Fiscal Policy (Pols 220)

Introduction

Fiscal policy is one of the primary tools governments use to manage economic activity, working alongside monetary policy to influence growth, employment, and price stability. This note traces the etymological and conceptual origins of the term, surveys key scholarly definitions, and outlines its classifications, tools, and objectives.

Image depicting fiscal policy

Etymology and Origin of the Term

The term "fiscal" derives from the Latin word fiscalis, originally referring to a basket used for collecting money, and later coming to mean the state treasury or public purse. Another Italian word connected with fiscalis is Ilfisco which refers to the agency that collects taxes. The related term "fisc" (referring to a public treasury or exchequer) shares this Latin root.

Fiscal policy, therefore, refers broadly to policy related to taxation and public finances. In English, the expression "fiscal policy" was apparently first used by Edwin Seligman, a prominent professor of public finance at Columbia University in the early 20th century. He used this expression to criticize Adolf Wagner, a German economist who had suggested that governments should engage in the redistribution of income through their budgetary activities.

The Keynesian revolution changed the meaning of fiscal policy by moving it away from the tax or revenue side of the budget to include both revenue and spending. To the Keynesians, fiscal policy refers to the manipulation of taxes and public spending to influence aggregate demand.

Scholarly Definitions

Similarly, Munongo (2012) defines fiscal policy as the deliberate use of government expenditure and revenue generation, primarily through taxation, to regulate economic activities. More broadly, fiscal policy can be understood as the use of government revenues and expenditure programs to generate desirable effects and mitigate undesirable effects on national income, production, and utilization.

According to Ghingan (2003), fiscal policy comprises deliberate actions of government spending and taxation undertaken to control inflation, promote economic growth, and ensure that national output and employment reach desired levels.

Classification of Fiscal Policy

Fiscal policy can be classified into two categories:

Discretionary Fiscal Policy — This refers to deliberate measures adopted by the government or its agencies to influence the economy in a desired direction, typically through adjustments to expenditure and taxation, in order to achieve macroeconomic objectives. Discretionary fiscal policy may take either an expansionary or contractionary form.

i) Expansionary Fiscal Policy — This is intended to stimulate aggregate demand by increasing economic activity, with the aim of reducing unemployment, combating recession, and fostering economic growth. This approach is typically adopted when the government seeks to pull the economy out of a downturn, by lowering taxes and increasing public expenditure.

ii) Contractionary Fiscal Policy — This is designed to reduce aggregate demand in order to curb inflation and address balance of payment challenges. It is usually pursued by raising taxes and reducing public spending.

Tools of Fiscal Policy

1. Government expenditure

2. Taxation

3. Government subsidy

Taxation — Taxation is an instrument through which government seeks to achieve macroeconomic objectives. Under expansionary fiscal policy, taxes may be reduced to increase disposable income and stimulate aggregate demand, production, and employment. Conversely, contractionary policy involves increasing taxes to reduce purchasing power and aggregate demand, especially during inflationary periods or balance of payment disequilibrium.

Objectives of Taxation

1. Regulate consumption

2. Protect domestic industries

3. Encourage investment

4. Reduce inequality

Government Expenditure — Rather than pursuing an expansionary fiscal policy solely through tax cuts, government may also stimulate aggregate demand by increasing its expenditure. This approach is typically adopted during periods of recession characterized by high unemployment, weak demand, and declining output of goods and services. Conversely, under contractionary fiscal policy, government reduces expenditure (alongside raising taxes) to curb aggregate demand, particularly during inflationary periods and balance of payment deficits.

Objectives of Government Expenditure

1. Reduce inequality

2. Public support

3. Increase economic growth

4. Defense

5. Law and order

Objectives of Fiscal Policy

1. To achieve full employment

2. Economic growth

3. Debt control

4. Inflation control

Conclusion

Fiscal policy remains a central instrument of macroeconomic management, evolving from a narrow focus on taxation to a broader framework encompassing both government revenue and expenditure. Through its discretionary application — whether expansionary or contractionary — and its core tools of taxation, spending, and subsidies, fiscal policy continues to shape national efforts to stabilize output, control inflation, and promote sustainable growth.