Bimo Danu Priambudi

C1J014019

PUBLIC FINANCE II

Top 8 Objectives of Fiscal Policy

Fiscal policy must be designed to be performed in two ways-by expanding investment
in public and private enterprises and by diverting resources from socially less desirable to
more desirable investment channels. The objective of fiscal policy is to maintain the
condition of full employment, economic stability and to stabilize the rate of growth. For an
under-developed economy, the main purpose of fiscal policy is to accelerate the rate of
capital formation and investment. Therefore, fiscal policy in under-developed countries has a
different objective to that of advanced countries.

Generally following are the objectives of a fiscal policy in a developing economy:

1. Full Employment:
The first and foremost objective of fiscal policy in a developing economy is to
achieve and maintain full employment in an economy. In such countries, even if full
employment is not achieved, the main motto is to avoid unemployment and to achieve a state
of near full employment. Therefore, to reduce unemployment and under-employment, the
state should spend sufficiently on social and economic overheads. These expenditures would
help to create more employment opportunities and increase the productive efficiency of the
economy.

2. Price Stability:
There is a general agreement that economic growth and stability are joint objectives
for underdeveloped countries. In a developing country, economic instability is manifested in
the form of inflation. Prof. Nurkse believed that “inflationary pressures are inherent in the
process of investment but the way to stop them is not to stop investment. They can be
controlled by various other ways of which the chief is the powerful method of fiscal policy.”

Therefore, in developing economies, inflation is a permanent phenomena where there

is a tendency to the rise in prices due to expanding trend of public expenditure. As a result of
rise in income, aggregate demand exceeds aggregate supply. Capital goods and consumer
goods fail to keep pace with rising income.

Thus, these result in inflationary gap. The price rise generated by demand pull
reinforced by cost push inflation leads to further widening the gap. The rise in prices raises
demand for more wages. This further gives rise to repeated wage-price spirals. If this
situation is not effectively controlled, it may turn into hyper inflation.
 In short, fiscal policy should try to remove the bottlenecks and structural rigidities
which cause imbalance in various sectors of the economy. Moreover, it should strengthen
physical controls of essential commodities, granting of concessions, subsidies and protection
in the economy. In short, fiscal measures as well as monetary measures go side by side to
achieve the objectives of economic growth and stability.

4. Optimum Allocation of Resources:

Fiscal measures like taxation and public expenditure programmes, can greatly affect
the allocation of resources in various occupations and sectors. As it is true, the national
income and per capita income of underdeveloped countries is very low. In order to gear the
economy, the government can push the growth of social infrastructure through fiscal
measures. Public expenditure, subsidies and incentives can favorably influence the allocation
of resources in the desired channels.

Tax exemptions and tax concessions may help a lot in attracting resources towards the
favored industries. On the contrary, high taxation may draw away resources in a specific
sector. Above all, direct curtailment of consumption and socially unproductive investment
may be helpful in mobilization of resources and the further check of the inflationary trends in
the economy. Sometimes, the policy of protection is a useful tool for the growth of some
socially desired industries in an under-developed country.

5. Equitable Distribution of Income and Wealth:

It is needless to emphasize the significance of equitable distribution of income and
wealth in a growing economy. Generally, inequality in wealth persists in such countries as in
the early stages of growth, it concentrates in few hands. It is also because private ownership
dominates the entire structure of the economy. Besides, extreme inequalities create political
and social discontentment which further generate economic instability. For this, suitable
fiscal policy of the government can be devised to bridge the gap between the incomes of the
different sections of the society.

To reduce inequalities and to do distributive justice, the government should invest in

those productive channels which incur benefit to low income groups and are helpful in raising
their productivity and technology. Therefore, redistributive expenditure should help
economic development and economic development should help redistribution.

6. Economic Stability:
 Fiscal measures, to a larger extent, promote economic stability in the face of short-run
international cyclical fluctuations. These fluctuations cause variations in terms of trade,
making the most favourable to the developed and unfavorable to the developing economies.
So, for the purpose of bringing economic stability, fiscal methods should incorporate built-in-
flexibility in the budgetary system so that income and expenditure of the government may
automatically provide compensatory effect on the rise or fall of the nation’s income.

Therefore, fiscal policy plays a leading role in maintaining economic stability in the
face of internal and external forces. The instability caused by external forces is corrected by a
policy, popularly known as ‘tariff policy’ rather than aggregative fiscal policy. In the period
of boom, export and import duties should be imposed to minimize the impact of international
cyclical fluctuations.

To curb the use of additional purchasing power, heavy import duty on consumer
goods and luxury import restrictions are essential. During the period of recession,
government should undertake public works programmes through deficit financing. In nut
shell, fiscal policy should be viewed from a larger perspective keeping in view the balanced
growth of various sectors of the economy.

7. Capital Formation and Growth:

Capital assumes a central place in any development activity in a country and fiscal
policy can be adopted as a crucial tool for the promotion of the highest possible rate of capital
formation. A newly developing economy is encompassed by a ‘vicious circle of poverty’.
Therefore, a balanced growth is needed to breakdown the vicious circle which is only feasible
with higher rate of capital formation. Once a country comes out of the clutches of
backwardness, it stimulates investment and encourage capital formation.

8. To Encourage Investment:
Fiscal policy aims at the acceleration of the rate of investment in the public as well as
in private sectors of the economy. Fiscal policy, in the first instance, should encourage
investment in public sector which in turn effect to increase the volume of investment in
private sector. In other words, fiscal policy should aim at rapid economic development and
must encourage investment in those channels which are considered most desirable from the
point of view of society.

It should aim at curtailing conspicuous consumption and investment in unproductive

channels. In the early stages of economic development, the government must try to build up
economic and social overheads such like transport and communication, irrigation, flood
control, power, ports, technical training, education, hospital and school facilities, so that they
may provide external economies to induce investment in industrial and agricultural sectors of
the economy.

These economies will be helpful for widening the size of the market, reducing the cost
of production and increasing the social marginal productivity of investment. Here it must be
remembered that projects of social marginal productivity should wisely be selected keeping
in view its practical implication.

Economic Policy

The economic policy of governments covers the systems for setting levels
of taxation, government budgets, the money supply and interest rates as well as the labor
market, national ownership, and many other areas of government interventions into the
economy. Most factors of economic policy can be divided into either fiscal policy, deals with
government actions regarding taxation and spending, or monetary policy, which deals with
central banking actions regarding the money supply and interest rates. Such policies are often
influenced by international institutions like the International Monetary Fund or World
Bank as well as politicalbeliefs and the consequent policies of parties.

Types Of Economic Policy

almost every aspect of government has an important economic component. A few

examples of the kinds of economic policies that exist include:

 Macroeconomic stabilization policy, which attempts to keep the money supply growing
at a rate that does not result in excessive inflation, and attempts to smooth out
the business cycle.
 Trade policy, which refers to tariffs, trade agreements and the international institutions
that govern them.
 Policies designed to create economic growth
 Policies related to development economics
 Policies dealing with the redistribution of income, property and/or wealth
 As well as: regulatory policy, anti-trust policy, industrial policy and technology-based
economic development policy
 Macroeconomic Stabilization Policy

Stabilization policy attempts to stimulate an economy out of recession or constrain

the money supply to prevent excessive inflation.

 Fiscal policy, often tied to Keynesian economics, uses government spending and taxes to
guide the economy.
 Fiscal stance: The size of the deficit or surplus
 Tax policy: The taxes used to collect government income.
 Government spending on just about any area of government
 Monetary policy controls the value of currency by lowering the supply of money to
control inflation and raising it to stimulate economic growth. It is concerned with the
amount of money in circulation and, consequently, interest rates and inflation.
 Interest rates, if set by the Government
 Incomes policies and price controls that aim at imposing non-monetary controls on
inflation
 Reserve requirements which affect the money multiplier

Tools and Goals

Policy is generally directed to achieve particular objectives, like targets

for inflation, unemployment, or economic growth. Sometimes other objectives, like military
spending or nationalization are important. These are referred to as the policy goals: the
outcomes which the economic policy aims to achieve.

To achieve these goals, governments use policy tools which are under the control of
the government. These generally include the interest rate and money supply, tax and
government spending, tariffs, exchange rates, labor market regulations, and many other
aspects of government.

Public Finance

Public finance is the study of the role of the government in the economy.[1] It is the
branch of economics which assesses the government revenue and government expenditure of
the public authorities and the adjustment of one or the other to achieve desirable effects and
avoid undesirable ones.
The purview of public finance is consideredto be threefold: governmental effects on
(1) efficient allocation of resources, (2) distribution of income, and (3) macroeconomic
stabilization.

The proper role of government provides a starting point for the analysis of public
finance. In theory, under certain circumstances, private markets will allocate goods and
services among individuals efficiently (in the sense that no waste occurs and that individual
tastes are matching with the economy's productive abilities). If private markets were able to
provide efficient outcomes and if the distribution of income were socially acceptable, then
there would be little or no scope for government. In many cases, however, conditions for
private market efficiency are violated. For example, if many people can enjoy the same good
at the same time (non-rival, non-excludable consumption), then private markets may supply
too little of that good. National defense is one example of non-rival consumption, or of
a public good.

Market failure occurs when private markets do not allocate goods or services
efficiently. The existence of market failure provides an efficiency-based rationale for
collective or governmental provision of goods and services.[3] Externalities, public goods,
informational advantages, strong economies of scale, and network effects can cause market
failures. Public provision via a government or a voluntary association, however, is subject to
other inefficiencies, termed "government failure."

Under broad assumptions, government decisions about the efficient scope and level of
activities can be efficiently separated from decisions about the design of taxation systems
(Diamond-Mirlees separation). In this view, public sector programs should be designed to
maximize social benefits minus costs (cost-benefit analysis), and then revenues needed to pay
for those expenditures should be raised through a taxation system that creates the fewest
efficiency losses caused by distortion of economic activity as possible. In practice,
government budgeting or public budgeting is substantially more complicated and often
results in inefficient practices.

Government can pay for spending by borrowing (for example, with government
bonds), although borrowing is a method of distributing tax burdens through time rather than a
replacement for taxes. A deficit is the difference between government spending and revenues.
The accumulation of deficits over time is the total public debt. Deficit finance allows
governments to smooth tax burdens over time, and gives governments an important fiscal
policytool. Deficits can also narrow the options of successor governments.

Public finance is closely connected to issues of income distribution and social equity.
Governments can reallocate income through transfer payments or by designing tax systems
that treat high-income and low-income households differently. The public choice approach to
public finance seeks to explain how self-interested voters, politicians, and bureaucrats
actually operate, rather than how they should operate.

National budget

A government budget is an annual financial statement presenting the government's

proposed revenues and spending for a financial year that is often passed by the legislature,
approved by the chief executive or president and presented by the Finance Minister to the
nation. The budget is also known as the Annual Financial Statement of the country. This
document estimates the anticipated government revenues and government expenditures for
the ensuing (current) financial year.[1] For example, only certain types of revenue may be
imposed and collected. Property tax is frequently the basis for municipal and county
revenues, while sales tax and/or income tax are the basis for state revenues, and income
tax and corporate tax are the basis for national revenues.

Types

overnment budgets are of the following types:

 Union Budget : The union budget is the budget prepared by the central government for
the country as a whole.
 State Budget : In countries like India, there is a federal system of government thus every
state prepares its own budget.
 Plan Budget: It is a document showing the budgetary provisions for important projects,
programmes and schemes included in the central plan of the country. It also shows the
central assistance to states and union territories.
 Performance Budget: The central ministries and departments dealing with development
activities prepare performance budgets, which are circulated to members of parliament.
These performance budgets present the main projects,programmes and activities of the
government in the light of specific objectives and previous years' budgets and
achievements.
 Supplementary Budget: This budget forecasts the budget of the coming year with regards
to revenue and expenditure.
 Zero-Based Budget: This is defined as the budgetary process which requires each
ministry/department to justify its entire budget in detail. It is a system of budget in which
all government expenditures must be justified for each new period.

Elements

The two basic elements of any budget are the revenues and expenses. In the case of
the government, revenues are derived primarily from taxes. Government expenses include
spending on current goods and services, which economists call government
consumption; government investment expenditures such as infrastructure investment or
research expenditure; and transfer payments like unemployment or retirement benefits.

Classification

A budget can be of 3 types:

 Balanced Budget: When government receipts are equal to the government

expenditure, it is called a balanced budget.
 Deficit Budget: When government expenditure exceeds government receipts, the
budget is said to be deficit. A deficit can be of 3 types, Revenue, Fiscal and Primary
deficit.
 Surplus: When government receipts are more than expenditure.

A budget can be classified in 2 categories which are:

 according to Function
 according to Flexibility