A comprehensive summary of fiscal policy for Economics 348 2015. These notes allowed the learner to achieve a distinction in the examination. There is also a bundle available with: (1) Macroeconomic policy, (2) Fiscal policy, (3) Environmental policy, (4) Economic development and distribution polic...
Economics 348
Fiscal Policy
PUBLIC ECONOMICS CHAPTER 16: ESTIAN CALITZ AND KRIGE SIEBRITS
The nature of fiscal policy
Definition of fiscal policy: Fiscal policy may be defined as decisions by national
government regarding the nature, level and composition of government
expenditure, taxation and borrowing aimed at pursuing particular goals.
We distinguish the following macroeconomic goals of fiscal policy:
Economic growth
Job creation
Price stability
Balance of payments stability
A socially acceptable distribution of income
Poverty alleviation
Note also that price stability, balance of payments stability and cyclical economic
growth are short-term goals; the others (including long-term economic growth)
are of a longer-term or structural nature.
The sectoral goals of fiscal policy include the following:
The development of particular economic sectors (agriculture, tourism,
mining, manufacturing or the financial markets)
The pursuance of social goals pertaining to sectors such as housing,
education, health and welfare.
It is also possible to specify microeconomic goals of fiscal policy. Goals of this
nature relate to fiscal action aimed at a single economic participant or group of
participants, for example, improving efficiency by addressing negative
externalities in respect of a particular product (for example, tobacco) or activity
(for example, toxic waste disposal by a chemical plant).
Instruments of fiscal policy
The macro instruments include total government expenditure, the economic
categories of consumption and capital expenditure (in other words, the
composition of government expenditure), the total tax amount and the budget
deficit as well as the way in which the deficit is financed.
The fiscal authorities in South Africa
The key figure in fiscal policy-making is the Minister of Finance, who is given
certain statutory powers by acts of parliament.
The Minister has the authority to take and implement decisions on some matters
immediately, for example, changing the rates of value-added tax, excise duties
or the fuel levy during the course of the government’s financial year.
On other matters, such as changing income tax rates or implementing the
appropriation of state monies in the annual budget, parliamentary approval in
the form of specific acts of parliament is required before any changes can be
made. The Minister of Finance does not take important decisions without
consulting and/or obtaining the approval of Cabinet. He or she is accountable to
parliament for all decisions made.
The South African Constitution furthermore requires consultation between the
Minister of Finance and the South African Reserve Bank regarding the
implementation of monetary policy.
, The two key institutions that bear the responsibility for macroeconomic
policymaking are the National Treasury (macroeconomic and fiscal policy,
expenditure allocation and control) and the South African Reserve Bank
(monetary and exchange rate policy). Another very important fiscal institution is
the South African Revenue Service (SARS). The responsibilities of SARS not only
include tax collection and the enforcement of tax law; SARS also plays an
important supportive and advisory role in the determination of tax policy.
The macroeconomic role of fiscal policy
The Keynesian approach
The Keynesian approach (anti-cyclical fiscal policy-making) came to dominate
fiscal policy-making after 1945.
In the three decades that followed, most governments saw it as part of their task
to actively ensure that aggregate demand equalled aggregate supply at the full
employment level of income.
Keynesian economists and policy-makers also believed that the structure of
income taxes and unemployment benefits strengthens the demand-stabilising
impact of active fiscal policy. The argument was that income tax and
unemployment benefits act as automatic stabilisers because changes in income
would automatically trigger changes in tax revenue and transfer payments that
would stabilise aggregate demand, income and output.
There are two types of countercyclical policies:
(a) Passive policies: These involve automatic stabilisers, such as the income
tax system and unemployment benefits.
(b) Active policies: These involve manipulation of fiscal policy instruments,
such as the tax rate and spending programmes.
Figure 16.2 employs this
framework to illustrate the distinction
between active and passive fiscal
policies. Our point of departure is point A at
income level Y0. The budget is in
balance with tax revenue t0 and
government spending g0. Suppose the
economy in question experiences an
exogenous shock (say, a decrease in
export earnings) that reduces
income to Y1. This fall in income
reduces total tax revenue to t1
(point C on curve T0). The drop in tax
revenue cushions the impact of the
adverse shock because it represents a
reduction in the extent of leakage from
the circular flow of income and expenditure in the
economy. The budget now exhibits a deficit (equal to g 0 – t1 or the vertical
distance BC), which Keynesian economists traditionally regard as a stimulus to
economic activity. Note that the government took no active steps. The stabilising
influence and/or counter-cyclical stimulus to economic activity are the entirely
spontaneous results of structural aspects of the tax system, hence the name
‘automatic fiscal stabilisers’. The working of automatic fiscal stabilisers, or
passive fiscal policies, is depicted as movements along the tax revenue and
government spending curves.
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