Fiscal policy is the use of government expenditure and revenue collection (taxation) to influence the economy. Fiscal policy can be contrasted with the other main type of macroeconomic policy, monetary policy, which attempts to stabilize the economy by controlling interest rates and the money supply. The two main instruments of fiscal policy are government expenditure and taxation. Changes in the level and composition of taxation and government spending can impact variables in the economy including aggregate demand and real GDP.
Governments use fiscal policy to influence the level of aggregate demand in the economy, in an effort to achieve economic objectives of price stability, full employment, and economic growth. Keynesian economics suggests that increasing government spending and decreasing tax rates are the best ways to stimulate aggregate demand, and decreasing spending and increasing taxes after the economic boom begins. Keynesians argue this method be used in times of recession or low economic activity as an essential tool for building the framework for strong economic growth and working towards full employment.
What is fiscal policy?
According to Samuelson,
Fiscal Policy is concerned with all those arrangements which are adopted by the Government to collect the revenue and make the expenditures so that economic stability could be attained/maintained without inflation and deflation´
According to Lee, Fiscal policy considers:
- Imposition of taxes
- Government expenditures
- Public Debt
- Management of Public Debt
Objectives of fiscal policy in Pakistan
- self reliance
- expansion of exports
- containment of import of luxury and non-essential goods
- promotion of investment
- reduction in income disparity
How does fiscal policy works?
- Fiscal Policy is based on Keynesian theory which states that government can influence macroeconomic productivity levels by increasing or decreasing tax levels and public spending.
Types of Fiscal Policy
Expansionary:
An increase in government purchases of goods and services, a decrease in net taxes, or some combination of two for the purpose of increasing aggregate demand and expanding real output
Contractionary:
A decrease in government purchases of goods and services, an increase in net taxes, or some combination of the two for the purpose of decreasing aggregate demand and thus controlling inflation.
Methods of Raising Funds
Governments expenditure can be funded in a number of different ways:
- Taxation of the population.
- Borrowing money from the population, resulting in a fiscal deficit.
- External resources: Foreign grant and loans
- Privatization proceeds.
- Change in provincial cash balance.
Types of Taxes
Direct:
Direct tax is the one paid directly to the Government by the persons (natural or juristic)on who it is imposed.
- Income Tax
- Corporate Tax
- Transfer Taxes-estate Tax & Gift Tax
- Property Tax
- Capital Value Tax
Indirect:
An indirect Tax is a tax collected by an intermediary (such as a retail store) from the person who bears the ultimate economic burden of the tax (such as the customer ).
- Sales Tax
- Value Added Tax (VAT)
- Federal Excise Duty
Common issue regarding collection of Taxes
Tax Evasion:
It is an illegal practice where a person, organization or corporation intentionally avoids paying his/her/its true tax liability.
Causes for Tax Evasion
- People do not want to disclose their true income
- Too many unlawful business activities such as drugs, hoarding, black money, etc.
- No fear of punishment
- Complex tax structure
- Some economic sectors are exempted: Agriculture, real estate and capital gain
- Tax payers see their taxes being used to further rich citizens interests.
- Uncontrolled inflation and high cost of living.
- Low level of literacy among tax payers.
Why Pakistan faces large revenue expenditure gap?
The principal reason lies in the structural weaknesses of Pakistan’s tax system which is:
- Complex
- Inefficient
- Unfair
Principles of Tax Policy
- Widening the tax base
- Lowering tax rates
- Taxing all value additions including services, not just manufacturing sector
- Establish an effective and efficient tax system.
- Overcome the culture of tax avoidance and evasion
