Understanding Fiscal Policy with Reference to India

Understanding Fiscal Policy with Reference to India

In the last blog we had learnt that fiscal policy deals with revenue collection through taxes and government spending. Let us study the impact of taxes and government spending in an economy with special reference to India.

Impact of Taxes on Economy

When taxes are high the following is likely to be the impact on the economy:

  • There will be a reduction in the money supply in the economy.
  • A fall in aggregate demand is expected.
  • Economic activity is likely to fall.
  • GDP is likely to fall.
  • Inflation is likely to reduce.
  • Tax compliance will be poor. There will be a rise in black economy.

When taxes are low the impact on the economy is likely to be the reverse. GDP and economic activity is likely to rise along with inflation.

Various other Impacts of Taxes/Subsidies

  • Taxes can be used to promote exports and thus improve balance of payment situation by giving benefits/breaks.
  • Tax breaks can promote small scale industries and job creation.
  • High taxes can curb imports.
  • High taxes on specific products can reduce exports when government is so inclined.
  • High income taxes on the rich individuals and corporate and on luxury goods/services can increase revenue without impacting the poor. Along with this direct transfer of money to the poor and subsidies on essential goods can achieve the aim of redistribution of wealth in the economy.

Impact of Government Spending

When government expenditure is more than the revenue (fiscal deficit) then following are the likely impacts:

  • Increase in economic activity, reduction in unemployment and rise in GDP.
  • Rise in inflation.
  • Lowering of exchange value of currency.

When government opts for very low fiscal deficit or an almost balanced budget then following are the likely impacts:

  • Inflation gets controlled.
  • GDP growth may be curtailed.

Macroeconomic Complexities and India

The above explanation of fiscal policy is a very simplistic approach. There are a lot many complexities peculiar to each economy, further compounded by the impact of globalization. These aspects have not been discussed deliberately to ease comprehension. In the case of India at the moment in my perception fiscal deficit and inflation are high, but acceptable. There is a drastic need to fuel  economic growth by great increase in public spending on infrastructure. Fiscal deficit can be reduced by increasing the pace of disinvestment.

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