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Fiscal Policy

Objectives and Scope of Fiscal Policy. Fiscal Policy Instruments: Taxation, -Government Expenditure, Public Debt, Deficit Financing. Crowding-in and Crowding-out Controversy Budget Basics: What is the Budget, Government Accounts, Revenue and Capital Budget, Revenue Deficit, Fiscal Deficit, Primary Deficit

Plan and Non-Plan Expenditure..

Adverse Impact of a High Fiscal Deficit Fiscal Policy in India

Meaning & Scope of Fiscal Policy

Fiscal policy is the economic term that defines the set of principles and decisions of a government in setting the level of public expenditure and how that expenditure is funded. It is the deliberate change in government spending, government borrowing or taxes to stimulate or slow down the economy. It contrasts with monetary policy, which describes the policies about the supply of money to the economy. Fiscal policy is also called as Budgetary Policy

Objectives of Fiscal Policy

Following are the objectives of Fiscal Policy: To achieve desirable price level To Achieve desirable consumption level To Achieve desirable employment level To achieve desirable income distribution Increase in capital formation Degree of inflation

Instruments of Fiscal Policy

Fiscal Policy is implemented through fiscal instruments which are: i) Budgetary Surplus and Deficit ii) Taxation Direct and Indirect iii) Government Expenditure iv) Public Borrowings v) Deficit Financing

Instruments of Fiscal Policy Contd..

1) Budgetary Surplus & Deficit: Keeping budget in balance itself is a fiscal instrument. When the government spends more than its expected revenue, it is pursuing a deficit budget policy When the government follows a policy of keeping its expenditure below its current revenue it follows a surplus-budget policy When the government keeps its total expenditure equal to its revenue, it follows a balanced-budget policy

Government Expenditure
2) Government Expenditure: means the sum of public spending on purchase of goods & services, public investment & transfer payments

Government Expenditure
Government Expenditure is divided into two parts: a) Revenue or Current Expenditure, which is classified into categories: Government spending on goods & services Transfer payments Interest payments on national debt a) Capital Expenditure: is government spending on new roads, buildings & structures, new machines & equipments which results in further production of goods & services over a period of time.

3) Taxes: are an important source of revenue for the government. They re of two types: a) Direct Taxes: are levied on income or income related assets eg: personal income tax, corporate income tax, wealth tax, capital gains tax etc.. b) Indirect Taxes: are levied on production & sale of goods & services. Two important central indirect taxes are excise & customs State indirect taxes are sales tax, motor vehicle tax, & stamp duties.

Government Borrowings
4) Government borrowings: include both Internal & external borrowings. Internal Borrowings are of two types: Borrowing from public by means of government bonds & treasury bills. Borrowing from central bank i.e deficit financing External Borrowings include Borrowings from foreign government International organizations like World bank & IMF Market borrowing.

Government Borrowings
Government Borrowing In Recessions : In recessions, government borrowing will increase. This is because: Higher unemployment means less people will be paying income tax Lower consumption levels mean lower VAT and excise duties. Lower company profits mean lower corporation tax Higher unemployment increases cost of social security payments - unemployment benefit, income support, housing benefit e.t.c Falling house and asset prices reduce stamp duties

Government Borrowings
Furthermore, in a recession, government often try to stimulate the economy using expansionary fiscal policy. This could involve: Cutting taxes so people (hopefully) spend more Increasing public sector spending to stimulate aggregate demand

Government Borrowings
Should We Worry about Government Borrowing in a Recession? Apart from the most hardline neo-classical economist, most economists would say that a rise in government borrowing in a recession, is unwelcome but necessary. To balance the budget would cause a much deeper recession. If the government tried to balance the budget through higher taxes and cuts in public spending it would cause a bigger fall in GDP and lead to even lower tax receipts.

Government Borrowings
However this is what the UK did in 1930, exacerbating the Great Depression (unemployment benefits were cut and taxes raised on the advice of 'treasury economists' By borrowing more the government is trying to increase aggregate demand and economic growth. The hope is by preventing a deep recession, they will get better tax revenues in the future. The key thing is that this cyclical deficit should prove temporary. This is different to a structural deficit (when the government is borrowing even with high growth)

Government Borrowings
Problems of borrowing:
May cause crowding out. Government borrow from private sector so private sector have less to spend. Therefore, demand doesn't increase If government cut taxes in a recession, then they need to raise them when the economy recovers and starts to grow. The problem is politicians forget to do this. Its easy to cut taxes, but, then they don't want to reverse the tax cuts or spending increases in times of a boom. If National debt becomes unmanageable, it may cause interest rates to rise, or if the Central bank starts printing money inflation could occur. Will require higher tax rates in the future.

Government Borrowings
Rank Country National Debt ( % GDP ) 241.20 170.40 Year 1 2 Zimbabwe Japan 2008 2008

20 22

Germany United States

62.60 60.80

2008 2007





Deficit Financing
5) Deficit Financing: is the amount by which a government, private company, or individual's spending exceeds income over a particular period of time, also called simply "deficit," or "budget deficit . Budget deficits, surpluses and public debt Budget deficit is spending in excess of revenues, D = G T. To finance the deficit the government can either borrow money or print money. To borrow, it sells securities (IOUs called bonds and bills). If the government already owes money from previous deficits, then this year's deficit adds to the total government debt. Government debt is the total amount owed by the federal government, while the deficit is the amount this debt rises in a single year. Debt is the sum of past deficits minus past surplus

Instruments of Fiscal Policy Contd..

Deficit: good or bad? Deficits might be GOOD for: i) Countercyclical policy ii) Capital expenditures iii) Because the government, believe it or not, is extremely trustworthy, the federal deficit and the corresponding public debt offer a very secure, low risk investment to the financial markets. Banks and others who value safety and security hold onto these safe and secure government securities. There are two reasons why deficits are BAD: The budgetary burden of higher interest payments Crowding out

Crowding-out and Crowding-in Controversy

Crowding-Out: occurs when expansionary fiscal policy causes interest rates to rise, thereby reducing private spending, particularly investment. The mechanism of Crowding-out is simple, when the government takes recourse to deficit spending, it plans to spend more than it tax revenue, it tan has to borrow forms its central bank or from the market through the sale of its bonds. The two methods of borrowing force crowding-out in two different ways: a) Deficit spending through deficit financing b) Deficit spending through market borrowings

Crowding-out and Crowding-in Controversy

Crowding In : An increase in privatesector borrowing (and spending) caused by decreased government borrowing.

What is a budget
Budgets are cost projections They are also a window into how projects will be implemented and managed Well-planned reflects carefully throughout projects

Capital & Revenue Budget

Capital Budget: A separate budget used by state governments for items such as new construction, major renovations, and acquisition of physical property. Capital budgets are different from operating budgets, which cover most other general expenses. Revenue Budget: consists of revenue receipts of government (revenues from tax and other sources) and the expenditure met from these revenues. Tax revenues are made up of taxes and other duties that the Union government levies. The other receipts consist mainly of interest and dividend on investments made by Government, fees, and other receipts for services rendered by Government.

Revenue Deficit, Fiscal Deficit, Primary Deficit

Revenue Deficit: is the excess of revenue expenditure over revenue receipts. It shows the shortfall of governments current receipts over current expenditure. If the capital expenditure and capital receipts are taken into account too, there will be a gap between the receipts and expenditure of a year. This gap constitutes the overall budgetary deficit, and it is covered by the issue of 91-day Treasury Bills, mostly held by the RBI. Fiscal Deficit: The fiscal deficit is the difference between the government's total expenditure and its total receipts (excluding borrowing). The fiscal deficit can be financed by borrowing from the Reserve Bank of India (which is also called deficit financing or money creation) and market borrowing (from the money market, that is mainly from banks).

Revenue Deficit, Fiscal Deficit, Primary Deficit Contd..

Primary deficit: is fiscal deficit minus interest payments. It tells us how much of the government's borrowings are going towards meeting expenses other than interest payments.