Fiscal policy is the main guiding force in the Indian economy which helps the government take decisions around money matters such as expenditures and savings. It is primarily used to gauge the financial support required for boosting economic activity, and the amount of revenue required to be generated for the same. A fiscal policy helps to run the economy smoothly. 

In recent years, the significance of fiscal policy has seen an upward trend as it helps in achieving faster economic growth. Achieving faster economic growth is at the centre of the fiscal policy designed by the Government of India. Fiscal policy, in combination with monetary policy, helps in managing a nation’s economy with planning and diligence. Let’s dive deeper into the concept of Fiscal policy and surrounding factors.

Meaning of Fiscal Policy and Examples

With the help of the fiscal policy, the government can control the inflow of tax earnings and outflow of public expenditure in the economy. In case the government generates more revenue as compared to the expenditure, it has a surplus. On the other hand, if it has more expenses than the tax and other receipts, it has a deficit. For meeting additional expenditures, the government must borrow either from the domestic market or from international institutions. The government can also choose to use its foreign exchange reserves or pump additional money in the economy by printing more currency.

Let’s take an example to better understand fiscal policy. In case of an economic slowdown, the government could begin using its reserves in building more projects, spend on welfare schemes, offer business incentives, etc. The main objective is to make the dormant money available for people, liquidate some money and give it in the hands of people so that they can have the finances for spending. It also helps to encourage businesses in making additional investments. Simultaneously, the government can choose to levy taxes on businesses and reduce the tax burden on people, thereby reducing their income.

What is the purpose of fiscal policy?

Here are some of the key objectives of any fiscal policy designed by the government:

  • Economic growth: Fiscal policy helps the economy’s growth rate to remain stable to achieve certain specific economic objectives.
  • Price stability: It helps in controlling the price levels across the nation especially in case of inflation when prices can shoot up significantly.
  • Full employment: Fiscal policy helps in achieving full employment or at least near full employment. This, in turn, helps the economy to recover easily from a downturn.

Types of Fiscal Policies

Fiscal policy can be broadly divided into three different categories or types. Each is chosen based on the present economic state and also the government’s objectives.

  • Expansionary Policy - Governments take up an expansionary fiscal policy when promoting growth becomes critical due to the economic downturn. An expansionary fiscal policy requires a larger amount of spending as compared to tax revenue generated. It focuses on measures which help in increasing employment (like undertaking new construction works) and reduction in taxes. The main objective is to stimulate consumer demand by pumping money into the economy.
  • Contractionary Policy – In case an economy experiences unusually high growth levels and complete employment, governments may choose a contractionary fiscal policy. The idea is to apply brakes on an expanding economy, especially if higher inflation is the primary concern. A contractionary fiscal policy requires a reduction in government spending and the levying of higher taxes. 
  • Neutral Policy - Fiscal policy can also be said to be neutral when the level of government spending as compared to tax revenue is stable over time. This could be considered the “default” policy when an economy is neither rapidly expanding nor contracting, and the government doesn’t intend to actively intervene in the economy.

Is fiscal policy the same as monetary policy?

The government has to use a combination of monetary and fiscal policy while trying to meet the nation’s economic objectives. The primary responsibility of administering monetary policy in a country lies with the central bank. In India, the RBI is responsible for the design and implementation of Monetary Policy. Monetary policy primarily deals with currency, money, and interest rates. On the other hand, the fiscal policy covers taxation and expenditure which is planned and implemented by the government.

Why is fiscal policy important to the Indian economy?

  1. Capital Formation:

The Fiscal policy of any country plays an important role in capital formation within the public and private sectors. India has seen a rise in the gross domestic capital formation as a percent of total GDP from 10.2% back in 1950-51 to 22.9% during 1980-81. It then jumped to nearly 24.8% during 1997-98. Thus, over the years, it has had a favourable impact on both, public as well as private sector investments across the nation. In 2019, the capital formation rate stood at 30.21%

2. Mobilisation of Resources:

Fiscal policy has significantly helped in mobilizing larger amounts of resources via taxes, public debt etc. This has further helped in easily financing various developmental projects planned by the government. Internal resource mobilisation has drastically increased from a mere 70% in 1965-66 to nearly 90% in 1997-98.

3. Promotes Savings:

The fiscal policy provides various incentives to encourage savings in households as well as corporate sectors. This is primarily done through various policy changes, namely, tax exemptions, tax holidays, etc. Thus, the savings rate has gone up from a mere 10.4% in 1950-51 to 23.1% in 1997-98. In recent years, it has gone up to as high as 30.1%.

4. Support to Private Sector:

The private sector sees a constant inducement via fiscal policy measures of the country. This helps in expanding economic activities. Tax holidays, tax exemptions, subsidies etc. are included in budgets to provide sufficient incentives to the private sector industries, infrastructure agencies and export sector in India.

5. Reduction of Inequality:

Fiscal policy has constantly aimed at reducing inequality especially when it comes to the distribution of wealth and income. Progressive income tax and wealth tax exemption, grants, subsidies, etc. are designed to help reduce such inequality. Fiscal policy also helps to bring down the regional disparities via various budgetary policies.