- Government Expenditure: Spending on public works, education, defence and subsidies to control demand.
- Taxation: Direct and indirect taxes used to reduce inflation or increase demand during depression.
- Public Debt: Government borrowing from public or banks to regulate money flow.
- Deficit Financing: Printing of new money to meet budget deficit and boost economic activity.
- Budget Policy: Use of balanced, cyclical or compensatory budgets to ensure stability and growth.
Definitions [2]
Definitions: Fiscal Policy
- "Fiscal Policy is the policy concerning the revenue, expenditure and debt of the government for achieving definite objectives." -Prof. Dalton
- "Fiscal policy involves alterations in government expenditures for goods and services or the level of tax rates. Unlike monetary policy, these measures involve direct government entrance into the market for goods and services (in case of expenditure) and a direct impact on private demand (in the case of taxes)." – Prof. Gardner Ackley
- "We define fiscal policy to include any design to change the price level, composition or timing of government expenditure or to vary the burden, structure or frequency of tax payment." – G.K. Shaw
- Fiscal policy includes those "Changes in government expenditure and taxation designed to influence the pattern and level of activity." – Harvey and Johnson
- Fiscal Policy includes those "Changes in taxes and expenditure which aim at short run goals of full employment, price level and stability." – Otto Eckstein
Definition: Public Finance
- According to Hugh Dalton: “Public finance is one of those subjects which are on the borderline between economics and politics. It is concerned with the income and expenditure of public authorities and with the adjustment of one with the other.” Since we study the activities of the governments in political science too, public finance also constitutes a part of the study of political science.
- According to Prof. Findlay Shirras: “Public finance is the study of the principles underlying the spending and raising of funds by public authorities.”
Key Points
Key Points: Instruments of Fiscal Policy
Key Points: Objectives of Fiscal Policy
- Economic Stability: Control booms and depressions.
- Full Employment: Create jobs and reduce involuntary unemployment.
- Economic Growth: Increase output and raise living standards.
- Price Stability: Control inflation and maintain value of money.
- Reduce Inequality: Ensure fair distribution of income and wealth.
- External Equilibrium: Maintain balance of payments stability.
Key Points: Fiscal Measures for Stabilisation
- During Inflation: Cut public spending, raise taxes, increase borrowing, run surplus budget.
- During Deflation: Increase public spending, cut taxes, use deficit financing and pump priming.
- Exchange Stability: Promote exports, restrict imports, encourage import substitution.
Key Points: Methods of Fiscal Policy in Developing Countries
- Taxation Policy: Mobilises resources, promotes savings and capital formation, reduces luxury consumption and inequality.
- Public Expenditure Policy: Government invests in infrastructure, power, transport, irrigation, health and education to boost development.
- Public Debt Policy: Used to raise funds for development, encourage savings, control inflation and meet emergencies.
- Deficit Financing: Creation of new money to finance development projects and accelerate economic growth.
Key Points: Limitations of Fiscal Policy
- Lack of Accurate Forecasting: Difficult to predict booms or depressions correctly.
- Time Lag: Decisions and effects of fiscal policy take time due to legislative delays.
- Public–Private Sector Conflict: Increased public spending may discourage private investment.
- Full Employment Issues: Leads to wage–price rise and fails to remove structural unemployment.
- Debt Burden: Heavy use of fiscal measures increases public debt problems.
- Problems of Deficit Financing: Excessive deficit financing causes inflation and slows development.
- Conflict of Objectives: Social goals may clash with economic objectives.
- Adverse Psychological Effects: Large deficits create fear of instability and capital flight.
Key Points: Public Revenue
- Public revenue is the total income collected by the government from different sources.
- It is needed to finance public expenditure and is a core topic in public finance and economics.
- The two main sources of public revenue are tax revenues and non‑tax revenues.
Key Points: Instruments of Fiscal Policy - Taxation
- Taxes are compulsory payments made by people to the government to meet public expenditure.
- Main features of taxes: compulsory in nature, personal obligation, meant for general welfare.
- No quid pro quo: taxpayers do not receive any direct or equal return for taxes paid.
- Role in fiscal policy: taxation helps raise revenue, reduce inequality, control inflation, and promote economic stability.
Key Points: Tax Reforms in India
- GST was introduced on 1 July 2017 as a single indirect tax on goods and services, replacing multiple central and state taxes.
- It has created a unified national market and simplified the indirect tax system.
- GST improves transparency, tax compliance, and revenue collection.
- Though it faced initial problems, GST is expected to support economic growth with better implementation.
Key Points: Proportional, Progressive and Regressive Taxes
- Proportional Tax: Same tax rate for all income levels (e.g., 20% for everyone).
- Progressive Tax: Tax rate increases as income increases; rich pay a higher percentage.
- Regressive Tax: Tax rate decreases as income increases; poor bear heavier burden.
- Degressive Tax: Tax rate rises up to a limit, then becomes constant (mix of progressive + proportional).
Key Points: Public Expenditure
- Public expenditure is government spending by central, state and local bodies for public welfare and development.
- It includes spending on defence, administration, health, education, roads and social welfare schemes.
- Revenue expenditure covers day‑to‑day running costs like salaries, pensions and routine services.
- Capital expenditure creates assets and development, e.g. infrastructure projects and loans.
- Developmental expenditure is productive and raises employment, output and welfare (health, education, industry, R&D).
- Non‑developmental expenditure is mainly compulsory and less productive, such as defence and general administration.
- Public expenditure is rising due to more government welfare functions, population growth, urbanisation and higher defence and administration costs.
Key Points: Importance of Public Expenditure
- Boosts production & investment: Improves infrastructure, human skills, confidence of investors, and supports key industries.
- Promotes growth & development: Develops agriculture, industry, education, health, and infrastructure for long-term growth.
- Ensures social justice: Reduces income and regional inequalities through welfare schemes and subsidies.
- Maintains economic stability: Acts as an anti-cyclical tool—raises spending in depression, cuts spending in inflation.
Key Points: Public Debt
Public debt is government borrowing when its spending is more than its income.
| Basis | Internal Debt | External Debt |
|---|---|---|
| Source of borrowing | Borrowed within the country (citizens, banks, RBI, institutions) | Borrowed from foreign governments, banks, IMF, World Bank, etc. |
| Currency | Borrowed in domestic currency | Borrowed in foreign currency |
| Management | Easier to manage | Harder to manage |
Key Points: Reasons for Borrowing by the Government
- To meet budgetary deficit when revenue falls short of expenditure.
- To finance wars and defence, which need huge funds.
- To fund development plans and infrastructure projects.
- To obtain foreign exchange and meet balance of payments deficits.
- To control recession by increasing public expenditure.
- To meet emergencies like floods, famines, epidemics, etc.
Key Points: Public Debt - Redemption
- Repudiation: Refusal to repay debt (used only in extreme situations).
- Refunding: Taking new loans to repay old ones.
- Debt Conversion: Converting high-interest debt into low-interest debt.
- Budgetary Surplus: Using surplus revenue to repay debt.
- Terminal Annuities: Repayment in equal annual instalments (principal + interest).
- Sinking Fund: Creating a special fund for gradual debt repayment.
- Statutory Reduction of Interest: Legally reducing interest rates on debt.
- Capital Levy: One-time heavy tax on wealth to repay debt (usually during war).
- Export Surplus: Using excess exports to repay external debt.
Key Points: Deficit Financing
- Meaning: Government meets deficit by printing new money.
- Use: For war, depression, and development.
- Benefits: Raises funds fast, boosts demand, output, and jobs.
- Problems: Causes inflation, inequality, and speculative investment.
- Conclusion: Useful, but should be limited.
Key Points: Fiscal Policy in Action
- Inflation: ↑ Taxes, ↓ public spending, ↑ borrowing
- Depression: ↓ Taxes, ↑ spending, deficit budget
- Growth: Tax incentives, subsidies, infrastructure spending
- Equity: Progressive taxes, welfare spending for poor
Important Questions [2]
Concepts [20]
- Structure of Public Finance > Fiscal Policy
- Public Finance
- Instruments of Fiscal Policy
- Objectives of Fiscal Policy
- Miscellaneous Objectives of Fiscal Policy
- Fiscal Measures for Stabilisation
- Methods of Fiscal Policy in Developing Countries
- Limitations of Fiscal Policy
- Structure of Public Finance > Public Revenue
- Instruments of Fiscal Policy - Taxation
- Types of Taxes
- Tax Reforms in India
- Proportional, Progressive and Regressive Taxes
- Structure of Public Finance > Public Expenditure
- Importance of Public Expenditure
- Structure of Public Finance > Public Debt
- Reasons for Borrowing by the Government
- Public Debt - Redemption
- Deficit Financing
- Fiscal Policy in Action
