In the modern economy, the state needs effective tools to influence economic processes. One of the key leverage is fiscal policy. Using tools that work with taxes and the budget, the government can stabilize economic downturns and regulate inflation.
The essence of fiscal policy
When a term such as fiscal policy is used, this refers to a set of measures taken by the government to maintain the stability of the economy by changing the size of expenditures and / or revenues of the state budget. For this reason, fiscal policy will rightly be called budget.
Since fiscal policy can be described as countercyclical, that is, stabilization (smooths out cyclical fluctuations in the economy), the implementation of the following tasks is relevant to its key objectives:
- ensuring price level stability, which implies the maximum possible solution to a problem such as inflation;
- continuous economic growth;
- full employment of resources (neutralization is a priority cyclical unemployment).
Fiscal policy can also be defined as government regulatory policy. aggregate demand (this is first of all). To regulate the economy in order to achieve this objective, an impact is made on the value of total costs.
Types of fiscal policy
Instruments of influence on economic indicators used by the state are divided into two key types. This is a non-discretionary and discretionary fiscal policy.
The set of measures, characterized as non-discretionary, is characterized by an automatic change in government spending and taxes, which is caused by significant changes in the state of the economy (tax rates and transfer programs remain unchanged). At the same time, discretionary and automatic fiscal policies are characterized by the fact that the latter uses built-in stabilizers as the main tool: farm subsidies, progressive income tax, unemployment benefits and poverty, which affect the reduction or increase of the state budget deficit.
In other words, if due to the crisis, incomes of enterprises and the population begin to decrease significantly, then higher interest rates are used to levy progressive taxes, including income tax on individuals. Such a scheme leads to an automatic increase in tax revenues to the state budget.
Studying the differences between discretionary and non-discretionary fiscal policies, it is worth noting that built-in stabilizers with an automatic exposure system are used to achieve one key goal - to overcome the negative effects of inflation and a possible production decline.
It is worth noting the fact that the influence of the state on the economy can reach new performance indicators if it is correctly combined with the conduct of monetary policy.
A fiscal policy is discretionary if changes are made to government expenditures, balances and state budget taxes, and the reason for such changes is special government decisions that are aimed at increasing production, employment, stabilizing the balance of payments and inflation.
Fiscal Stimulus
This type of measure of influence on economic indicators is relevant when the state is forced to go through a period of depression and recession. Such a strategy involves lowering taxes and raising government spending. The final stage of this set of measures is the budget deficit.
If we consider the short term, then discretionary fiscal policy will have as a main guideline the overcoming of such a problem as a cyclical recession of the economy, which implies a reduction in taxes, an increase in government spending or the integrated use of these measures.
Paying attention to a longer term, it can be noted that such a policy, based on tax cuts, can cause the expansion of production factors and the subsequent growth of economic potential. Thus, a discretionary stimulating fiscal policy is an actual state response to the clear signs of an economic downturn.
It is important to understand that the implementation of such tasks implies a comprehensive reform in the field of tax legislation, which will be accompanied by a change in the process of optimizing the structure of public spending.
Restraining Tools
The mechanism of discretionary fiscal policy also implies measures that restrain economic growth. This approach is relevant at a time when there is an economic boom and inflation is increasing at the same time. To stabilize the economy, taxes are raised, and government spending are decreasing. The consequence of this strategy is an excess of the state budget.
As the main goal of a restraining policy, one can define the limitation of the cyclical economic recovery.
If we consider such a strategy in the long term, then the impact of a progressing tax wedge can lead to the development of a stagnation mechanism (meaning a noticeable slowdown in economic development), and the aggregate supply will be in decline. Such a forecast is especially relevant when the creation of useful priorities for government investment in market infrastructure is not observed, and government spending is reduced proportionally to all budget items.
In a short period, restraining measures can significantly reduce demand inflation through a decline in production and rising unemployment.
Discretionary Fiscal Policy Tools
In order to achieve the goals set regarding the regulation of economic processes in the country, effective tools are needed.
These mechanisms include government subsidies and competent manipulation of various types of taxation (excise taxes, income tax, etc.). To do this, either lump-sum taxes or directly the rates themselves are changed. Another group of instruments, the use of which implies a discretionary fiscal policy, is different types of government spending and transfer payments.
It should be noted that the impact on the economy of various instruments may vary significantly.
If you pay attention to the impact of an increase in the lump sum tax, you can see that the result of this process is a reduction in total expenses, as a result of which, however, there is no change in the multiplier. But in the case of an increase in personal income tax rates, there is a simultaneous decrease in both the multiplier and total expenses.
Discretionary fiscal policy also involves various types of impacts on incentives that affect the development of the economy and its level of effectiveness. Do not forget about the choice of specific types of government spending, each of which has a special impact on the effect produced by the multiplier.
It is important to understand the fact that fiscal policy instruments can be used in different ways. It all depends on the cycle in which the economy is located. Different types of fiscal policies can also change the approach to instruments.For example, if you pay attention to the stimulating direction, it makes sense to talk about the following measures of influence on the state of the economy:
- increase in transfers;
- general tax reduction;
- increase in public procurement.
If the goals of a discretionary fiscal policy focused on a deterrent effect are achieved, then the actions of the government will be diametrically opposite:
- transfers are reduced;
- volumes of public procurement, respectively, increase;
- taxes are increasing.
Problems of time when implementing a regulatory strategy
Discretionary fiscal policy and its tools on a theoretical plane look much simpler than at the time of implementation. In practice, the state is faced with certain difficulties in trying to manage economic processes.
And if we talk about such a factor as time, it makes sense to pay attention to the following problems that appear under its influence:
- Administrative delay. It is too slow for parliament to make a decision. Entire quarters and even years may go into consideration of some issues, which is unacceptable in a constantly changing economic situation.
- Functional Delay. This should be understood as the occurrence of a time lag between the moment of decision-making regarding fiscal measures and the time of their actual effect on the state of the economy.
- Recognition time lag. When complicating this kind of discretionary fiscal policy may not be effective due to the long period of analysis of the real state of the economy - inflation or recession.
Political Issues
Political processes can also have a significant impact on the level of effectiveness of fiscal policy. In this case, it makes sense to pay attention to the following difficulties:
- A business cycle that is driven by political motives. According to most economists, in this case, the emphasis is not on the prospects for the development of the national economy, but on the task of re-election. For this reason, before the election, a stimulating policy is being pursued, the result of which will inevitably be inflation. And to lower its level, restraining mechanisms of influence will subsequently be used.
- The presence of additional goals. This means that economic stability is not defined as a government priority.
- Orientation to stimulating goals. The problems of discretionary fiscal policy may be related to the incorrect allocation of priorities: increasing costs and lowering taxes are perceived as a more attractive strategy compared to raising taxes. The result of this approach to regulating the state of the economy are deficits.
The impact of factors of a foreign economic nature
Discretionary fiscal policies may not be effective due to the impact of the net export factor. We are talking about the economic effect, which is based on the influence of the state on the interest rate, which subsequently affects the exchange rate of the domestic currency. The result of this process is the impact on net exports, minimizing the percentage of effectiveness of regulatory measures.
Unforeseen international changes in demand can also make any kind of fiscal policy ineffective. In order to understand the negative impact of this factor, one needs to imagine the following situation: for example, a number of stimulating actions were carried out, the result of which was a successful increase in aggregate demand, which allowed full employment. But at the same time, the country, which is a trading partner, is experiencing rapid economic growth. As a result, there is such a rapid increase in aggregate demand that inflation arises.
Crowding out effect
In this case, we are talking about specific theoretical arguments, according to which discretionary and non-discretionary fiscal policies are not effective by definition. The essence of this argument is as follows: in the case of, for example, stimulating deficit measures of influence, an increase in interest rates and a reduction in investment costs will manifest themselves. Such processes lead to a weakening and even neutralization of the stimulating effect of fiscal policy.
In practice, this may look as follows: to increase government spending, the government begins to finance the deficit, thereby increasing the demand for money. As a result, the interest rate rises, and investment decreases. But if investments fall by the same percentage that was recorded in the process of increasing costs, the effect of such a strategy will be zero.
It is worth paying attention to the fact that this theory is confirmed as relevant by no means by all economists.
Discretionary fiscal policy in the Russian economy
At the moment, the formation of the base for the modern tax system in Russia has already been completed. And if you pay attention to the key parameters of the tax system in the Russian Federation, you can see that they do not reflect Soviet realities. The current system is based on the key types of taxes that are relevant in modern world practice, which are used taking into account the current economic conditions of the Russian Federation.
In Russia, discretionary fiscal policy involves the transformation of the tax system with the parallel implementation of budget reform. In order to solve various problems that impede the successful implementation of the tax reform strategy, the Russian government uses popular tools to influence the economy. An example is the use of a flat tax rate on personal income. But in some cases, the effectiveness of the system is reduced due to unproductive administration and the application of legislation on taxes and fees.
As a result, it can be noted that discretionary and automatic fiscal policies are mechanisms of influence, with proper use of which the state is able to permanently effectively stabilize the state of the economy and overcome both various crises and inflation, which also requires qualified control.
Macroeconomics. Fiscal policy
