1. What is Fiscal Policy?

Fiscal Policy, also called Budgetary Policy, refers to the government’s policy of taxation, public expenditure and borrowing to influence the economy.

In simple words:
Fiscal policy answers two basic questions:

1. Where should the government spend money?
2. From where should the government get money?

These decisions are taken through the Government Budget.

2. Core Components of Fiscal Policy

Fiscal policy mainly works through three instruments:

(a) Public Expenditure

Government spending on:

• Defence, police
• Education and health
• Infrastructure (roads, railways, canals, airports)
• Welfare schemes and subsidies

Example: More spending on health during an epidemic.

(b) Taxation

Government raises revenue by:

• Imposing new taxes
• Changing existing tax rates
• Deciding who to tax more and what to tax

Example: Higher tax on luxury goods, lower tax on essentials.

(c) Public Borrowing

When tax revenue is insufficient, the government borrows from:

• Public (bonds, NSC, Kisan Vikas Patra)
• Foreign sources

Borrowing helps meet expenditure but creates future liabilities.

3. Types of Fiscal Policy

Fiscal policy can be classified into three types, based on the relationship between government spending and taxation.

1. Neutral Fiscal Policy

Government Spending = Tax Revenue

• No attempt to stimulate or slow down the economy
• Budget remains balanced

Used when the economy is stable.

2. Expansionary Fiscal Policy

Government Spending > Tax Revenue

• Government increases spending and/or reduces taxes
• Leads to budget deficit

Used when:

• Economy is slowing down
• Unemployment is high
• Recession-like conditions exist

Objective: Increase demand, production and employment.

3. Contractionary Fiscal Policy

Government Spending < Tax Revenue

• Government reduces spending and/or increases taxes

Used when:

• Inflation is high
• Economy is overheating

Objective: Control inflation and excess demand.

4. Fiscal Policy vs Monetary Policy

5. Objectives of Fiscal Policy

1. Promote Economic Growth

• Government invests in basic and heavy industries
• Builds infrastructure like roads, railways, power, education, health

Private sector avoids these due to huge investment needs, so government steps in.

2. Reduce Income and Wealth Inequality

• Higher taxes on rich
• Higher spending on poor (subsidies, welfare, employment schemes)

Ensures inclusive growth.

3. Generate Employment

Government creates jobs by:

• Setting up public sector enterprises
• Encouraging private sector through subsidies & tax concessions
• Promoting small-scale and cottage industries
• Launching public works (roads, bridges, canals)

4. Ensure Price Stability

• Controls prices of essential goods
• Maintains buffer stocks and ration shops
• Provides subsidies on LPG, electricity, transport

Protects common people from inflation.

5. Correct Balance of Payments (BoP) Deficit

When imports exceed exports:

• Government discourages imports through taxes
• Encourages exports via subsidies and incentives

Helps reduce foreign exchange outflow.

6. Ensure Effective Administration

Government spends on:

• Defence
• Police
• Judiciary
• Legislature

Necessary for law, order and governance.

Recall Trick

Remember Fiscal Policy with “T–E–B–O–S–P”

• T – Taxation
• E – Expenditure
• B – Borrowing
• O – Output growth
• S – Stability
• P – Poverty reduction