Fiscal policy (Meaning, Instruments)

Fiscal Policy

Fiscal policy is a policy concerning the receipts and expenditures of the government. It refers to the policy related to the budget of the government. It operates through changes in the government expenditures, taxation, and public borrowings.

Fiscal policy is used as a balancing device in the development of an economy. The modern fiscal policy is a technique to achieve and regulate full employment by manipulating public expenditure and revenue in such a way as to maintain equilibrium between effective demand and supply services at a particular time. In other words, the modern fiscal policy is nothing but the application of the principle of functional finance. In short, fiscal policy is the policy which is concerned with the effects of government expenditure, taxation and public borrowing on income, production, and employment. An effective and good fiscal policy uses various fiscal agents like expenditure, taxation and public borrowing in a proper combination so as to achieve the best possible results in terms of the desired economic objectives like maintaining economic stability, high employment and accelerating economic growth.

Instruments of Fiscal Policy

There are mainly four instruments or constituents of the fiscal policy; these are, (i) budget, (ii) public expenditure, (iii) public revenue and (iv) public debt. All these constituents must work together to make the fiscal policy sound and effective.

The main instruments are explained below:

1. Budget

A budget is an estimate of government expenditures and revenues for a fiscal year, usually presented to the parliament by the finance minister. In Nepal, the budget is submitted to the parliament by the finance minister in the month of Ashadh, each fiscal year. It is a financial document containing a preliminary approval of estimates of government expenditures and revenues. In other words, the estimated statements of the government revenues and expenditures are called budget. There are three types of budgetary policies:

1. Balanced budget policy
   When the government keeps its total expenditure equal to its revenue, as a matter of policy, it means it has adopted a balanced budget policy.
2. Deficit budget policy
   When the government spends more than its expected revenue, as a matter of policy, it is following a deficit budget policy.
3. Surplus budget policy
   When the government follows a policy of keeping its expenditure considerably below its current revenue, it is following a surplus budget policy. These budgetary policies affect the economy in different ways and in different directions.

2. Public Expenditure

Public expenditure refers to the expenses made by public authorities and central and local governments. The expenditure incurred by the central authorities (in running the government) in the form of public expenditure on administration and maintenance of law and order are the examples of public expenditure. An expenditure made on health, education, transport, communication, public works, etc. are familiar examples of public expenditure incurred for the satisfaction of collective wants. In the modern welfare state, the government has to undertake a number of social and economic activities for which it has to incur expenditure. Public expenditure needs to be incurred in providing social security to the public (i.e. old age pensions, unemployment allowances, etc.) in providing economic and / or social overheads (such as transport and communication, health, education, electricity, drinking water, etc.) in maintaining economic stability, in providing welfare activities and in promoting economic development.

Public expenditure can be classified in three ways:

1. Current Expenditure and Capital Expenditure
   All types of administrative and defense expenditure and debt services fall under current expenditure. This expenditure is incurred on civil administration such as police, parliament, government staff salary, judiciary, etc. Capital expenditures are intended for the creation of net productive capacity of the nation. Expenditures on the construction of dams, public works, agricultural and industrial development are examples of capital expenditure.
2. Direct Expenditure and Transfer Expenditure
   All types of expenditure incurred by the government on the purchase of current services of factors of production are called direct expenditure. Expenditure incurred on defense, civil services, educational services, educational services, judiciary, post office and investment expenditure are examples of direct expenditure. Transfer expenditures are the expenditures which take the form of payments made without corresponding return of any factor services.
3. Productive and Unproductive Expenditure
   Productive expenditures are those expenditures which help in or add to the productive capacity or efficiency of the economy. Unproductive expenditures are those expenditures which do not add to the productive efficiency of the economy directly.

3. Public Revenue

The government needs income for performing a variety of functions. The income of the government which is obtained through sources such as taxes, grants, fees, and borrowings are called public income or public revenue. Generally, government revenue implies the income raised from the public by the state through taxes. There are various other non-tax sources of public revenue such as taxes, price, fees, fines, penalties, gifts, profits and special assessments. A fund raised through taxes is referred to as tax revenue. A tax is a compulsory payment to the government. Tax may be direct or indirect. The tax which is paid by a person, on whom it is imposed and cannot be shifted is called a direct tax. Thus, income tax, corporate profit tax, property tax, capital gains tax are examples of direct taxes. Indirect tax, on the other hand, is the tax which is initially paid by one individual but the burden of which is driven over to some other individual who ultimately bears it. Excise duty, VAT, and customs duty are examples of indirect taxes.

4. Public Debt

In modern times, borrowing by the government has become a normal method of government finance such as taxes, fees, etc. Borrowing by the government leads to public debt.
Public debt is the debt which the government owes to its subject or to the nationals of other countries. The government can borrow from individuals, business enterprises and banks. It can borrow from within the country and from outside the country. The main objectives of government borrowings are to meet the budgetary deficit, to finance a war, to finance development plans and to fight depression. Internal debt refers to the public loans floated within the country. External debt refers to the obligations of a country to borrow from a foreign government or an international organization.

Reference

Bernake and Abel, Macroeconomics, Singapore, Pearson Education latest edition