By fiscal policy we mean, the government’s tax efforts, public expenditure and public borrowing. Through these the government can effectively encourage consumption, investment and savings habits and also restrict them. For example, suppose there is inflation in a country. Inflation implies that the people have high purchasing power and so they demand goods. To curb this, the government may raise the personal tax and also the corporate tax. Similarly, by altering its expenditure on various public projects, the government would be able to influence the prevailing economic condition. Public borrowing involves government issuing bonds and encouraging common public and other institutions to buy them. By this, the government would be able to bring down the level of purchasing power in the economy and control the inflation.
The following are the objectives of fiscal policy:
- Maximization of the aggregate saving is the first objective. Tins are achieved by encouraging people to reduce the current and future consumption. Specifically the attempt is to bring down and control the conspicuous consumption of the rich people. The government can impose taxes on them and can provide the basic necessities of life to the poor class on low rate. In this way by providing incentives, savings can be increased.
- Maximization of capital formation is the second objective. Through this objective the country can try to achieve an accelerated economic growth. This will help the country to overcome the stagnation and achieve a higher rate of economic growth.
- The third objective is to divert the available resources from the less productive to most productive purposes. Resource allocation refers to assigning the available resources of the economy to the specific uses chosen among many possible and competing alternatives. It gives answer to what to produce and how to produce -questions of the economy. Fiscal policy should ensure the optimum allocation of the resources. It should divert the resources from unproductive sectors to the productive sectors of the economy. It is the long-run objective of the government. The emphasis of the government upon the full employment, price stability and economic growth should not overshadow the resource allocation goal. Through this it is hoped that the resources will be applied more for socially useful projects. In a country where centralized planning is followed, the plan determines the priorities of the country and the fiscal policy ensures the accomplishment of these priorities through redistribution of productive resources.
- Fiscal policy also helps in protecting the economy from inflation. Inflation in an under developed country is very dangerous, if it is not controlled in the initial stage itself. Though inflation cannot be avoided in the growth process, yet it has to be under full control as otherwise the benefits of growth will be eaten away by inflation.
- Fiscal policy also helps in removing the sectoral imbalance in the economy in the process of growth. Usually in a developing economy, the price level may go up in certain sector in the growth process affecting that sector badly. Fiscal policy through appropriate tools can always prevent this sectoral imbalance, and help to maintain overall price stability.
- Fiscal policy provides the necessary incentives for the industries which are capable of generating employment opportunities in large scale. For instance, the small scale industries are employment oriented and so fiscal policy can extend incentives to them.
- A very important objective of fiscal policy is to bring down and eliminate inequalities in income and through that ensure equitable redistribution of income and wealth in society. This may be considered as the social objective of fiscal policy. But this objective is in contradiction with the growth, objective. That is, to achieve rapid economic growth, the savings in the economy should increase to facilitate rapid growth of capital formation. For this purpose, the rich should save maximum. If the fiscal policy tries to eliminate income and wealth inequality then the saving potential of the economy will come down and affect the growth prospects. Hence, the fiscal policy should neither be too much growth conscious nor attach importance to social objective. An ideal mix of these two objectives is the right fiscal policy.