In view of growing cost of health services, it is recommended for Australian government to adapt a combine strategy of tax and subsidy on food and beverages (theconversation.com 2017). The imposition of tax increases the effective price paid by the consumer while subsidy reduces the effective price that consumers pay. Many countries have already imposed tax on unhealthy foods and sugary drinks. The extent of the policy impact depends on elasticity of supply and demand.
Figure 1: imposition of tax on sugar and sweet snacks
Consider a tax on sweet and sugar snacks. Elasticity of high, low calorie sweets and sugar snacks are relatively inelastic with own price elasticity of -0.270 and -0.295. This means the demand curve for these items are steep. With inelastic demand, buyers share a greater burden of taxation. This is shown in the above diagram. After tax the supply reduces from Q* to Qt. The demand for cigarette and alcohol generally have an inelastic demand. In Australia, imposition of tax on cigarette and alcohol has reduced smoking and drinking.
Figure 2: imposition of subsidy on fruits and vegetables and dairy products
With a subsidy, producers face a low cost of production and receive a high price. The supply in the market increases from Q* to Q1 when a subsidy is introduced in the market for fruits and vegetables and dairy products. These are the products having own price elasticity of greater than one. In response to low price people increases the demand for these items largely and shift consumption habit towards a healthy diet.
The idea that is considered is the idea of fiscal stimulation to revive the economy from recession. The Keynesian theory points towards active intervention of government in the economy. This contradicts the classical view of free market economy where price mechanism works as invisible hand to maintain stability in the market. During recession, the economy faces a low aggregate demand. According to Keynes, here government has an active role to play. An increase in government spending increases private spending as well. The increased spending has a direct impact on aggregate demand. The fiscal stimulation was given priority because the framework of monetary policy was not introduced until then.
In times of business cycle fluctuation, some changes automatically occurs in the government budget. In the phase of recession, production in the economy goes down. This reduces income. With a declining income, a low tax revenue is earned in a progressive tax structure. In times of recession, corporate tax automatically decreases (cis.org.au 2017). Because of an increased unemployment, the transfer payment to unemployment increases.
Discretionary fiscal policy works with same instrument but government implements those. In times of economic slowdown, fiscal stimulus is given with a reduction in the tax rate or increases in government spending or transfer payment. Government face a budget deficit when spending increases significantly as compared to its revenue.
It is generally believed that an expansionary fiscal policy helps to expand economic activity and improves macroeconomic performance. A fiscal contraction can also boost macroeconomic performance given the contraction is taken to restrict unnecessary or unproductive expenditure. This increases investment by reducing the interest rate in the money market. With fiscal expansion, there is a crowd out effect of investment because of money market operation. The fiscal contraction results in crowd in investment and helps to increase productive activity (cis.org.au 2017). An associated effect of reduction in the interest rate is an increase in the exchange rate. The stronger exchange rate has additional impact on national income.
The basics of economic stimulus is investment. The main instrument of monetary policy is the available money supply. The central bank increases or decreases available money supply to influence the interest rate. The effective monetary policy works in the form of a decline in interest rate. Investors are encouraged to invest more driven by a low interest rate. The low interest rate comes with a depreciation of exchange rate. The depreciated currency increases export and raise national income.
In Australia, foreign borrowing plays an important role (cis.org.au 2017). Australia possesses a strong financial sector through which foreign capital enters. Hence, monetary expansion works more effectively than fiscal stimulus in Australia.
Cis.org.au. (2017). Fiscal Fallacies : The Failure of Activist Fiscal Policy. [online] Available at: https://www.cis.org.au/publications/policy-forum/fiscal-fallacies-the-failure-of-activist-fiscal-policy/ [Accessed 24 Oct. 2017].
The Conversation. (2017). Why the government should tax unhealthy foods and subsidise nutritious ones. [online] Available at: https://theconversation.com/why-the-government-should-tax-unhealthy-foods-and-subsidise-nutritious-ones-72790 [Accessed 24 Oct. 2017].