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Fiscal Policy – Definition, Types and Objectives


Fiscal Policy refers to the governing bodies spending and taxation to influence the economic conditions, mainly the macroeconomic condition. It includes employment, inflation, aggregate demand for goods and services and economic growth. The question is how much income it receives through taxes and how much it is spent on defence, welfare, and education. Although, the concept even contracts with monetary policy regulated by the central bankers influencing the quantity of money and credit in an economy. Both the concepts are helpful to accelerate growth when an economy begins to moderate growth. In addition, fiscal policy is also helpful in redistributing income and health.

Types of Fiscal Policy

Neutral Policy: The first type of fiscal policy is a neutral policy, which is also known as a balanced budget. This is where the government brings in enough taxation to pay for its expenditures. In other words, government spending equals taxation.

Expansionary Fiscal Policy: Expansionary fiscal policy is where the government spends more than it takes in through taxes. This may involve a reduction in taxes, an increase in spending, or a mixture of both. In turn, it creates what is known as a budget or fiscal deficit.

Contractionary Fiscal Policy: Contractionary fiscal policy is where the government collects more in taxes than it spends. A government may wish to do this for several reasons. Primarily, it is used to help stem inflation. For example, the more government tax, the less disposable income consumers have. In turn, this reduces aggregate demand which may seem like a bad thing, but it helps reduce inflation.

Objectives of Fiscal Policy

A Government has several fiscal policy objectives in mind when making decisions. Some governments may favour an objective over the other one. Below are the five main objectives of the fiscal policy.

Economic growth: As an economy develops, its citizens become flourishing on the whole. Also, the economy’s government should be careful, as a violent fiscal policy may turn destructive in the long run.

Full employment: It is the primary objective of a government to get people into work. Not only do the higher taxes benefit the governments, but also the lower expenditures on social security. Although, an expansionary policy may invest in infrastructure to create employment opportunities in future. Likewise, it may also minimize taxes to supply more money to consumers to stimulate employment indirectly from purchases.

Control debt: Operating a budget deficit is not a harm. It creates more and more debt over time. If the tax receipts and economic growth do not increase its line, a nation witnesses an unsustainable debt. Thus, a rational fiscal policy tends to control to avoid drastic action.

Redistribution: The transfer of wealth from rich to poor is another government’s objective. High taxes may result in high tax receipts, but not always. Although avoidance and evasion may occur, small incremental increases may not be impactful in the short term.

Control Inflation: When an economy develops strongly, it may witness inflation depending on the monetary policy. Although inflation is a monetary phenomenon, the government still takes necessary steps to stem such a situation. Nevertheless, governments take steps by increasing taxes to minimize disposable incomes and consumption.

Read Also: Role of Fiscal Policy in Resource Mobilization

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