Monetary policy vs.

Fiscal policy
Monetary policy and fiscal policy refer to the two most widely recognized tools used to
influence a nation's economic activity. Monetary policy is primarily concerned with the
management of interest rates and the total supply of money in circulation and is generally
carried out by central banks. Fiscal policy is the collective term for the taxing and
spending actions of governments. National fiscal policy is determined by the government
of the day.

Sources of Government Revenue

The following points highlight some of the main sources of government revenue.

1. Tax:

A tax is a compulsory levy imposed by a public authority against which tax payers cannot claim
anything. It is not imposed as a penalty for only legal offence. The essence of a tax, as
distinguished from other charges by the government, is the absence of a direct quid pro quo (i.e.,
exchange of favour) between the tax payer and the public authority.

Tax has three important features:

(i) It is a compulsory contribution, to the state from the citizen. Anyone refusing to pay tax is
punished under law. Nobody can object to taxation on the ground that he is not getting the
benefit of certain state services,

(ii) It is the personal obligation of the individual to pay taxes under all circumstances,

(iii) There is no direct relationship between benefit and tax payment.

2. Rates:

Rates refer to local taxation, i.e., taxation levied by (or for) local rather than central government.
Normally rates are proportional to the estimated rentable value of business and domestic
properties. Rates are often criticized as being unrelated to income.

3. Fees:

Fee is a payment to defray the cost of each recurring service undertaken by the government,
primarily in the public interest.

4. License fee:
A license fee is paid in those instances in which the government authority is invoked simply to
confer a permission or a privilege.

5. Surplus of the public sector units:

The government acts like a business- person and the public acts like its customers. The
government may either sell goods or render services like train, city bus, electricity, transport,
posts and telegraphs, water supply, etc. The government also earns revenue from the production
of commodities like steel, oil, life-saving drugs, etc.

6. Fine and penalties:

They are the charges imposed on persons as a punishment for contravention of a law. The main
purpose of these is not to raise revenue from the public but to force them to follow law and order
of the country.

7. Gifts and grants:

Gifts are voluntary contribution from private individuals or non-government donors to the
government fund for specific purposes such as relief fund, Defence fund during war or an
emergency. However, this source provides a small portion of government revenue.

8. Printing of paper money:

It is another source of revenue of the government. It is a method of creating extra resources. This
method is normally avoided because if once this method of financing is started, it becomes
difficult to stop it.

9. Borrowings:

Borrowings from the public is another source of government revenue. It includes loans from the
public in the form of deposits, bonds, etc. and also from the foreign agencies and organizations.

Government Expenditure (How government spends

Revenue):
In order to carry on their functions, governments must obtain the services of labour and other factor units
and (except in a completely socialist economy) acquire goods produced by private business firms.

Public expenditure consists of expenditure by the central government and state governments, local
authority (such as municipalities and public corporations), with central government accounting for the
major portion of such expenditure. Thus the central government is required to maintain good roads,
bridges, Defence activities, canals and harbours, to protect trade, to maintain the coinage and to provide
social security, education and religious instruction.

Categories of Government Expenditures:

Government expenditures can be classified into several categories. First, some outlays are for direct
government purchases of goods and services. Purchases of goods and services include government
expenditures on the services of individuals, such as those in the armed forces, and on goods, such as food,
medicine schools, hospitals, highways, and motor cars. Many of the purchases the government makes are
for goods and services that are provided for all members of the society — including those who have not
paid for their use.

When a good or service is provided for everyone and no one can be excluded from its use, it is termed a
public good. Flood control and national defence systems are examples of public goods. When government
provides a good or service that could be sold in a private market, such as education or fire protection, it is
providing a quasi-public good. The provision of public and quasi-public goods is a widely recognized
function of the government.

A second category of government expenditure is transfer payments, which are payments from the
government for which nothing is received in return. Social security benefits, compensation to unemployed
people, benefits to senior citizens and pensions to retired government employees and freedom fighters are
all examples of transfer payment programmes.

Interest paid on borrowed funds is another type of government expenditure. At times, government units
finance some of their activities through borrowing, and the interest on those borrowed funds is an expense
that the government unit must meet.

The government may also incur expenses for running or contributing to the operation of various public
enterprises such as toll roads, airports, and hospitals, or for providing intergovernmental grants. These
grants are given primarily by the Central Government to State and Local Governments.

The Principles of Public Expenditure:

Public expenditure refers to the expenditure incurred by the Central Government. There are different
types of such expenditure. The usual distinction is between consumption expenditure and investment
expenditure. Another distinction is between revenue expenditure and capital expenditure.

Public expenditure is likely to have beneficial effect on society, i.e., reduction of income inequality,
control of business cycles, and achievement of employment and so on.

It is guided by the following five principles:

1. Economic Development:

A developing country like India must undertake various projects such as road and bridge construction,
irrigation dams, power plants and so on. These constitute infrastructure of the economy or social overhead
capital and are of vital importance for accelerating the pace of economic development. Investment in such
projects is so high and return from them is so low that private investors do not undertake such projects
voluntarily.

The government usually takes a long view of the economy’s requirements. So it is imperative that the
government undertakes such projects. In India and other developing countries, such development projects
are undertaken through the planning system.
2. Fiscal Policy:

Public expenditure creates jobs and incomes during depression and unemployment. This is why Keynes
advocated the policy of increasing public expenditure for creating effective demand and thus helping the
economy to achieve foil employment.

Contrarily, a cut-back in government expenditure is necessary when the economy faces the problem of
inflation. Such variation in public expenditure is necessary to control business cycles or to stabilise the
economy. So, variation of public expenditure is a part of the anti-cyclical fiscal policy.

3. Maximum Social Advantage:

One of the objectives of a modern government is to achieve the social goal of income equality. For this, it
is necessary to reduce poverty and inequality. This is why the government transfers incomes or
purchasing power from one section of society to another through various tax-subsidy measures. The
government collects revenue, mainly, by imposing taxes and selling bonds. The money raised in the
process is utilised to pay wages and compensation of government employees and the suppliers of various
materials to government departments and public sector undertakings.

Moreover, in a modern mixed economy, payments are made to certain sections of society without
requiring them to provide anything to the government in exchange. Such payments are called transfer
payments. Examples are unemployment compensation, widow pensions, subsidies (concessions) to the
freedom fighters, payments to needy families, the handicapped and so on.

Moreover, outright subsidies are also paid to the small farmers, artisans and other weaker sections of
society at the cost of the tax-payers. Such measures are to taken to improve the existing pattern of income
distribution or for reducing income inequality.

Since the marginal (extra) utility of every rupee to a poor man is much greater than that to a rich man,
appropriate use may be made of fiscal (i.e., the government’s combined revenue- expenditure) policy to
secure maximum social advantage. However, care has to be taken to ensure that taxes are not too high to
have unfavourable effects on incentives to produce, earn and save.

Richard Musgrave has suggested that the government should use public expenditure- cum-tax policy to
maximise society’s welfare, i.e., to secure the maximum possible net advantage. This implies that the
government should make the difference between the benefit of public expenditure and social cost
involved in raising the money (to finance the expenditure) as large as possible.

However, in practice, it is very difficult to measure or quantify social welfare.

4. Economy:

It may also be noted, in this context, that it is not just the amount of public expenditure that is incurred
which is of importance to the economy. What is equally — if not more — important is the purpose of
such expenditure.

The use or purpose of such expenditure determines the adequacy and effectiveness of such expenditure.
Excessive expenditure may cause inflation. Moreover, if the government has to impose taxes at high rates,
there will be loss of incentives (mainly due to the present system of progressive taxation). So it is
necessary to avoid unnecessary expenditure to the maximum possible extent.

It is very important to drastically curtail or totally avoid wasteful expenditure that causes uneconomic use
of resources.

There are two ways of securing such ‘economy’ in government expenditure:

(1) The annual budget of the Central Government must lay down the amount to be spent for particular
purposes and the government servants or departments should not be permitted to spend in excess of the
budgetary allocations.

(2) As soon as the budget grants are spent, the accounts are to be scrutinised by the Public Accounts
Committee of the Parliament.

5. Avoidance of Harmful Effects:

Finally, it is of considerable importance to ensure that government expenditure does not have any
injurious effect on production and distribution. It is equally vital to ensure that the government
expenditure is solely in the public interest and does not serve any private interest or that of any group of
persons.