Discuss the major instruments of fiscal policy?

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Question – Discuss the major instruments of fiscal policy? How can tax rates be used to stimulate/depress investment or demand in the economy? Describe in detail. 19 February 2022


Fiscal policy is based on the principles of the famous economist John Maynard Keynes. Also popularly known as Keynesian economics, this theory basically states that governments can affect macroeconomic productivity levels by increasing or decreasing the tax level and public expenditure.

The idea is to find a balance between tax rates and public spending depending on the circumstances in the economy. Inflationary pressures in the economy warrant a ‘contractual fiscal policy’, which includes increasing taxes, reducing public spending, or both.

Following are the important tools of fiscal policy, and how it work:

Fiscal policy is implemented through the policies related to income, expenditure and debt of the government. Fiscal policy maintains a proper system of expenditure, debt, tax, income, financial management, etc., for achieving the highest objectives in the economy, such as economic development, price stability, employment, taxation, public income-expenditure, public debt etc. All these are arranged in fiscal policy.

Government levies taxes on the basis of fiscal policy. It sees whether the tax paying capacity of the people in the country is increasing or decreasing. The government determines the taxes only after estimating all these things. Those decisions are also included in the expenditure policy which have an impact on the economy. Credit policy is concerned with obtaining purchasing power through loans of individuals. Government debt management policy is concerned with paying interest and repayment of loans.

Objectives of Fiscal Policy:

  • Under fiscal policy, efforts are made to increase savings by reducing current consumption by taxation, so that the necessary funds can be obtained for capital formation.
  • Apart from capital formation, the second important objective of fiscal policy is to increase the national income.
  • Maintaining equality of distribution of income and wealth is not only a goal of economic development but also a pre-requisite. Therefore, the government should formulate its fiscal policy in such a way that the inequalities of wealth distribution can be minimized in the country.
  • One of the objectives of fiscal policy is to maintain the state of full employment in the economy.

Tools of Fiscal Policy:

  • Taxation: Taxation should be done on the basis of taxable capacity. The taxation should be done in such a way that it does not have a bad effect on the willingness and ability to work, as well as the income can be received by the government.
  • Public Expenditure: This is an important tool of fiscal policy, the objective of public expenditure should be public welfare. Public expenditure should be productive so that the infrastructure can be managed.
  • Public Debt Policy: Public debt also has an important place under fiscal policy. These loans are both internal and external. A developing country is not able to do its proper development due to lack of resources, as a result, it has to run its economy by taking loans.

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