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Fiscal Policy. What is Fiscal Policy?. Fiscal Policy is the decision of the government about: How to earn revenue and gather resources from various sources For what to spend those earnings and resources How much to spend and When to spend. There are two sides of fiscal policy.
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What is Fiscal Policy? • Fiscal Policy is the decision of the government about: • How to earn revenue and gather resources from various sources • For what to spend those earnings and resources • How much to spend and • When to spend
Why does the government need revenue? • To maintain its daily activities, i.e. to run the government • To ensure protection for the helpless • To provide necessary services to people that otherwise nobody would provide (Market failure) • To ensure development of the country • To build buffer against risk!
Where does the revenue come from? • Tax revenue • Direct: income tax, wealth tax etc. • Indirect: VAT, tariff, excise duty etc. • Non-Tax revenue • Fees & charges: registration, sales of forms, stamps etc. • Fines: mobile court fines, police fines etc. • Printing of money
Where does the government keep its revenue? • The government’s account is maintained by the Treasury which is located at Bangladesh Bank • The “account” in which all these revenues are deposited is called the “Consolidated Fund” • Consolidated Fund was created under Article 84 of our constitution
Resources from other sources • Grants • Loans from • Domestic sources • Treasury bills/bonds • savings schemes • borrowing from the banks • Foreign sources • Bilateral • Multilateral
Revenue trend in Bangladesh • Revenue as percent of GDP is increasing • Around 80 percent of public revenue in Bangladesh is derived from tax sources.
How does spending help? Theoretical framework • How much spending will affect depends on two factors- • The multiplier effect and • The crowding-out effect • The multiplier effect denotes that a certain amount of spending will have bigger impact than the size of the spending. • The crowding-out effect arises out of a mechanism that offsets the increase in AD.
The multiplier effect • The MPC helps the money spent rolling from hand to hand in an infinite chain of successive rounds of spending. • Suppose, the MPC in Bangladesh is 0.75 and govt. increases spending by Tk. 20 billion for social safety net. • The rounds of spending are as below: Govt. spending = Tk. 20 billion First change in consumption (C) = (MPC X Tk. 20 billion) Second change in C = (MPC X MPC X Tk. 20 billion) Third change in C= (MPC X MPC X MPC X Tk. 20 billion) … … … … … Total change in C = (1 + MPC + MPC2 + MPC3 + …….) X Tk. 20 billion = Tk. 20 billion /(1 – MPC) = Tk. 80 billion.
The Crowding-out effect 3. As a result r increases r P 4. And AD falls back 2. This increases money demand r2 r1 MD2 AD2 MD1 AD3 AD1 M Y 1. An increase in G increases AD
How does spending help?If the government wants to increase GDP…
How does spending help?If the government wants to check inflation…
For what to spend? Through spending the government tries to affect: • Macroeconomic stabilization • Equity: horizontal and vertical • Efficiency in resource allocation: • Provision of public goods • Check market failure
Macroeconomic Stabilization • To stabilize price • To raise growth rate • To raise employment level • To reduce deficit
How government spending helps keep macroeconomic stabilization?
How government spending helps keep macroeconomic stabilization?
Equity • Inequality prevails in all societies. • Government tries to reduce the gap between the rich and the poor • For this, the government collects taxes from the rich and spends it for the poor
Efficiency of resource allocation • Private entrepreneurs may not be interested in investments where return of investment is not good for him but good for the country • In this case, the government may step ahead and supply resources for such investments • Example: building roads and highways, Public-Private Partnership (PPP)
Is government spending always good? • Government spending is necessary to keep the economy on track. • However, if the spending is not in line with the economic objective then it may be detrimental • Example: Suppose a country is facing high inflation. Price is increasing very rapidly. But as the national election is close the government decides to spend more on social safety net programs and development activities to win popularity. What will be its impact on the economy?
Public Expenditure: Types • Government spending may be broadly classified into two categories- • Revenue expenditure • Development expenditure • Revenue expenditure mainly includes government employees salary, benefits and establishment costs. • Development expenditure mainly includes money spent on development activities. • Is revenue expenditure good or bad?
In which way public expenditure of Bangladesh moving? • The government spends huge amounts of money on • building socio-economic and physical infrastructure • human resource development and • poverty alleviation. • Besides, the government has to incur expenditure for: • Administrative • welfare and • other service oriented activities.
Economic structure of revenue expenditure% share of major economic categories
Is the government fulfilling its welfare commitment? • Public Expenditure By Social Sectors: The Social Sectors are getting increasing prominence day by day
Annual Development Program expenditure for social sectors (crore taka)
What is the balance in the government’s pocket? • If revenue earning is higher than expenditure, the government has surplus • If revenue earning is lower than expenditure, the government faces deficit • In Bangladesh the government maintains a deficit budget
How the deficit is met • Deficit means that spending is more than earning • Therefore, additional money is needed for filling out the gap between spending and earning • This additional money is called “financing” • Financing may be either from domestic or foreign sources • From foreign sources financing may come as bilateral or multilateral loans • Financing from domestic sources comes from borrowing from banks, issuance of savings schemes and bonds… and if needed from printing money. • Which one would you prefer for deficit financing- domestic or foreign?
Implications of budget deficit • High budget deficit means government is spending more than its ability • And in doing so it is borrowing from various sources • If the borrowing comes from domestic sources it means less money is available for the private sector. This may hinder private sector development initiatives. • If the borrowing comes from foreign sources it means the country is exposed to foreign currency risk (for example- speculative attack, current account deficit) • Increased amount of borrowing increases interest rate and, therefore, debt liabilities. High interest rate may make debt unsustainable. In such cases, the country will be exposed to financial crisis. Recent example is Greece.
Question: • What is the most prominent document that elaborates the Fiscal Policy of Bangladesh? • As head of the government how would you design your next fiscal policy?
