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The fiscal policy is concerned with the raising of government revenue and incurring of
government expenditure. To generate revenue and to incur expenditure, the government frames a
policy called budgetary policy or fiscal policy. So, the fiscal policy is concerned with government
expenditure and government revenue.
Fiscal policy has to decide on the size and pattern of flow of expenditure from the
government to the economy and from the economy back to the government. So, in broad term
fiscal policy refers to "that segment of national economic policy which is primarily concerned
with the receipts and expenditure of central government." In other words, fiscal policy refers to
the policy of the government with regard to taxation, public expenditure and public borrowings.
The importance of fiscal policy is high in underdeveloped countries. The state has to play active
and important role. In a democratic society direct methods are not approved. So, the government
has to depend on indirect methods of regulations. In this way, fiscal policy is a powerful weapon
in the hands of government by means of which it can achieve the objectives of development.
At the same time schemes have been introduced to widen the base of the tax. These
together with lower tax and a wider base are very likely to raise the yield of taxes. And with
growth in the activities and income of the economy, the tax receipts will increase.
This approach is totally different from the one pursued so far on the premise of a high taxrate on a narrow base. The new tax-regime will reduce and if pursued further eliminate the
difference between the domestic tax-rates and the tax rates in the foreign country.
This will help in integrating the Indian economy with the world economy. The benefits to
the country will be an increase in exports and a larger inflow of foreign direct investment. The
competitive strength and efficiency of the Indian economy will also improve.
(iii) Promoting Socially Desirable Activities:
The Government in the new fiscal policy has also provided larger expenditure, tax
concessions and other incentives for the expansion of socially important sectors. These are the
sectors which are normally the responsibility of the government. The development of
infrastructure is one such field of key significance for the economy.
While most of it is to be undertaken by the Government, several incentives have been
extended to seek private sectors involvement in some areas like power to ensure that the supply
of infrastructural services becomes adequate.
Tax concessions in the form of tax holiday have been given to encourage the private sector
to set up industries in the backward regions. Similar incentives have also been given to industries
producing pollution-control equipment.
Provision has also been made for the development of R&D (Research and Development)
to upgrade the technological base of the economy. Besides public expenditure, tax concessions
have been given to the private sector for this purpose.
(iv) Market-Oriented Development:
The new fiscal policy in line with the new economic policy aims at promoting allocation of
resources largely in terms of the market prices. The government has already dismantled a
significant part of state- intervention and enlarged the field for the private sector. The fiscal policy
has carried this process further by offering money incentives through lower tax-rates and taxconcession to the private sector.
Supply constraints in the market have also been caused by several fiscal measures.
Reduction in custom duties on the import of capital goods to modernise domestic production is
one such measure to step-up the supply of goods and services.
The lowering of the rates of indirect taxes on the consumer goods including luxury items
like electronics goods, cars, etc., will encourage a growth-pattern largely based on the expansion
of consumer goods industries.
The market orientation of development is also sought to be promoted by providing a
demand stimulus to the economy. How direct taxes will mean larger disposable income with the
people. Low indirect taxes will result in lower prices. Both of these will increased demand.
The crucial determinant of economic growth is the rate of savings and, therefore savings
cannot be left to themselves to grow automatically. On the contrary, fiscal measures have to be
adopted to increase the savings of the people and to mobilise them for productive purpose. In the
words of Nurkse, fiscal policy, assumes a new significance in the face of the problem of capital
formation in under-developed countries.
The backward countries are caught in the vicious circle of low income, high consumption,
low savings, and low rate of capital formation and therefore, low incomes. To get out of this
vicious circle of poverty, the fiscal policy can play a constructive and dynamic role for the
economic development of the underdeveloped countries.
To break out of this circle, apart from foreign aid, observes an expert UN study calls for
vigorous taxation and government development programmes. Thus in poor countries, the
importance of fiscal policy lies in raising the rate and volume of savings and to divert them into
the desired channels.
In this connection, the UN report on Taxes and Fiscal Policy says, Fiscal policy is
assigned the central task of wresting from the pitifully low output of under-developed countries
sufficient savings to finance economic development programmes and to set the stage for more
vigorous private and public investment activity.
The limitations and ineffectiveness of monetary policy in securing an accelerated rate of
economic growth has further added to the importance of fiscal policy. Fiscal policy was designed
to supplement monetary policy but now it seems to have supplanted monetary policy altogether.
The role of fiscal policy in economic development cannot be overemphasized. The importance of
fiscal policy as an instrument of economic development was first envisaged by Keynes in his
General Theory wherein he showed that the total national income was an index of economic
activity and brought out the relation of economic activity of total spending.
The direct and indirect effects of fiscal policy on aggregate spending in the community
were clearly established and as a result the budgetary policy of the government as a weapon of
economic control and development came into prominence.
The fiscal policy can affect the rate of economic development in a variety of ways such as
by increasing the rate of saving and investment, affecting the allocation of resources, controlling
inflation, promoting economic stability. We now discuss them in detail.
Such an investment widens the extent of the market; helps reduce cost of production and
raise productivity by creating external economies. Private enterprise cannot be expected to
provide such basic facilities as the investment involved in them is very huge and they are low
yielding and slow yielding projects.
Therefore, Governments of under-developed countries should take upon themselves the
responsibilities to the execution of these basic facilities. However, such projects should be
financed through taxation and not with borrowed funds because they do not yield direct returns
necessary for the repayment of these debts.
The raising of collective compulsory saving through taxation for such development
programmes is now widely recognised. Thus fiscal measures should be directed to secure the
optimum pattern of investment so as to accelerate the pace of economic development of the
underdeveloped countries.
To Counteract Inflation:
The process of economic development in underdeveloped countries inevitably leads to
inflationary pressures as a result of the imbalances between the demand for and supply of real
resources.
The pressure of wages on prices, structural rigidities of their economic systems, market
imperfections and bottle- necks impede the supply of goods and services and prices start rising.
Inflation feeds on itself and if it goes out of control, it ruins the entire economy and all progress
comes to standstill.
That is why economic growth and stability are regarded as joint objectives for underdeveloped
countries to pursue. Today the choice is not between economic growth and stability but only
over the inter-relations ups between them and over the policies necessary to achieve them.
The fiscal measures should be used to counter act the inflationary pressures by reducing over a
effective demand for the attainment of this objective. The tax structure should be so devised that it
mops up a major portion of the rise in money income.
For that, greater reliance should be placed on progressive direct taxes and commodity taxes, the
yield of which changes more than in proportion to changes in tax base. Special anti-inflationary
taxes on excess profits, capital gains and other windfalls including taxes on articles of
conspicuous consumption may be imposed.
Besides, the fiscal policy of the Government should extend to the removal of structural rigidities,
market imperfections and imposition of physical controls including subsidies and protection to
decrease in government spending and equivalent decrease in tax revenue brings about a reduction
in national income and expenditure on account of its reverse operation.
If these fiscal changes result in a redistribution of income between the beneficiaries of
government expenditure and tax payers in such a way that it results in reduction in government
expenditure. A balanced budget multiplier greater than unity will in this situation have an antiinflationary impact upon the economy.
This discussion clearly brings out the fact that variation in taxes is the most crucial
instrument of an anti-inflationary fiscal policy. There is a controversy about the relative antiinflationary impact of income-tax and consumption tax of an equal yield.
The latter is sometimes conceived as more effective, since it results entirely in reducing
consumption. The income tax, on the contrary, falls partly upon consumption and partly upon
savings, to the extent income-tax reduces savings, if will not help in curtailing inflationary
pressure.
To Promote Economic Stability:
The underdeveloped countries are susceptible to economic instability resulting from
deficiency of effective demand in the short-run and fluctuations in demand for their products in
the world market. Underdeveloped countries mainly export agricultural and mineral products the
demand for which is generally less elastic.
On the other hand these countries import capital goods and finished manufactured articles,
the demand for which is elastic. When the prices of export goods fall in the international markets
the terms of trade becomes unfavourable, foreign exchange earnings decline and national income
falls which produces depression effects on the economy.
The under-developed countries cannot push their, exports to take advantage of the fall in
prices because their capacity to produce more is limited. Similarly, when the prices of the exports
rise due to the boom conditions in the world-markets, the increase in export earnings does not
lead to increased output and employment but instead it is dissipated in conspicuous consumption
and speculative investment which further generate inflationary pressure in the economy.
Fiscal measures can be used to offset the effects of international cyclical fluctuations in the prices
of exports. For example, in booms heavy export and imports duties may be imposed export duties
to neutralise the windfall gains arising from the rise in world market prices and import duties to
discourage conspicuous consumption.
The earnings from such export and import duties should be used for capital formation. In
periods of depression on the other hand, subsidies may be given to encourage exports and
government should directly intervene to maintain the level of effective demand through public
work programmes etc.
Thus, contra-cyclical fiscal policy should be followed to mitigate the effects of
international cyclical movements and all out efforts should be made to develop all sectors of the
economy so as to reduce an excessive dependence on the primary sector alone. Hence a welldevised fiscal policy can go a long way in promoting economic stability.