Australias GDP and Discretionary Fiscal Policy - Assignment Example

Fiscal policy Case Study Student Name Instructor Name Course Code and Name University Date of Submission Fiscal policy Case Study Question 1 The definition of the fiscal policy has evolved over time from the expression that Edwin R.A. Seligman used to criticize a German economist’s that suggested that suggested that governments should engage in some redistribution of income through their budgetary activities. However, the meaning of fiscal policy changed during the Keynesian revolution where it moved away from the revenues and tax side of the budget to include both revenue and spending. Therefore, from a Keynesians perspective fiscal policy refers to the manipulation of taxes and public spending to influence aggregate demand. Fiscal policies are not necessarily meant to stabilize an economy but also reallocate resources and redistribute income. One assumption of the fiscal policy theory that the author uses is that there exists a unitary form of government in Australia that has the political power to set the desired objectives and change the policy instruments in a desired direction and by a needed magnitude (Battaglini & Coate 2014, p. 15). What this assumption means is that there exists an all-inclusive budgetary process and no public finance decision is made outside of the budget or at least, all decisions, whether in or out of the formal budget are directly or indirectly controlled by the government (Lewis 2002, p. 14). In addition, the fiscal policy theory also assumes that policy decisions made by government are influenced by public interest. This means that policymakers always avoid making populist policies that go against the public interest even when the policies have short run appeals that could help those in power win the next election. In general, the fiscal theory assumes that the electoral cycle does not play a role in the budgetary decisions (Augello & Guidi 2012, p. 102). The case study provides some fiscal policy measures that the Howard government put in place in the 2000-01 budgets. There is evidence to prove that the government operates a surplus budget as the forecasted surplus for the current budget was $1.5 billion. Another budgetary policy that was fiscal in nature was the tax break that the budget expected to bring forth for the older generation in Australia. It can be assumed that this was meant to boost aggregate demand among members of this demographic. The tax breaks for motor vehicle manufacturers to claim full tax input to the tune of $600 million as a way of stimulating the economy. Other budgetary policies that are related to fiscal policy relates to the increased government spending on welfare projects such as health so as to create employment opportunities to nurses, and expenditure on the Job Network program and the new working credit scheme that seeks to increase discretionary income among those returning to work by proving income support until one accumulates $1,000 in earnings. This may be assumed to be targeted at the economy to stimulate spending in the economy as a way of growing industries in the economy. The author’s criticism is based on the skepticism that is associated with the fiscal policy theory in the real world. To start with, it is difficult to establish how to determine public interest due to the heterogeneity of the Australian population. The postponement of the expected privatization of Telstra Corp, which is one of the largest public companies in Australia to 2003-04 has been termed by the author as political as it would generate a public outcry during the electioneering period. Aside from that, there are disagreements between the ruling party and the opposition in the Australian parliament on what should be included in the budget estimates. For example, the leader of the Australian Democrats terms the tax breaks to the old as stated in the budget as a ‘generational port barreling and that the budget has blocked increased government spending that were meant to take effect in the budgeting period. Another failure that the author mentions as making the budget a campaign budget relates to the lack of economic analysis in coming up with the policy decision. There seems to be no serious assessment of the effects a policy decision will produce, and how much it will cost or will generate revenue with a case in point being the tax breaks for motor vehicle manufacturers that would deny the government more than $600 million in revenues. The author also mentions of the decision to increase funding for to the health sector, which is seen as a labor party strong point. The case study is a perfect example of the realist approach to the fiscal policy as it is difficult to have absolute power over budget making as well as difficult to differentiate between public interest and personal interests of the ruling class. Question 2 Discretionary fiscal policy refers to the deliberate manipulation of government spending, transfers and taxation in order to promote macroeconomic goals such as price stability, full employment and economic growth. In addition, discretionary fiscal policies require the approval of either parliament or the prime minister thus are affected by lags that occur as a result of enactment of the changes in fiscal policy (Auerbach 2002, p. 52). More often, the implementation of the modified fiscal policy requires changes in legislation, thus may take time to implement. An example may be the effecting tax breaks where before the changes in tax law are adopted by parliament and are passed into laws, it may have a moderate impact of increasing the disposable income of the working population, which is meant to increase aggregate demand (Feldstein 2002, p. 153). Discretionary fiscal policy can be used to counter business cycles in two ways; either through expansionary fiscal policy, or through restrictive/contractionary fiscal policy which have different impact on the rate of growth of GDP. The major assumption of discretionary fiscal policies is that aggregate supply grows constantly and only aggregate demand is affected by the discretionary fiscal policy. The annual budget plays a critical role in the development of discretionary fiscal policy given that it provides an outline of the tax reforms that the government wants to take in place either to increase disposable income or increase government revenue. In addition, the annual budget provides the annual expenditure by the government as well as the sources and targets of the funds. This means that the annual budget provides the discretionary fiscal policy items and is usually dependent on the business cycles. The discretionary fiscal policy is better explained through graphs showing the impact of restrictive or expansive fiscal policies. Graph showing increase in taxes or reduced government spending AD1 ASo ADo RGDP From the graph it is evident that the reduced government spending and increased taxes reduced aggregate demand, which is signified by the arrows in the graph which results in a fall in the real GDP as well as a rise in unemployment. The graph depicts the restrictive fiscal policy. Conversely, where expansionary fiscal policy is applied, the arrows change direction to the reverse with respect to the aggregate demand curve, increasing real GDP and reducing unemployment during periods of recession. The annual budget plays an important role with regards to fiscal policy given the basic equation of government budget = government purchases (G) + Transfer payments – tax revenue from all sources. Therefore, government budget = G –T where T refers to taxes net of transfers. However, annual budget includes fiscal policy changes not only with G but also with T which results in shifts in consumption (C) and aggregate demand AD. From the equation, we can describe a budget deficit by G-T>0 and budget surplus by G-T Read More