Top 7 Roles of Fiscal Policy in a Developing Economy

This article throws light upon the top seven roles of fiscal policy in a developing economy. The roles are: 1. Resource Mobilization 2. Development of Private Sector 3. Optimization of Resources Allocation 4. Creation of Social and Economic Overheads 5. Balanced Regional Development 6. Economic Stability 7. Reduction of Inequality.

1. Resource Mobilization:

Owing to acute poverty, the marginal propensity to consume is very high in developing economies. As a result the level of saving is very low in these economies. Therefore fiscal policy has an important role to play in mobilizing saving for capital formation through taxation and public borrowing.


It can also influence capital formation and sav­ings in the private sector through granting of various tax conces­sions and subsidies. This also involves diversion of wasteful and luxury spending to saving and productive investment. For achieving this objective, the tax system must have an adequacy of depth and range.

So additional taxation of a wide range of luxury or semi luxury products at higher rate, accompanied with broad based taxation of articles of mass consumption at comparatively low rate is an impor­tant requisite of a sound tax policy.

Coupled with this, highly pro­gressive income tax should be imposed on personal income. Hence for mobilization of required financial resources, there should be a judicious combination of direct and indirect taxes.

2. Development of Private Sector:

In a developing economy private sector forms an important constitu­ent of the economy. The production and productivity of private sector can be influenced by fiscal policy.

Tax relief, rebates, subsides may be granted to boost up the productive activity in the private sector. Fiscal tools and measures can be used to activate capital market to ensure availability of adequate resources for the private sector.

Tax holiday or tax concession can be used to promote private sector productive activity in the desirable direction. Likewise discrimina­tory fiscal policy will ensure flow of resources into the desirable chan­nels of production, diverting resources from undesirable lines of pro­duction.

3. Optimization of Resources Allocation:


In developing economies, fiscal tools can be utilized to effect opti­mum allocation of resources. Very often resources in private sector are directed towards the production of goods which cater to the re­quirement of richer section of society.

Fiscal tools can be employed to allocate the mobilized resources in desirable channels of invest­ment. That is to divert resources from less useful production to so­cially necessary lines of production. Reallocation of resources can be determined according to well defined priorities of plan. Thus pro­cess of reallocation can be done by various tax incentive measures and subsidy programmes.

4. Creation of Social and Economic Overheads:

In developing economics there is the lack of the proper development of basic infrastructure which are vital requirements for economic de­velopment. Provision of social overheads like education and health service will directly enhance the productive capacity of the people.

These are expenditure incurred for the provision of economic overheads like transport facilities, power generation and telecommunication fa­cilities which will speed up the process of industrialization.


Building of social and economic overheads requires lumpy investments which can never be expected from the private sector, since they are not profit induced. Hence government has to provide these investments through fiscal measures of taxation and expenditure programmes.

Government has also to invest considerable amount of resources to provide such basic facilities in the agricultural sector, such as irriga­tion network, subsidized inputs, infrastructure facilities for market­ing to enhance agricultural production and productivity.

5. Balanced Regional Development:

Developing economies face the problem of regional imbalance in the matter of economic development. Private investments usually con­centrate in urban area where critical infrastructures are easily ac­cessible and better marketing facilities are available.

Moreover pro­duction in concentrated on those luxury goods, which are mostly consumed by the richer income group. Backward areas and regions are neglected in the process of investment and production process.


Therefore governmental intervention in the process of decision mak­ing relating to investment location is imperative for achieving bal­anced regional development and growth. Therefore government can set up public sector production in backward area for achieving bal­anced development.

Fiscal tools like tax concession, tax holiday, subsidies, concessions in infrastructure utilization etc., can be given to private investors to attract private investment in these backward geographical areas as part of the strategies for balanced growth.

6. Economic Stability:

Fiscal tools such as taxation and expenditure programmes can be utilized as an effective tool to control cyclical fluctuations arising during the process of economic development. Taxation is an effec­tive instrument to deal with inflationary and deflationary situations.

The tax structure should be devised which will automatically coun­teract economic disturbance as and when they occur. Moreover tax should be flexible enough to make adequate changes in the tax system according to the prevailing situations. The system should be based on the principle of progression.

The expenditure programme also can be utilized to fight inflation by varying public expenditure the government can counteract the inflationary and deflationary situ­ations in the economy.

7. Reduction of Inequality:

Provision of equality in income wealth and opportunities form an integral part of economic development in developing economics. Fiscal policy has an important role to play in reducing inequality.

Instru­ments of taxation must be used as a means to bring about redistri­bution of income. The various fiscal measures directed towards re­duction of inequality in income, wealth and opportunity are: progres­sive taxation of income and property, imposition of heavy taxation on luxury goods, tax exemption or concession to commodities of mass consumption, government expenditure on relief programmes, and provi­sion of essential commodities at subsidized price through fair price shops to the poor etc.

These fiscal measures will help to reduce the glaring inequality in the society thereby to reduce the gap between poverty and prosperity.

Raja J. Chelliah advocates that developing economies should frame a well-structured fiscal policy so as to give maximum emphasis on measures:

(a) To check actual and potential consumption in order to raise the rate of investment,

(b) To regulate the flow of purchasing powers in the true spirit of the economic plan,

(c) To achieve a proper distribution of income in the society,

(d) To divert resources from con­sumption,

(e) To investment to provide fiscal incentives to save and in­vest,

(f) To facilitate transfer of resources from private sector to gov­ernment sector and from less desirable lines of production to more desirable lines of production, and

(g) To reduce regional imbalance in economic development.

Moreover developing economies depend largely on foreign coun­tries and funding agencies for capital goods and foreign invest tents. Therefore fiscal measures have to be adopted to safeguard domestic economy against foreign capital flows.

The domestic economy must be adequately safe guarded against world economies fluctuations. Thus the role of fiscal policy can be linked to the driving of a motor vehicle. While driving up a gradient, an increase in power is needed.

However when the vehicle moves against the national interest it is necessary to control the supply of powers. It is also necessary to apply breaks judiciously to ensure that the vehicle does not slip out of control, but keep on moving. Therefore the national exchequer should see that the breaks are not pressed so much as to bring the vehicle to a halt.

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