Fiscal policy

2016
IHSAN ULLAH
UNIVERSITY LAW COLLEGE QUETTA
8/5/2016
FISCAL POLICY
Name IHSAN ULLAH
Roll No 11
Class LLB First Year
Submitted to Sir Nizam

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Contents
Fiscal Policy.............................................................................................................................................2
Which is an example of fiscal policy? ..............................................................................................2
What does the fiscal policy include?................................................................................................2
Who is in control of fiscal policy? .....................................................................................................2
What are the tools of fiscal policy?...................................................................................................2
What is 'Fiscal Policy............................................................................................................................2
Criticism of fiscal policy.......................................................................................................................3
Evaluation of fiscal policy....................................................................................................................3
Brief history of fiscal policy ................................................................................................................4
Types of Fiscal Policy............................................................................................................................4
Expansionary fiscal policy...................................................................................................................4
Contractionary fiscal policy ................................................................................................................5
Tools of Fiscal Policy ............................................................................................................................5
Fiscal Policy vs. Monetary Policy .....................................................................................................5
Fiscal Policy in Pakistan .....................................................................................................................5
Capital Receipts: ....................................................................................................................................6
External Resources:..............................................................................................................................6
Government Expenditure....................................................................................................................6
There are six major heads of current expenditure of Federal Government of Pakistan:
......................................................................................................................................................................7
Tax Structure of Pakistan...................................................................................................................7
Deficit Financing in Pakistan............................................................................................................8
CONCLUSION AND RECOMMENDATIONS ......................................................................8
Reference..................................................................................................................................................9

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Fiscal Policy
Fiscal policy is the means by which a government adjusts its spending levels and tax rates to
monitor and influence a nation's economy. It is the sister strategy to monetary policy through which
a central bank influences a nation's money supply.
Which is an example of fiscal policy?
Types of Fiscal Policy. The government has control over both taxes and government spending.
When the government uses fiscal policy to increase the amount of money available to the populace,
this is called expansionary fiscal policy. Examples of this include lowering taxes and raising
government spending.
What does the fiscal policy include?
Expansionary fiscal policy involves government spending exceeding tax revenue, and is usually
undertaken during recessions. Contractionary fiscal policy occurs when government spending is
lower than tax revenue, and is usually undertaken to pay down government debt.
Who is in control of fiscal policy?
Fiscal policy is a broad term used to refer to the tax and spending policies of the federal
government. Fiscal policy decisions are determined by the Congress and the Administration; the
Federal Reserve plays no role in determining fiscal policy.
What are the tools of fiscal policy?
The two main tools of fiscal policy are taxes and spending. Taxes influence the economy by
determining how much money the government has to spend in certain areas and how much money
individuals have to spend. For example, if the government is trying to spur spending among
consumers, it can decrease taxes.
What is 'Fiscal Policy
Government spending policies that influence macroeconomic conditions. Through fiscal policy,
regulators attempt to improve unemployment rates, control inflation, stabilize business cycles and
influence interest rates in an effort to control the economy. Fiscal policy is largely based on the
ideas of British economist John Maynard Keynes (1883–1946), who believed governments could
change economic performance by adjusting tax rates and government spending.
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

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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 is said to be tight or contractionary when revenue is higher than spending (i.e., the
government budget is in surplus) and loose or expansionary when spending is higher than revenue
(i.e., the budget is in deficit). Often, the focus is not on the level of the deficit, but on the change
in the deficit. Thus, a reduction of the deficit from $200 billion to $100 billion is said to be
contractionary fiscal policy, even though the budget is still in deficit.
Criticism of fiscal policy
 The government may have poor information about the state of the economy and struggle
to have the best information about what the economy needs.
 Time lags. To increase government spending will take time. It could take several months
for a government decision to filter through into the economy and actually affect AD. By
then it may be too late.
 Crowding out. Some economists argue that expansionary fiscal policy (higher government
spending) will not increase AD, because the higher government spending will crowd out
the private sector. This is because government have to borrow from the private sector who
will then have lower funds for private investment.
 Government spending is inefficient. Free market economists argue that higher government
spending will tend to be wasted on inefficient spending projects. Also, it can then be
difficult to reduce spending in the future because interest groups put political pressure on
maintaining stimulus spending as permanent.
 Higher borrowing costs. Under certain conditions, expansionary fiscal policy can lead to
higher bond yields, increasing the cost of debt repayments.
Evaluation of fiscal policy
The success of fiscal policy will depend on several factors, such as
 It depends on the size of the multiplier. If the multiplier effect is large, then changes in
government spending will have a bigger effect on overall demand.
 It depends on the state of the economy. Fiscal policy is most effective in a deep recession
where monetary policy is insufficient to boost demand. In a deep recession (liquidity trap).
Higher government spending will not cause crowding out because the private sector saving
has increased substantially. See: Liquidity trap and fiscal policy – why fiscal policy is more
important during a liquidity trap.
 It depends on other factors in the economy. For example, if the government pursue
expansionary fiscal policy, but interest rates rise and the global economy is in a recession,
it may be insufficient to boost demand.

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 Bond yields. If there is concern over the state of government finances, the government may
not be able to borrow to finance fiscal policy. Countries in the Eurozone experienced this
problem in the 2008-13 recession.
Brief history of fiscal policy
 Keynes advocated the use of fiscal policy as a way to stimulate economies during the great
depression.
 Fiscal Policy was particularly used in the 50s and 60s to stabilize economic cycles. These
policies were broadly referred to as ‘Keynesian’
 In the 1970s and 80s governments tended to prefer monetary policy for influencing the
economy. Fiscal policy became more prominent during the great depression of 2008-13
Types of Fiscal Policy
There are two types of fiscal policy. The first, and most widely-used, is expansionary.
Expansionary fiscal policy
It stimulates economic growth. It's most critical at the contractionary phase of the business cycle.
That's when voters are clamoring for relief from a recession.
How does it work? The government either spends more, cuts taxes, or does both if it can. The idea
is to put more money into consumers' hands, so they spend more. That jumpstarts demand, which
keeps businesses running, and hopefully adds jobs. Of course, there is a debate about which works
better. Advocates of supply-side economics prefer tax cuts. They say it frees up businesses to hire
more workers to pursue business ventures. For more, see Do Tax Cuts Create Jobs?
Advocates of demand-side economics say additional spending is more effective than tax cuts.
Examples include as public works projects, unemployment benefits, and food stamps.
The money goes into the pockets of consumers, who go right out and buy the things businesses
produce. For more, see Unemployment Solutions, How Extended Unemployment Benefits Boost
the Economy and 14 Ways to Create Jobs.
Expansionary fiscal policy is usually impossible for state and local government.
That's because they often are mandated to keep a balanced budget. If they haven't created a surplus
during the boom times, they must cut spending to match lower tax revenue during a recession.
That makes it worse.
Fortunately, the Federal government has no such constraints, so it can use expansionary policy
when needed. Unfortunately, it also means Congress has created budget deficits during boom
times. That's despite a national debt ceiling. As a result, the critical debt-to-GDP ratio has exceeded
100%.

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Contractionary fiscal policy
The second type, contractionary fiscal policy, is rarely used. That's because its goal is to slow
economic growth. Why would you ever want to do that? One reason only, and that's to stamp out
inflation. That's because the long-term impact of inflation can damage the standard of living as
much as a recession.
The tools of contractionary fiscal policy are used in reverse. Taxes are increased, and spending is
cut. You can imagine how wildly unpopular this is among voters. Thus, it's hardly ever used.
Fortunately, monetary policy is effective in preventing inflation.
Tools of Fiscal Policy
The first tool is taxation. That includes income, capital gains from investments, property, sales, or
just about anything else. Taxes provide the major revenue source that funds the government. The
downside of taxes is that whatever or whoever is taxed has less income to spend themselves. That
makes taxes unpopular. Find out exactly how the U.S. Federal budget is funded in Federal Income
and Taxes.
The second tool is government spending. That includes subsidies, transfer payments including
welfare programs, public works projects, and government salaries. Whoever receives the funds
has more money to spend. That increases demand and economic growth.
The Federal government is losing its ability to use discretionary fiscal policy. Each year, more of
the budget must go to mandated programs. As the population ages, the costs of Medicare,
Medicaid, and Social Security are rising. Changing mandatory fiscal policy requires an Act of
Congress, and that takes a long time. One exception was the ARRA, or Economic Stimulus Act,
which Congress passed quickly. That's because legislators knew they must stop the worst recession
since the Great Depression.
Fiscal Policy vs. Monetary Policy
Monetary policy is when a nation's central bank changes the money supply. It increases it with
expansionary monetary policy and decreases it with contractionary monetary policy. It has many
tools it can use, but it primarily relies on raising or lowering the Fed funds rate. This benchmark
rates then guides all interest rates. When interest rates are high, the money supply contracts, the
economy cools down, and inflation is prevented. When interest rates are low, the money supply
expands, the economy heats up, and a recession is usually avoided.
Monetary policy works faster than fiscal policy. The Fed can just vote to raise or lower rates at it’s
regularly FOMC meeting. It may take about six months for the impact of the rate cut to percolate
throughout the economy.
Fiscal Policy in Pakistan
Government Receipts

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The Government receipts consist of the following four sources:
Revenue Receipts (Net of Provincial Shares): In Pakistan, the heavy dependence is upon revenue
receipts, about 65-70% of the revenue is estimated to be drawn from revenue receipts. It includes
tax revenue, non-tax revenue, and surcharges.
A. Tax Revenue: In taxes we have direct taxes such as income tax, and wealth tax. Indirect
taxes such as central excise, sales tax, and custom duty. Direct tax comprises about 70%
of Pakistan’s total tax revenue.
B. Non-Tax Revenue: It includes income from government property and enterprises and
receipts from Civil Administration and other functions.
C. Surcharges: Surcharges on natural gas and petroleum fall under this category.
Capital Receipts:
Capital receipts include external borrowing and internal non-bank borrowings consisting of
unfunded debt, public debt, treasury and deposit receipts besides the revenue account surplus and
the surplus generated by public sector, etc.
External Resources:
External resources are loans and grants which come from various sources. These sources include
consortium, non-consortium and Islamic sources of aid:
(Consortium: Consortium provides aid at both bilateral and multilateral levels:
i. Sources of consortium bilateral aid are Belgium, Canada, France, Germany, Italy, Japan,
Netherlands, Norway, Sweden, United Kingdom and United States.
ii. Consortium multilateral aid comes from Asian Development Bank (ADB), International
Bank for Reconstruction and Development (IBRD), Int. Development Association (IDA),
Int. Finance Corporation (IFC), and Int. Fund for Agricultural Development (IFAD).
iii. Non-Consortium: Non-consortium sources of loans and grants mostly provide bilateral aid.
These include Australia, China, Czech Republic, Denmark, Finland, Rumania,
Switzerland, Russia and Yugoslavia.
iv. Islamic Aid: Bilateral aid from Islamic countries come from Saudi Arabia, Kuwait, Qatar,
United Arab Emirates, Turkey, Lebanon, Libya and Iran. While multilateral Islamic
sources of aid are OPEC Fund, and IDB.
Loans and grants received by Pakistan can be classified into ‘project’ and ‘non-project aid’. Non-
project aid can be further decomposed into food, non-food, BOP and Relief aid.
Self-Financing by Autonomous us Bodies: This is actually the surplus left after meeting all the
expenses of these bodies. This surplus is available to government for revenue and development
expenditures.
Government Expenditure
Government expenditure is classified into current expenditure and development expenditure:

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Current Expenditure: It comprises mainly debt servicing, defence, general administration, social
services, law and order, subsidies, community services, economic services, grants to Azad Jammu
and Kashmir, Railway and others.
Development Expenditure: Public Sector Development Program (PSDP) is another name given to
Government’s development expenditure. The priority areas are transport and communication,
power and water. These three sectors combined cover about 50% of total allocation of PSDP.
The share of current expenditure is always remain substantial, it constituted around 70-80% of
total Government expenditure. Non-development expenditure is generally regarded as being
excessive and therefore subjected to persistent public criticism. With sharp increase in population,
constant threat from the enemies and increasing cost of corruption, non-development expenditure
is subjected to a rising trend which could only be controlled by rapid economic development. On
the other hand, negligence of non-development expenditure may result into ill-equipped and under-
staffed hospitals, dispensaries and educational institutes, and arrears in maintenance of roads,
dams, bridges, electricity and forests. Non-development expenditure should be economically
managed in order to ensure the economic development of Pakistan.
There are six major heads of current expenditure of Federal
Government of Pakistan:
 Defence,
 Debt servicing,
 Subsidies and grants,
 General administrative,
 Social services, and
 Others.
Tax Structure of Pakistan
The narrow base enigma has been a base in Pakistan’s tax structure from the beginning.
In 1987 when population of the country was more than a hundred million, the total number of
taxpayer was just over a million.
The main base taxes imposed are direct and indirect taxes.
Direct tax of the Federal Government comprises of income tax, wealth tax and corporate tax
Indirect tax, on the other hand, consists of custom duty, excise duty, sales tax, import duty and all
others.
Indirect tax contributes the predominant share to the total tax collection. Direct taxes have
persistently dropped their share in total tax revenue.
Indirect tax, on the other hand, contributes more than 70% of the total tax revenue. Indirect tax is
regressive. It may cause the inflation to rise and its incidence is fall on poor class of the economy.

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Deficit Financing in Pakistan
Following are the sources of deficit financing in Pakistan:
Printing new currency notes
Public borrowings
Foreign loans, aid and grants
Using previous balances, and
Borrowings from banks including from the central bank.
Dr. Mahboobul Haq defines deficit financing in the following words:
1. Net borrowings by the government from the banking system which includes the State Bank
of Pakistan (SBP) and commercial banks but excludes non-banking institutions and
individuals, and
2. Net borrowings by the Government from the SBP only.
But the public debt does not only constitute the above sources, it also includes money lent to
Government out of the balances of the banks which would have been held if the Government had
not borrowed them.
Deficit financing is a sound and necessary instrument of the Government finance and its role, its
desirability and limitations of its use in mobilizing revenue, must be properly analyzed in the
context of its broad implications on the economy and compared to the adequacy of other techniques
of resource mobilization.
It was planned in Third Five-Year Plan that there will be no deficit financing during the said plan
but the government had to revise the plan. In the Fourth Five-Year Plan there were annual plans
and major upsets in the economy. In the Fifth and Sixth Five-Year Plans, though there were very
large amounts of foreign remittances but there was not remarkable reduction in deficit financing.
A well-managed deficit financing could be a key to greater economic achievements especially for
a less developed country. A wise finance minister has to keep an eye on all the factors of the
economic development and spent the public fund in the manner that is most beneficial to the nation.
CONCLUSION AND RECOMMENDATIONS
This research study investigates the role of fiscal policy in managing economic growth in the frame of
Pakistan by taking the annual time series data from the period from 1982 to 2010. Ordinary least square
(OLS) procedure has been applied. Government revenue and expenditure account are considered. Revenue
account is disaggregated into federal and provincial level whereas expenditures are broken down into
current and development expenditures. The result shows that federal tax revenue and provincial tax revenue
are negatively contributed to economic growth. This may be happened for two possible causes; one reason
is our tax administration is extremely corrupted and most of the time they are involved with and support
the tax liable persons not to pay the tax amount for the sake of themselves and illegally take money and
hide the income data of tax payers. Secondly, the agriculture sector is free from tax because the big fishes

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who are involved with agriculture sector are really clever and fully trained not to pay tax and hide income
accounts from the tax department and also benefited from gigantic political control. Even above 80%
parliament members are from the feudal class or are the supporter of this group
. When we move on expenditure side of fiscal policy, the non-development expenditure is not significant
for the reason that the government not appropriately spends money on this side. Only development
expenditure found significantly contributed in economic growth. Hence, it is imperative to cautiously spend
the resources on current expenditure and spend as much as possible on development projects to increase
the speed of economic growth of Pakistan. At last after analyzing the empirical results, are that there is a
strong relation exist between economic growth and fiscal policy therefore the policy makers of Pakistan
should formulate their polices after carefully considering fiscal policy variables. The tax structure of
Pakistan is based on 1973 Constitution in which they outline the taxes and duties in federal legislative list,
the federal and provincial government can collect from assesse only from these ways. After analyzing the
results, the tax system of both federal and provincial government must be restructure to make them
positively correlated with the economy because they are oppositely contributed in the growth as concluded
by our study’s results. Both sources of revenue (taxes and non-taxes) must be positively contributed in
managing economic growth of Pakistan because Pakistan is not financial so strong that they not only rely
on just non-tax source. The fiscal policy makers must have to rethink about the structure of taxes imposed
on assesse when they are formulating and implementing fiscal policy. There is an urgent need to make a
large part of non-tax revenue in collecting total revenue. In contrast, government should focus more on
development expenditures like spending on dams, roads, ports etc. The advantages from this type of
spending are long term and growth oriented. On the other hand, government should avoid much spending
on current expenditures. The current expenditure are of two types; necessary current expenditure like
pensions, salaries, law and order, defence etc. should not reduce because these are necessary to our economy
and sustainability but un-necessary current expenditure like purchasing of bullet-proof vehicles for
ministers personal use, un-necessary movements of ministers convoy from one place to another should
reduce because those visits require VVIP protocols for security purpose at the expense of taxpayers, the
royal expenses of our ministers etc. because amount spend on these types of expenditures will have no
significant effects on economic growth. Expenditures on non-development projects should be reduced and
their amount should be spend on long term projects as they were empirically identified as growth oriented
in this study
Reference
https://www.thebalance.com/what-is-fiscal-policy-types-objectives-and-tools-3305844
http://study.com/academy/lesson/what-is-fiscal-policy-definition-effects-example.html
http://www.economicshelp.org/macroeconomics/fiscal-policy/fiscal_policy/
http://www.investopedia.com/terms/f/fiscalpolicy.asp
http://www.econlib.org/library/Enc/FiscalPolicy.html
https://sites.google.com/site/maeconomicsku/home/fiscal-policy-in-pakistan

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