The meaning of Fiscal Policy
Fiscal policy refers to the use of government revenue and expenditure to influence the economy. It relates to development guidelines where all welfare projects have to be completed. Essentially, fiscal policies influence macroeconomic activities by balancing tax and public spending.
Two examples of these fiscal policies include taxation and government expenditure, which aim at funding development functions, as well as, enhancing equality. Such policies curb inflation, and in the end increase employment and maintain the value of money (Perry 2008). In addition, proper fiscal policies determine the pace of the country’s economic growth. However, should there be a lack of restraint to the economic growth money will soak the market thereby leading inflation.
Instrument of fiscal policies
Taxation policies are the main government techniques for influencing the economy, as well as a weapon for saving a collapsing economy. The government uses taxation and spending to influence economic activities by increasing and reducing it. Taxation is the main source of income for the government.
The most common method of taxation is direct taxation. Other forms of taxation include personal taxes, value added tax, fees levied on licenses and permits, as well as, fines. The introduction of tax cuts helps in stimulating aggregate demand (Krug 2011, 34-5).
If the government increases taxes, the public will be heavily burdened, which will reduce their production and purchasing power. On the other hand, if the government decreases taxes, money supply will be high. This will then lead to high inflation. A reduction in taxes will increase disposable income and households will end up consuming the money that should have been taxed.
An increase in taxes will also affect businesses. It will lower the profit margin and hence lead to an increase in production. Increased production will increase the demand for raw material and laborers. Therefore, there will be an increase in employment and the money earned will increase the level of income in the economy.
There is the need to analyze taxation policy in order to avoid inflationary tendencies. Additionally, it is the mandate of all policy makers to use the power vested in them by the state to maintain a stable economy. This is because stability centres on the kind of macroeconomic policies made.
Another tool used by the government as fiscal policy is government expenditure, which are recurrent and development. Various development expenditures include opening education institution, building and maintaining infrastructure. On the other hand, recurrent expenditure involves paying salaries to the civil service and employing a new workforce.
An increase in the government expenditure goes to economic development, paying wages and salary, which involves changing the budget. Investing in infrastructure development requires skilled and casual labourers to complete the projects. This creates direct employment opportunities for the people involved in construction work and other indirect opportunities for those supplying services and logistics to the building process.
The employed citizens, either directly or indirectly, earn wages and salaries, which increase their ability to purchase goods, and hence an increase in aggregated demand. In addition, the government can increase spending on education hence increase the skills and knowledge of its citizens. In the end, government will increase the employment to its people.
Deficit financing policy is another example of fiscal policy, although not popular. This happens when the government expenditure is more than its revenue; the deficit can be filled when and if the central bank decides to issue new currency (Baumol & Blinder 1994). It will reduce the purchasing power of the masses hence inflation and in the end, the value of currency will increase.
The government can opt for domestic borrowing as a solution when it feels that deficit financing is insufficient. This is by issuing government securities and bonds; however, it will increase the cost of budget in the form of interest. Fiscal policies, if not sustained carefully, increases inflation and the rate of unemployment.
The fiscal policy stance in the 2011-2012 Federal Budget
The government implemented the contractionary fiscal policy by spending lower than the tax revenue. This is usually because of the pay down of government debt, which saw the 2011/2012 budget with many significant cuts. This is an indication that the government is using fiscal policies as a means of stimulating growth.
This policy affected the dependent spouse tax as a budgetary component thus stimulates aggregate demand. This move will save the government an amount of $755 million (Australian budget services, 2011). Additionally, $1.1 will be saved by raising the public sector dividends and a further $470 by scrapping off low income tax offset. Businesses have not been spared, since those with a turnover of $2 million and below are written off on any motor purchases.
There is a noted increase in spending on the health and education sectors. Notably, the government will offset this by executing sharp cuts on defense expenditure in order to enhance operational competence in the communal service. In addition, other measures will affect natural disaster expenditure ($1.2bn this year), and the flood levee (raising $1.5bn).
The government’s transfer payment policy such as unemployment benefits, social security funds to the elderly, and payments made to the poor had cuts. Consequently, reducing the transfer payment will reduce the amount of disposable income to those involved.
Suitability of the Australian government’s fiscal policy stance
By reducing the government’s expenditure, the banks will be willing to lend to the government because of the increase in liquidity. This will reduce the yearly government debt, consequently reducing the total public sector debt. Arguably, cutting government expenditure will reduce borrowing, which is dangerous and can downgrade the bond market.
Notably, current research points out that one-dollar of tax cuts can increase G.D.P by $3, compared to a supplementary dollar of government expenditure increasing GDP by $1.40. Reducing government expenditure also reduces the level of inflation, because little money remains in circulation (Russell & Heathfield 1999).
Introducing infrastructure tax benefits is also justified and appropriate. The government cut on the infrastructure can affect productive capacity in the end. Notably, introduction of the benefits has opened the opportunity for private investors willing to invest in infrastructure development to proceed.
This will ensure improved infrastructure, which will lead to increased business activities. Increasing expenditure on health and education has increased the skills and knowledge on its citizen. Essentially, this will increase the employment to the people, as well as their disposable income (Symes 1995). Increasing government expenditure will bolster economic growth by increasing the disposable income.
Alternatively, the private sector should offer these essential services to the masses at minimal cost. However, quality should not be compromised. Privatizing the airports, postal services, and improving the educational sector should be strategic by shifting to a model that is based on competition and choice.
The government’s transfer payment policy such as unemployment benefits, social security funds to the elderly, and payments made to the poor had cuts. The transfer payment will reduce the amount of disposable income to the individuals involved hence justifiable.
List of References
Australian budget services, 2011, Federal Budget. Web.
Baumol, W & Blinder, S, 1994, Economics: principles and policy, 6th Edn, Dryden Press, Fort Worth.
Krug, S, 2011, Optimal Taxation in a Federal System of Governments, GRIN Verlag GmbH, München.
Perry, E, 2008, Fiscal policy, stabilization, and growth: prudence or abstinence?, World Bank, Washington, DC.
Russell, M & Heathfield, F, 1999, Inflation and UK monetary policy, 3rd Edn., Heinemann, Oxford.
Symes, V 1995, Unemployment in Europe: problems and policies, Routledge, London.