Asignment arifa-fiscal policy and its importance

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  • 1. University of Sindh Jamshoro Name: Arifa Dars Father’s Name: Sikindar Ali Dars Role No: 2k12/20/HBB Subject: Pakistan Economy Assignment Title: Fiscal Policy and its importance Date: 10/12/2013 Submitted to
  • 2. Respected Sir Vishnu Mal Parmar Fiscal Policy and Its importance Fiscal Policy: Fiscal policy is the use of government spending and taxation to influence the economy. When the government decides on the goods and services it purchases, the transfer payments it distributes, or the taxes it collects, it is engaging in fiscal policy. The primary economic impact of any change in the government budget is felt by particular groups—a tax cut for families with children, for example, raises their disposable income. Discussions of fiscal policy, however, generally focus on the effect of changes in the government budget on the overall economy. Although changes in taxes or spending that are “revenue neutral” may be construed as fiscal policy—and may affect the aggregate level of output by changing the incentives that firms or individuals face—the term “fiscal policy” is usually used to describe the effect on the aggregate economy of the overall levels of spending and taxation, and more particularly, the gap between them. Fiscal policy of Govt. of Pakistan primarily deals with levels and composition of taxation, spending and borrowing by Government. Fiscal policy encompasses several fundamental policy issues, including the proper role and size of the State, role of Government in promoting growth, creating jobs, social development and redistribution of benefits of economic growth, nature and extent of public services and fairness between the present and the future generations. Government's fiscal policy has both micro and macroeconomic objectives. Micro Economic Objectives It includes an improved distribution of income and wealth, equitable access to social services, meeting the basic needs of poor, promoting investment in public goods and enhancing efficiency with which public and private sectors produce goods and services and their responsiveness to the needs of consumers. Macro Economic Objectives It relate to evolution of economy as a whole, national income and output, inflation and balance of payments. Fiscal policy must also ensure that level and structure of taxes promote equality and redistribution and do not interfere unduly in people's investment and consumption decisions.
  • 3. Central objective of govt. economic policy therefore, is to build a strong economy with a view to creating employment opportunities for all and improve the standards of living of the people of Pakistan. The policies pursued thus far have injected fiscal discipline, reduced the country's debt burden, created a stable macroeconomic environment, revived economic activity and most importantly have created a strong platform of economic stability which is vital for building prosperity and achieving social justice. Economic stability allows business, individuals and the government to plan more effectively for the long-term improvement in the quantity and quality of investment. The Government is committed to locking in stability and investing in the country's future, enabling it to meet the challenge and rise to the opportunities of the global economy. A sound fiscal policy is essential for preventing macroeconomic imbalances and realizing the full growth potential. Pakistan has witnessed serious macroeconomic imbalances in 1990s mainly on account of its fiscal profligacy. Persistence of large fiscal deficit resulted in unsustainable levels of public debt, adversely affecting country's macroeconomic environment. Pakistan accordingly paid a heavy price for its fiscal indiscipline in terms of deceleration in economic growth and investment and the associated rise in poverty. Considerable efforts have been made to inculcate financial discipline by pursuing a sound fiscal policy. Pakistan's hard earned macro economic stability is underpinned by fiscal discipline. Functions of Fiscal Policy: Below are the major functions of fiscal policy Allocation The first major function of fiscal policy is to determine exactly how funds will be allocated. This is closely related to the issues of taxation and spending, because the allocation of funds depends upon the collection of taxes and the government using that revenue for specific purposes. The national budget determines how funds are allocated. This means that a specific amount of funds is set aside for purposes specifically laid out by the government. This has a direct economic impact on the country. Distribution Whereas allocation determines how much will be set aside and for what purpose, the distribution function of fiscal policy is to determine more specifically how those funds will be distributed throughout each segment of the economy. For instance, the government might allocate $1 billion toward social welfare programs, but $100 million could be distributed to food stamp programs, while another $250 million is distributed among low-
  • 4. cost housing authority agencies. Distribution provides the specific explanation of what allocation was intended for in the first place. Stabilization Stabilization is another important function of fiscal policy in that the purpose of budgeting is to provide stable economic growth. Without some restraints on spending, the economic growth of the nation could become unstable, resulting in periods of unrestrained growth and contraction. While many might frown upon governmental restraint of growth, the stock market crash of 1929 made it clear that unfettered growth could have serious consequences. The cyclical nature of the market means that unrestrained growth cannot continue for an indefinite period. When growth periods end, they are followed by contraction in the form of recessions or prolonged recessions known as depressions. Fiscal policy is designed to anticipate and mitigate the effects of such economic lulls. Development The fourth major function of fiscal policy is that of development. Development seems to indicate economic growth, and that is, in fact, its overall purpose. However, fiscal policy is far more complicated than determining how much the government will tax citizens one year and then determining how that money will be spent. True economic growth occurs when various projects are financed and carried out using borrowed funds. This stems from the the belief that the private sector cannot grow the economy by itself. Instead, some government input and influence are needed. Borrowing funds for this economic growth is one way in which the government brings about development. This economic model developed by John Maynard Keynes has been adopted in various forms since the World War II era. Importance of Fiscal Policy: Following are the major importance of Fiscal Policy 1. Attainment of maximum welfare of common man. 2. Increase in the employment opportunities. 3. Equitable distribution of national wealth. 4. Development of rural areas and reduction in disparity. 5. Control on inflation/price level. 6. Provision/development of health/education facilities. 7. Reduction in non-development expenditure. 8. Encouragement of private investment. 9. Fuller utilization of national resources. 10. Improvement in balance of payments position.
  • 5. Weaknesses of Pakistan Fiscal Policy: Tax policy is concerned with the design of a tax system that is capable of financing the necessary level of public spending in the most efficient in the equitable way possible. An efficient tax system should raise enough revenue to finance essential expenditures without recourse to excessive public sector borrowing and raise the revenue in ways that are equitable and that minimize its disincentive effects on economic activities. In developing countries, including, Pakistan, the establishment of effective and efficient tax system faces some formidable challenges. The first of these challenges is structure of economy that makes it difficult to impose and collect certain taxes. Economy of Pakistan is often characterized by a large share of agriculture in total output and employment, by large informal sector activities and occupations by many small establishment by a small share of wages in total national income and so on. All these characteristics reduce the possibility of relying on certain taxes such as income tax and to a much lesser extent on sales tax. The structure of economy of Pakistan in association with low literacy and how human capital makes it difficult to develop a good tax administration. The staff of tax administration is not well educated and well trained, resources to pay good salary and to buy necessary equipment are limited, the tax payers have limited ability to keep accounts, the use of modern communication network is limited, it is difficult to create an efficient tax administration. The consequence of this situation is that Pakistan; often end up with too many small tax sources, too heavy reliance on foreign trade taxes and relatively insignificant use personnel income taxes. The non-availability of reliable statistics from the business makes it even more difficult for tax administration to assess the potential taxes that need to be collected. Uneven income distribution is also a major constraint in Pakistan's efficient tax system. To generate higher tax revenue, the top deciles are supposed to be taxed significantly more proportionality than low deciles. But economic and political powers are concentrated in the top deciles, which makes the task of tax department rather more difficult to collect taxes from top deciles/rich people. This is one major reason that the number of income tax payers in Pakistan is very low.
  • 6. Monitory Policy and Importance of Monitory Policy in economic development of a country Monitory Policy: Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low unemployment. Monetary economics provides insight into how to craft optimal monetary policy. Monetary policy is referred to as either being expansionary or contractionary, where an expansionary policy increases the total supply of money in the economy more rapidly than usual, and contractionary policy expands the money supply more slowly than usual or even shrinks it. Expansionary policy is traditionally used to try to combat unemployment in a recession by lowering interest rates in the hope that easy credit will entice businesses into expanding. Contractionary policy is intended to slow inflation in order to avoid the resulting distortions and deterioration of asset values. Monetary policy differs from fiscal policy, which refers to taxation, government spending, and associated borrowing. “The actions of a central bank, currency board or other regulatory committee that determine the size and rate of growth of the money supply, which in turn affects interest rates. Monetary policy is maintained through actions such as increasing the interest rate, or changing the amount of money banks need to keep in the vault (bank reserves).” Importance of Monitory Policy in economic development of a country: Some of the comments seem dramatically at odds with the views that have prevailed among economists and central bankers around the world over the past three decades. It is therefore appropriate to take another glance at the basic ideas that “are now accepted by monetary authorities and governments in almost all countries of the world” as being the key to a successful monetary policy strategy, as Frederic Mishkin, a governor of the Federal Reserve Bank of the United States. The predominant goal of monetary policy – and in fact, its principal contribution to economic welfare – is the promotion of price stability. Clear institutional support for this goal will increase the credibility of the policy framework, thus improving the effectiveness
  • 7. of monetary policy and reduce the costs of bringing inflation back to target when it has drifted away from it. Credibility is therefore the key for successfully anchoring infation expectations and stabilising the real economy in Iceland. It is also conducive to dampening the undesirable effects of exchange rate fluctuations on the domestic economy. All ideas aiming to blur the mandate of the Central Bank or limit its monetary policy independence are likely to undermine this credibility and damage both monetary policy and the Icelandic economy.