Fiscal policy refers to changes in governmentexpenditures and / or taxes to achieve economic goals, such as lowunemployment, price stability, and economic growth. It is the use ofgovernment revenue collection (mainly taxes) and expenditure (spending) to influence the economy. According to Keynesian economics, when the government changes the levels of taxation and governmentspending, it influences aggregate demand and the level of economic activity.
Fiscal policy isoften used to stabilize the economy over the course of the business cycle. Thus, I would liketo suggest two types of fiscal policy that can be implemented to have asustainable GDP growth which are automatic fiscal stabilisers and discretionaryfiscal policy. Automatic fiscal stabilisers are economic policies and programsdesigned to offset fluctuations in a nation’s economic activity withoutintervention by the government or policymakers on an individual basis. Thebest-known automatic stabilizers are corporate and personal taxes, and transfersystems such as unemployment insurance and welfare.
Automatic stabilizers are so calledbecause they act to stabilize economic cycles and are automatically triggered without explicitgovernment action. For instance, progressive income taxes, this is the type oftax that increases when income of a person increases.Progressive taxation push people into higher income tax brackets during boomtimes, substantially increasing their tax bill and reducing government budgetdeficits (or increasing government surpluses). During recessions, manyindividuals fall into lower tax brackets or have no income tax liability. Thisincreases the size of the government budget deficit (or reduces the surplus).
Whereas for discretionary fiscal policy, it is the non mandatory changes ingovernment expenditures and taxes that need specific approval from the Congressor the President in response to economic events or changes in economicconditions. Discretionary fiscal policy often occurs in period of recession oreconomic turbulence. For example, increases in spending on roads, bridges, stadiums, and otherpublic works in an attempt to lower the unemployment rate.
On the contrary, the national income willincrease if the government is running a budget deficit. This is because GDPwill rise if aggregate expenditure exceeds GDP. Government Budgetis a detail accounting for the income received by the government such as peoplewho pay the taxes and fees and the payments government made such as purchasesand transfer payments. A budget deficit occurs when the government spends morethan what they receive.
A budget deficit means thatgovernment expenditure which is an injection is greater than taxation which isa withdrawal. Besides that, budget surplus is the opposite of the budgetdeficit which is taxation greater than government expenditure.When thegovernment running a budget deficit and the governmentexpenditure increases, it will directly proportional influence the nationalincome since government expenditure is one of the determinants for equilibriumlevel of national income. This occurs based on the formula, national income =total expenditure ( consumption + investment + government expenditure)It isdifficult to fine tune the economy by using fiscal policy because there are afew obstacles that are against it.
Oneof the obstacles is time lag because if the scheme of the government isincreasing the spending and this may take a long time process to filter intothe economy or may be too late. Spending plans are only setting once a year, sothere will certainly be a delay in implementing any changes in governmentplans.After that ,fiscal policy decision needs approval by the government andthis will require a longer time to approval.So, that is why decisions are nottaken at proper time and this will cause time lag.
Besides,the multiplier effect also is an obstacle tofiscal policy because fiscal policy is depending on multiplier effect.Thefiscal multiplier effects occur when an initial injection into an economy andcause a larger final increase in national income. So, increase the multipliereffect may have any changes in injections and the size of the multiplier willbecome larger.If the income increase,the multiplier effect will be low and theeffectiveness of fiscal policy will also be reduced.In expansionary policy, theextent to which government spending and tax cuts increase aggregate demanddepends on spending and tax multipliers.The spending multiplier is bigger thanthe tax multiplier because the entire increase in government spending isachieved by increasing aggregate demand, but only a portion of the increase indisposable income (due to the lower taxes) is consumed.
So,the multiplier effectof a tax cut can be affected by the size of the tax cut, the marginalpropensity to consume.Fiscal policy willsuffer if the government has poor information.Poor information gives rise topoor decision and a decisions cannot be better than the information on whichthey are based .Poor information also can have very serious consequences suchas affect the economic growth For example, if the government assumed there isgoing to be an inflation next year and they will decrease the aggregatedemand.However, if this prediction was wrong and the economy grew slowly, thegovernment action would cause the recession.
Furthermore,the fourth obstacle is side effects on public spending.If the government decide to reduce government spending(G) to decrease inflationary pressure, the government spending can harm long-term productivity. The government spending involves investment in increasingcapital stock and productive capacity, such as building new roads, publictransport and education and this cause market failure and social inefficiency.Then, lower the government also will lead to lower the economic growth. Also,it will be difficult to reduce spending in the future. If the governmentchooses to reduce government spending (G) to decrease inflationary pressure, itcould adversely affect public services such as public transport and educationcausing market failure and social inefficiency.
The last obstacle iscrowding out. Crowding out occurs when expansionary fiscal policy of increasedgovernment spending (G) and will not increase the aggregate demand or increaseslowly .For example, if the government spending increase , because they borrowmoney from the private sector, so private sector will reduces private sectorinvestment and spending. However, private saving rates rise quickly during therecession.
Thus, an expansionary fiscal policy helps to counteract the rises ofprivate sector saving and put money into the circular flow so will not causeany crowding out.