Fiscal Policy

Concept / Term
Fiscal Policy
Branch
Macroeconomics
Definition & Explanation

Fiscal Policy

Fiscal policy refers to the use of government spending and taxation to influence the overall health of the economy. Its primary goals are to manage aggregate demand, stimulate economic growth, reduce unemployment, and control inflation.

Authority in Nepal

  • Ministry of Finance: This ministry is responsible for formulating and implementing Nepal's fiscal policy. It prepares and presents the annual national budget to Parliament.
  • Nepal's Annual Budget: The national budget, outlining government revenue (taxes) and expenditure plans for the upcoming fiscal year, is typically presented by the Ministry of Finance on Jestha 15 (around late May) each year.

Key Tools of Fiscal Policy

Government uses two main tools to implement fiscal policy:

  1. Government Expenditure: This includes spending by the government on public goods and services such as infrastructure projects (roads, bridges), health services, education, defense, and public administration. Increased government spending directly injects money into the economy and can stimulate aggregate demand.
  2. Taxation: The imposition of taxes on individuals and corporations. Taxes reduce the disposable income of individuals and the profits of businesses, thereby influencing consumption and investment.
    • Direct Taxes: Taxes levied directly on income or wealth, such as income tax, corporate tax, and property tax.
    • Indirect Taxes: Taxes levied on goods and services, such as Value Added Tax (VAT), customs duties, and excise duties. These are collected by sellers and passed on to the government.

Types of Fiscal Policy

  • Expansionary Fiscal Policy: Implemented during economic downturns or recessions. It involves increasing government spending (e.g., on infrastructure projects) or decreasing taxes. The aim is to boost aggregate demand, stimulate economic growth, and reduce unemployment.
  • Contractionary Fiscal Policy: Implemented to curb inflation or reduce a budget deficit when the economy is overheating. It involves decreasing government spending or increasing taxes. The aim is to reduce aggregate demand and cool down inflationary pressures.

Budget Deficit

  • A budget deficit occurs when total government expenditure exceeds its total revenue (from taxes and other sources) in a fiscal year.
  • Budget deficits are typically financed through government borrowing, either from domestic sources (e.g., by issuing treasury bills and bonds) or from foreign sources (e.g., international loans from institutions like the World Bank or IMF, or bilateral loans).

Nepal's Tax Structure

  • Inland Revenue Department (IRD): This is the primary government agency in Nepal responsible for the administration and collection of various taxes, including income tax, Value Added Tax (VAT), and excise duties.
  • Standard VAT Rate: The standard Value Added Tax (VAT) rate in Nepal is currently $13%$.
  • Corporate Tax Rate: Generally set at $25%$ for most companies, although specific industries or types of businesses may be subject to different or preferential rates.
  • Tax-to-GDP Ratio: Nepal's tax revenue as a percentage of its GDP is approximately $\sim 20%$. This ratio indicates the overall tax burden and is often compared to regional averages and developed economies to assess fiscal health.

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