Regulatory and Control Mechanism Such as Fiscal Policy

Fiscal policy is the guiding force that helps the government decide how much money it should spend to support the economic activity, and how much revenue it must earn from the system, to keep the wheels of the economy running smoothly.

Fiscal policy refers to the use of government spending and tax policies to influence economic conditions, especially macroeconomic conditions, including aggregate demand for goods and services, employment, inflation, and economic growth.

Fiscal policy in India

Fiscal policy in India is the guiding force that helps the government decide how much money it should spend to support the economic activity, and how much revenue it must earn from the system, to keep the wheels of the economy running smoothly. In recent times, the importance of fiscal policy has been increasing to achieve economic growth swiftly, both in India and across the world. Attaining rapid economic growth is one of the key goals of fiscal policy formulated by the Government of India. Fiscal policy, along with monetary policy, plays a crucial role in managing a country’s economy.

Through the fiscal policy, the government of a country controls the flow of tax revenues and public expenditure to navigate the economy. If the government receives more revenue than it spends, it runs a surplus, while if it spends more than the tax and non-tax receipts, it runs a deficit. To meet additional expenditures, the government needs to borrow domestically or from overseas. Alternatively, the government may also choose to draw upon its foreign exchange reserves or print additional money.

For example, during an economic downturn, the government may decide to open up its coffers to spend more on building projects, welfare schemes, providing business incentives, etc. The aim is to help make more of productive money available to the people, free up some cash with the people so that they can spend it elsewhere, and encourage businesses to make investments. At the same time, the government may also decide to tax businesses and people a little less, thereby earning lesser revenue itself.

Functions of Fiscal Policy

Although particular tax or expenditure measures affect the economy in many ways and may be designed to serve a variety of purposes, several more or less distinct policy objectives may be set forth. They include:

1. Allocation Function

The provision for social goods, or the process by which total resource use is divided between private and social goods and by which the mix of social goods is chosen. This provision may be termed as the allocation function of budget policy. Social goods, as distinct from private goods, cannot be provided for through the market system.

The basic reasons for the market failure in the provision of social goods are: firstly, because consumption of such products by individuals is non rival, in the sense that one person’s partaking of benefits does not reduce the benefits available to others.

The benefits of social goods are externalised. Secondly, the exclusion principle is not feasible in the case of social goods. The application of exclusion is frequently impossible or prohibitively expensive. So, the social goods are to be provided by the government.

2. Distribution Function

Adjustment of the distribution of income and wealth to assure conformance with what society considers a ‘fair’ or ‘just’ state of distribution. The distribution of income and wealth determined by the market forces and laws of inheritance involve a substantial degree of inequality. Tax transfer policies of the government play an important role in reducing the inequalities in income and wealth in the economy.

3. Stabilization Function

Fiscal policy is needed for stabilization, since full employment and price level stability do not come about automatically in a market economy. Without it the economy tends to be subject to substantial fluctuations, and it may suffer from sustained periods of unemployment or inflation. Unemployment and inflation may exist at the same time. Such a situation is known as stagflation.

The overall level of employment and prices in the economy depends upon the level of aggregate demand, relative to the potential or capacity output valued at prevailing prices. Government expenditures add to total demand, while taxes reduce it. This suggests that budgetary effects on demand increase as the level of expenditure increases and as the level of tax revenue decreases.

4. Economic Growth

Moreover, the problem is not only one of maintaining high employment or of curtailing inflation within a given level of capacity output. The effects of fiscal policy upon the rate of growth of potential output must also be allowed for. Fiscal policy may affect the rate of saving and the willingness to invest and may thereby influence the rate of capital formation.

Capital formation in turn affects productivity growth, so that fiscal policy is a significant factor in economic growth.

Objectives of Fiscal Policy

Fiscal policy has a number of objectives depending upon the circumstances in a country.

Important objectives of fiscal policy are:-

1. Optimum allocation of economic resources. The aim is that fiscal policy should be so framed as to increase the efficiency of productive resources.

To ensure this, the government should spend on those public works which give the maximum employment.

2. Fiscal policy should aim at equitable distribution of wealth and income. It means that fiscal policy should be so designed as to bring about reasonable equality of incomes among different groups by transferring wealth from the rich to the poor.
3. Another objective of fiscal policy is to maintain price stability. Deflation leads to a sharp decline in business activity. On the other extreme, inflation may hit the fixed income classes hard while benefiting speculators and traders. Fiscal policy has to be such as will maintain a reasonably stable price level thereby benefiting all sections of society.
4. The most important objective of fiscal policy is the achievement and maintenance of full employment because through it most other objectives are automatically achieved. Fiscal policy aimed at full employment envisages the direction of tax structure, not with a view to raising revenue but with a view to noticing the effects with specific kinds of taxes have on consumption, saving and investment.