The specific concerns of fiscal policy are to maintain over time a balanced budget with taxation levels which do not restrict private business development, to ensure that the national debt does not become a burden on the budget, and the question how to use the budget as an anti-cyclical instrument in case of business cycles and external shocks.
Fiscal policy thus deals with government budget expenditures and revenues and with national debt. The budgeting process results in an inventory of needs for funding and by prioritising the expenditure level is brought in line with government revenues. With it expenditure policies the government influences the provision of goods and services in the economy, and with its revenue collection policies (taxation) it influences the consumption and saving levels of households and business.
When analyzing a government budget one can make a distinction between real expenditures and transfers, and between capital expenditure and current expenditure. To fund its expenditures the government has a number of instruments at its disposal:
1 Taxes, Fees, utility pricing, sales of assets
2 Foreign borrowing
3 Borrowing from domestic non-bank sources
4 Borrowing from the domestic banking system
If the government budget is not in balance, one speaks of a deficit or surplus. A much used rule is that government deficits should not exceed GDP growth. Moreover the golden rule applied in market economies is that if governments issue bonds (treasury bills) to finance the deficit, the amount borrowed should be linked to capital expenditure in transport infrastructure, improved health system and education. It should not be used to fund recurrent expenditure deficits. The logic is that deficit financing increases the national debt. This needs to be repaid in the future and for that national income has to increase.
Having said this, it is clear that in fast growing economies, the government can afford a budget deficit, as long as its can attract foreign borrowing to finance the budget deficit. Likewise, a country can afford a current account deficit ( more imports than exports) as long as Foreign direct investment and Government level loans in foreign exchange are available and the capital account thus shows a surplus to match the current account deficit.
The main instrument for financing government expenditures is taxation. Deficits are funded by borrowing. Tax policy indicates that the optimal mix of tax instruments is used to generate a specific amount of government revenues. Tax instruments include taxes on income (and profits), taxes on consumption, taxes on (net) wealth, and user charges. The whole tax system should conform to a set of desirable characteristics, such as, efficiency, equity, and at low costs, for both the taxpayer and the tax administration.
In market economies a main consideration in designing taxation systems and in changing tax levels is that the overall tax level should not be so high as to significantly affect the possibilities of individuals and firms to engage in private activities.
The deregulation of world trade, by removing quota and lowering import tariffs inline with the Most Favoured Nation principles set by the WTO has contributed to the increase in world trade. Export oriented policies have made significant contributions to economic growth in many ASEAN countries as well as in the new member states of the European Union. On this basis there is a general consensus that trade liberalisation can be an engine for revitalising economic growth. A most obvious example is the importation of machinery and technology that can be used to produce more efficiently.
Trade liberalisation thus can bring positive and negative effects. The more flexibility there is in an economy the more important the positive effects will prove to be. Typically farmers tend to respond well to economic liberalisation with higher food and cash crop production. For heavy industry with outdated equipment, the competition with foreign producers tends to be hopeless.
The balance of exports and imports is the trade surplus (or deficit), it is called the current account. Transition economies typically have a trade deficit as a lot of consumer and investment goods are imported. This will lead to an accumulation of foreign debt that will have to be repaid in the future. The higher productive capacity that results from the importation of capital goods may be sufficient to repay such a debt. Trade regulations, the exchange rate and the type of exchange rate regime are the most important instrument a government has to influence the current account.