factors effecting fiscal policy

Factors Affecting FiscalFactors Affecting Fiscal

Policy in Pakistan.Policy in Pakistan.

By Muhammad Haris KhanBy Muhammad Haris Khan

5186651866

DEFINITION:DEFINITION:

Fiscal Policy refers to Fiscal Policy refers to actions by the Government actions by the Government to spend, or collect money to spend, or collect money in taxes, with a purpose of in taxes, with a purpose of influencing the condition of influencing the condition of

the national incomethe national income..

A government might intervene A government might intervene in the economy byin the economy by : :

• • Spending more money and financing Spending more money and financing this expenditure by borrowing.this expenditure by borrowing.

• • Collecting more in taxes without Collecting more in taxes without increasing spending.increasing spending.

• • Collecting more in taxes in order to Collecting more in taxes in order to increase spendingincrease spending..

The 3 possible stances of fiscal The 3 possible stances of fiscal policypolicy

A neutral stance : G = T A neutral stance : G = T

(Government spending = Tax revenue)(Government spending = Tax revenue)

An expansionary stance : G > TAn expansionary stance : G > T

An contractionary stance : G < TAn contractionary stance : G < T

ExpenditureExpenditure The government at a national or local level The government at a national or local level

and through nationalized industries and through nationalized industries spends moneyspends money..

i)i) To provide goods and services.To provide goods and services.

ii)ii) To provide payments to certain To provide payments to certain members of the society.members of the society.

iii)iii) To encourage investment by the private To encourage investment by the private

sectorsector..

IncomeIncome

Expenditure must be financed, and the Expenditure must be financed, and the

government must have incomegovernment must have income..

i)i) Income from TaxIncome from Tax

ii)ii) Seigniorage, the benefit from Seigniorage, the benefit from printing money.printing money.

iii)iii) Borrowing from populationBorrowing from population

SeigniorageSeigniorage

The net revenue derived from the The net revenue derived from the issuing of currency.issuing of currency.

Derived from coins arises from the Derived from coins arises from the difference between the face value of difference between the face value of a coin and the cost of producing, a coin and the cost of producing, distributing and eventually retiring it distributing and eventually retiring it from circulation.from circulation.

Also referred to as an Also referred to as an inflation taxinflation tax

SeigniorageSeigniorage

No seigniorage occurs in the No seigniorage occurs in the following situation: A person has one following situation: A person has one ounce of gold, trades it in for a gold ounce of gold, trades it in for a gold certificate (which allows him to certificate (which allows him to redeem the certificate for one ounce redeem the certificate for one ounce of gold), keeps that certificate for a of gold), keeps that certificate for a year, and then trades it in for gold -- year, and then trades it in for gold -- he or she ends up with exactly one he or she ends up with exactly one ounce of gold againounce of gold again..

SeigniorageSeigniorage Seignorage does occur in this situation: A Seignorage does occur in this situation: A

government does not issue gold government does not issue gold certificates and instead converts gold into certificates and instead converts gold into currency at the market rate. A person currency at the market rate. A person trades in an ounce of gold for its worth in trades in an ounce of gold for its worth in currency, keeps that currency for a year, currency, keeps that currency for a year, and then trades the currency back in for and then trades the currency back in for an amount of gold -- he or she may an amount of gold -- he or she may receive a different amount of gold from receive a different amount of gold from that which he or she started with, if the that which he or she started with, if the price of gold has increased or decreased price of gold has increased or decreased during that year. during that year.

Implications of Fiscal policy on Implications of Fiscal policy on budgetbudget

It can increase the demand It can increase the demand indirectly by reducing taxation.indirectly by reducing taxation.

i)i) Cuts in taxation can be matched by Cuts in taxation can be matched by cuts in Govt. Spending.cuts in Govt. Spending.

ii)ii) Alternatively tax cuts can be Alternatively tax cuts can be financed by more govt. borrowing.financed by more govt. borrowing.

Fiscal Policy and Macroeconomic Fiscal Policy and Macroeconomic objectivesobjectives

Fiscal policy is concerned with govt. Fiscal policy is concerned with govt. spending and taxationspending and taxation

a)a) If govt. spending is increased, there If govt. spending is increased, there will be an increase in the amount of will be an increase in the amount of injections; expenditure in an economy injections; expenditure in an economy will rise so National income would rise.will rise so National income would rise.

b)b) If taxation is increased, there will be If taxation is increased, there will be an increase in the withdrawals from an increase in the withdrawals from the economy, expenditure and the economy, expenditure and national income will fallnational income will fall..

Implications of Fiscal policy on Implications of Fiscal policy on budgetbudget

The govt. can use either expenditure The govt. can use either expenditure changes or tax changes as its changes or tax changes as its policy instrument.policy instrument.

(i)(i) It can increase demand directly by It can increase demand directly by spending itself e.g. health, spending itself e.g. health, education etc.education etc.

(ii)(ii) Through higher taxesThrough higher taxes

(iii)(iii) Through borrowingThrough borrowing

Salient FeaturesSalient Features Defence expenditure has been higher Defence expenditure has been higher

than development expenditure.than development expenditure. Interest payments along with defence Interest payments along with defence

expenditure constitute more than half expenditure constitute more than half of annual expenditure.of annual expenditure.

The main source for financing the The main source for financing the fiscal deficit has been non-bank fiscal deficit has been non-bank borrowing.borrowing.

Domestic debt is greater then foreign Domestic debt is greater then foreign debt.debt.

- S. Akbar Zaidi- S. Akbar Zaidi

The overall fiscal deficit is down from an average of 7.0 The overall fiscal deficit is down from an average of 7.0 percent of GDP in the 1990s to 3.3 percent in 2004-05. percent of GDP in the 1990s to 3.3 percent in 2004-05. However, the fiscal deficit bounced back to 4.2 percent of However, the fiscal deficit bounced back to 4.2 percent of GDP in 2005-06 and 2006-07, mainly on account of GDP in 2005-06 and 2006-07, mainly on account of expenditure incurred on rehabilitation work in earthquake expenditure incurred on rehabilitation work in earthquake affected areas in these two years.affected areas in these two years.

The underlying fiscal deficit mainly remained below four The underlying fiscal deficit mainly remained below four percent of GDP for the last seven years. The associated percent of GDP for the last seven years. The associated public debt burden also declined sharply from over 100 public debt burden also declined sharply from over 100 percent of GDP in 1999-2000 to close to 53.4 percent by percent of GDP in 1999-2000 to close to 53.4 percent by end March 2007.end March 2007.

-Fiscal Development Report, Economic Survey of Pakistan-Fiscal Development Report, Economic Survey of Pakistan

Fiscal policy and the BudgetFiscal policy and the Budget

A government must plan:A government must plan:

a)a) What it wants to spend?What it wants to spend?

b)b) How much it needs to rise in income How much it needs to rise in income or by borrowing?or by borrowing?

c)c) How much taxation should be there?How much taxation should be there?

d)d) What form the taxes should take?What form the taxes should take?

e)e) Which sectors of the economy should Which sectors of the economy should the money come from?the money come from?

Vested Interests and Tax Vested Interests and Tax

Different Interest Groups.Different Interest Groups. Political powerPolitical power Party Donations Party Donations Supporting Influential PoliticiansSupporting Influential Politicians Credible ArgumentsCredible Arguments

- Hafiz Pasha, Political Economy of Tax Reforms: The Pakistan Hafiz Pasha, Political Economy of Tax Reforms: The Pakistan Experience,Experience,

Pakistan Journal of Applied Economics Vol IIPakistan Journal of Applied Economics Vol II


Agricultural lobby:Agricultural lobby:

Enormous political power.Enormous political power.

Arguments:Arguments: Sector already over taxed through the pricing Sector already over taxed through the pricing

mechanism. (domestic prices below world prices)mechanism. (domestic prices below world prices) Food production vital for national security.Food production vital for national security. High costs of collection of the tax on agricultural High costs of collection of the tax on agricultural

income will not be justified.income will not be justified. Likely low revenue yield.Likely low revenue yield...


Industrial Interest:Industrial Interest: Aggressively support tax holidays.Aggressively support tax holidays. Alliance with provincial govt. of Alliance with provincial govt. of

backward areas.backward areas.

ArgumentArgument Large and widening regional Large and widening regional

disparities in the country.disparities in the country.


Government Savings: Government Savings: MOF says:MOF says:

Exemption of interest income in govt. Exemption of interest income in govt. saving instruments improves the income saving instruments improves the income distribution .distribution .

High participation by lower & middle High participation by lower & middle income households.income households.

Reduces the need to resort to inflationary Reduces the need to resort to inflationary mechanisms for financing the budget mechanisms for financing the budget deficit.deficit.


Stock Exchange representations: Stock Exchange representations:

The need for retention of the capital The need for retention of the capital gains on financial assets.gains on financial assets.

Stressed need for fiscal incentives to Stressed need for fiscal incentives to attract foreign private portfolio attract foreign private portfolio investment.investment.

Improves balance of payment position.Improves balance of payment position.


Tax reforms effectively frustrated by Tax reforms effectively frustrated by entranced, powerful, well organize entranced, powerful, well organize and articulate interest groups.and articulate interest groups.

Failure of the government to broaden Failure of the government to broaden tax base.tax base.

Lack of commitment to the reforms Lack of commitment to the reforms by agents.by agents.

State capture by special groups.State capture by special groups.

FISCAL CONSIDERATIONFISCAL CONSIDERATIONRevenue Side:Revenue Side:

Low tax to GDP ratio.Low tax to GDP ratio. Narrow tax base.Narrow tax base. Taxation of services and taxation sector.Taxation of services and taxation sector. Large informed economy.Large informed economy. Documentation and enforcement.Documentation and enforcement. Revamping Tax administration.Revamping Tax administration.

Expenditure Side:Expenditure Side:

Creating fiscal space for human and infrastructure development.Creating fiscal space for human and infrastructure development. Low effectiveness of public expenditure.Low effectiveness of public expenditure. Management of financial and public sector.Management of financial and public sector.

-S Akbar Zaidi, Issues in Pakistan Economy-S Akbar Zaidi, Issues in Pakistan Economy

ConclusionConclusion

Fiscal prudence and Fiscal prudence and discipline is discipline is essential. essential.

factors effecting fiscal policy

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