The effectiveness of the use of fiscal policy and regulations derived from those policies for controlling economic factors that affect investment in the economy are often debated. Whether the classical model of correlation between tax, public spending and investment still works in the modern globalized economy is also a question.
Fiscal policy is based on the theories of British economist John Maynard Keynes, which hold that increasing or decreasing revenue (taxes) and expenditures (spending) levels influence inflation, employment, and the flow of money through the economic system. Fiscal policy is often used in combination with monetary policy, which is set by the Central Bank to influence the direction of the economy and meet economic goals.
These three factors are used as tools for fiscal policy implementation:
Business tax:
Taxes that businesses pay to the government affects profits and the amount of investment. Lowering taxes increases aggregate demand and business investment spending.
Individual taxes:
Taxes on individuals, such as income tax, affects their personal income and how much they can spend, injecting more money back into the economy.
Government spending :
Aggregate demand is increased by the government's own spending. Through imposition of higher tax on businesses in certain industries the government discourages consumption and flow of investments in those industries e.g. socially undesirable product . The opposite may be achieved through tax cuts for certain industries which are considered vital to economic growth or to encourage export e.g. light engineering. The imposition of higher tax on individuals results lower disposable income, thus reduces consumption in the whole economy. Ultimately, this effects the investments of individuals, and growth of industries. Higher government spending leaves more in the hands of the public, which ultimately leads to higher consumption and investment. Thus, spending is used as a tool for fiscal policy to drive government money to certain sectors needing an economic boost. Whoever receives this fund will have extra money to spend – and, as with taxes, the government hopes that money will be spent on other goods and services.
Fiscal policy and regulations effect the profitability of business and ultimately the flow of investment in the following ways:
1. Investment opportunities:
Businesses can see investment opportunities from government spending as well as private investment. This commonly happens during an expansionary policy, when more money is flowing into the economy from the government and from other sources since taxation is low. When there is a balance between price and demand, businesses expect to thrive.
2. Slower growth:
A contractionary financial policy leads to reduction in inflation. Businesses typically rein in their growth due to rising taxes and take measures to stay afloat with less money flowing through the economy. As a result, investment reduces to bare minimum.
3. Taxation changes:
Depending on the nature, businesses face several levels of direct and indirect taxation. Businesses must contend with how the Government taxes them and how it interweaves with the national fiscal policy. Sector-specific tax policy directly impacts the growth of industries in those sectors. In Bangladesh, telecom service providers have been hardly hit due to high corporate tax rate and introduction of minimum tax regardless of profit. This has forced the companies to re-consider plans for expansion and investment in newer technology. The Government has recently introduced long-term tax exemptions for automobile, agribusiness, light engineering, hospital, IT hardware manufacturer and home-appliance manufacturers. We are likely to see new investment in these industries. Reduction of tax will also enable existing businesses in these industries to remain competitive and expand for future growth. Similarly, imposition of advance income tax on imported fruits will discourage imports and give some protection of local producers, thus encouraging further investments in this industry.
4. Unemployment:
A major objective of fiscal policy is to minimize unemployment. For example, the Government can lower taxes to put more money back in consumers' pockets. As such, people will be able to spend more money, and companies may face increased demand. With increased demand additional production requirement is created, and businesses can respond by creating more jobs and hiring more employees. With proper fiscal policy in place, a low unemployment rate may gradually increase. A reduction of unemployment sometimes inhibit the growth of small industries that have to compete with large corporates for attracting and retaining employees. Such a situation has been observed in post-COVID North American economies recently. In case of resource-scarce countries like Bangladesh, regulatory support in the form of cohesive tax policy, stable interest rate and foreign exchange rate plays a vital role for creating conducive environment for local investment and attracting foreign direct investment. A least discussed aspect of fiscal policy is the impact of stability and continuity on the investment. The feasibility of an investment may become invalid due to abrupt change in the regulatory environment. An investment-friendly regulatory environment can be achieved through continuity in tax laws and monetary policy.
