ECONOMICS PROJECT

Name of Student: Radhika Vaid

Class: XII Section: E

Roll No:
 ACKNOWLEDGEMENT

I would like to express my gratitude to the

School Director Ms. Sudha Goyal and my
Economics teacher Ms. Neha Bansal for guiding
me throughout the completion of this project. I
would also like to thank my family and my
friends for supporting me and for helping me
carry out this project work. This project would
not be as it is now if not for them.
INDEX
 Acknowledgement
 Introduction
 Meaning of Fiscal Policy
 Types of Fiscal Policy

1) Expansionary Fiscal Policy

2) Contractionary Fiscal Policy

 Components and sub-Components of Fiscal Policy

1) Budget
2) Taxation
3) Public Expenditure
4) Public Works
5) Public Debt

 How does Fiscal Policy effect an Economy?

 Conclusion
 Bibliography
 INTRODUCTION
Fiscal policy is concerned with the use of taxes and government expenditures.
Government has to meet various expenditures like salaries, defense expenses,
 infrastructure development, etc. Another part of government expenditure also goes in
the form of transfer payments like financial assistance to the elderly and unemployed.
All these expenses leave a positive effect on the overall economy. The impact of
government spending is also felt on the overall spending in the economy, thus
influencing the size of the GDP.
 The other part of the fiscal policy is generation of revenues for the government. Taxes
are the main source of revenue for any government. Taxes affect the economy and the
individuals in two ways. First, taxes imposed on the income of the people bring down
the disposable income in the hands of the consumers. This reduces the spending in the
economy. Second, the taxes levied on goods and services make them costlier. This
discourages the firm to invest in capital goods
 Fiscal Policy is a counter cyclical policy that involves a government determining and
applying spending activity and taxation rates to achieve certain economic objectives that
is better for the economy as a whole. Fiscal Policy is designed to effectively influence the
reallocation of resources, the redistribution of income and stabilisation of economic
activity. The policy is the only arm of macroeconomic policy that is directly controlled by
the government and how the government implements fiscal policy is depicted through
the Commonwealth Budget showing the planned spending and revenue for the next
financial year.
MEANING OF FISCAL POLICY
Fiscal policy is what the government employs to influence and balance the economy, using
taxes and spending to accomplish this. Fiscal policy tries to nudge the economy in different
ways through either expansionary or contractionary policy, which try to either increase
economic growth through taxes and spending or slow economic growth to cutback inflation,
respectively. Basically, fiscal policy intercedes in the business cycle by counteracting issues in an
attempt to establish a healthier economy, and uses two tools - taxes and spending - to
accomplish this. Fiscal policy is often utilized alongside monetary policy, which involves the
banking system, the management of interest rates and the supply of money in circulation. The
main goals of fiscal policy are to achieve and maintain full employment, reach a high rate of
economic growth, and to keep prices and wages stable. But fiscal policy is also used to curtail
inflation, increase aggregate demand and other macroeconomic issues. In expansionary fiscal
policy (which is the most common method employed), the government implements policies
that can increase or decrease taxes, spend money on projects to stimulate the economy and
increase employment, or increase productivity levels in the economy.
TYPES OF FISCAL POLICY
Separate from monetary policy, fiscal policy mainly focuses on increasing or cutting taxes and
increasing or decreasing spending on various projects or areas. But, depending on the signals
from the current state of the economy, fiscal policy may focus more on restricting economic
growth (often done to mediate inflation), or attempt to expand economic growth by reducing
taxes, encouraging borrowing and spending, or spending on projects to stimulate the economy
or increase employment. Expansionary Fiscal Policy and Contractionary Fiscal Policy accomplish
these tasks.
Expansionary Fiscal Policy

Expansionary fiscal policy is used by the government when attempting to balance out
the contraction phase of the business cycle (especially when in or on the brink of a
recession), and uses methods like cutting taxes or increasing government spending on
things like public works in an attempt to stimulate economic growth. Expansionary fiscal
policy, therefore, attempts to fix a decrease in demand by giving consumers tax cuts
and other incentives to increase their purchasing power (and, how much they
spend). The goal behind expansionary fiscal policy is to lower tax rates and increase
consumer aggregate demand, which will increase demand for products, requiring
businesses to hire more employees to support the higher demand - and thus, increase
employment.

Contractionary Fiscal Policy

On the other hand, contractionary fiscal policy entails increasing tax rates and
decreasing government spending in hopes of slowing economic growth for various
reasons. In this way, the government may deem it necessary to halt or deter economic
growth if inflation caused by increased supply and demand of cash gets out of hand. In
this manner, contractionary fiscal policy reduces the amount of money in circulation,
and, therefore - the amount available for consumers to spend. If an economy is
booming and growing too rapidly (as may be caused by expansionary fiscal policy) -
which, according to normal rates, should be no more than 3% per year - contractionary
fiscal policy may be required to right it. So, contractionary fiscal policy is often employed
when the growth of the economy is unsustainable and is causing inflation, high
investment prices, unemployment below healthy levels and recession. However,
because the point of contractionary fiscal policy is to reduce the amount of money in
circulation and allow the economy to grow at a healthier rate, it is often very unpopular
due to how it generally increases taxes, cuts or reduces subsidy and welfare programs,
or cuts government jobs. And, this unpopularity often leads to an increase in the budget
deficit via the government issuing more treasury bonds - which, given the imbalance of
GDP to debt, will cause interest rates to increase due to how holders of the treasury
bonds become anxious over not being repaid by the indebted government. Still,
increased interest rates simply perpetuate many of the problems.
COMPONENTS AND SUB COMPONENTS OF FISCAL POLICY
A. Budget:
The budget of a nation is a useful instrument to assess the fluctuations in an economy.

Different budgetary principles have been formulated by the

economists, prominently known as:
(1) Annual budget,

(2) cyclical balanced budget and

(3) fully managed compensatory budget.

1. Annual Balanced Budget:

The classical economists propounded the principle of annually balanced budget. They
defended it with force till the deep-rooted crisis of 1930’s.

2. Cyclically Balanced Budget:

The cyclical balanced budget is termed as the ‘Swedish budget’. Such a budget implies
budgetary surpluses in prosperous period and employing the surplus revenue receipts
for the retirement of public debt. During the period of recession, deficit budgets are
prepared in such a manner that the budget surpluses during the earlier period of
inflation are balanced with deficits.

The excess of public expenditure over revenues are financed through public borrowings.
The cyclically balanced budget can stabilize the level of business activity. During
inflation and prosperity, excessive spending activities are curbed with budgetary
surpluses while budgetary deficits during recession with raising extra purchasing power.

3. Fully Managed Compensatory Budget:

This policy implies a deliberate adjustment in taxes, expenditures, revenues and public
borrowings with the motto of achieving full employment without inflation. It assigns
only a secondary role to the budgetary balance. It lays down the emphasis on
maintenance of full employment and stability in the price level. With this principle, the
growth of public debt and the problem of interest payment can be easily avoided. Thus,
the principle is also called ‘functional finance.’

B. Taxation:

Taxation is a powerful instrument of fiscal policy in the hands of public authorities

which greatly affect the changes in disposable income, consumption and investment. An
anti- depression tax policy increases disposable income of the individual, promotes
consumption and investment. Obviously, there will be more funds with the people for
consumption and investment purposes at the time of tax reduction.

This will ultimately result in the increase in spending activities i.e., it will tend to
increase effective demand and reduce the deflationary gap. In this regard, sometimes, it
is suggested to reduce the rates of commodity taxes like excise duties, sales tax and
import duty. As a result of these tax concessions, consumption is promoted. Economists
like Hansen and Musgrave, with their eye on raising private investment, have
emphasized upon the reduction in corporate and personal income taxation to overcome
contractionary tendencies in the economy.

Now, a vital question arises about the extent to which unemployment is reduced or
mitigated if a tax reduction stimulates consumption and investment expenditure. In
such a case, reduction of unemployment is very small. If such a policy of tax reduction is
repeated, then consumers and investors both are likely to postpone their spending in
anticipation of a further fall in taxes. Furthermore, it will create other complications in
the government budget.
 TYPES OF TAXES

Direct Tax

It is a tax levied directly on a taxpayer who pays it to the Government and cannot pass it
on to someone else.

Indirect Tax

It is a tax levied by the Government on goods and services and not on the income, profit
or revenue of an individual and it can be shifted from one taxpayer to another. Earlier,
an indirect tax meant paying more than the actual price of a product bought or a service
acquired. And there was a myriad of indirect taxes imposed on taxpayers.

Regressive Tax

 A regressive tax is a type of tax that is assessed regardless of income, in which

low- and high-income earners pay the same dollar amount.

 This kind of tax is a bigger burden on low-income earners than high-income

earners, for whom the same dollar amount equates to a much larger percentage
of total income earned.

 A regressive system differs from a progressive system, in which higher earners

pay a higher percentage of income tax than lower earners.

 In the U.S. and certain other developed nations, a progressive tax is applied to
income, but other taxes are levied uniformly, such as sales tax and user fees.
Progressive Tax

 A progressive tax is a tax system that increases rates as the taxable income goes
up.

 Examples of progressive tax include investment income taxes, tax on interest

earned, rental earnings, estate tax, and tax credits.

 The opposite of the progressive system is the regressive tax rate where tax
liability reduces as the taxable amount increases.

Proportional Tax

 A proportional tax system, also referred to as a flat tax system, assesses the same
tax rate on everyone regardless of income or wealth.

 Proportional taxation is intended to create greater equality between marginal tax

rates and average tax rates paid.

 Proponents of proportional taxes believe they stimulate the economy by

encouraging people to spend more and work more because there is no tax penalty
for earning more.

C. Public Expenditure:

The active participation of the government in economic activity has brought public
spending to the front line among the fiscal tools. The appropriate variation in public
expenditure can have more direct effect upon the level of economic activity than even
taxes. The increased public spending will have a multiple effect upon income, output
and employment exactly in the same way as increased investment has its effect on them.
Similarly, a reduction in public spending, can reduce the level of economic activity
through the reverse operation of the government expenditure multiplier.

(i) Public Expenditure in Inflation:

During the period of inflation, the basic reason of inflationary pressures is the excessive
aggregate spending. Both private consumption and investment spending are abnormally
high. In these circumstances, public spending policy must aim at reducing the
government spending. In other words, some schemes should be abandoned and others
be postponed. It should be carefully noted that government spending which is of
productive nature, should not be shelved, since that may aggravate the inflationary
dangers further.
However, reduction in unproductive channels may prove helpful to curb inflationary
pressures in the economy. But such a decision is really difficult from economic and
political point of view. It is true, yet the fiscal authority can vary its expenditure to
overcome inflationary pressures to some extent.

(ii) Public Expenditure in Depression:

In depression, public spending emerges with greater significance. It is helpful to lift the
economy out of the morass of stagnation. In this period, deficiency of demand is the
result of sluggish private consumption and investment expenditure. Therefore, it can be
met through the additional doses of public expenditure equivalent to the deflationary
gap. The multiplier and acceleration effect of public spending will neutralize the
depressing effect of lower private spending’s and stimulate the path of recovery.

D. Public Works:
Keynes General Theory highlighted public works programme as the most significant
anti-depression device. There are two forms of expenditure i.e., Public Works and
‘Transfer Payments. Public Works according to Prof. J.M. Clark, are durable goods,
primarily fixed structure, produced by the government.

They include expenditures on public works as roads, rail tracks, schools, parks,
buildings, airports, post offices, hospitals, irrigation canals etc. Transfer payments are
the payments such like interest on public debt, subsidy, pension, relief payment,
unemployment, insurance and social security benefits etc. The expenditure on capital
assets (public works) is called capital expenditure.

Keynes had strong faith in such a programme that he went to the extent of saying that
even completely unproductive projects like the digging up of holes and filling them up
are fully admissible.

Public works are supported as an anti-depression device on the

following grounds:
(i) They absorb hitherto unemployed workers.

(ii) They increase the purchasing power of the community and thereby stimulate the
demand for consumption goods.

(iii)They help to create economically and socially useful capital assets as roads, canals,
power plants, buildings, irrigation, training centers and public parks etc.

(iv) They provide a strong incentive for the growth of industries which are generally hit
by the state of depression.

(v) They help to maintain the moral and self-respect of the work force and make use of
the skill of unemployed people.

(vi) The public works do not have an offsetting effect upon private investment because
these are started at a time when private investment is not forthcoming.

The above stated points are, therefore, the evidence that public works programme fully
satisfies, the main criteria as laid down for public expenditure.

E. Public Debt:
Public debt is a sound fiscal weapon to fight against inflation and deflation. It brings
about economic stability and full employment in an economy.

The government borrowing may assume any of the following

forms mentioned as under:
(a) Borrowing from Non-Bank Public:
When the government borrows from non-bank public through sale of bonds, money
may flow either out of consumption or saving or private investment or hoarding. As a
result, the effect of debt operations on national income will vary from situation to
situation. If the bond selling schemes of the government are attractive, the people
induce to curtail their consumption, the borrowings are likely to be non-inflationary.

When the money for the purchase of bonds flows from already existing savings, the
borrowing may again be non-inflationary. Has the government not been borrowing,
these funds would have been used for private investment, with the result that the debt
operations by the government will simply bring about a diversion of funds from one
channel of spending to another with the similar quantitative effects on national income.

If the government bonds are purchased by non-bank individuals and institutions by

drawing upon their hoarded money, there will be net addition to the circular flow of
spending. Consequently, the inflationary pressures are likely to be created. But funds
from this source are not commonly available in larger quantity. Its main implication is
that borrowings from non-bank public is more advantageous in an inflationary period
and undesirable in a depression phase. In short, the borrowing from non-bank public
are not of much significant magnitude whether it comes out of consumption, saving,
private investment or hoarding.

(b) Borrowing from Banking System:

The government may also borrow from the banking institutions. During the period of
depression, such borrowings are highly effective. In this period, banks have excessive
cash reserves and the private business community is not willing to borrow from banks
since they consider it unprofitable.

When unused cash lying with banks is lent out to government, it causes a net addition to
the circular flow and tend to raise national income and employment. Therefore,
borrowing from banking institution have desirable and favourable effect specially in the
period of depression when the borrowed money is spent on public works programmes.

On the contrary, borrowing from this source dry up almost completely in times of brisk
business activities i.e., boom. Actually, demand is very high during inflation period,
since profit expectation is high in business. The banks, being already loaded up and
having no excess cash reserves. Find it difficult to lend to the government. If it is done, it
is only through reducing their loans somewhere else.
This leads to a fall in private investment. As the government spending is off-set by a
reduction in private investment, there will be no net effect upon national income and
employment. In nut shell, borrowing from banking institutions have desirable effect
only in depression and is undesirable or with a neutral effect during inflation period.

(d) Printing of Money:

Printing of money i.e., deficit financing is another method of public expenditure for
mobilizing additional resources in the hands of government. As new money is printed, it
results in a net addition to the circular flow. Thus, this form of public borrowing is said
to be highly inflationary.

Deficit financing has a desirable effect during depression as it helps to raise the level of
income and employment but objection is often raised against its use at the time of
inflation or boom. Here, it must be added that through this device, the government not
only gets additional resources at minimum cost but can also create appropriate
monetary effects like low interest rates and easy money supply and consequently
economic system is likely to register a quick revival.

HOW DOES FISCAL POLICY EFFECT AN ECONOMY?

IMPACT ON ECONOMIC GROWTH

Fiscal policy is an important tool for managing the economy because of its ability to affect the
total amount of output produced—that is, gross domestic product. The first impact of a fiscal
expansion is to raise the demand for goods and services. This greater demand leads to
increases in both output and prices.

IMPACT ON INFLATION
The goal of fiscal stimulus is to increase aggregate demand within the economy. However, if
fiscal stimulus is applied too aggressively or is implemented when the economy is already
operating near full capacity, it can result in an unsustainably large demand for goods and
services that the economy is unable to supply. When the demand for goods and services is
greater than the available supply, prices tend to rise, a scenario known as inflation. A rising
inflation rate can introduce distortions into the economy and impose unnecessary costs on
individuals and businesses, although economists generally view low and stable inflation as a
sign of a well managed economy. As such, rising inflation rates can hinder the effectiveness of
fiscal stimulus on economic activity by imposing additional costs on individuals and interfering
with the efficient allocation of resources in the economy.

IMPACT ON ECONOMIC STABILITY

To measure whether fiscal policy contributes to stability, the Fiscal Monitor introduces the
novel concept of the fiscal stabilization coefficient (FISCO). FISCO measures how much a
country’s overall budget balance changes in response to a change in economic slack (as
measured by the output gap).

If FISCO is equal to 1 it means that when output falls below potential by 1% of GDP, the overall
balance worsens by the same percentage of GDP. The higher the FISCO, the more counter-
cyclical is the conduct of fiscal policy, where governments build fiscal buffers in good times that
they can then rely on during bad times. The average FISCO among advanced economies is 0.7,
with considerable cross-country differences (see figure 1).

The FISCO takes into account the fact

that many revenue and expenditure
items respond to the state of the
economy even though the
underlying provisions or programs
were primarily designed for other
reasons. Monitoring the relationship
between the budget balance and the
output gap would help policymakers
understand how much their action
contributes to output stability,
including in comparison to other
countries.

IMPACT ON UNEMPLOYMENT
Fiscal policy can decrease unemployment by helping to increase aggregate demand and the
rate of economic growth. The government will need to pursue expansionary fiscal policy; this
involves cutting taxes and increasing government spending. Lower taxes increase disposable
income (e.g. VAT cut to 15% in 2008) and therefore help to increase consumption, leading to
higher aggregate demand (AD).
With an increase in AD, there will be an increase in Real GDP (as long as there is spare capacity
in the economy.) If firms produce more, there will be an increase in demand for workers and
therefore lower demand-deficient unemployment. Also, with higher aggregate demand and
strong economic growth, fewer firms will go bankrupt meaning fewer job losses. In a recession,
resources (both capital and labour) are idle. Therefore, the government should intervene and
create additional demand to reduce unemployment.

CONCLUSION
The Fiscal Policy encompasses wo separate but related decisions; public expenditures and the
level and structure of taxes. It occupies the central place for maintaining full employment
without inflationary forces in the economy. With its various instruments it influences the
economic stability of an economy.

The objectives of fiscal policy such as economic development, price stability, social justice etc.
can be achieved only if the tools of policy like Public Expenditure, taxation, Borrowing and
deficit financing are effectively used. The success of fiscal Policy depends upon taking timely
measures and their effective administration during implementation.

The fiscal policy of the Indian government has been very successful in several fields such as
mobilization of resources for economic development, increasing rate of savings and capital
formation, developing cottage and small scale industries, reducing the incidence of poverty.
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1) https://www.economicsdiscussion.net

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6) https://www.jagranjosh.com/

7) https://www.vskills.in/

8) https://fas.org/sgp/crs/misc/R45723.pdf