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The fiscal paradox - a note

Hector McNeill1

Perverse policy incentives:- Fiscal policy attempts to manage mutually contradictory objectives including revenue raising, a progressive income redistribution and aggregate demand management. Therefore the coherence between social and economic needs and effective and efficient public provisions is poor.

The fiscal paradox

The ad hoc elements of macroeconomic policy made up of the Aggregate Demand Model (ADM) the profit motive, fiscal (government revenue-seeking) and monetary control (imposed interest rates) create a series of economic paradoxes for the management of private enterprises by making efficient resource allocation in line with the objectives and capabilities of each firm extremely difficult or almost impossible. The fiscal paradox dynamics and effects are described below.

Fiscal policy covers mutually contradictory elements:
  • 1. Taxation and levies, the means of raising government revenue, have a role of collecting sufficient money to pay for desired government expenditures and services

  • 2. Taxation doubles up as a means of improving the distribution of disposable incomes on the basis of progressive taxation

  • 3. The power to vary taxation and levies is also used as a means to influence, so-called, aggregate demand
Therefore although a specific budget might be quantified as being necessary, the actual growth in the economy, or lack of it, frequently causes fiscal policy to veer off track and alter taxes and levies to dampen or encourage growth.

When a government gets into debt a method of repayment is to cut government services so as to channel government revenue to repayment of debt via the increasingly trodden path of "austerity".

Sometimes rises in taxes accompany rises in interest rates to control inflation through monetary policy (see The monetary paradox), for example.

The overall outcome is that the other objectives of "macroeconomic management" under conventional policies complicate and detract from a transparent and coherent revenue-raising functions for justified public services.

The general concept of introducing financial initiatives to introduce private services to introduce "competition" and lower pricing for government services has a general track record of failure. This is largely because contracts using public funds tend to pay excessive interest payments and where guarantees of sales and services, which don't exist in the free market, are included irrespective of required consumption. As a result the element of competition and lower prices is eliminated. Such decisions are political and do not have a firm economic and financial cost-benefit justification.

1 Hector McNeill is the director of SEEL-Systems Engineering Economics Lab.

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