Question

Give two examples of fiscal stimuli and explain why a government would use these. Explain how can corporate tax cuts be an engine for economic growth. According to the RWM article, explain 2 ways in which the GOP Tax plan would increase income inequality

Answer 1

What is a fiscal stimulus?

During a downturn governments can step in with a set of measures to reinvigorate the economy. Most often these involve increased spending by the government to increase employment and general demand in the economy, which acts as a signal for companies to increase production, which in turn will lead to more hiring and so on through the virtuous economic cycle.

Why does India need a fiscal stimulus?

Picture the Indian economy as an airplane with four engines: Three of the four engines (exports, private investments and consumer demand) are sputtering and the last engine (government spending) is keeping the airplane afloat. Also, anecdotal evidence suggests that unemployment has increased. Hence, the need to provide support for the economy.

Breaking down Fiscal Policy

The government could lower taxes in order to put more money in consumers hands so that they spend more. However, since India has switched to the Goods and Services Tax the government may find it difficult to cut indirect tax, unless it reduces the rates on petroleum products. The government will have to wait till the next budget to announce a cut in Income Tax.

The other option is to increase government spending – building more ports, highways, bridges etc – which stimulates construction activity and reduces unemployment.

So why are some people arguing against a fiscal stimulus?

In order to increase spending the government has to borrow money, since its tax revenues cannot meet the shortfall. However, a government borrowing from the open market reduces the pool of money available for companies to borrow, and raises their interest costs. It is also argued that deficit spending by the government increases inflation, which in turn hurts the economy.

Some economists argue that the benefits of a fiscal stimulus are overstated since the extra spending will come out of the government’s tax revenue, in other words, from the productive activities of the private sector, and so this is vigourously opposed by them.