Fiscal Policy is a concept and a strategy that involves the use of government revenue collection, primarily through taxation, and expenditure to influence a country's economy. It is essentially the government's budgetary policy. The concept is rooted in the theories of the British economist John Maynard Keynes, whose work theorized that government changes in taxation and spending could influence aggregate demand and economic activity. This approach developed in reaction to the Great Depression of the 1930s, which demonstrated the failure of the previous laissez-faire economic management.
The mechanism of Fiscal Policy works by manipulating two key variables: the level of government spending and the tax rate. For instance, an Expansionary Fiscal Policy involves higher government spending or lower taxes to stimulate demand and boost economic growth, while a Contractionary Fiscal Policy involves the opposite to control inflation.
In India, Fiscal Policy is closely connected to the Fiscal Responsibility and Budget Management (FRBM) Act, 2003, which was enacted to institutionalize financial discipline and reduce the fiscal deficit. The FRBM Bill was introduced in 2000 and the Act came into effect on July 5, 2004. It initially mandated bringing the fiscal deficit to a manageable 3% of GDP by March 2008. The government is required to present three statements—the Medium-term Fiscal Policy Statement, the Fiscal Policy Strategy Statement, and the Macroeconomic Framework Statement—along with the Annual Financial Statement (Budget) to both Houses of Parliament.
A significant recent change in the tax component of fiscal policy was the introduction of the Goods and Services Tax (GST) in 2017, which unified the country's indirect tax system. Fiscal Policy is the sister strategy to Monetary Policy, which is managed by the central bank (RBI) and deals with the money supply and interest rates.