Fiscal Policy

Fiscal policy is the overall set of measures through which the public sector regulates its revenues and expenditures to achieve economic objectives. This policy aims to guide the economy through fiscal instruments such as public revenues (primarily taxes) and public expenditures. State intervention in the economy via fiscal policy to realize economic and social goals is widely used as a key instrument, particularly in market economies.

The main objectives of fiscal policy include promoting economic growth, increasing employment, improving income distribution, ensuring price stability, and maintaining external economic balance.

Fiscal Policy Instruments

1. Taxes

Taxes serve not only as the primary means of financing public expenditures but also fulfill functions such as influencing resource allocation, regulating income distribution, and maintaining economic equilibrium. Taxes can affect economic growth through various channels. The level, structure (direct/indirect), rates (progressive, regressive, proportional), and composition of taxes under tax policy can yield different outcomes for growth.

Direct taxes (such as income and corporate taxes) can directly influence the decisions of individuals and firms, leading to changes in investment, savings, and labor supply. For example, taxing capital income may reduce capital accumulation. In contrast, indirect taxes (such as VAT and excise duties) can distort price mechanisms by affecting consumption decisions and result in efficiency losses in resource allocation.

However, while some empirical studies argue that taxes have no significant impact on economic growth, others have found that certain types of taxes—particularly direct taxes—may exert negative effects on growth.

2. Public Expenditures

Public expenditures constitute another fundamental instrument of fiscal policy. The state can contribute to economic growth by increasing aggregate demand through its consumption and investment spending. Moreover, public investments, particularly in areas such as infrastructure, education, and health, promote long-term economic growth by enhancing productivity and human capital.

According to the Keynesian view, increasing public expenditures during periods of economic stagnation generates demand-driven expansion and helps reduce unemployment. In this context, expansionary fiscal policies stimulate employment and production.

3. Budget Balance and Borrowing

Within the framework of fiscal policy, whether the public budget runs a deficit or surplus directly affects resource allocation in the economy. Budget deficits are financed through domestic or external borrowing. Domestic borrowing may reduce private sector access to funds and thereby lower investment, while external borrowing, when used appropriately, can support economic growth.

Some empirical studies on Türkiye have found that external borrowing has positive effects on growth, whereas domestic borrowing negatively affects growth. In contrast, taxes have been found to have no statistically significant impact on economic growth.

Fiscal Policy During Stagflation Periods

Stagflation refers to situations characterized by high inflation alongside economic stagnation and rising unemployment. The presence of this dual problem limits the effectiveness of traditional fiscal policies. This is because policies aimed at increasing aggregate demand can fuel inflation, while policies designed to reduce inflation may increase unemployment. In this context, the use of fiscal policy instruments becomes more complex, and solutions are often sought through “stop and go” type policies.

Historical Development and Changes in Practice

The implementation of fiscal policy has undergone significant changes over time. Following the Great Depression of 1929, public intervention increased under the influence of Keynesian policies, with expansionary fiscal policies coming to the forefront. In the 1970s, rising inflation and budget deficits led to a renewed emphasis on classical fiscal discipline. In the 1990s, maintaining fiscal discipline and implementing market-friendly policies gained importance. After the 2008 global financial crisis and the COVID-19 pandemic, fiscal policy was once again adopted as an active and expansionary tool.