Page 243 - DECO201_MACRO_ECONOMICS_ENGLISH

Macro Economics

Notes 2. Expansionary stance of fiscal policy involves a net increase in government spending.
3. Contractionary fiscal policy is usually associated with a budget deficit.

14.2 Instruments of Fiscal Policy

Fiscal policy instruments are operated by the government at various levels – Central, State and
Local. The constituents of fiscal policy are discussed in following subsections.

14.2.1 Public Revenue

The government normally raises revenue through taxation: Direct and Indirect. Direct taxes are
imposed on income, wealth and property of the individual or the corporate unit. By contrast, the
indirect taxes are imposed on commodities.

Example: Excise, customs, octroi and sales tax are all examples of indirect tax.
Direct taxes like income tax and wealth tax are geared to ensure distributive justice. This is the
reason we have 'progressive' income tax whereby the rate of tax increases, as income increases.
In case of 'proportional' income tax, the tax and income move together in the same proportion
and same direction; and thus it has no redistributive effect. In case of 'regressive' taxation, the tax
rate comes down as the income increases. It is clear that regressive taxes may induce propensity
to serve and invest, but the egalitarian principle of justice is violated.

Indirect taxes are normally used for revenue raising purpose. If a very thin burden of taxes is
spread widely over a large number of commodities, a huge amount of revenue can be easily
raised; this is the reason a Minimum Alternative Tax (MAT) was introduced in our country.
Administrating a tax system and structure is a managerial problem. If the cost of administering
a tax is larger than the revenue it raises, then it is uneconomic. Similarly, the norms of 'simplicity'
and 'convenience' must be satisfied along with 'economy' as 'Cannons' of a good tax system.
Sometimes, it is argued that indirect taxes are inflationary in nature, because those taxes
immediately raise the cost of supply and may discourage production. Of course, if such taxes are
imposed on 'non-merit goods', then social benefits outweigh social costs; the production loss
and supply rigidity in those cases do stand justified. In fact, indirect taxes are often used to
ensure allocative efficiency in the process of utilisation of scarce resources, keeping public good
in mind.
If taxes do not suffice to raise sufficient revenue for the government, then non-tax revenue may
be raised through sources like profits of public enterprises, disinvestment of shares of public
sector undertakings or even borrowing from the public internally or raising loans externally.

14.2.2 Public Expenditure

Revenues are raised towards financing public expenditure. This is called 'functional finance'.
In present days, the government has to spend money on defence and development. Maintaining
internal law and order and country's sovereignty involves huge expenditure. Some economists
feel that these are unproductive consumption expenditure, but there is no escape. Sometimes
war like situation may force the government to divert resources from development to
non-development expenditure, from planned to non-planned expenditure. Development
expenditures are supposed to be productive in the long run. In the short run, such investment
oriented public expenditures may release inflationary forces, because income generated may
not be by immediate supply of output.

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