What is Fiscal Policy?

We mentioned Fiscal Policy in our last article/blog, but do you understand what it means and why it’s crucial for our economy? In this blog, we’ll break down fiscal policy, its components, and its role in India’s economic journey. So, let’s dive in!

What is Fiscal Policy?

At its core, it’s the way the government manages its spending and taxation to influence the economy. Imagine it as a way for the government to adjust the economic thermostat—turning it up when things are too cold (recession) or cooling it down when it’s too hot (inflation). The main goals? To manage the economy, aiming to stabilise growth, control inflation, and redistribute income.

Key Objectives of Fiscal Policy

Fiscal policy in India is designed to address several key objectives:

• Economic Stability: Managing inflation and deflation is crucial for maintaining economic balance. During economic downturns, the government may increase spending to boost demand and stabilise prices, while during periods of rapid growth, it might cut back on spending to prevent overheating.
  

• Economic Growth: The Indian government promotes long-term growth through infrastructure, education, and healthcare investments. These investments not only improve quality of life but also stimulate economic activity and job creation.
  

• Redistribution of Income: Fiscal policy aims to reduce income inequality through progressive taxation and social welfare programs. For example, schemes like the Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA) provide marginalised communities with financial support and job opportunities.
  

Components of Fiscal Policy

Understanding fiscal policy requires a closer look at its main components: government revenue and expenditure.

1. Government Revenue

• Direct Taxes: These include income tax and corporate tax. Direct taxes are collected directly from individuals and businesses based on income and profits.
• Indirect Taxes: These encompass GST, excise duty, and customs duty. Indirect taxes are levied on goods and services and are typically included in the price of products.
• Non-Tax Revenue: This includes earnings from public enterprises, fees, and interest receipts. Non-tax revenue helps supplement the government’s budget beyond taxes.
  

2. Government Expenditure

• Plan Expenditure: This covers development projects to improve infrastructure and public services. For example, funding for new highways or rural development programs falls under this category.
• Non-Plan Expenditure: This includes routine expenses like salaries and subsidies, which are essential for maintaining government operations and supporting various sectors.
• Capital Expenditure: This refers to spending on assets that have long-term benefits, such as building new schools or hospitals.
• Revenue Expenditure: This covers day-to-day expenses required for the functioning of the government.
  

Fiscal Policy Tools

Let’s talk about how the government uses its fiscal tools to shape the economy:

1. Taxation

Taxation includes different types, such as progressive, regressive, and proportional taxes. Progressive taxes impose higher rates on those with higher incomes, while regressive taxes affect lower-income individuals more heavily, and proportional taxes apply the same rate to everyone. Each type of tax impacts the economy and individuals differently. Changes in tax rates can influence consumer spending and business investment, with lower taxes potentially boosting spending and higher taxes reducing consumption. Tax incentives, such as breaks for businesses, can encourage investment, job creation, and innovation, driving economic activity.

2. Public Expenditure

Public expenditure has a direct impact on aggregate demand in the economy. Increased government spending can stimulate demand, while reduced spending can slow it down. Additionally, by funding various projects and services, public expenditure plays a crucial role in creating employment opportunities, helping to reduce unemployment and boost overall economic activity.

3. Public Debt

Public debt can be categorised into internal debt, borrowed from within the country, and external debt, sourced from foreign entities. Each type has distinct implications for the economy. Borrowing contributes to the fiscal deficit, the gap between the government's total revenue and expenditure.

4. Fiscal Deficit

A fiscal deficit occurs when the government's total expenditure exceeds its total revenue and is typically measured as a percentage of GDP. A high fiscal deficit can lead to increased inflation and higher interest rates, impacting economic stability. The government may implement fiscal consolidation measures to manage and reduce deficits, such as cutting unnecessary expenditures or increasing revenues.

All in all, fiscal policy is all about how the government balances its books to keep the economy on track. Whether it’s through taxes, spending on public projects, or managing debt, these decisions impact everything from job creation to the cost of living. By understanding fiscal policy, we understand how our economy works and why certain decisions are made. It’s not just about numbers—it's about shaping a better future for everyone. Staying informed helps us understand these changes and their effects on our everyday lives.