FISCAL POLICY

 FISCAL POLICY FOR REDUCTION IN INEQUALITIES OF INCOME AND WEALTH

• Many developed and developing economies are facing the challenge of rising inequality in incomes and opportunities. Fiscal policy is a chief instrument available for governments to influence income distribution and plays a significant role in reducing inequality and achieving equity and social justice. 
• The distribution of income in the society is influenced by fiscal policy both directly and indirectly. While current disposable incomes of individuals and corporates are dependent on direct taxes, the potential for future earnings is indirectly influenced by the nation’s fiscal policy choices.
• Government revenues and expenditure have traditionally been regarded as important instruments for carrying out desired redistribution of income. 

 We shall see a few such measures as to how each of these can be manipulated to achieve desired distributional effects.

•  A progressive direct tax system ensures that those who have greater ability to pay contribute more towards defraying the expenses of government and that the tax burden is distributed fairly among the population.
• Indirect taxes can be differential: for example, the commodities which are primarily consumed by the richer income group, such as luxuries, are taxed heavily and the commodities the expenditure on which form a larger proportion of the income of the lower income group, such as necessities, are taxed light.
• A carefully planned policy of public expenditure helps in redistributing income from the rich to the poorer sections of the society. This is done through spending programmes targeted on welfare measures for the disadvantaged , such as

1.    poverty alleviation programmes
2. free or subsidized medical care, education, housing, essential commodities etc. to improve the quality of living of poor
3.  infrastructure provision on a selective basis
4. various social security schemes under which people are entitled to old-age pensions, unemployment relief, sickness allowance etc.
5.  subsidized production of products of mass consumption
6. public production and/ or grant of subsidies to ensure sufficient supply of essential goods, and
7.  strengthening of human capital for enhancing employability etc.

Choice of a progressive tax system with high marginal taxes may act as a strong deterrent to work save and invest. Therefore, the tax structure has to be carefully framed to mitigate possible adverse impacts on production and efficiency. Additionally, the redistributive fiscal policy and the extent of spending on redistribution should be consistent with the macroeconomic policy objectives of the nation.

 LIMITATIONS OF FISCAL POLICY
We have seen above that discretionary fiscal policy is the conscious manipulation of government spending and taxes to influence the economy. However, there are some significant limitations in respect of choice and implementation of fiscal policy.

1. One of the biggest problems with using discretionary fiscal policy to counteract fluctuations is the different types of lags involved in fiscal-policy action. There are significant lags are:

•  Recognition lag: The economy is a complex phenomenon and the state of the macro economic variables is usually not easily comprehensible. Just as in the case of any other policy, the government must first recognize the need for a policy change.
•  Decision lag: Once the need for intervention is recognized, the government has to evaluate the possible alternative policies. Delays are likely to occur to decide on the most appropriate policy.
•  Implementation lag: even when appropriate policy measures are decided on, there are possible delays in bringing in legislation and implementing them.
• Impact lag: impact lag occurs when the outcomes of a policy are not visible for some time.

2. Fiscal policy changes may at times be badly timed due to the various lags so that it is highly possible that an expansionary policy is initiated when the economy is already on a path of recovery and vice versa.

3. There are difficulties in instantaneously changing governments’ spending and taxation policies.

4. It is practically difficult to reduce government spending on various items such as defence and social security as well as on huge capital projects which are already midway.

5. Public works cannot be adjusted easily along with movements of the trade cycle because many huge projects such as highways and dams have long gestation period. Besides, some urgent public projects cannot be postponed for reasons of expenditure cut to correct fluctuations caused by business cycles.

6. Due to uncertainties, there are difficulties of forecasting when a period of inflation or deflation may set in and also promptly determining the accurate policy to be undertaken.

7. There are possible conflicts between different objectives of fiscal policy such that a policy designed to achieve one goal may adversely affect another. For example, an expansionary fiscal policy may worsen inflation in an economy

8. Supply-side economists are of the opinion that certain fiscal measures will cause disincentives. For example, increase in profits tax may adversely affect the incentives of firms to invest and an increase in social security benefits may adversely affect incentives to work and save.

9. Deficit financing increases the purchasing power of people. The production of goods and services, especially in under developed countries may not catch up simultaneously to meet the increased demand. This will result in prices spiraling beyond control.

10. Increase is government borrowing creates perpetual burden on even future generations as debts have to be repaid. If the economy lags behind in productive utilization of borrowed money, sufficient surpluses will not be generated for servicing debts. External debt burden has been a constant problem for India and many developing countries.

11. If governments compete with the private sector to borrow money for spending, it is likely that interest rates will go up, and firms’ willingness to invest may be reduced. Individuals too may be reluctant to borrow and spend and the desired increase in aggregate demand may not be realized. This phenomenon is described below.