Explain the Fiscal Policy Instruments

1. Taxation
Taxation implies the charges or levies imposed on the agents of production, (labour, capital, entrepreneur, land). Taxation is normally tuned to the state of the economy. Taxation affects consumption and production. During times of depression the taxable capacity is low and in such a period there should be a reduction in taxes so as to sustain at least minimum levels of consumption and investment. Indirect taxes should be cut to stimulate consumption demand. During times of inflation, taxes should be raised to siphon of the increased liquidity in the economy. Given that taxes reduce, the disposable income in the hands of the public, it then implies that demand will be decelerated. The manipulation of tax rate is an effective and cyclical device. Implying tax rates can be manipulated either to give incentive to production or give des-incentive to consumption.
A deflation requires an expansionary tax policy. The deficient aggregate demand and recession calls for a cut in tax rates in order to stimulate consumption spending. This in itself will increase investment and employment. Investment spending may also be stimulated by reduction in corporate income tax, tax holiday, depreciation allowance, tax credits in purchases of capital good etc. tax changes are therefore stabilization device.

2. Public Expenditure
Public expenditure is the opposite of taxation. It implies government spending tax revenues to achieve fiscal policy objectives. Both consumption expenditure and private investment tends to go down during periods of deflation. A time like this, public expenditure is necessary for it has a stabilizing effect. One major effect is through government multiplier, which affects income and employment positively. During inflation government expenditure should be reduced and the government should budget for a surplus and set in motion the reverse multiplier. Taxation should be increased to mop up the surplus liquidity in the economy and at the same time government should go slow on its public work programmes and spent less non urgent items.

3. Debt Management
It implies the ways in which the government tries to ensure that indebtedness is either cleared or prudently managed. When government spending cannot be covered by taxation and other sources like income from public property and public undertakings government has to borrow. Borrowing if productivity invested increases output, income and employment and it has an expansionary effect on the economy. The economy can achieve more credit feedback effect on all the sectors of the economy. Borrowing takes many forms but it depends on the cost and the convenience of borrowing by the government. For instance borrowing through bonds has several advantages:
i) It is absolutely safe.
ii) Its one form of public participation in economic development.
iii) There is ready market for bonds and they are easily marketable.
iv) They can be held as transition income pending disposal at an opportune time (moment)
- The demand for government bonds depends on the credit standing of the government and on an attractive rate of interest

4. External Borrowing
A wise public debt management with proper timing and choice of the most appropriate type of debt and mode of repayment can reduce the budgetary cost of servicing the debt and promote economic growth. Without a public policy, there is likely to be a deep deflation with falling prices, falling profits and liquidation of firms and mass unemployment. Public debt management enables the Central Bank to undertake open market operations in pursuance of its credit control policy.

5. Deficit Financing
Means government expenditure in excess of taxation and non bank borrowing i.e. borrowing from the public. Public expenditure is financed by taxation, non bank borrowing and deficit financing. Taxation and non bank borrowing are financed out of genuine saving and they do not add to money supply or community purchasing power. Budget deficit is covered either by drawing down the cash balance or borrowing from the Central Bank which creates new money. This new money is inflationary because it is not matched by increased production.
Deficit financing or deficit spending is different from a deficit without spending. Government may reduce taxation without any increase in expenditure thus creating a budget deficit. The reduction of taxation increases the disposable income of the public and raises the level of consumption and employment.
Deficit is financed also by new money which is matched by increased productivity and does not therefore raise the price level. This is a situation where Central Bank prints more to finance a deficit on condition that the economy is stable.

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Wilfykil answered the question on March 8, 2019 at 13:30