Fiscal Policy, Equitable Distribution of Income and Price Stability

Fiscal Policy and Equitable Distribution of Income –

Existence of inequalities is a social evil and no measure of economic development can increase welfare unless an equitable distribution of income or national product is assured.

Taxation can be used to bring about a redistribution of income in favor of the poorer sections of the society. It also necessary to strike a balance between the two objectives of lessening economic inequalities and, sustaining and strengthening incentives to invest and increase production. Fiscal policy must maintain unbroken flow of savings and investment for sustained economic growth.

Greater equality and larger production both are of high importance for economic growth and social policy. Higher incomes can be taxed without adverse effects on private productive activities. Optimum rate of growth and maximum social welfare are not irreversible and can be achieved by the formulating a well balanced fiscal policy.

Lessening inequalities by taxing is only one form of fiscal operations. A better and complementary fiscal policy consists of increasing public expenditure for promoting welfare of the less privileged classes.

Increasing public expenditure on anti-poverty or employment generating programmes such as construction of rural public works and employment guarantee schemes will ensure equity in income distribution.

Increasing expenditure on education and health will greatly improve the economic conditions of the poor people.

Active public expenditure policies aimed at raising the consumption of the poor are far more effective in promoting equity as compared to tax policies aimed at heavily taxing the incomes of the rich.

Fiscal Policy and Price Stability –

Developing countries have been experiencing the problem of both types of inflation which are demand-pull inflation and cost-push inflation.

The main cause of demand-pull inflation has been the fiscal deficit in government’s budgets which have increased considerably because they have not been able to finance the mounting public expenditure through revenue from taxes and public sector surpluses.

In India, fiscal deficit was about 8.3% of the GDP in year 1990-91 and was about 4% in year 2004-05.

IMF recommends it to be 3% of GDP, to achieve price stability.

The government finances its deficit by two ways –

1. By borrowing from the market

2. By printing new money

A high degree of fiscal deficit leads to excess market borrowing by the government which causes expansion in money supply in the economy which in turn causes inflation.

Excessive government borrowing from the market also leads to the rise in interest rate which discourages private investment.

A part of fiscal deficit is monetised by borrowing from the Central Bank (RBI in India) which issues new currency for the government. This causes greater expansion in the money supply by the process of money multiplier and creates inflationary situation in the economy.

So, to check the rate of inflation, fiscal deficit can be reduced to a reasonable level by both rising revenue of the government and reducing non-developmental government expenditure.