Objectives and Instruments of Fiscal Policy

The word fiscal comes from a French word Fisc, which means treasure of Government. All the taxation and expenditure decisions of the government comprise the Fiscal Policy.

Fiscal Policy is different from monetary policy in the sense that monetary policy deals with the supply of money and rate of interest. The government and RBI use these two policies to steer the broad aspects of the Indian Economy. While government is conducts Fiscal Policy, RBI is responsible for monetary policy. RBI also helps the government in implementing its fiscal policy decisions.

Conducting fiscal policy is one of the main duties of the government. Via fiscal policy, the government collects money from different resources and utilizes it for different expenditures. Since all welfare projects are carried out under public expenditures, fiscal policy is closely related to the development policy.

Objectives of Fiscal Policy

The objectives of the fiscal policy of the government are as follows:

Resource Mobilization

Fiscal policy allows the government to mobilize resources for public expenditure and development. There are three ways of resource mobilization viz. taxation, public savings and private savings through issue of bonds and securities.

Resource Allocation

The funds mobilized under fiscal policy are further allocated for development of social and physical infrastructure. For example, the government collected tax revenues are allocated to various ministries to carry out their schemes for development.

Redistribution of Income

The taxes collected from rich people are spent on social upliftment of the poor and this fiscal policy in a welfare state tried to reduce inequalities of income using resource allocation.

Price stability, control of Inflation, Employment generation

Government uses fiscal measures such as taxation and public expenditure to stabilize the prices and control inflation. Government also generates employment by speeding infrastructure development.

Balanced Regional Development

A large part of the government tax revenues are given out to less developed states as statutory and discretionary grant. This helps in the balanced regional development of the country.

Balance of Payments

Using fiscal policy measures government tries to promote exports to earn foreign exchange. This helps in maintaining favourable balance of trade and balance of payments.

Capital Formation and National Income

Fiscal policy measures help in increasing the capital formation and economic growth. Increased capital formation leads to increase in national income al

Components of Fiscal Policy

There are four key components of Fiscal Policy are as follows:

  • Taxation Policy
  • Expenditure Policy
  • Investment & Disinvestment policy
  • Debt / surplus management.
Taxation Policy

We have already discussed in detail about the taxation policy in previous module. The government gets revenue from direct and indirect taxes. Via its fiscal policy, government aims to keep the taxes as much progressive as possible. Further, judicious taxation decisions are very important for economy because of two reasons:

  • Higher than usual tax rate will reduce the purchasing power of people and will lead to an decrease in investment and production.
  • Lower than usual tax rates would leave more money with people to spend and this would lead to inflation.

Thus, the government has to make a balance and impose correct tax rate for the economy.

Expenditure Policy

Expenditure policy of the government deals with revenue and capital expenditures. These expenditures are done on areas of development like education, health, infrastructure etc. and to pay internal and external debt and interest on those debts. Government budget is the most important instrument embodying expenditure policy of the government. The budget is also used for deficit financing i.e. filling the gap between Government spending and income.

Investment and Disinvestment Policy

Optimum levels of domestic as well as foreign investment are needed to maintain the economic growth. In recent years, the importance of FDI has increased dramatically and has become an instrument of integrating the domestic economies with global economy.

Debt / Surplus Management

If the government received more than it spends, it is called surplus. If government spends more than income, then it is called deficit. To fund the deficit, the government has to borrow from domestic or foreign sources. It can also print money for deficit financing.

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