The government uses various fiscal instruments or tools in order to achieve rapid economic growth. The main tools of fiscal policy are grouped under two main heads (i) Non discretionary controls or measures. (ii) Discretionary fiscal policy.
(i) Non-discretionary Measures
(1) Automatic or Built-in Stabilizers: The automatic fiscal stabilizers are those which contribute to keep economic system in balance without human control. These controls are built into the economy and so are called built in stabilizers. The main automatic stabilizers are as follows.
(a) Progressive income tax: Personal income taxes are the largest source of revenue to the government. The tax rate, the individuals pay on their rising income is progressive. When the disposable income of the people increases in the boom period, the higher amount of the tax reduces disposable income, reduces consumption and decreases the aggregate demand which helps in curbing economic boom. A reduction in income tax increases disposable personal income, increases consumption, increases aggregate demand and thus helps in curbing recession. The expansionary and contractionary fiscal policies can be summed up and brought under two approaches.
A) Demand Side Fiscal Policy.
B) Supply Side Fiscal Policy.
A) Demand side policy originated as a direct result of Keynesian belief. According to Keynes during recession, the goal is to raise aggregate demand to the full employment level. This objective may be achieved by (1) an increase in government spending (G) (2) a decrease in tax revenue (T) brought about by reduction in tax rates.
During a period of rapid inflation the goal is to lower aggregate demand to full employment level. The fiscal policy will be 1) a decrease in government expenditure 2) an increase in taxes brought about by rise in the rates.
B) Supply side policy is a new approach to fiscal policy. The modern economists are of the view that fiscal policy can also influence the level of economic activity through their impact on aggregate supply. When the firms experience an increase in resource costs due to sharp rise in the world price of major raw material say oil, the higher costs cause a decrease in aggregate supply creating a recessionary gap. Therefore an expansionary fiscal policy in the form of reduced corporate taxes and pay roll tax can help in closing the recessionary gap. Conversely, an increase in the corporate tax rate and pay roll tax etc can hep in closing inflationary gap.
(b) Unemployment compensation: In advanced countries of the world people receive unemployment compensation and other welfare payments when they are not of job. As soon as they get job these payments are stopped. During boom years, the unemployment compensation reserve funds help in moderating the inflationary pressure by curtailing income and consumption. When the economy is contracting unemployment, consumption and other welfare payments augment the income stream and they prove a powerful factor in increasing income output and employment in the country.
(c) Farm Aid programmes: Farm aid programmes also stabilize against the wave like cyclical fluctuations. When the prices of the agricultural products are falling and economy is threatened with depression, government purchases the surplus products of the farmers at the set prices. The income and total spending of the agriculturists thus remain stabilized and conration phase is warded off to some extent. When economy is expanding the government sells these stocks and absorbs surplus purchasing power. It thus reduces inflationary potential by increasing the supply of goods and contracting the pressure of too great spending.
(d) Corporate Savings and Family Savings: The credit of having automatic or built in stabilizer does not go to the state alone. The corporations and companies and wise family members too play an important part to contract cyclical fluctuations. For example, the companies pay a fixed amount every year to the share holders and with hold the part of dividends of the boom year to pay in the depression years. Thus holding back some earnings of goods years contracts the purchasing power and releasing of money in poorer years expands the purchasing power of the people.
(ii) The Discretionary Fiscal Policy
By discretionary policy is meant the deliberate charging of taxes and government spending for the purpose of off setting cyclical fluctuations in output and employment. The discretionary fiscal policy has short run as well as long run objectives. Let us examine these one by one.
Short-run Counter Cyclical Fiscal Policy: The main weapons or stabilizers of short-run discretionary fiscal policy are (1) Precautions (2) Changes in tax rates (3) Varying public works expenditure (4) Credit aids (5) Transfer payments.
(1) Guide Maps: In a capitalistic society, the entrepreneurs are not aware of each others investment plans. They therefore in competition with one-another over invest capital in a particular industry or industries thus cause over production and unemployment in the economy. Similarly in depression period there is no agency to guide them. If the government publishes the total investment plans and marginal efficiency of capital in various industries, much of the investment can proceed at a moderate sped and there can be stability to some extent in income, out put and employment.
(2) Change in Tax Rates: It is an important weapon of fiscal policy for eliminating the savings of business cycle. When the government finds that planned investment is exceeding planned savings and the economy is likely to be threatened with inflationary gap. It increases the rate of taxes. The higher taxes, other thins remaining the same, reduce the disposable income of people they are forced to cut down their expenditure. The economy is thus saved from inflationary situation.
(3) Varying Public Works Expenditure: Another important factor which influences economic activity is public expenditure. In times of depression the government can contribute directly to the income stream by initiating public works programmes and in boom period it can withdraw funds from the income stream by curtailing them.
(4) Credit Aids: The government can also avert depression by offering long term credit aids to the needy industrialists for starting or expanding the business. It can also give financial help to insurance companies and bankers to prevent their failures.
(5) Transfer Payments: Variation in transfer expenditure programmes can also help in moderating the business cycle. When the business is brisk the government can refrain from giving bonuses to the workers and thus can lessen the pressure of too great spending to some extent. When the economy is in recession, these pagmerts can be released and more bonuses can be given to stimulate aggregate effective demand.
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