What is Fiscal Policy?
Fiscal policy refers to the revenue and expenditure policies of the government and helps to correct the situations of excess and deficient demands. It is also called the budgetary policy of the government.
Components of Fiscal Policy
- Government expenditure is increased to adjust deficient demand and decreased to adjust excess demand.
- Tax burden is decreased to adjust deficient demand and increased to adjust excess demand.
- Public borrowing is increased to adjust excess demand and decreased to adjust deficient demand.
- Borrowing from RBI is increased to adjust deficient demand and decreased to adjust excess demand.
Instruments of Fiscal Policy
The main instruments of fiscal policy are taxation policy and expenditure policy.
- Direct taxes are those taxes whose burden cannot be shifted to the others. Tax on individual income and profits of business enterprises are examples of direct tax. After the reforms, there were reductions in the tax rates of individual income.
- Indirect taxes are those taxes whose burden can be shifted to the others, e.g. tax on commodities. Many reforms are initiated to encourage the taxpayers by lowering the tax rate.
|Direct taxes||Indirect taxes|
|Direct taxes refer to taxes that are really paid by those on whom they are legally imposed.||Indirect taxes refer to taxes that are imposed on an individual but are paid by another person either partly or wholly.|
|The tax burden cannot be shifted to any other individual or firm by the taxpayer.||The tax burden can be shifted by the taxpayer.|
|It is progressive because the tax rate increases with an increase in income slabs.||It is regressive because the common people bear this tax burden.|
|The impact and incidence of tax fall on the same|
|The producer bears the impact and incidence of tax on the consumer.|
Merits & demerits of Direct Tax – Read here
Merits & demerits of Indirect Tax – Read here
Other Kinds of Taxes – Read here
Public expenditure is incurred to maximize the social and economic welfare of the economy. It is incurred to
curb the inequalities of income and wealth in the economy.
Role of public expenditure in economic development:
- The public expenditure on infrastructural development improves the production efficiency of industries and increases employment opportunities.
- It encourages private enterprises by initialising stateowned financial and banking institutions to provide cheap credits.
- It helps in increasing the production of certain essential commodities to end private monopolies and by helping the state start public enterprises.
- It reduces income inequalities through welfare measures such as education and medical facilities.
- The aggregate demand increases with an increase in the public expenditure, thereby the producer receives an incentive to increase the production level. Because of excess demand for these products in the market, the stocks of their goods exhaust completely. Hence, the producers increase the production capacity to maintain the stock. This creates more demand for capital and labour, causing an increase in the level of production. Thus, it leads to an increase in the level of employment within an economy.
- It helps in removing regional disparities.
- It provides financial assistance to producers who establish industries in backward regions.
The State and Economic Development
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