenditure:
  • To control inflation aggregate demand should be reduced so as to reduce the purchasing power of people.
 
  • For this purpose, government expenditure should be reduced.
 
  • Part of the government expenditure is essential in nature, so it can not be reduced.
 
  •  But unproductive expenditure of government, which to some extent is non – essential in nature, should be reduced.
 
  • For example, expenditure on defence and unproductive work should be reduced.
 
  3. Public Borrowing :
  • Public borrowing can also be used in controlling inflation.
 
  •  Inflation is caused by increased total demand for goods and services and lack of corresponding increase in total supply of these goods and services.
 
  • If total demand is decreased, the inflation can be controlled to a limit.
 
  •  By means of public borrowing, the purchasing power with the people can be reduced and thereby the total demand is decreased in an economy.
 
  •  Public borrowing also enables the government to meet its expenditure and thereby reduce the need for deficit financing.

Therefore, the fiscal policy which aims to generate a budget surplus, by decreasing government expenditure and increasing government revenue ( by increasing taxes and public borrowing) , would be efficient to control inflation in an economy.

 
 
 Fiscal Policy and Economic Stability: 
 
      The main aim of the fiscal policy of a country is to overcome problems like depression and unemployment and to establish, economic stability.
 
   The following economic measures are to be taken for this purpose:  
 
     1. Depression in an economy is caused by lack of total demand and low level of income and high level of unemployment. If government expenditure is increased, several unemployed resources are used to increase the level of income and decrease the level of unemployment.
   The fiscal policy that support the government expenditure by using deficit financing is thereby helpful in controlling depression.
 
  2. Taxes should be reduced so that the purchasing power of people in an economy will be increased and hence the  consumption expenditure is increased.
 
  3. Public expenditure on developing social overhead should be increased. Social security like old age pensions and unemployment relief funds, also increase the income level and hence the purchasing power with the people. 
 
   4. The government should borrow funds from those people with whom the funds are lying idle.
 
  Therefore, to overcome depression and unemployment, government should follow an expansionary fiscal policy.
 
   “Expansionary fiscal policy is the policy of increasing government expenditure and reducing taxation.”
 
   All the above mentioned measures will increase the aggregate demand and thereby increase output and employment.
 
   Therefore, government should adapt counter – cyclical fiscal policy to achieve economic stability. Means, taxes and government spending may be varied in an anti – cycle direction. 
 
   During the expansionary phase of the cycle means, boom and inflation, government should cut down the public spending and taxes should be increased.
 
     On the other hand, during the contraction phase, means depression, government expenditure should be increased and taxes should be decreased. 
 
 
  Fiscal Policy and Economic Growth:  
 
   Fiscal policy can be used to accelerate the rate of economic growth so that  the real income in a country is increased.
 
   Follow step can be taken to accelerate economic growth : 
 
  1.  Taxation and public borrowing policies can be used effectively so that they induce saving and investment.
 
  2. The government may grant subsidies and tax relief to entrepreneur to stimulate investments in the economy. This will positively affect on the economic growth of the country.
 
  3. Special tax incentives like  “tax holidays” and subsidies should be granted to the entrepreneurs to set up industries in the backward regions. This will promote development in backward region.
 
   4. Direct and indirect public expenditure in promoting development of economic overheads. Direct government expenditure in the development of agricultural and industrial sectors. Indirectly promote growth by providing economic infrastructure such as transport and communication, power irrigation etc.
 
    The government can establish capital goods and basic key industries to promote economic development.
 
   5. The government may develop social overheads and infrastructure. It may promote development by providing education, training and research facilities. 
 
 
Fiscal Policy and Equity:
 
      The main objective of economic policy in any developing country is “growth with equity”.
 
     So it is wise to choose such policy that make the distribution of income equitable  by reducing the existing inequalities of income and wealth.
 
    This can be achieved by pursuing  redistributive taxation and public expenditure policy.
   This can be done in the following ways:
 
  1. The tax system should be made progressive under which heavy direct taxes should be imposed on the rich and the very poor should be exempted from taxes.
 
   2. Items of luxuries and those items which are consumed by the rich section of society should be taxed heavily. Items of daily needs and which are consumed more by the poor, should be subjected to low taxes.
 
  3. Government expenditure should be done more on the activities which benefit the low income groups for example, expenditure on social services like free education to poor and providing free medical facilities to lower income groups etc., should be increased.
 
     Even old age pensions, unemployment benefits and technical training will increase their efficiency to work and increase their income and further will reduce inequality.
 
   4. Government should undertake investment in setting up industries in backward regions. This will remove region disparities.
 
     Entrepreneurs can be motivated to set up industries in the backward areas by giving them subsidies and tax concession such as – lower taxes, tax holidays etc.
 
 
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