What is Fiscal Policy? Tools, Types & Role in Economic Growth

Fiscal policy is how the government uses spending and taxes to manage the economy. The government increases spending and reduces taxes to increase economic growth during slowdowns.

During the COVID-19 pandemic, India's government announced a ₹20 lakh crore stimulus package. The government had previously reduced corporate tax rates from 30% to 22% for businesses in September 2019. It also increased spending on healthcare by ₹2 lakh crores extra as part of the pandemic response. 

The government provided direct cash transfers of ₹500 per month to poor families. These measures helped people and businesses survive the economic crisis effectively.

Fiscal Policy Tools Table

This table demonstrates how India's government deployed various fiscal policy instruments during the COVID-19 economic crisis.
 

The comprehensive fiscal response totalling ₹9,00,000 crores successfully supported businesses and households through the pandemic crisis.

Governments use fiscal policy to control inflation, unemployment, and economic growth rates.

1. Fiscal Policy Tools and Instruments

Governments use various fiscal policy tools to influence economic activity effectively. Tax policy includes income tax, corporate tax, and indirect taxes like GST. The government can increase or decrease these rates to control spending. Lower taxes put more money in people's pockets, encouraging consumption.

Government spending includes both revenue and capital expenditure on various sectors. Revenue spending covers salaries, subsidies, and day-to-day operations of the government. Capital spending includes infrastructure projects, roads, railways, and public facilities. Public debt management involves borrowing to finance government activities and projects.

Transfer payments like pensions, unemployment benefits, and subsidies help redistribute income. These payments support vulnerable sections of society during economic hardships. The government also uses public sector enterprises to implement fiscal policy.

This comprehensive overview examines India's current fiscal instruments and their recent modifications to stimulate economic growth.
 

These strategic adjustments across fiscal instruments demonstrate the government's commitment to fostering economic growth whilst maintaining revenue stability.

2. Types of Fiscal Policy

Fiscal policy can be either expansionary or contractionary, depending on the economy. Expansionary policy means the government spends more and cuts taxes to boost growth and create jobs during a slowdown. It borrows money to fund this extra spending.

Contractionary policy means the government spends less and raises taxes to control inflation when the economy grows too fast.

Some tools, called automatic stabilisers, work on their own. For example, tax collections rise during booms, and unemployment benefits increase during recessions, helping to balance the economy.

This framework categorises different fiscal policy approaches based on economic conditions and their corresponding implementation strategies.
 

India's adaptive fiscal policy approach enables responsive economic management across different cyclical conditions and external shocks.

3. Role in Economic Growth

Fiscal policy plays a crucial role in promoting sustainable economic growth. Government investment in infrastructure creates jobs and improves productivity across sectors. Roads, railways, and airports connect markets and reduce transportation costs. Education and healthcare spending build human capital for long-term growth.

Tax incentives encourage private sector investment in priority areas. Research and development tax credits promote innovation and technology adoption. Export incentives help domestic companies compete in global markets successfully.

Fiscal policy also helps redistribute income and reduce inequality in society. Progressive taxation ensures that wealthy people contribute more to development. Social spending programmes provide basic services to poor and marginalised communities.

This analysis quantifies how government investment across key sectors attracts private capital and generates employment opportunities.

Technology

60,000

2,00,000

8,00,000 jobs

Manufacturing

2,00,000

4,00,000

35,00,000 jobs