Page 245 - DECO201_MACRO_ECONOMICS_ENGLISH

Macro Economics

Notes 6. In a ........................ taxation system, the tax rate comes down as income increases.
7. Expenditure on defence and subsidies are classified as ........................ expenditures.
8. When public expenditure is more than the revenue collected, we have a ........................ .

14.3 Transmission of Fiscal Policy

Fiscal policy is a potent tool in the hands of Govt. to regulate the economic growth. As deficit
financing is the very effective tool in the hands of the govt. for increasing effective demand in
recession. To fill the deficit as Govt. borrows from RBI, Market and even create additional
currency and then spends it which increases the disposable income of people thus results in
favourable environment for investment. Market mechanism of an underdeveloped economy is
not likely to be able to generate enough of savings and investment needed for a rapid economic
growth. Fiscal policy plays a leading role in effecting savings in the economy. Budgets play a
direct role in capital accumulation and economic growth in an underdeveloped country. Saving
potential in an underdeveloped economy is very limited partly because of shortage of several
specific resources, partly due to lack of adequate demand, partly because of high cost of production.
This vicious circle can be broken by the govt. with the help of saving oriented budgets.
Through the fiscal policy govt. can also encourage the growth of particular industries and in
particular areas. For this industries are provided with specific tax concessions and subsidies such
as tax holidays, higher depreciation allowances etc. can be designed and incorporated in the
budgetary policy. Further the role of Fiscal policy in economic growth can be understood
through the impact of Public Debt, Deficit Financing, and Taxes.

14.3.1 Role of Taxes in Economic Growth

Taxation is an effective tool of budget to influence the level of savings and investment in
country. Abolition and reduction of various taxes pushes up profits and reduces cost of production
and prices. Lower prices are expected to increase demand production and employment, which in
turn add to effective demand, and so on. Similar steps can be taken in case of custom duties.
Raising import duties diverts the domestic demand for imports to home produced goods, and
reducing or abolishing exports duties or giving export subsidies increase the demand for export
and contributes towards recovery from depression. It will be more helpful to lower tax rates on
those goods which have a higher elastic demand.

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Caution Demand will be very high if persons with a higher marginal propensity to consume
are given a relief in direct taxation. In the same manner investment may be encouraged by
specific tax concession like tax holidays, greater depreciation allowance and the like.
Taxes are also considered to be effective tool in controlling the inflation. It can do it in two ways.
First as built - in stabilizers and the second relates to the common belief that taxes can be used to
curb prices and demand.

14.3.2 Taxes as In-Built Stabilizers

Given the level of govt. expenditure the tax system itself tend to create a budgetary surplus
during a boom and a deficit during a depression. A budgetary surplus would curb expenditure
and demand while budgetary deficit would have the opposite effect and thus an anti-cyclical
pressure is generated. This happens because revenue from indirect and direct taxes is dependent
upon the level of economic activities.

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