International Finance: Importance of Fiscal Responsibility

Fiscal responsibility in very basic terms refers to the responsibility that arises when it comes to taking financial decisions. It should be ensured that all parties affected by such decisions are considered and the decisions are taken in the best interest of their needs and desires. For this paper we will study how this term is very important for a country’s government and what does it exactly mean for a country to be fiscally responsible.

For a nation to be fiscally responsible it can mean a variety of things and can be interpreted differently by different people. Nevertheless, there is no doubt about the fact that being fiscally responsible means that the government should take fiscal policy decisions that are in the best interests of the country’s economy and its population. Interpretation of this concept varies from one person to the other. From a neutral standpoint a country’s government is considered to be fiscally responsible. Which is indeed true when the expenditure of the government is equal to what they have from taxes. Based on this principle, governments make the choice of increasing taxation or reducing spending. An irresponsible government would happen to land up in situations where they spend more rather than reduction of expenditure, as there are not too many earnings through taxes.

How you achieve such balance is mostly seen by different political standpoints. On the left they propose that national deficit and debt need to be reduced. According to them, this is done through the addition of extra taxes that affect those that are wealthy. They believe that the rich should pay more taxes for the betterment of the country and thus propagate a higher degree of fiscal responsibility. Whereas on the right their view is that a balanced budget is the appropriate way to fiscal responsibility. Cutting off expenditures made by the government is supported, together with imposing less-stringent regulations for the stimulation of the economy.

On a generic level fiscal responsibility implies a government pursues the appropriate level of government spending and tax to:

• Maintain sustainable public finances.
• Ensure fiscal policy aids the optimal rate of economic growth.
• Maintain appropriate levels of public investment.

Why is Fiscal Responsibility Important?

Fiscal responsibility is essential to creating a better, stronger, more prosperous nation for the next generation.There is a direct link between the country’s economic future and the fiscal responsibility of its government. The decisions they take affects the lives of people 10-20 years down the line. What society can enjoy tomorrow is dependent on the budget deficits today. Hence eliminating budget deficit is seen as one of the most important steps.

Fiscal policy can have a detrimental impact on the health of the economy in the long run, as it affects national saving and the growth of productivity. National savings can be generated privately, by households and business, or publicly, by government. Although fiscal policy can, in theory, help boost private saving, this has proven difficult, in practice. Instead, the most important effect of fiscal policy on national saving has been through the direct government budget. When the government runs deficits, it siphons off private savings (reducing national saving), leaving less available for capital investment. With less capital investment, less new equipment is provided to workers, and, all else being equal, future productivity growth rates and levels are lower.

Now to study the importance of being fiscally responsible we will consider arguments that show how it can impact a nation.

Borrowings – In a situation where a government has more expenditure than what it earns, it borrows the rest. A substantial amount comes from private earnings. But the rest if financed through domestic lenders leaves less for investing in the home country. Whereas if the debt is taken through international sources, there is a chance to owe a lot to international lenders with an increasing interest cost ever year. Hence it’s important to pay heed to how much is borrowed.

Deficits- Budget deficits are not always inappropriate. However, massive budget deficits threaten economy in other ways as well. They increase the likelihood of re-igniting inflation by putting pressure on the government simply to print more money to pay off its debt. The more money is printed, the less each currency in your wallet is worth. The consequences that deficits bring the future cannot be ignored. Growing commitments made by one generation to the next cannot be honored on empty pocketbooks. An economy which has been stagnant for a long while cannot support retirement payments, medical care, and all the other benefits and services a country would like. And it cannot support economic opportunity for today’s youth to live as well as their parents’ generation.

Foreign Ownership – As a country starts to lend ownership of state owned resources to foreigners, it’s dependence on them increases and they’re susceptible to the actions of foreign investors and governments. Such international entities then come to own more of a country’s production capacity. Hence how much foreign intervention the fiscal policy allows has an impact on how business is done, as there is a chance for the foreign companies to not pay attention to economic and social needs of the country they’re operating in. Such ownership also increases burden to pay to foreign nationals.

However only a focus on these areas is not enough. Other than having a balanced budget: reduced consumption, increasing savings and investment, continued improvements in productivity, improved education, inflation and interest rates at desirable levels, and a favorable worldwide economic climate are very much important to have the best fiscal results. But unless the problem with deficit is not paid attention to it’s difficult to enjoy other benefits.

What does it mean to be Fiscally Responsible?

For a country to mean Fiscally responsible can mean a variety of things as discussed earlier because each an every country has different situations when it comes to the financial situation of their country and something like having a budget surplus which is neutrally seen as being fiscally responsible can be irresponsible for another country. However, by considering a study that was proposed by the state of Alberta in the United States, we will come down to a few major areas which need to be considered when discussing financial responsibility.

Balanced budgets

Having a balanced budget is something all governments desire, but of course there is a difference in their capacity to carry debt and in what circumstances, and for how long

It has been propagated by a lot of politicians that there is no one level of an acceptable deficit or debt. There are some who believe that a government’s operating budget should balance every year. Such people say it’s okay to borrow money for capital expenditures such as schools and roads. When there is recession some governments increase capital budgets to create jobs, take advantage of low interest rates, along with reduced cost of materials and labor.

Why does it matter to business if the government doesn’t balance the budget or borrows money?

It matters, because if the government is making interest payments on debt, that is the money which could have gone to necessary public services. All programs and services are at risk when governments need to cut back on spending to dig their way out of debt. High debt will impact a government’s credit rating, and therefore borrowing rates. Governments will look for more revenue sources, and business are an easy target for increased taxes. So it’s in the best interest for a country’s population to have a balanced budget.

Revenue

There are multiple ways through which a government generates revenue. Governments tax personal income, corporate income, receive royalty payments for the extraction of (publicly owned) fossil fuels, and tax carbon, alcohol, and tobacco.

Most governments use progressive tax rates, meaning rates go up with income level so those who make more money, pay higher rates. But to achieve fiscal responsibility it is assumed that the policies should have tax rates that serve both the wealthy and the poor. If you charge the wealthy less, it is unjustified for the poor who don’t get too many opportunities and would have to pay similar taxes with less income. But if there is an increase in taxes on the wealthy, it will impact business growth, entrepreneurial activity, and governments will collect less tax revenue. Making a corporate tax system more competitive will encourage private sector investment, and reward entrepreneurship.

Spending

There is a lot of debate that surrounds on the fact that on what sector should government spend more that it serves the best interests of the nation. The reason why this does rounds all around the news is because many developed countries spend more on defense and trade rather than sectors that would act as better foundations for a country’s future which are education and healthcare. It is suggested that for a country to be fiscally responsible you undertake expenditures that would give you gains in the long term, rather than spending more to appease international investors or increase credit ratings. Appropriate attention should be given to the fact that there is least corruption in government expenditure schemes and politicians don’t launder the tax payers money.

Savings

It is very important for a government to have appropriate plans in their fiscal policy that protects and saves its resources financial and natural that can will be utilised by future generations. It should promote policies that encourages the population to keep a part of their money in their savings accounts. The policy makers can also start specific funds that focus on savings.