Faculty of Architecture, Planning and Surveying

NAME : DAHLIA BINTI AB AZIZ 2012611132

INTRODUCTION Fiscal policy is the use of government spending and taxation to influence the economy. When the government decides on the goods and services it purchases, the transfer payments it distributes, or the taxes it collects, it is engaging in fiscal policy. The primary economic impact of any change in the government budget is felt by particular groupsa tax cut for families with children, for example, raises their disposable income. Discussions of fiscal policy, however, generally focus on the effect of changes in the government budget on the overall economy. Although changes in taxes or spending that are revenue neutral may be construed as fiscal policyand may affect the aggregate level of output by changing the incentives that firms or individuals facethe term fiscal policy is usually used to describe the effect on the aggregate economy of the overall levels of spending and taxation, and more particularly, the gap between them. Fiscal policy is said to be tight or contractionary when revenue is higher than spending (i.e., the government budget is in surplus) and loose or expansionary when spending is higher than revenue (i.e., the budget is in deficit). Often, the focus is not on the level of the deficit, but on the change in the deficit. Thus, a reduction of the deficit from $200 billion to $100 billion is said to be contractionary fiscal policy, even though the budget is still in deficit. During the early stages of the Asian financial crisis, the government tightened budgetary operations to bring about a reduction in the current account deficit of the balance of payments and to reduce inflationary pressures arising from the depreciation of the ringgit. As the regional economic crisis continued into 1998, fiscal policy turned expansionary to support economic activity. The fiscal measures included a selective increase in infrastructure spending, establishment of funds to support small and medium-sized enterprises, a higher allocation for social sector development and a reduction in taxes. Special funds were also established or expanded to provide credit to priority sectors at

concessionary rates. The fiscal stimulus package was MYR 7 billion or 2.5% of GDP, of which MYR 1 billion was allocated for social safety net measures to mitigate the impact of the crisis on the poor. As a result of these measures, a fiscal deficit of 1.8% of GDP emerged after five years of surpluses. As global economic uncertainties continued to persist, the 1999-2003 budgets maintained an expansionary stance, with the authorities conscious of the need to maintain debt sustainability. The countercyclical fiscal policy, implemented largely through discretionary measures, was effective in supporting economic recovery and sustaining domestic demand. In particular, when external demand contracted significantly in 2001, Malaysia was still able to record a positive growth rate. The effectiveness of fiscal policy was also supported by other strategies and policies that continue to build on Malaysias strong economic fundamentals.

ECONOMICS EFFECT 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 increasing government spending and decreasing tax rates are the best ways to stimulate aggregate demand, and decreasing spending & increasing taxes after the economic boom begins. Keynesians argue this method be used in times of recession or low economic activity as an essential tool for building the framework for strong economic growth and working towards full employment. In theory, the resulting 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 a 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 spending from the economy will reduce levels of aggregate demand and contract the economy, thus stabilizing prices. Economists debate the effectiveness of fiscal stimulus. The argument mostly centers on crowding out, whether government borrowing leads to higher interest rates that may offset the stimulative impact of spending. When the government runs a budget deficit, funds will need to come from public borrowing (the issue of government bonds), overseas borrowing, or monetizing the debt. When governments fund a deficit with the issuing of government bonds, interest rates can increase across the market, because government borrowing creates higher demand for credit in the financial markets. This causes a lower aggregate demand for goods and services, contrary to the objective of a fiscal stimulus. Neoclassical economists generally emphasize crowding out while Keynesians argue that fiscal policy can still be effective especially in a liquidity trap where, they argue, crowding out is minimal.

Some classical and neoclassical economists argue that crowding out completely negates any fiscal stimulus; this is known as the Treasury View[citation needed], which Keynesian economics rejects. The Treasury View refers to the theoretical positions of classical economists in the British Treasury, who opposed Keynes' call in the 1930s for fiscal stimulus. The same general argument has been repeated by some neoclassical economists up to the present. In the classical view, the expansionary 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 foreign goods now cost less than they did before. Consequently, exports decrease and imports increase. Other possible problems with fiscal stimulus include the time lag between the implementation of the policy and detectable effects in the economy, and inflationary effects driven by increased demand. In theory, fiscal stimulus does not cause inflation when it uses resources that would have otherwise been idle. For instance, if a fiscal stimulus employs a worker who otherwise would have been unemployed, there is no inflationary effect; however, if the stimulus employs a worker who otherwise would have had a job, the stimulus is increasing labor demand while labor supply remains fixed, leading to wage inflation and therefore price inflation.

Fiscal policy refers to the use of the government budget to influence economic activity. The three main stances of fiscal policy are: Neutral fiscal policy is usually undertaken when an economy is in equilibrium. Government spending is fully funded by tax revenue and overall the budget outcome has a neutral effect on the level of economic activity. Expansionary fiscal policy involves government spending exceeding tax revenue, and is usually undertaken during recessions. Contractionary fiscal policy occurs when government spending is lower than tax revenue, and is usually undertaken to pay down government debt.

This simple flow-chart above identifies some of the possible channels involved with the fiscal policy transmission mechanism The multiplier effects of an expansionary fiscal policy depend on how much spare productive capacity the economy has; how much of any increase in disposable income is spent rather than saved or spent on imports. And also the effects of fiscal policy on variables such as interest rates

Government spending Government (or public) spending each year takes up over 40% of gross domestic product. Spending by the public sector can be broken down into three main areas:

Transfer Payments: Transfer payments are government welfare payments made available through the social security system including the Jobseekers Allowance, Child Benefit, the basic State Pension, Housing Benefit, Income Support and the Working Families Tax Credit. These transfer payments are not included in the national income accounts because they are not a payment for output produced directly by a factor of production. Neither are they included in general government spending on goods and services. The main aim of transfer payments is to provide a basic floor of income or minimum standard of living for low income households in our society. And they also provide a means by which the government can change the overall distribution of income in a country.

Current Government Spending: i.e. spending on state-provided goods & services that are provided on a recurrent basis every week, month and year, for example salaries paid to people working in the NHS and resources used in providing state education and defence. Current spending is recurring because these services have to be provided day to day throughout the country. The NHS claims a sizeable proportion of total current spending

Capital Spending: Capital spending would include infrastructural spending such as spending on new motorways and roads, hospitals, schools and prisons. This investment spending by the government adds to the economys capital stock and clearly can have important demand and supply side effects in the medium to long term.

Method 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 welfare benefits. This expenditure can be funded in a number of different ways Borrowing A fiscal deficit is often funded by issuing bonds, like treasury bills or consols and gilt-edged securities. These pay interest, either for a fixed period or indefinitely. If the interest and capital requirements are too large, a nation may default on its debts, usually to foreign creditors. Public debt or borrowing : it refers to the government borrowing from the public. Consuming prior surpluses A fiscal surplus is often saved for future use, and may be invested in either local currency or any financial instrument that may be traded later once resources are needed; notice, additional debt is not needed. For this to happen, the marginal propensity to save needs to be strictly positive. Seigniorage Seigniorage may be counted as revenue for a government when the money that is created is worth more than it costs to produce it. This revenue is often used by governments to finance a portion of their expenditures without having to collect taxes. If, for example, it costs the U.S. government $0.05 to produce a $1 bill, the seigniorage is $0.95, or the difference between the two amounts. The difference between the value of money and the cost to produce it - in other words, the economic cost of producing a currency within a given economy or country. If the seigniorage is positive, then the government will make an economic profit; a negative seigniorage will result in an economic loss.

Automatic stabilisers and discretionary changes in fiscal policy Discretionary fiscal changes are deliberate changes in direct and indirect taxation and govt spending for example a decision by the government to increase total capital spending on the road building budget or increase the allocation of resources going direct into the NHS. Automatic stabilisers include those changes in tax revenues and government spending that come about automatically as the economy moves through different stages of the business cycle

Tax revenues: When the economy is expanding rapidly the amount of tax revenue increases which takes money out of the circular flow of income and spending

Welfare spending: A growing economy means that the government does not have to spend as much on means-tested welfare benefits such as income support and unemployment benefits

Budget balance and the circular flow: A fast-growing economy tends to lead to a net outflow of money from the circular flow. Conversely during a slowdown or a recession, the government normally ends up running a larger budget deficit.

Taxation

Direct taxation is levied on income, wealth and profit. Direct taxes include income tax, national insurance contributions, capital gains tax, and corporation tax.

Indirect taxes are taxes on spending such as excise duties on fuel, cigarettes and alcohol and Value Added Tax (VAT) on many different goods and services

Progressive, proportional and regressive taxes

With a progressive tax, the marginal rate of tax rises as income rises. I.e. as people earn more income, the rate of tax on each extra pound earned goes up. This causes a rise in the average rate of tax (the percentage of income paid in tax). The UK income tax system is progressive. Everyone is entitled to a tax-free income. Thereafter, as income grows, people pay the starting rate of tax (10%) before moving onto the basic tax rate (22%). Higher income earners pay the top rate of tax (40%) on each additional pound of income over the top rate tax limit. This is the highest rate of income tax applied.

With a proportional tax, the marginal rate of tax is constant. For example, we might have an income tax system that applied a standard rate of tax of 25% across all income levels. If the marginal rate of tax is constant, the average rate of tax will also be constant. National insurance contributions are the closest example in the UK of a proportional tax, although low-income earners do not pay NICs below an income threshold, and NICs also do not rise for income earned above a top threshold.

With a regressive tax, the rate of tax falls as incomes rise I.e. the average rate of tax is lower for people of higher incomes. In the UK, most examples of regressive taxes come from excise duties of items of spending such as cigarettes and alcohol. There is welldocumented evidence that the heavy excise duty applied on tobacco has quite a regressive impact on the distribution of income in the UK.

Fiscal Policy and Aggregate Supply Changes to fiscal policy can affect the supply-side capacity of the economy and therefore contribute to long term economic growth. The effects tend to be longer term in nature.

Labour market incentives: Cuts in income tax might be used to improve incentives for people to actively seek work and also as a strategy to boost labour productivity. Some economists argue thatwelfare benefit reforms are more important than tax cuts in improving incentives in particular to create a wedge or gap between the incomes of those people in work and those who are in voluntary unemployment.

Capital spending. Government capital spending on the national infrastructure (e.g. improvements to our motorway network or an increase in the building programme for schools and hospitals) contributes to an increase in investment across the whole economy. Lower rates of corporation tax and other business taxes might also be a policy to stimulate a higher level of business investment and attract inward investment from overseas

Entrepreneurship and new business creation: Government spending might be used to fund an expansion in the rate of new small business start-ups

Research and development and innovation: Government spending, tax credits and other tax allowances could be used to encourage an increase in private business sector research and development designed to improve the international competitiveness of domestic businesses and contribute to a faster pace of innovation and invention

Human capital of the workforce: Higher government spending on education and training (designed to boost the human capital of the workforce) and increased investment in health and transport can also have important supply-side economic effects in the long run. An enhanced transport infrastructure is seen by many business organisations as absolutely essential if the UK is to remain competitive within the European and global economy

FISCAL POLICY Figure 1 shows the federal budget surplus over the period 19622003. The data in the figure are corrected to remove the effects of business cycle conditions. For example, in fiscal year 2003, the actual budget deficit was $375 billion, of which an estimated $68 billion was due to the lingering effects of a recession, so that the cyclically adjusted deficit was $307 billion. The data are also standardized to eliminate the effects of inflation and the effects of quirks in the timing of revenues and outlays, such as the receipt of payments from Desert Storm allies that arrived in the fiscal years following the war itself. Notable on the figure are the fiscal stimulus of the Vietnam War, the Kemp-Roth tax cuts of the early 1980s, and the program of tax cuts enacted under George W. Bush. The most immediate effect of fiscal policy is to change the aggregate demand for goods and services. A fiscal expansion, for example, raises aggregate demand through one of two channels. First, if the government increases its purchases but keeps taxes constant, it increases demand directly. Second, if the government cuts taxes or increases transfer payments, households disposable income rises, and they will spend more on consumption. This rise in consumption will in turn raise aggregate demand. Fiscal policy also changes the composition of aggregate demand. When the government runs a deficit, it meets some of its expenses by issuing bonds. In doing so, it competes with private borrowers for money loaned by savers. Holding other things constant, a fiscal expansion will raise interest rates and crowd out some private investment, thus reducing the fraction of output composed of private investment. In an open economy, fiscal policy also affects the exchange rate and the trade balance. In the case of a fiscal expansion, the rise in interest rates due to government borrowing attracts foreign capital. In their attempt to get more dollars to invest, foreigners bid up the price of the dollar, causing an exchange-rate appreciation in the short run. This appreciation

makes imported goods cheaper in the United States and exports more expensive abroad, leading to a decline of the merchandise trade balance. Foreigners sell more to the United States than they buy from it and, in return, acquire ownership of U.S. assets (including government debt). In the long run, however, the accumulation of external debt that results from persistent government deficits can lead foreigners to distrust U.S. assets and can cause a deprecation of the exchange rate.

Figure 1 Cyclically Adjusted and Standardized Budget Surplus as a Percentage of GDP:

1962-2003 Source: Congressional Budget Office, Washington, D.C.

Fiscal policy is an important tool for managing the economy because of its ability to affect the total amount of output producedthat is, gross domestic product. The first impact of a fiscal expansion is to raise the demand for goods and services. This greater demand leads to increases in both output and prices. The degree to which higher demand increases output and prices depends, in turn, on the state of the business cycle. If the economy is in recession, with unused productive capacity and unemployed workers, then increases in demand will lead mostly to more output without changing the price level. If the economy is at full employment, by contrast, a fiscal expansion will have more effect on prices and less impact on total output. This ability of fiscal policy to affect output by affecting aggregate demand makes it a potential tool for economic stabilization. In a recession, the government can run an expansionary fiscal policy, thus helping to restore output to its normal level and to put unemployed workers back to work. During a boom, when inflation is perceived to be a greater problem than unemployment, the government can run a budget surplus, helping to slow down the economy. Such a countercyclical policy would lead to a budget that was balanced on average. Automatic stabilizersprograms that automatically expand fiscal policy during recessions and contract it during boomsare one form of countercyclical fiscal policy. Unemploymentinsurance, on which the government spends more during recessions (when the unemployment rate is high), is an example of an automatic stabilizer. Similarly, because taxes are roughly proportional to wages and profits, the amount of taxes collected is higher during a boom than during a recession. Thus, the tax code also acts as an automatic stabilizer. But fiscal policy need not be automatic in order to play a stabilizing role in business cycles. Some economists recommend changes in fiscal policy in response to economic

conditionsso-called discretionary fiscal policyas a way to moderate business cycle swings. These suggestions are most frequently heard during recessions, when there are calls for tax cuts or new spending programs to get the economy going again. Unfortunately, discretionary fiscal policy is rarely able to deliver on its promise. Fiscal policy is especially difficult to use for stabilization because of the inside lagthe gap between the time when the need for fiscal policy arises and when the president and Congress implement it. If economists forecast well, then the lag would not matter because they could tell Congress the appropriate fiscal policy in advance. But economists do not forecast well. Absent accurate forecasts, attempts to use discretionary fiscal policy to counteract business cycle fluctuations are as likely to do harm as good. The case for using discretionary fiscal policy to stabilize business cycles is further weakened by the fact that another tool, monetary policy, is far more agile than fiscal policy. Whether for good or for ill, fiscal policys ability to affect the level of output via aggregate demand wears off over time. Higher aggregate demand due to a fiscal stimulus, for example, eventually shows up only in higher prices and does not increase output at all. That is because, over the long run, the level of output is determined not by demand but by the supply of factors of production (capital, labor, and technology). These factors of production determine a natural rate of output around which business cycles and macroeconomic policies can cause only temporary fluctuations. An attempt to keep output above its natural rate by means of aggregate demand policies will lead only to everaccelerating inflation. The fact that output returns to its natural rate in the long run is not the end of the story, however. In addition to moving output in the short run, expansionary fiscal policy can change the natural rate, and, ironically, the long-run effects of fiscal expansion tend to be the opposite of the short-run effects. Expansionary fiscal policy will lead to higher output

today, but will lower the natural rate of output below what it would have been in the future. Similarly, contractionary fiscal policy, though dampening the output level in the short run, will lead to higher output in the future. A fiscal expansion affects the output level in the long run because it affects the countrys saving rate. The countrys total saving is composed of two parts: private saving (by individuals and corporations) and government saving (which is the same as the budget surplus). A fiscal expansion entails a decrease in government saving. Lower saving means, in turn, that the country will either invest less in new plants and equipment or increase the amount that it borrows from abroad, both of which lead to unpleasant consequences in the long term. Lower investment will lead to a lower capital stock and to a reduction in a countrys ability to produce output in the future. Increased indebtedness to foreigners means that a higher fraction of a countrys output will have to be sent abroad in the future rather than being consumed at home. Fiscal policy also changes the burden of future taxes. When the government runs an expansionary fiscal policy, it adds to its stock of debt. Because the government will have to pay interest on this debt (or repay it) in future years, expansionary fiscal policy today imposes an additional burden on future taxpayers. Just as the government can use taxes to transfer income between different classes, it can run surpluses or deficits in order to transfer income between different generations. Some economists have argued that this effect of fiscal policy on future taxes will lead consumers to change their saving. Recognizing that a tax cut today means higher taxes in the future, the argument goes, people will simply save the value of the tax cut they receive now in order to pay those future taxes. The extreme of this argument, known as Ricardian equivalence, holds that tax cuts will have no effect on national saving because changes in private saving will exactly offset changes in government saving. If these economists were

right, then my earlier statement that budget deficits crowd out private investment would be wrong. But if consumers decide to spend some of the extra disposable income they receive from a tax cut (because they are myopic about future tax payments, for example), then Ricardian equivalence will not hold; a tax cut will lower national saving and raise aggregate demand. Most economists do not believe that Ricardian equivalence characterizes consumers response to tax changes. In addition to its effect on aggregate demand and saving, fiscal policy also affects the economy by changing incentives. Taxing an activity tends to discourage that activity. A high marginal tax rate on income reduces peoples incentive to earn income. By reducing the level of taxation, or even by keeping the level the same but reducing marginal tax ratesand reducing allowed deductions, the government can increase output. Supply-side economists argue that reductions in tax rates have a large effect on the amount of labor supplied, and thus on output (see supply-side economics). Incentive effects of taxes also play a role on the demand side. Policies such as investment tax credits, for example, can greatly influence the demand for capital goods. The greatest obstacle to proper use of fiscal policyboth for its ability to stabilize fluctuations in the short run and for its long-run effect on the natural rate of outputis that changes in fiscal policy are necessarily bundled with other changes that please or displease various constituencies. A road in Congressman Xs district is all the more likely to be built if it can be packaged as part of countercyclical fiscal policy. The same is true for a tax cut for some favored constituency. This naturally leads to an institutional enthusiasm for expansionary policies during recessions that is not matched by a taste for contractionary policies during booms. In addition, the benefits from expansionary policy are felt immediately, whereas its costshigher future taxes and lower economic growthare postponed until a later date. The problem of making good fiscal policy in the face of such obstacles is, in the final analysis, not economic but political.

MALAYSIA In the 1970s, the Malaysian government played a key role in the economy. The government ventured beyond its traditional functions and took on a more direct and active role in the countrys overall social and economic development process. This period saw the governments direct participation in the private sector through the establishment of large commercial enterprises. Government participation in the economy expanded further in 1980-82 as it pursued an expansionary countercyclical fiscal policy aimed at stimulating economic activity and sustaining growth to ride out the effects of the global recession.

The countercyclical policy led to twin deficits in the governments fiscal position and the balance of payments. When confronted with this twin deficit problem, the government implemented comprehensive structural programmes to reduce spending and reordered national objectives consistent with domestic resource availability and to ensure prudence in its recourse to external borrowing. The new direction in public policy also sought to promote the private sector as the main engine of growth for the economy. The most significant development was the reduction of the public sectors commercial activities, implemented through the privatisation programme. Subsequently, government intervention has been largely in support of private sector initiatives towards overall development of the country. The tax structure was also reformed to increase international competitiveness as well as promote national savings to meet future levels of growth and investment requirements.

The shift in emphasis towards private sector-driven growth contributed to a marked improvement in the governments financial position as well as a reduction in its borrowing requirements. As a strengthened fiscal position emerged in the late 1980s, the government was able to prepay its external debt, thereby improving the nations external debt profile. It also culminated in fiscal surpluses for five years during 1993-97. With the consolidation of

public activities, the share of public expenditure to GDP declined to 21% in 1997, from a peak of 44% in 1982. The total debt level of the federal government was substantially reduced to 32% of GDP by the end of 1997, from a peak of 103% in 1986. The external debt of the government was also low, at 4.6% of GDP or 7.6% of total external debt in 1997. The prudent policies adopted accorded the government greater flexibility in implementing expansionary measures to support growth during the crisis years.

FISCAL OPERATIONS AND POLICY The 1999 Budget announced in October 1998 focused on the counter-cyclicalrole of fiscal policy to revitalise economic activities and strengthen thenations resilience and competitiveness. Various measures were alsointroduced to further improve the balance of payments; strengthen the financial sector; promote the services and agriculture sectors; and improve governance in the public and private/business sectors as well as ensure social well-being. Overall, the budget strategy reinforced the fiscal stimulus adopted in 1998 in line with the plan to revilatise the economy as set out in the National Economic Recovery Plan. The fiscal stimulus in 1999 as reflected by a budget deficit of 3.4 percent of GNP contributed to the restoration of consumer and investor confidence, particularly in the second half of 1999. While the government undertook a stimulative role, fiscal prudence and discipline continue to be maintained to contain the fiscal deficit at a manageable level so as not to jeopardise long-term growth. The level of expenditure, therefore, was managed with the consideration that current revenue should be sufficient to finance operating expenditure; fiscal deficit be contained at a sustainable level, and availability of domestic and external financing without crowding out the private/business sector. Meanwhile, the better-than-expected revenue out-turn in 1999, reflecting the strong pick-up in the momentum of economic recovery as the year

progressed, provided the government with increased flexibility in managing its fiscal policy. It enabled the government to expand its fiscal stimulus to reinvigorate the economy further through increased expenditure during the course of 1999, without further deteriorating the budgetary position of the government.

Analysis of fiscal accounts, 1998-2002

Malaysia keeps all policies under constant review, to respond to changing circumstances. During 1998-2002 monetary conditions also supported the expansion of private sector activities. Interest rates were cut to historically low levels in 1999, with the intervention rate reduced by 550 basis points. Following the events of 11 September 2001, it was cut by a further 50 basis points. In pursuing expansionary demand management policies, care was taken that fiscal and monetary measures would not unduly risk creating imbalances which might jeopardise the long-term growth potential, price stability or gains made in achieving a robust balance of payments.

Given that the exchange rate is pegged, the government is fully committed to ensuring that the overall stance of macroeconomic policy is consistent with and supportive of the exchange rate regime to ensure its sustainability. In this regard, both fiscal and monetary policies have been carefully applied to support economic recovery, whilst preserving Malaysias economic fundamentals.

In determining the size of the fiscal deficit, major considerations are:

ensuring that revenue is able to meet operating expenditure and hence, that a surplus in the current account is maintained at all times; ensuring the availability of domestic and external financing without crowding out the private sector; ensuring that debt servicing does not exceed 20% of total operating expenditure.

Overall, to ensure that public debt remains at manageable levels, a legislated borrowing rule stipulates a ceiling for federal government debt.

Impact of fiscal expansion Size of the overall budget In terms of fiscal policy, the adjustments called for an 18 per cent reduction in government expenditure (including a 10 per cent pay cut for government ministers), as well as the postponement of several infrastructure mega-projects such as the Bakun dam, the Express Rail Link, and the land bridge to Thailand. As a strategy to maintain competitiveness, policies to strengthen the countrys balance-of-payments account were pursued.

For example, exports were encouraged and imports were discouraged, the latter through an increase in import taxes on certain goods and services. Measures to increase exports included reducing the cost of doing business through such means as tax incentives to boost the manufacturing, agriculture, and services sectors. In order to stem the outflow of domestic funds at that time, the government also imposed a freeze on new overseas investments by Malaysian firms which in 1996 had amounted to RM 10.5 billion (including retained earnings overseas).

The unemployment rate in 1998 was 3.9 per cent. Although current employment opportunities still seem weak, a slight improvement is expected in the future. With more consumers expecting better job opportunities in the coming months, it is anticipated that the unemployment rate will at least stabilize, if not decline slightly, mainly due to the brighter prospects in the manufacturing, construction, and financial sectors which were all severely hit by the crisis. Thus, there are unmistakable signs of recovery for the Malaysian economy.

Following the implementation of fiscal stimulus packages, government spending increased from an average of 22% of GDP in 1995-97 to 30% in 2001, or an average of nearly 25% of GDP during 1998-2001.

On the revenue side, receipts have remained robust, providing flexibility for increases in development expenditure without exceeding the size of the overall deficit. The improvement was due to an ongoing tax reform programme aimed at improving tax buoyancy and tax receipts as well as increases in petroleum-based revenue, arising from higher oil prices. Petroleum-based revenue accounts for about one fifth of total revenue. In 2001, revenue collected recovered to the pre-crisis level of 24% of GDP, having averaged only 19% of GDP during 1998-2000. Non-tax revenue (20% of total revenue) was relatively stable at about 4-5% of GDP during the crisis period. Consequently, the overall fiscal deficit has been contained at below 6% of GDP.

Nature of the fiscal deficit To evaluate fiscal risks, it is important to determine the nature of the deficit. Estimates of derived cyclically neutral balance, based on a structural balance concept, indicated a deficit of less than 1% of GDP, compared to an average deficit of about 4% of GDP during 19982002. The fiscal stance adjusted for the cyclically neutral stance remained positive, indicating that the fiscal policy was adding stimulus to the economy. In estimating the cyclically neutral balance, 1995 was selected as the base year, as actual and potential GDP were at about the same levels. The fiscal stance indicated a policy deficit induced by the countercyclical measures taken by the government, and not induced by longer-term structural rigidities arising from either locked-in operating expenditure or a persistent decline in revenues due to inefficiency in collection or weak fundamentals. Hence, the impact of the measures on the fiscal balance is expected to be only transitory. As the fiscal stimulus largely comprised higher development expenditure, the capacity to move towards a surplus is greater when economic activities recover. Revenue growth during these years has also remained favourable, reflecting the strong underlying economic fundamentals. Table

1997 Overall balance (budget definition) Primary balance Cyclically neutral balance (base year 1995) Fiscal stance Fiscal impulse Revenue Expenditure -1.7 -2.0 -0.4 -1.6 2.4 4.6 0.7

1998 -1.8 0.7 -1.9

1999 -3.3 -0.5 -0.7

2000 -5.8 -3.1 0.2

2001 -5.5 -2.6 -0.4

2002e -4.7 -2.0 -0.1

-0.1 1.6 3.3 -1.7

2.4 2.5 0.5 2.0

6.0 3.6 1.4 2.1

5.1 -0.9 -5.7 4.8

4.6 -0.4 0.3 -0.7

Fiscal policy flexibility Discussion on the fiscal flexibility of Malaysia has always centred on the unwritten fiscal rule of maintaining a surplus in the current account, the annual budget formulation process and the greater reliance on discretionary measures rather than built-in stabilisers to address cyclical developments. Such a stance has been considered to accord less fiscal flexibility in times of crisis. In this regard, Malaysia has always reiterated that the prudent stance of maintaining at least a surplus position in the current account over the course of the business cycle reduces the longer-term risks for the country.

Malaysia is not convinced of the merits of introducing unemployment and social security benefits because such measures have proven to be costly in other countries. Moreover, the existing informal social safety net is considered adequate. The aim is to move towards a fiscal surplus over the medium term to provide more effective built-in stabilisers and allow the use of discretionary measures at appropriate times to protect employment and social cohesion. In implementing the current fiscal stimulus programme, Malaysia did face implementation constraints initially. Hence, existing procedures were adjusted in order to enhance the efficiency of project implementation, speed up payments to contractors and remove bureaucratic delays. Besides a review of procedures, rules and guidelines on the implementation of development projects, procurement and payment to contractors, the implementation of projects was also more closely monitored.

The government is planning to move towards a broad-based consumption tax, although the timing will depend on economic conditions. Meanwhile, measures have been implemented to gradually widen the scope and coverage of sales and service taxes. Recognising also the merits of moving towards multi-year planning in the budgeting process, beginning with the 2003 budget the budget preparation and examination process will be carried out once every two years instead of annually.

In 2012 Malaysian economy continuing on its growth path. This is despite increasingly challenging global economic conditions in the latter part of 2011 and which is expected to remain so in 2012. Growth will be driven by domestic activities with increased domestic consumption and public and private investments.

This is in part the result of an uptake in the inflow of Foreign Direct Investment (FDI). A mildly expansionary policy stance initiated in the previous years in the form of a Special Stimulus Package through the Private Finance Initiatives (PFI) is expected to result in higher disposable income and greater employment opportunities. Income per capita is expected to increase from RM 28,725 to RM 30,856. On the negative side, inflationary trends in the form of rising food and fuel prices continue to be a concern to policy makers, and this has resulted in the implementation of the Goods & Services Tax (GST) being further delayed. The economy is expected to grow between 5% to 5.5% in 2011, and the anticipation is for an overall growth rate of between 5% to 6% in 2012. The fiscal deficit is expected to improve to 4.7% of Gross Domestic Product from the 2011 position of 5.4%. A total of RM232.8 billion is allocated for the 2012 operating and development expenditure. Of this amount, 78% (RM181.6 billion) is for operating expenditure and the rest on development expenditure. Total Government revenue is expected to increase marginally to RM186.9 billion in 2012. This leaves a current account surplus of RM5.3 billion but an overall deficit of just over RM43 billion. * The 2012 Budgets fiscal thrust is tax neutral in many respects no new taxes are introduced and neither were there any substantive increases in tax rates in light of the policy commitment to reduce the fiscal deficit. There is a lack of a concrete tax

rationalisation framework involving a review of the corporate tax, personal tax, tax concessions and the impending GST, so as to build a solid tax base for the future. * There was no significant claw-back of tax incentives or re-alignment of tax reliefs other than a minor tinkering with the shipping tax exemption and the reinvestment allowance. * The increase in total Government revenue of 1.9% to RM186.9 billion will be mainly from the economic expansionary effects of the Government Economic Transformation Plan (ETP) initiatives announced and instituted about a year ago, and this is expected to contribute positively towards the Government coffers by way of additional tax revenues. In addition, there will be greater reliance on the tax authorities carrying out more tax audits and enforcement and compliance-enhancing initiatives. * It is noteworthy that the Government, notwithstanding a marginal expected increase in revenue, has undertaken to deliver a lower fiscal deficit of 4.7% in 2012. It would appear that the thrust of such achievement is underpinned by the slew of PFI projects to be implemented. Some of these projects are already underway and many public projects will be implemented in due course. * The services sector is expected to remain the key driver of growth and the further liberalisation of the services sector (including the professional sub-sectors) is a positive move. * The social aspect of Government spending is another feature of this budget. It includes a slew of measures intended to benefit the less privileged and excluded segments of Malaysian society.

CONCLUSION Fiscal policy is based on the theories of British economist John Maynard Keynes. Also known as Keynesian economics, this theory basically states that governments can influence macroeconomic productivity levels by increasing or decreasing tax levels and public spending. This influence, in turn, curbs inflation (generally considered to be healthy when at a level between 2-3%), increases employment and maintains a healthy value of money The idea, however, is to find a balance in exercising these influences. For example, stimulating a stagnant economy runs the risk of rising inflation. This is because an increase in the supply of money followed by an increase in consumer demand can result in a decrease in the value of money - meaning that it will take more money to buy something that has not changed in value. When inflation is too strong, the economy may need a slow down. In such a situation, a government can use fiscal policy to increase taxes in order to suck money out of the economy. Fiscal policy could also dictate a decrease in government spending and thereby decrease the money in circulation. Of course, the possible negative effects of such a policy in the long run could be a sluggish economy and high unemployment levels. Nonetheless, the process continues as the government uses its fiscal policy to fine tune spending and taxation levels, with the goal of evening out the business cycles.

A strong commitment to fiscal sustainability is critical for macroeconomic stability as well as to ensure sustainable long-term growth. Malaysia continues to enjoy flexibility in expanding its fiscal position, which remains sustainable given the governments fiscal prudence and discipline. The impact of countercyclical measures on the fiscal deficit is expected to be transitory. The government, as part of the fiscal prudence policy, will closely monitor its

spending. Over the medium term, its fiscal position will be consolidated as the economy recovers and is able to expand at its own momentum. The pace of consolidation will be guided by developments in external demand and domestic economic developments, with a focus on medium-term public debt sustainability considerations.

REFERENCES
http://mylandlaw.info/booksandarticles/2012-malaysian-budget-highlights-65.html http://en.wikipedia.org/wiki/Fiscal_policy http://www.investopedia.com/articles/04/051904.asp http://tutor2u.net/economics/revision-notes/as-macro-fiscal-policy.html http://www.econlib.org/library/Enc/FiscalPolicy.html http://econsmalaysia.blogspot.com/2011/03/inflation-and-fiscal-policy.html