Fiscal Policy has been extensively used in all the countries in controlling inflation and in bringing about economic stability, growth and equity.
Fiscal Policy (Measures) to Control Inflation
Fiscal Policy is often used to control inflation. Contractionary fiscal policy can be used to reduce aggregate demand and thereby control demand-pull inflation. Contractionary fiscal policy is the policy of reducing government expenditure and increasing government revenues.
The operation of anti-inflationary contractionary fiscal policy through its various tools is explained below:
1. Taxation: The major plank of anti-inflationary fiscal policy is to increase the tax burden by increasing the tax rate and by imposing new taxes. Direct taxes can be used for this purpose. Direct taxes like income tax, corporate tax, etc. reduce the disposable income of the taxpayers and thereby reduce their expenditure. At the same time, tax system should be so evolved as to promote saving habits among the people and also to provide incentives for undertaking productive investment.
2. Public Expenditure: Public Expenditure is an important component of aggregate demand. In order to control inflation, it is essential that government expenditure is reduced. However, part of government expenditure is of essential nature and, hence, cannot be reduced. Therefore, what is important is that unproductive expenditure of government, which to some extent is non-essential in nature, should be reduced. For example, expenditure on defense and unproductive works should be reduced.
3. Public Borrowing: Public Borrowing, i.e., borrowing by the government from public, can also be used in controlling inflation. Public borrowing enables the government to meet its expenditure and thereby reduce the need for deficit financing. Moreover, public borrowing helps in reducing the amount of purchasing power with the people and thereby in reducing total demand in the economy. However, if people give loans to the government out of their savings rather than by curtailing their expenditure, total demand may not fall.
Thus, a decrease in government expenditure and increase in government revenue (by increasing taxes and borrowing) and generating a surplus budget is the type of the fiscal policy which can be used to control inflation.
Fiscal Policy and Economic Stability
Fiscal Policy may be effectively used in achieving economic stability. The following fiscal measures need to be taken to overcome depression and unemployment:
1. The government should follow a policy of deficit budget wherein expenditure of the government exceeds its revenue. The deficit may be financed through deficit financing. This will increase government expenditure.
2. Taxes should be reduced so that more purchasing power is left in the hands of the individuals. This will increase consumption expenditure.
3. Public expenditure should be increased, particularly in the form of more expenditure on public works and in providing social security like pensions and unemployment benefits.
4. The government should borrow funds from those people with whom the funds are lying idle.
Thus, the government should follow the expansionary fiscal policy to overcome unemployment in the economy. Expansionary fiscal policy is the policy of increasing government spending and reducing taxes.
All these measures will increase the aggregate demand and thereby increase output and employment.
Thus, the government should follow counter- cyclical fiscal policy to achieve economic stability. This means that taxes and government spending may be varied in an anti-cycle direction: government spending being cut and taxes increased in the expansionary phase of the cycle (boom and inflation), and government spending being increased and taxes decreased during the contraction (depression) phase.
Fiscal Policy and Economic Growth
Fiscal Policy can be used effectively to accelerate the rate of economic growth so as to increase the real national income in a country. The following fiscal steps may be taken to accelerate economic growth:
1. Taxation and public borrowing policies can be used to provide incentives for saving and investment.
2. The government may grant tax relief and subsidies to entrepreneurs to stimulate investment in the economy. This will have a positive effect on the level of economic activity and economic growth thereby.
3. Special tax incentives like ‘tax holiday’ and subsidies can be given to the entrepreneurs to set up industries in the backward regions. This will promote development of backward regions.
4. Revenue collected by the government can be used in promoting development of agricultural and industrial sectors. The government can also use these funds in providing economic infrastructure such as transport and communication, power, irrigation, etc. The government can establish capital goods and basic or key industries to promote economic development.
5. Public expenditure policy can be effectively used in promoting economic development by developing social overheads and infrastructure. It may promote development by providing education, training and research facilities.
Fiscal Policy and Equity
Growth with equity is the primary objective of economic policy in the developing countries. The objective of equity means making the distribution of income equitable by reducing the existing inequalities of income and wealth can be reduced 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 the rich are required to pay much more taxes than the poor. Heavy direct taxes should be imposed on the rich and the very poor should be exempted from such taxes.
2. Items of luxuries and those items which are consumed by the rich section of the society should be taxed heavily. Items of daily necessities, which are consumed more by the poor, should be subjected to low taxes.
3. The government must spend more on those activities which benefit the low income groups. For example, expenditure on social services like education, public health, etc., should be increased, and these services should be provided free of cost or at subsidized prices to the poor. These expenditures will increase the income of the poor by increasing their efficiency and will reduce inequalities thereby. Similarly, expenditure on social security schemes such as pensions, unemployment relief, sickness benefits etc. may be increased.
4. The government should undertake investment in setting up industries in the backward regions. This will remove regional disparities. Entrepreneurs can be motivated to set up industries in the backward areas by giving them special tax concessions such as lower taxes, tax holidays, etc.
