In this article we will discuss about the anti-inflationary fiscal policy and its aims.
The government often makes deliberate adjustments in revenues and expenditures for the purpose of obtaining greater economic stability. Such adjustments go by the name ‘fiscal policy’. Since fiscal policy operates mainly through the budget, it is also known as the budgetary policy.
The generally accepted goal of fiscal policy is economic stability which implies both full employment and the price level stability. Economic stability requires comparable rates of increase in aggregate demand and productive capacity. If aggregate demand outruns the rate of increase in output, inflation will result.
Anti-inflationary fiscal policy involves adjustments in government expenditures, taxation and borrowing and debt management policies. Borrowing and debt management policies are related to the central bank’s monetary policy and is treated as a third type of stabilisation policy distinct from either monetary policy or fiscal policy.
If fiscal policy is to control inflation, there is need to curtail the volume of spending in such a manner that costs of production are not increased. In other words, for fiscal policy to control inflation there is need for a maximum reduction in government expenditures and increase in taxes so as to achieve a balance between aggregate expenditure and output.
Since excessive aggregate spending is the root cause of inflation, a reduction in government spending, which is one major components of total spending, is likely to lessen inflationary pressures. During inflation it is necessary to eliminate wasteful public expenditure or those public works programmes which may be justifiable in periods of low employment, but are not warranted in full employment.
Secondly, inflationary pressures can be reduced by postponing public construction of various types, such as the building of new post offices, bridges, or highways.
One type of government expenditure, namely, government subsidies, if used judiciously, may aid in checking inflationary pressures. Prima facie, if a critical item like steel is in short supply, subsidies to marginal producers may help raise output and thus eliminate specific inflationary (cost + push) pressures because steel is used as input by many industries.
Secondly, subsidies may be provided to producers of essential items of consumption to offset cost increases, so that these firms will not have to raise prices and thus increase the cost of living and set off general wage increases.
However, subsidy payments themselves are inflationary, since they result in increased purchasing power in the hands of the public. But if they bring about significant increases in output of very scarce goods, the increased supply will more than offset net excess demand pressure.
In fact, the most effective type of subsidy from the inflationary point of view is one applied to imports. Such a subsidy increases the domestic supply of subsidised commodities without adding to domestic purchasing power. However, the gains may partly be lost due to the ability of other countries to buy our products.
Taxes seem to have the greatest anti-inflationary effects. However, the effectiveness of taxes depend not only on the individual taxes but also on the overall tax structure.
A tax on personal income reduces inflationary pressures by reducing people’s disposable income. It does have a minimum effect on business cost, except to the extent that reductions in disposable income lead trade unions to demand wage increases.
On the contrary, it does not place a burden on persons who do not fall under the tax net or who are able to evade taxes or who spend huge sums from accumulated wealth. Moreover, a major portion of the tax may be absorbed from savings and thus it may give no direct incentive to curtail spending. Thus, its anti-inflationary effect will be less per rupee than that of a tax on spending.
Consequently, “if given inflationary pressures are to be checked by the use of income-tax increases, the tax rates must be higher than they would need to be with a tax having a greater effect in curtailing spending. Accordingly, the adverse effect on incentives to work and produce will be somewhat greater.”
Excise duty and sales tax affect inflationary pressures in a different way. Demand-shifting excise are designed to discourage persons from buying particularly scarce commodities. The tax acts as an alternative to the rationing system. The policy will prove to be effective only if the demand for the product is fairly elastic.
Contrarily, demand-absorbing excise are levied upon commodities having inelastic purchasing power that would otherwise be used for inflationary spending. However, the fact is that most commodities of inelastic demand are of widespread use and the burden of tax will be distributed in a regressive manner (i.e., the poor will pay more than the rich).
However, income-tax on companies may be raised to control inflation. Such a tax is deflationary in two ways. First, to the extent that dividends are reduced, individual spending is curtailed, at least partly. Secondly, business firms are left with less funds for expansion and so they must reduce their investment spending.
During inflation it is also necessary to reduce budgetary deficit or to increase budgetary surplus. This is more so in developing countries like India where the root cause of inflation is governmental deficit on current account. The pertinent question here is: to what extent is a balanced budget surplus required if inflationary pressures are to be eliminated?
The answer is — the higher the level of government expenditures, the greater is the like-hood that a budget surplus will be required to check inflation, unless governmental activities are of such as to discourage private investment.