Fiscal Policy is the "housekeeping policy" of the government. It is concerned with the level, timing and composition of government expenditure and revenue. The culmination of this policy is the Budget where revenue and expenditure both current and capital, are presented for the year ahead.
2 The Budget
The finances of the government are divided into two categories, the Current Budget and the Capital Budget.
The current account presents the day-to-day revenue and spending activities of government. Current receipts arise within one year. It is the money received by the government mainly in direct tax and indirect tax during the year. Current expenditure involves spending on social welfare such as old age pensions and unemployment benefit, wages and salaries of those working in the public sector.
Capital expenditure is spending on items which are not consumed during the year, with such examples as infrastructure, telecommunications and aroad developments. The revenue to finance capital expenditure is primarily raised by borrowing.
There are four budget types which governments might adopt. They are
This occurs where government current expenditure is greater than current revenue.
A situation where government current expenditure is less than current revenue
When government current revenue is equal to current expenditure
A neutral budget neither stimulates nor deflates the economy. Such budgets could be surplus or deficit depending on the situation that prevails. If the government had a surplus of + 500 then a budget deficit of - 500 should neutralise the position.
3 The Budget as part
of an Economic Strategy
While the budget may be fundamental arithmetic and basic book-keeping it is nevertheless a powerful economic instrument. If the government presents a deficit budget where they spend more than is taken in then this can act as a stimulant to the economy. This can have the effect of increasing aggregate demand by increasing spending power. Tactics which the government can use to stimulate the economy would be to reduce income tax, increase public sector pay or increase social welfare being three channels through which funds will flow into the economy. This is known as an expansionary budget.
However, if the government feels the threat of inflation through excessive spending then they may adopt a surplus budget where more revenue earning factors are employed than there is expenditure. The result is a withdrawal of spending power from the economy. This could be managed through increases in income tax or a reduction in items of expenditure. Such budgets are regarded as contractionary or deflationary.
4 Government Objectives
There are four primary economic objectives of government as below
Balance of Payments Equilibrium
The strategy of the government will be to manipulate its Fiscal Policy to achieve these objectives.
To achieve full employment through fiscal measures the government will adopt an expansionary budget may reduce income tax to increase spending power, tax incentives could be given to employers to take on extra labour.
It first must be established is it demand pull or cost push inflation. If it is demand pull inflation then a deflationary budget directed at drawing spending power out of the economy. The minister for finance could increase income tax, or reduce government expenditure there would be reduction in aggregate demand.
Cost push inflation could be attacked by reducing VAT or by assisting industry to reduce their prices by reducing corpooration tax.
Balance of Payments
The government could introduce a deflationary budget such as reducing the level of its expenditure aimed at making our exports more competitive. One strategy would be to give exporters tax incentives.
Economic growth can be achieved through an expansionary budget such as would apply in the case of full employment.