Fiscal policy

Fiscal policy refers to the use of government revenue and expenditure to influence
the economy. The objectives of fiscal policy can vary depending on the economic
conditions and government priorities. Here are some common objectives of fiscal
policy:
1. Economic Growth: One of the primary objectives of fiscal policy is to promote
and sustain economic growth. Governments may use fiscal measures such as
increased government spending or tax cuts to stimulate economic activity
and boost overall production.
2. Full Employment: Fiscal policy aims to achieve and maintain full employment
in the economy. By increasing government spending or implementing policies
that encourage business investment, fiscal measures can contribute to
reducing unemployment levels.
3. Price Stability: Governments aim to control inflation and maintain stable
prices in the economy. Fiscal policy can be used to prevent excessive inflation
by adjusting tax rates, controlling public spending, and implementing other
measures to manage overall demand in the economy.
4. Income Distribution: Fiscal policy can be used to address issues of income
inequality. Progressive tax systems and targeted social spending programs
are examples of fiscal measures that can help redistribute income and reduce
disparities among different segments of the population.
5. Budgetary Stability: Governments aim to maintain a stable budget by
balancing revenues and expenditures over the long term. This helps prevent
excessive debt accumulation, which can have negative consequences for the
economy.
6. External Balance: Fiscal policy may also be used to achieve external balance
by influencing the balance of trade. For example, a government may
implement fiscal measures to encourage exports and reduce imports, thereby
improving the trade balance.
7. Counter-Cyclical Measures: Fiscal policy is often used as a tool to counteract
economic cycles. During periods of economic downturn, governments may
increase spending or reduce taxes to stimulate demand and support
economic recovery. Conversely, during periods of high inflation or economic
overheating, governments may implement contractionary fiscal policies to
cool down the economy.
8. Public Investment: Fiscal policy can be used to support public infrastructure
and investment projects. Governments may allocate resources to areas such
as education, healthcare, transportation, and technology to enhance the
long-term productivity and competitiveness of the economy.

Importance
Fiscal policy is of paramount importance for economic management due to its
multifaceted impact on the economy. It serves as a vital tool for stabilising the
economy during fluctuations, achieving full employment, and controlling inflation.
Additionally, fiscal measures contribute to income redistribution, enable public
investment in critical sectors, and support external balance. The flexibility of fiscal
policy allows quick adaptation to changing economic conditions, and its
coordination with monetary policy enhances overall effectiveness. In essence, fiscal
policy plays a pivotal role in maintaining economic stability, fostering growth, and
addressing socio-economic challenges.

Or

1. Economic Stabilisation (1 mark):

a. Fiscal policy is crucial for stabilising the economy during periods of
recession.
b. Adjustments in government spending and taxation influence aggregate
demand.
2. Full Employment (1 mark):
a. Fiscal policy promotes full employment by stimulating economic
activity.
b. Increased government spending or tax cuts boost consumer and
business spending, leading to job creation.
3. Inflation Control (1 mark):
a. Fiscal policy helps control inflation by adjusting government spending
and taxation.
b. Contractionary fiscal measures can reduce overall demand during
periods of high inflation.
4. Income Distribution (1 mark):
a. Progressive taxation and targeted spending programs address income
inequality.
b. This ensures a fair distribution of wealth and promotes social
cohesion.
5. Public Investment (1 mark):
a. Fiscal policy enables public investment in infrastructure, education,
healthcare, and other essential services.
b. This contributes to the well-being of the population and enhances
long-term productivity.

Types of Fiscal Policy

1. Discretionary Fiscal policy
2. Non-discretionary Fiscal policy
● Discretionary Fiscal Policy:
○ Definition: Discretionary fiscal policy refers to intentional and active
changes in government spending, taxation, or both, undertaken by
policymakers in response to specific economic conditions or to
achieve particular economic goals.
○ Tools:
■ Government Spending Changes: Increasing or decreasing
expenditures on programs, projects, or services.
 ■ Tax Policy Changes: Adjusting tax rates or implementing tax
incentives.
○ Implementation:
■ Decisions are made by government authorities, usually through
legislative processes.
■ Requires intentional actions by policymakers based on
economic assessments.
○ Examples:
■ During a recession, a government might implement discretionary
fiscal measures, such as increasing spending on infrastructure
projects or cutting taxes to stimulate economic activity.
● Non-discretionary Fiscal Policy (Automatic Stabilizers):
○ Definition: Non-discretionary fiscal policy, or automatic stabilizers,
refers to the automatic and built-in features of the fiscal system that
respond to economic conditions without the need for explicit
government action.
○ Tools:
■ Progressive Income Taxes: Tax collections automatically
increase when incomes rise.
■ Unemployment Benefits: Government spending on
unemployment benefits automatically increases during
economic downturns.
○ Implementation:
■ No specific legislative action is required; these measures are
inherent in the structure of the fiscal system.
■ Responses are automatic and based on the economic cycle.
○ Examples:
■ During a recession, individuals may experience a reduction in
income, which leads to lower tax payments. At the same time,
government spending on unemployment benefits automatically
increases. These actions help stabilise the economy without the
need for policymakers to take explicit discretionary actions.
● Key Differences:
● Flexibility:
○ Discretionary fiscal policy involves deliberate and specific decisions by
policymakers.
○ Non-discretionary fiscal policy responds automatically to economic
conditions.
● Timing:
○ Discretionary measures can be implemented at any time based on
policymakers' judgments.
 ○ Non-discretionary measures operate continuously, adjusting
automatically as economic conditions change.
● Decision-Making Process:
○ Discretionary policies require legislative approval and formal
decision-making processes.
○ Non-discretionary policies are built into the tax and spending structure
and do not require specific actions for implementation.

Nondiscretionary fiscal policy consists of policies that are built into the system so
that an expansionary or contractionary stimulus can be given automatically.
Automatically the market gets adjusted no need for government intervention.
Fiscal policy is run by the government.
Unemployment insurance, the progressive income tax, and welfare serve as the
built-in policies.
1. If the economy is in recession, those who lose their jobs are granted
unemployment and/or welfare benefits and they owe less in taxes.
2. If the economy is growing at an unsustainable rate, people are making a lot of
money and are faced with higher tax rates and there are fewer people eligible
for government benefits.

How Discretionary Fiscal Policy Works

If we are in a recession the fiscal policy to stimulate the economy would consist of
1. Government buying Stuff
2. Government paying people to do stuff
3. Decrease in taxes
4. Giving money directly to people

If we are in an inflationary period the fiscal policy to contract the economy would
consist of just the opposite (I will focus on the first one since it is more relevant)
1. Government selling Stuff
2. Increase in taxes
3. The Government collects money directly by selling securities to the people.

Taxation
Taxation is the process by which governments collect revenue from individuals and
businesses to fund public expenditures and services. Taxes are a compulsory
financial contribution imposed by the government on its citizens, and they play a
crucial role in financing public goods and services, infrastructure, and various
government functions.
Classification of taxes

​ Progressive Taxes:
● Definition: In a progressive tax system, the tax rate increases as the
taxable amount or income increases. The idea is that those who earn
more should contribute a higher percentage of their income in taxes.
This is often seen as a way to promote income equality.
● Example: Many income tax systems around the world are designed to
be progressive. As individuals move into higher income brackets, they
face higher tax rates on the additional income they earn.
​ Regressive Taxes:
● Definition: In a regressive tax system, the tax rate decreases as the
taxable amount or income increases. This means that lower-income
individuals pay a higher percentage of their income in taxes compared
to higher-income individuals. Regressive taxes tend to place a heavier
burden on those with lower incomes.
● Example: Sales tax is often considered regressive. Regardless of
income, individuals pay the same percentage on their purchases. This
disproportionately affects lower-income individuals who spend a larger
proportion of their income on goods and services.
​ Proportional Taxes (Flat Taxes):
● Definition: In a proportional tax system (or flat tax system), the tax rate
remains constant regardless of the taxable amount or income. Every
taxpayer pays the same percentage of their income in taxes, regardless
of whether their income is high or low.
● Example: A hypothetical flat income tax of 15% would mean that an
individual earning $20,000 pays 15% of that income in taxes ($3,000),
and an individual earning $200,000 pays 15% of their income ($30,000).
Advocates argue that flat taxes are simple and fair, treating all
taxpayers equally.

Degressive Taxes (Possible Interpretation):

● Potential Definition: If one were to use the term "degressive taxes," it
might refer to a tax system where the tax rate decreases with
increasing income, similar to regressive taxes. However, the use of
"degressive" is not standard, and it's crucial to clarify the context when
encountering this term.

It's important to note that debates over the fairness and efficiency of different tax
systems continue, and the choice between progressive, regressive, or proportional
taxation often involves considerations of social justice, economic goals, and political
ideologies. Different countries may adopt different approaches to taxation based on
their specific economic and social priorities.
Direct and indirect taxes

Direct and indirect taxes are two primary categories of taxes based on who bears the
economic burden of the tax. These distinctions are crucial in understanding the
impact and implementation of various taxes:

​ Direct Taxes:

Definition: Direct taxes are taxes that are levied on individuals and
businesses, and the burden of these taxes cannot be shifted to
someone else. The person or entity on whom the tax is levied bears the
economic impact.

Examples:

● Income Tax: Imposed on an individual's or business's income.

● Corporate Tax: Applied to the profits of corporations.
● Property Tax: Levied on the value of real estate or property.

Characteristics:

● Direct taxes are progressive, meaning that the tax rate often
increases as the taxable income or profit increases.
● Individuals or businesses directly pay these taxes to the
government.
​ Indirect Taxes:
● Definition: Indirect taxes are taxes imposed on the consumption or use
of goods and services. The economic burden of indirect taxes can be
shifted from one party to another, typically from businesses to
consumers.
● Examples:
● Sales Tax: Applied to the sale of goods and services at the point
of purchase.
● Value-Added Tax (VAT): A consumption tax imposed at each
stage of the production and distribution chain.
● Excise Duty: Imposed on specific goods like alcohol, tobacco, or
gasoline.
● Characteristics:
● Indirect taxes are regressive in nature, as they tend to take a
higher proportion of income from lower-income individuals.
● The actual economic burden may be passed on to consumers in
the form of higher prices for goods and services.
Key Differences:

Bearing of Economic Burden:

● Direct taxes are borne by the individual or entity on which they are
imposed.
● Indirect taxes can be shifted from one party to another, usually from
businesses to consumers.

Progressivity:

● Direct taxes are often progressive, with higher-income individuals or

businesses paying a higher percentage of their income or profits.
● Indirect taxes are typically regressive, affecting lower-income
individuals more significantly as a proportion of their income.

Visibility:

● Direct taxes are more visible to taxpayers as they directly impact

income or profits.
● Indirect taxes may be less visible, as consumers may not always be
aware of the tax embedded in the price of goods and services.