Understanding Fiscal Policy and Its Impact on Economic Stability
Fiscal Policy: Includes all government decisions on the amount of expenditure by the public sector and the specific composition of that expenditure. Taxes: Payments are mandatory, unilaterally imposed by governments. They are the main form of income for the public sector, aiming to have all members of the economy help support public expenditure according to their capabilities. Apart from the impact of revenue collection, which involves obtaining resources for financing public expenditure, taxes also impact the redistribution of income. They can often be used as the main tool of the distributive policy for the welfare state to improve equity. However, the payment of taxes incurs a set of costs to society. This includes not only the cost to the individual for the payment of taxes but also the cost in terms of deadweight loss due to distortions introduced by incentive systems, which affect economic decisions made by individuals. When we refer to a deadweight loss from taxes, we mean that the reduction in economic welfare for taxpayers may be greater than the amount of revenue collected by the state. Therefore, when designing fiscal policy, it is crucial to note that this effect distorts the incentive system. The chosen tax system, i.e., the specific form of government revenue, should have the least social cost in terms of total loss of efficiency in the allocation of resources.
Macroeconomic Stability and Fiscal Policy: According to Keynes, there are situations in which macroeconomic imbalances occur, such as recessions and unemployment, which originate from insufficient demand for goods and services. Correcting these imbalances requires stability through public sector intervention via demand policy. The main policies of demand are monetary and fiscal policies. – When generating economic recession and unemployment, an expansionary fiscal policy would be necessary to offset the insufficiency of demand by increasing public expenditure on goods and services and reducing taxes. – When aggregate demand generates excessive inflation, a contractionary fiscal policy that reduces the demand for goods and services would help moderate price growth. The Problems of the Public Finance Deficit: The use of fiscal policy as a stabilizing tool is proposed by the Keynesian approach. Definition: The public deficit is defined as the difference between spending and revenue. The public sector can finance its deficit in two ways: through loans from the central bank or by issuing money. If the increase in the amount of money in circulation becomes excessive, it may lead to an unwanted inflationary process. Application for loans to the rest of economic agents occurs through public debt. This debt is established by a set of financial securities issued by the public sector. The Problems of the Public Debt: The savings of economies are limited; private companies also need to capture such savings to conduct their productive investment projects. Relying on the public sector for financing shifts the burden onto the private sector, resulting in a portion of business investment projects not being performed. A second problem is that the issuance of debt securities acquired by the public sector creates a commitment to repay loans and pay future interest. This shifts payment obligations to future generations. However, leveraging can be beneficial if public spending is used for public investment, as it will increase future capacity to generate more income in the country.