Fiscal Functions
Need of To answer basic questions of what, how and for whom to produce, how
much resources to use
Economic
3 economic systems- Market, Government and Mixed system
System
Richard 3 branch
taxonomy
Musgrave’s Functions of Government
Three-
function Resource
Redistribution Stabilization
allocation
framework Microeconomic Microeconomic Macroeconomic
1. Resource Allocation
Meaning Corrective action when private markets fail to provide the right and
desirable combination of goods and services.
Way in which the available factors of production are allocated among the
various uses.
How much of various goods and services are to be produced
Reasons Markets generate misallocation due to:
Presence of monopoly power – leading to over/under production
Failure to provide collective goods
Externalities can influence production decisions
Factor immobility
Imperfect information
Inequalities in income and wealth distribution
Instruments Direct production by government
for Resource Influencing private allocation through incentive/disincentive
allocation Competition and merger policies to prevent anti-competitive agreements
Regulatory activities – licensing, directives on location of industry
Legal and administrative framework
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2. Redistribution Function
Meaning For whom should an economy produce goods and services.
Aims at redistribution of income to ensure equity and fairness to promote
the wellbeing of all sections of people.
Reasons Left to the market, the distribution of income and wealth among individuals
in the society is likely to be skewed
Aims Achieve an equitable distribution of societal output
Advancing the well-being of the deprived
Providing equality in income, wealth and opportunities
Providing security for people who have hardships,
Ensuring minimum standard of living for everyone
Instruments Progressive system of taxation
Provision of subsidies for the poor
Proceeds from progressive taxes used for financing public services
Employment reservations and preferences
Special schemes for backward regions
Conflicting Conflict between efficiency and equity
objectives Efficiency costs and deadweight loss
Disincentive to work due to progressive taxation
3. Stabilization Function
Meaning Business cycles are natural phenomena in any economy and they tend to
occur periodically.
A market economy does not automatically generate full employment and price
stability and therefore the governments should pursue deliberate stabilization
policies.
To counteract the instabilities in the form of recession, inflation etc.
Instruments Monetary policy – to control the size of money supply and interest rate
Fiscal policy- to regulate the level of economic activity (aggregate demand, output,
employment, general price level) by means of expenditure and taxation decisions)
Recession: Expansionary FP -Increase government expenditure; reduce taxes
Boom: Contractionary FP –Decrease government expenditure; increase taxes
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