Main instruments or tools of fiscal policy
The government
uses various fiscal instruments or tools in order to achieve rapid economic
growth. The main tools of fiscal policy are grouped under two main heads (i)
Non discretionary controls or measures. (ii) Discretionary fiscal policy.
(i)
Non-discretionary Measures
(1) Automatic or
Built-in Stabilizers: The automatic fiscal stabilizers are those which
contribute to keep economic system in balance without human control. These
controls are built into the economy and so are called built in stabilizers. The
main automatic stabilizers are as follows.
(a) Progressive
income tax: Personal income taxes are the largest source of revenue to the
government. The tax rate, the individuals pay on their rising income is
progressive. When the disposable income of the people increases in the boom
period, the higher amount of the tax reduces disposable income, reduces
consumption and decreases the aggregate demand which helps in curbing economic
boom. A reduction in income tax increases disposable personal income, increases
consumption, increases aggregate demand and thus helps in curbing recession.
The expansionary and contractionary fiscal policies can be summed up and
brought under two approaches.
A) Demand Side
Fiscal Policy.
B) Supply Side Fiscal
Policy.
A) Demand side
policy originated as a direct result of Keynesian belief. According to Keynes
during recession, the goal is to raise aggregate demand to the full employment
level. This objective may be achieved by (1) an increase in government spending
(G) (2) a decrease in tax revenue (T) brought about by reduction in tax rates.
During a period
of rapid inflation the goal is to lower aggregate demand to full employment
level. The fiscal policy will be 1) a decrease in government expenditure 2) an
increase in taxes brought about by rise in the rates.
B) Supply side
policy is a new approach to fiscal policy. The modern economists are of the
view that fiscal policy can also influence the level of economic activity through
their impact on aggregate supply. When the firms experience an increase in
resource costs due to sharp rise in the world price of major raw material say
oil, the higher costs cause a decrease in aggregate supply creating a
recessionary gap. Therefore an expansionary fiscal policy in the form of
reduced corporate taxes and pay roll tax can help in closing the recessionary
gap. Conversely, an increase in the corporate tax rate and pay roll tax etc can
hep in closing inflationary gap.
(b) Unemployment
compensation: In advanced countries of the world people receive unemployment
compensation and other welfare payments when they are not of job. As soon as
they get job these payments are stopped. During boom years, the unemployment
compensation reserve funds help in moderating the inflationary pressure by
curtailing income and consumption. When the economy is contracting
unemployment, consumption and other welfare payments augment the income stream
and they prove a powerful factor in increasing income output and employment in
the country.
(c) Farm Aid
programmes: Farm aid programmes also stabilize against the wave like cyclical
fluctuations. When the prices of the agricultural products are falling and
economy is threatened with depression, government purchases the surplus
products of the farmers at the set prices. The income and total spending of the
agriculturists thus remain stabilized and conration phase is warded off to some
extent. When economy is expanding the government sells these stocks and absorbs
surplus purchasing power. It thus reduces inflationary potential by increasing
the supply of goods and contracting the pressure of too great spending.
(d) Corporate
Savings and Family Savings: The credit of having automatic or built in
stabilizer does not go to the state alone. The corporations and companies and
wise family members too play an important part to contract cyclical
fluctuations. For example, the companies pay a fixed amount every year to the
share holders and with hold the part of dividends of the boom year to pay in
the depression years. Thus holding back some earnings of goods years contracts
the purchasing power and releasing of money in poorer years expands the
purchasing power of the people.
(ii) The
Discretionary Fiscal Policy
By discretionary
policy is meant the deliberate charging of taxes and government spending for
the purpose of off setting cyclical fluctuations in output and employment. The
discretionary fiscal policy has short run as well as long run objectives. Let
us examine these one by one.
Short-run
Counter Cyclical Fiscal Policy: The main weapons or stabilizers of short-run
discretionary fiscal policy are (1) Precautions (2) Changes in tax rates (3)
Varying public works expenditure (4) Credit aids (5) Transfer payments.
(1) Guide Maps:
In a capitalistic society, the entrepreneurs are not aware of each others
investment plans. They therefore in competition with one-another over invest
capital in a particular industry or industries thus cause over production and
unemployment in the economy. Similarly in depression period there is no agency
to guide them. If the government publishes the total investment plans and
marginal efficiency of capital in various industries, much of the investment
can proceed at a moderate sped and there can be stability to some extent in
income, out put and employment.
(2) Change in
Tax Rates: It is an important weapon of fiscal policy for eliminating the
savings of business cycle. When the government finds that planned investment is
exceeding planned savings and the economy is likely to be threatened with
inflationary gap. It increases the rate of taxes. The higher taxes, other thins
remaining the same, reduce the disposable income of people they are forced to
cut down their expenditure. The economy is thus saved from inflationary
situation.
(3) Varying
Public Works Expenditure: Another important factor which influences economic
activity is public expenditure. In times of depression the government can
contribute directly to the income stream by initiating public works programmes
and in boom period it can withdraw funds from the income stream by curtailing
them.
(4) Credit Aids:
The government can also avert depression by offering long term credit aids to
the needy industrialists for starting or expanding the business. It can also
give financial help to insurance companies and bankers to prevent their
failures.
(5) Transfer
Payments: Variation in transfer expenditure programmes can also help in
moderating the business cycle. When the business is brisk the government can
refrain from giving bonuses to the workers and thus can lessen the pressure of
too great spending to some extent. When the economy is in recession, these
pagmerts can be released and more bonuses can be given to stimulate aggregate
effective demand.
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