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INTRODUCTION

The word fisc means ‘state treasury’ and fiscal policy refers to policy
concerning the use of ‘state treasury’ or the govt. finances to achieve the
macroeconomic goals.

“any decision to change the level, composition or timing of govt. expenditure or to

vary the burden ,the structure or frequency of the tax payment is fiscal policy

Federal taxation and spending policies designed to level out the business
cycle and achieve full employment, price stability, and sustained growth in the
economy. Fiscal policy basically follows the economic theory of the 20th-century
English economist John Maynard Keynes that insufficient demand causes
unemployment and excessive demand leads to inflation. It aims to stimulate demand
and output in periods of business decline by increasing government purchases and
cutting taxes, thereby releasing more disposable income into the spending stream,
and to correct overexpansion by reversing the process. Working to balance these
deliberate fiscal measures are the so-called built-in stabilizers, such as the
progressive income tax and unemployment benefits, which automatically respond
countercyclically. Fiscal policy is administered independently of Monetary Policy by
which the Federal Reserve Board attempts to regulate economic activity by
controlling the money supply. The goals of fiscal and monetary policy are the same,
but Keynesians and Monetarists disagree as to which of the two approaches works
best. At the basis of their differences are questions dealing with the velocity
(turnover) of money and the effect of changes in the money supply on the equilibrium
rate of interest (the rate at which money demand equals money supply.

Measures employed by governments to stabilize the economy, specifically by

adjusting the levels and allocations of taxes and government expenditures. When the
economy is sluggish, the government may cut taxes, leaving taxpayers with extra
cash to spend and thereby increasing levels of consumption. An increase in public-
works spending may likewise pump cash into the economy, having an expansionary
effect. Conversely, a decrease in government spending or an increase in taxes tends
to cause the economy to contract. Fiscal policy is often used in tandem with monetary
policy. Until the 1930s, fiscal policy aimed at maintaining a balanced budget; since

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then it has been used "countercyclically," as recommended by John Maynard

Keynes, to offset the cycle of expansion and contraction in the economy. Fiscal policy
is more effective at stimulating a flagging economy than at cooling an inflationary
one, partly because spending cuts and tax increases are unpopular and partly
because of the work of economic stabilizers.

Fiscal policy is manifested in a government's policies on taxation and

expenditures. To obtain funds for their operation, government units generally collect
some form of taxes. The expenditure of these funds not only provides goods and
services for constituents, but has a direct impact on the economy. For example, if
expenditures are larger than the funds received by the government, the resulting
deficit tends to stimulate the economy, as goods and services are produced for
government purchase. In contrast, if a government runs a surplus by not spending all
the funds it collects, economic growth will generally be curtailed, as the surplus funds
are removed from circulation in the economy

DEFINITION OF FISCAL POLICY

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Fiscal policy is the means by which a government adjusts its levels of

spending in order to monitor and influence a nation’s economy.

Fiscal policy is that part of government policy which is concerned with

razing revenue through taxation and other means and deciding on the level
and pattern of expenditure.

In other wards the term fiscal policy refers to the expenditure a

government undertakes to provide goods and services and to the way in which
the government finances these expenditures.

Objectives of Fiscal Policy

1. To achieve desirable price level:

The stability of general prices is necessary for economic stability.

The maintenance of a desirable price level has good effects on production,
employment and national income. Fiscal policy should be used to remove;
fluctuations in price level so that ideal level is maintained

2. To Achieve desirable consumption level:

A desirable consumption level is important for political, social and

economic consideration. Consumption can be affected by expenditure and
tax policies of the government. Fiscal policy should be used to increase
welfare of the economy through consumption level.

3. To Achieve desirable employment level:

The efficient employment level is most important in determining the

living standardof the people. It is necessary for political stability and for
maximization of production. Fiscal policy should achieve this level.

4. To achieve desirable income distribution:

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The distribution of income determines the type of economic

activities the amount of savings. In this way, it is related to prices, consumption
and employment. Income distribution should be equal to the most possible
degree. Fiscal policy can achieve equality in distribution of income.

5. Increase in capital formation:

In under-developed countries deficiency of capital is the main

reason for under-development. Large amounts are required for industry and
economic development. Fiscal policy can divert resources and increase capital.

6. Degree of inflation:

In under-developed countries, a degree of inflation is required for

economic development. After a limit, inflationary be used to get rid of this
situation

Fiscal Policy And Macroeconomic Goals

• Economic Growth: By creating conditions for increase in savings & investment.

• Employment: By encouraging the use of labour-absorbing technology

• Stabilization: fight with depressionary trends and booming (overheating)

indications in the economy

• Economic Equality: By reducing the income and wealth gaps between the rich
and poor.

• Price stability: employed to contain inflationary and deflationary tendencies in

the economy.

The purpose of Fiscal Policy:

• Reduce the rate of inflation.

• Stimulate economic growth in a period of a recession.

• Basically, fiscal policy aims to stabilize economic growth, avoiding the boom
and bust economic cycle.

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Instruments of Fiscal Policy

• Budgetary surplus and deficit

• Government expenditure

• Taxation- direct and indirect

• Public debt

• Deficit financing

Budgetary surplus and deficit

• “A budget is a detailed plan of operations for some specific future period”

• Keeping budget balanced (R=E) or deficit (R<E) or surplus (R>E) as a matter

of policy is itself a fiscal instrument.

• An accumulated deficit over several years (or centuries) is referred to as the

government debt

• A deficit is a flow. And a debt is a stock. Debt is essentially an accumulated

flow of deficits

Government expenditure

 It includes :

• Government spending on the purchase of goods & services.

• Payment of wages and salaries of government servants

• Public investment

• Transfer payments

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Taxation- direct and indirect

• Meaning : Non quid pro quo transfer of private income to public coffers by
means of taxes.

• Classified into

1. Direct taxes- Corporate tax, Div. Distribution Tax, Personal Income Tax,
Fringe Benefit taxes, Banking Cash Transaction Tax

2. Indirect taxes- Central Sales Tax, Customs, Service Tax, excise duty.

Public debt

• Internal borrowings

1. Borrowings from the public by means of treasury bills and govt. bonds

2. Borrowings from the central bank (monetized deficit financing)

• External borrowings

1. foreign investments

2. international organizations like World Bank & IMF

3. market borrowings

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The Golden Rule

Fiscal policy framework

The Government's fiscal policy framework is based on the five

key principles set out in the Code for fiscal stability - transparency, stability,
responsibility, fairness and efficiency.

The Code requires the Government to state both its objectives and the
rules through which fiscal policy will be operated. The Government's fiscal
policy objectives are:

• over the medium term, to ensure sound public finances and that spending and
taxation impact fairly within and between generations; and

• over the short term, to support monetary policy and, in particular, to allow the
automatic stabilisers to help smooth the path of the economy.

• These objectives are implemented through two fiscal rules, against which the
performance of fiscal policy can be judged. The fiscal rules are:

• the golden rule: over the economic cycle, the Government will borrow only to
invest and not to fund current spending; and

• the sustainable investment rule: public sector net debt as a proportion of GDP
will be held over the economic cycle at a stable and prudent level. Other things
being equal, net debt will be maintained below 40 per cent of GDP over the
economic cycle.

• The fiscal rules ensure sound public finances in the medium term while
allowing flexibility in two key respects:

• the rules are set over the economic cycle. This allows the fiscal balances to
vary between years in line with the cyclical position of the economy, permitting
the automatic stabilisers to operate freely to help smooth the path of the
economy in the face of variations in demand; and

• the rules work together to promote capital investment while ensuring

sustainable public finances in the long term. The golden rule requires the
current budget to be in balance or surplus over the cycle, allowing the
Government to borrow only to fund capital spending. The sustainable
investment rule ensures that borrowing is maintained at a prudent level. To
meet the sustainable investment rule with confidence, net debt will be
maintained below 40 per cent of GDP in each and every year of the current
economic cycle.

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Fiscal policy in action

 the effects of the fiscal policy in action as follow

The rise in AD leads to an increase in real national income, ceteris paribus,

unemployment would fall to 3% but at a cost of higher inflation

AD therefore shifts to the right to AD1

AD=C+I+G+(X-M)

Apart from G, C and I are also likely to be affected directly or indirectly by the
policy change.

If government ‘reduces taxes’ (remember the subtleties) and or increases

spending, it will have various effects:

Assume an initial equilibrium position with a level of National Income giving an

unemployment rate of 5% (U = 5%)

Fiscal Policy influences AD in the short term but can be used to affect AS in
the long run – depending on the nature of the policy.

Try your hand at Fiscal Policy by going to the Virtual Economy

 the graph are shown in the ppt slid

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BUDGET

• “A budget is a detailed plan of operations for some specific future period”

• It is an estimate prepared in advance of the period to which it applies.

COMPONENTS OF BUDGET

• Revenue receipts

• Capital receipts

• Revenue expenditure

• Capital expenditure

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other non plan exp. s tate 's s hare of

1 1% taxe s & duties
18%

subsidies
7%

non plan a ssistance

to s t ates
5%
defe nc e
12 % planne d state
assis ta nc e
7%

FISCAL
interestPOLICY
2 0%
ce ntra l plan
2 0% 17
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Government Income

• Tax Revenue

• Sale of Government Services – e.g. prescriptions, passports, etc.

• Borrowing (PSNCR)

Public Sector Income

700

600

500
Government Income (£ billion)
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Inland Revenue 1998- 1999- 2000- 2001- 2002- 2003-

99 00 01 02 03 04

Income Tax (gross of 88.4 95.7 106.1 110.3 112.6 118.3

tax credits)

Income Tax Credits -1.9 -1.8 -1.0 -2.3 -3.4 -4.3

Corporation Tax 30.0 34.3 32.4 32.0 29.5 28.1

Windfall Tax 2.6 0.0 0.0 0.0 0.0 0.0

Petroleum Revenue Tax 0.5 0.9 1.5 1.3 1.0 1.2

Capital Gains Tax 2.0 2.1 3.2 3.0 1.6 2.2

Inheritance Tax 1.8 2.1 2.2 2.4 2.4 2.5

Stamp Duties 4.6 6.9 8.2 7.0 7.5 7.5

NICs 55.1 56.4 60.6 63.2 64.6 72.5

Total Inland Revenue 183.2 196.5 213.4 216.8 215.8 228.0

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Customs and Excise 1998- 1999- 2000- 2001- 2002- 2003-

99 00 01 02 03 04

VAT 52.3 56.4 58.5 61.0 63.5 69.1

Fuel Duties 21.6 22.5 22.6 21.9 22.1 22.8

Tobacco Duty 8.2 5.7 7.6 7.8 8.1 8.1

Spirits Duties 1.6 1.8 1.8 1.9 2.3 2.4

Wine Duties 1.5 1.7 1.8 2.0 1.9 2.0

Beer and Cider Duties 2.7 3.0 3.0 3.1 3.1 3.2

Betting and Gaming Duties 1.5 1.5 1.5 1.4 1.3 1.3

Air Passenger Duty 0.8 0.9 1.0 0.8 0.8 0.8

Insurance Premium Tax 1.2 1.4 1.7 1.9 2.1 2.3

Land Fill Tax 0.3 0.4 0.5 0.5 0.5 0.6

Climate Change Levy 0.0 0.0 0.0 0.6 0.8 0.8

Aggregates Levy 0.0 0.0 0.0 0.0 0.2 0.3

Customs Duties and Levies 2.1 2.0 2.1 2.0 1.9 1.9

Total Customs and 94.0 97.3 102.2 104.9 108.7 115.7

Excise

1998- 1999- 2000- 2001- 2002- 2003-

99 00 01 02 03 04

VED 4.6 4.9 4.3 4.3 4.3 4.8

Oil Royalties 0.3 0.4 0.6 0.5 0.4 0.0

Business Rates 14.7 15.4 16.3 17.9 18.5 18.4

Council Tax 12.2 13.1 14.1 15.2 16.9 18.8

Other Taxes and Royalties 7.5 7.9 8.5 9.4 10.2 11.2

Net Taxes and NICs 316.6 335.4 359.3 369.1 374.9 196.7
conts

Interest and Dividends 5.0 4.3 6.0 4.7 4.5 4.4

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Gross Operating Surplus 18.2 18.1 18.8 19.9 19.0 19.4

and Rent

Other Receipts and -5.3 -0.7 -3.8 -5.7 -5.2 -1.8

Accounting Adjustments

Current Receipts 334.5 357.2 380.4 387.9 393.2 418.7

Government Income – Inland Revenue 2003-04

Government Income – Customs and Excise 2003-04

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Other Government Income 2003-04

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Fiscal policy is the economic term that defines the set of principles and decision of
government in setting the level of public expenditure and how the expenditure is
funded.

In economics, fiscal policy is the use of government spending and revenue

collection to influence the economy

Fiscal policy can be contrasted with the other main type of economic policy, monetary
policy, which attempts to stabilize the economy by controlling interest rates and the
supply of money. The two main instruments of fiscal policy are government spending
and taxation. Changes in the level and composition of taxation and government
spending can impact on the following variables in the economy:

• Aggregate demand and the level of economic activity;

• The pattern of resource allocation;
• The distribution of income.

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Fiscal policy refers to the overall effect of the budget outcome on economic
activity. The three possible stances of fiscal policy are neutral, expansionary, and
contractionary:

• A neutral stance of fiscal policy implies a balanced budget where G = T

(Government spending = Tax revenue). Government spending is fully funded
by tax revenue and overall the budget outcome has a neutral effect on the
level of economic activity.

• An expansionary stance of fiscal policy involves a net increase in government

spending (G > T) through rises in government spending, a fall in taxation
revenue, or a combination of the two. This will lead to a larger budget deficit or
a smaller budget surplus than the government previously had, or a deficit if the
government previously had a balanced budget. Expansionary fiscal policy is
usually associated with a budget deficit.

• A contractionary fiscal policy (G < T) occurs when net government spending is

reduced either through higher taxation revenue, reduced government
spending, or a combination of the two. This would lead to a lower budget
deficit or a larger surplus than the government previously had, or a surplus if
the government previously had a balanced budget. Contractionary fiscal policy
is usually associated with a surplus.

Methods of funding

Governments spend money on a wide variety of things, from the military and police to
services like education and healthcare, as well as transfer payments such as
benefits.

This expenditure can be funded in a number of different ways:

• Taxation
• Seignorage, the benefit from printing money
• Borrowing money from the population, resulting in a fiscal deficit
• Consumption of fiscal reserves.
• Sale of assets (e.g., land).

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Funding the deficit

A fiscal deficit is often funded by issuing bonds, like treasury bills or consols.
These pay interest, either for a fixed period or indefinitely. If the interest and capital
repayments are too large, a nation may default on its debts, usually to foreign
creditors.

Consuming the surplus

A fiscal surplus is often saved for future use, and may be invested in local
(same currency) financial instruments, until needed. When income from taxation or
other sources falls, as during an economic slump, reserves allow spending to
continue at the same rate, without incurring additional debt.

Economic effects of fiscal policy

Governments use fiscal policy to influence the level of aggregate demand in
the economy, in an effort to achieve economic objectives of price stability, full
employment, and economic growth. Keynesian economics suggests that adjusting
government spending and tax rates are the best ways to stimulate aggregate
demand. This can be used in times of recession or low economic activity as an
essential tool for building the framework for strong economic growth and working
toward full employment. The government can implement these deficit-spending
policies to stimulate trade due to its size and prestige. In theory, these deficits would
be paid for by an expanded economy during the boom that would follow; this was the
reasoning behind the New Deal.

Governments can use budget surplus to do two things: to slow the pace of
strong economic growth, and to stabilize prices when inflation is too high. Keynesian
theory posits that removing funds from the economy will reduce levels of aggregate
demand and contract the economy, thus stabilizing prices.

Some classical and neoclassical economists argue that fiscal policy can have
no stimulus effect; this is known as the Treasury View, which Keynesian economics
rejects. The Treasury View refers to the theoretical positions of classical economists

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in the British Treasury, who opposed Keynes' call in the 1930s for fiscal stimulus. The
same general argument has been repeated by neoclassical economists up to the
present. From their point of view, when government runs a budget deficit, funds will
need to come from public borrowing (the issue of government bonds), overseas
borrowing, or the printing of new money. When governments fund a deficit with the
release of government bonds, interest rates can increase across the market. This is
because government borrowing creates higher demand for credit in the financial
markets, causing a lower aggregate demand (AD), contrary to the objective of a
budget deficit. This concept is called crowding out; it is a "sister" of monetary policy.

In the classical view, fiscal policy also decreases net exports, which has a
mitigating effect on national output and income. When government borrowing
increases interest rates it attracts foreign capital from foreign investors. This is
because, all other things being equal, the bonds issued from a country executing
expansionary fiscal policy now offer a higher rate of return. In other words,
companies wanting to finance projects must compete with their government for
capital so they offer higher rates of return. To purchase bonds originating from a
certain country, foreign investors must obtain that country's currency. Therefore,
when foreign capital flows into the country undergoing fiscal expansion, demand for
that country's currency increases. The increased demand causes that country's
currency to appreciate. Once the currency appreciates, goods originating from that
country now cost more to foreigners than they did before and

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