Fiscal imbalance implies an instance when the future income torrents are different compared to the government’s future debt responsibilities. Income streams and debt obligations are usually measured based on their respective current values and discounted at a given spread plus risk-free rate. If the fiscal imbalance is positively sustained, tax revenues are likely to be raised in the future.
Mainly, there are two fiscal imbalance types. A vertical and a horizontal fiscal imbalance are the different types. In the horizontal imbalance, the generated revenues are not in line with the expenditures of the given region in a country. In vertical imbalance, the revenue does not meet the expenditure needs at the government level.
Fiscal imbalance can occur at any given point in time. Positively sustained fiscal imbalance and the resultant increase in tax revenues have a number of effects. Below are a number of policies that may be formulated due to fiscal imbalance and their effects.
- Balancing act
This is based on the idea of finding a balance between public spending and changing the tax rates, to maintain the economy. For example, lowering the tax rates and encouraging spending in a stagnant economy risks causing inflation. This is due to the fact that arise in an amount that is in circulation plus increased buyer demand decreases the monetary value.
If the economy stagnates, spending rates decrease, unemployment levels increase and business profits decrease. The government may decide to drive the economy. This is through tax reduction and increased government’s expenditure. This is known as “pump priming”
With the “pump priming”, there is more money in the economy and consumer demands increase. The economy becomes active due to the rekindling of businesses. If not closely checked, this can also lead to inflation in the long run
- Economic curbing
With increased inflation, the economy needs to be slowed down. In this situation, the government employs the use of fiscal policy. The fiscal policy works in that it leads to an increase in taxation rates so as to enable the sucking of money from the circulation. Also, results in a decrease in government expenditure which also contributes to decreased circulation of cash.
Economic curbing continues as the governing body used the fiscal policy adopted to fine-tune the economy. Possible adverse effects of this include a slow-moving economy with high levels of joblessness.
Monetization process involves the printing of money by the government via its central bank. The printed money is then used to purchase government debt, increasing its liquidity and bring down long-standing interest rates.
Immediate effects of this include deflation, which helps in bringing down the economy and reinstating money value. Even though deflation has its benefits, it is also catastrophic. It could lead to a renewed recession from recovery. An example of this is Japan’s economy in the late 1990s.
Monetization process may also lead to the loss of monetary value with time. When advanced official indebtedness plus monetization are combined, the probability of rising inflation needs to be highly considered. This is true even though inflation is less likely to occur in the near future.
The impact of fiscal imbalance is experienced differently. This depends on the objectives of the policymakers and political orientations. This means that a tax raise can only affect the middle-income earners, who make up the majority of the economic group. In case the economy keeps dropping, the middle-class group will experience rising taxation and salary decline or stagnation. This is in comparison to the upper class.
For the government, it cuts down its expenditure. This means that the government stops funding most of the activities, decreasing the amount of cash in circulation. In the long run, this leads to a stagnant economy and increased levels of unemployment.
The policymakers face a huge challenge in determining the extent to which the government needs to be involved in controlling the economy. At the same time, it is undeniable that the government is needed in sustaining an energetic economy.