In a microeconomic sense, a policy that displays fiscal neutrality does not incentivize encourage or discourage any type of transaction or economic behavior relative to others. Fiscal neutrality may also refer strictly to the budgetary impact of a policy change in that it neither increases nor decreases a projected budget deficit or surplus. Because the term fiscal neutrality can be applied in several different senses, it is important to understand the context and purpose for which it is being used in order to understand its meaning.
For example, a policy to provide tax credits for the purchase of new automobiles, along with an increase in the tax on gasoline, might be fiscally neutral if the tax increase is sufficient to pay for the cost of the tax credits. Legislative pay-as-you-go rules could encourage or even mandate that some or all new policy measures be fiscally neutral in this sense. In the realm of macroeconomic fiscal policy , government deficit spending, or budget surpluses, are encouraged as a means to increase or decrease aggregate demand in the economy in order to stabilize macroeconomic growth and avoid recessions.
A situation where spending exceeds the revenue generated from taxes is called a fiscal deficit and requires the government to borrow money to cover the shortfall.
When tax revenues exceed spending, a fiscal surplus results, and the excess money can be invested for future use. A balanced budget is an example of fiscal neutrality, where government spending is covered almost exactly by tax revenue — in other words, where tax revenue is equal to government spending.
Because the government doesn't have a surplus nor a budget deficit, according to Keynesian economics this type of fiscal policy will neither expand nor contract aggregate demand. Continuing the example of an auto tax credit coupled with an increase in gasoline taxes, it is clear that such a policy is also fiscally neutral in a macroeconomic sense provided the increased demand for new autos is offset by the decreased demand for gasoline thus creating no net change in aggregate demand.
In a microeconomic sense, fiscal neutrality centers on the idea that government policy can influence individual economic behavior. A neutral fiscal policy in sense is one that leaves individuals to decide to work, consume, save, invest, or engage in other economic actions unaltered. This type of fiscal neutrality focuses on designing mechanisms of taxation because it is never possible for government spending not to influence microeconomic behavior. When a government spends money to purchase real goods and services, it necessarily influences the prices of those goods and services and removes them from availability on the market or other users and uses thus altering the behavior of other market participants.
Once again continuing the example from above an auto tax credit and offsetting gasoline tax , such a policy is definitely not fiscally neutral in a microeconomic sense, because it influences consumers to change their economic behavior by buying more new autos and paying higher prices for gasoline.
GST Software. TaxCloud Direct Tax Software. Need Help? About us. Download link sent. Category Economy. Understanding Fiscal Neutrality Fiscal neutrality can be achieved through a balanced budget, where the total revenues are equal to or exceed the expenses.
Conclusion While conducting the annual budgeting exercise, a government must focus on having tax policies which are fiscally neutral. Related Terms. Examples of Budget neutrality in a sentence Budget neutrality means that a Medicaid agency cannot spend more federal funds to provide coverage under a waiver then it would have spent to provide coverage without the waiver.
Budget neutrality means that reimbursements resulting from rates paid to providers under a per discharge methodology do not exceed payments in the base year adjusted for inflation based on the CMS Input Price Index , which is the wage index published by CMS in the Federal Register.
Remediation Plan means a plan to improve the quality of the waters of the state that have been directly and adversely impacted by abandoned mine waste. The goal of budget neutrality is to avoid creating a spending deficit or adding to an existing deficit. According to the International Institute for Sustainable Development, the fiscal policy associated with legislative initiatives can be based on spending, generating revenue or budget neutrality. There are several ways to achieve budget neutral funding.
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