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National Income and Fiscal Policy National Income : Basic Measures Factors of production….labor, capital, land GDP= sum of payments to labor, capital, land and profits ˸Gross National Product (GNP) GDP+ Net receipts from abroad made as factor payments to domestically owned factors of production. National Income : Basic Measures •Net Domestic Product =GDP minus depreciation • NNP= NDP+ Net Receipts from abroad •Net National Income =NNP-Indirect taxes that Business pay Government in the Economy • Nothing arouses as much controversy as the Role of government in the economy. • Government can affect the Macro economy through two policy channels: fiscal policy and monetary policy. • Fiscal policy is the manipulation of government spending and taxation. • Monetary policy refers to the behavior of the RBI (Central Bank) regarding the nation’s money supply. Fiscal Policy Changes in the expenditures or tax revenues of the government, undertaken to promote full employment, price stability and reasonable rates of economic growth. It refers to nation’s policy relating to the government spending, taxing, borrowing and debt management. Objectives • Mobilization of resources • Acceleration of the economic growth • To minimize the inequalities of Income and Wealth. Three main constituents of the fiscal policy • Taxation policy • Public Expenditure policy • Public debt policy All these constituents must work together to make the fiscal policy sound and effective TAXATION POLICY The main objectives for which taxes are levied is to raise revenue by transferring resources from the public to government and the opposite applies when the government cut the taxes so that some resources are transferred from the government to public. It will depend on the tax system that how much it has impact on the economy. The characteristics of good tax system are: • Equity in distribution of tax burden • It should yield a satisfactory amount for the maintenance of a government. • It should maximize social benefit that is redistribution of wealth and reducing the inequalities of income. Therefore in the situation of recession the subsidies and tax cuts will increase the disposable income and hence increase the overall production of the economy and vice versa. Impact of Other policies Public Expenditure It is the most potent weapon to raise the consumption and to increase the economic growth. Increased government expenditure will open new job opportunities in the economy, which means creation of demand for goods and services. It can lead to pump priming, which means increase in private expenditure through an injection of fresh purchasing power in the form of an increase in public expenditure. Such expenditure should be progressively raised in the depression and reduced when the economy is overheated. Public Debt policy In case of recession, the government can reduce the public borrowing so that there is more resources with the public to increase the consumption. Expansionary Fiscal Policy • The government uses expansionary fiscal policy to increase the amount of money available to the general public. They do this through lowering taxes and raising government spending. • An increase in government spending and/or a decrease in taxes designed to increase aggregate demand in the economy, thus increasing real output and decreasing unemployment. Contractionary fiscal policy • Increasing taxes and lowering government spending. Decrease in government spending and/or an increase in taxes designed to decrease aggregate demand in the economy and control inflation. • This is applied when the economy needs to decrease output or national income. Government in the Economy • Tax rates are controlled by the government, but tax revenue depends on changes in household income and the size of corporate profits, which the government cannot control. • Discretionary fiscal policy refers to changes in taxes or spending that are the result of deliberate changes in government policy. Net Taxes (T), and Disposable Income (Yd) • Net taxes are taxes paid by firms and households to the government minus transfer payments made to households by the government. • Disposable, or after-tax, income (Yd) equals total income minus taxes. Yd Y T The Budget Deficit • A government’s budget deficit is the difference between what it spends (G) and what it collects in taxes (T) in a given period: Budget deficit G T • If G exceeds T, the government must borrow from the public to finance the deficit. It does so by selling Treasury bonds and bills. In this case, a part of household saving (S) goes to the government. The Economy’s Influence on the Government Budget • Tax revenues depend on the state of the economy. • Some government expenditures depend on the state of the economy. • Automatic stabilizers are revenue and expenditure items in the federal budget that automatically change with the state of the economy in such a way as to stabilize GDP. The Economy’s Influence on the Government Budget • The full-employment budget is a benchmark for evaluating fiscal policy. • The full-employment budget is what the federal budget would be if the economy were producing at a fullemployment level of output. The Economy’s Influence on the Government Budget • The cyclical deficit is the deficit that occurs because of a downturn in the business cycle. • The structural deficit is the deficit that remains at full employment.