Fiscal Policy- PP - IBE-12

8/6/2019 Fiscal Policy- PP - IBE-12

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1Indian Business Environment


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Modern Macroeconomics:Modern Macroeconomics:

Fiscal Policy, BudgetFiscal Policy, Budget

Deficits and theDeficits and theGovernment DebtGovernment Debt


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Objectives of the SessionObjectives of the Session

To know about the fiscal policy and its instrumentsTo know about the fiscal policy and its instruments

To know about fiscal policy and efficiency issuesTo know about fiscal policy and efficiency issues

To understand budget deficitsTo understand budget deficits

To understand public debtTo understand public debt

To know about the measurement of public debt in IndiaTo know about the measurement of public debt in India


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The Fiscal InstrumentsThe Fiscal Instruments

The tax and expenditure policies together constitute fiscalThe tax and expenditure policies together constitute fiscalpolicy of a government.policy of a government.

The fiscal policy has a direct bearing on the level ofThe fiscal policy has a direct bearing on the level of

aggregate demand and the level of economic activity.aggregate demand and the level of economic activity. The overall conduct of these policies play an importantThe overall conduct of these policies play an important

role in maintaining economic stability, including highrole in maintaining economic stability, including highemployment and control of inflation.employment and control of inflation.


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Modern Macroeconomics: Fiscal Policy,

Budget Deficit and the Government Debt 5

The Fiscal InstrumentsThe Fiscal Instruments

Tax Policy and StructureTax Policy and Structure

Principles ofTaxationPrinciples ofTaxation

Horizontal and Vertical EquityHorizontal and Vertical Equity Choice of BaseChoice of Base


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Requirements of a Good StructureRequirements of a Good Structure

Revenue yield should be adequateRevenue yield should be adequate

The distribution of tax burden should beThe distribution of tax burden should be

equitableequitable It is not only the impact point at which the tax isIt is not only the impact point at which the tax is

imposed, but also its final resting place whichimposed, but also its final resting place which

matters, for constructing a good tax structure.matters, for constructing a good tax structure.

Taxes should be chosen so as to minimizeTaxes should be chosen so as to minimizeinterference with economic decisions ininterference with economic decisions in

otherwise efficient markets.otherwise efficient markets.


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Requirements of a Good StructureRequirements of a Good Structure

The tax structure should facilitate the use of fiscal policy forThe tax structure should facilitate the use of fiscal policy forstabilization and growth objectives.stabilization and growth objectives.

The tax system should permit fair and nonThe tax system should permit fair and non--arbitraryarbitrary

administration and it should be understandable to theadministration and it should be understandable to thetaxpayer.taxpayer.

Administration and compliance costs should be as low as itAdministration and compliance costs should be as low as itis compatible with the other objectives.is compatible with the other objectives.


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The Problem ofTax IncidenceThe Problem ofTax Incidence

The problem of tax incidence deals with theThe problem of tax incidence deals with theway the tax burden is ultimately borne andway the tax burden is ultimately borne and

its total effect on work effort, saving,its total effect on work effort, saving,commodity prices, factor prices, resourcecommodity prices, factor prices, resourceallocations and the composition ofallocations and the composition ofproduction and consumption.production and consumption.

Taxes are not voluntary purchase paymentsTaxes are not voluntary purchase paymentsbut mandatory imposition, payable inbut mandatory imposition, payable in--linelinewith whatever tax statute has beenwith whatever tax statute has beenlegislated.legislated.


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The Tax StructureThe Tax Structure

Depending on whether the base is income determined orDepending on whether the base is income determined or

consumption determined, the authorities decide on theconsumption determined, the authorities decide on the

tax rate structure. They are:tax rate structure. They are: Progressive TaxProgressive Tax Regressive TaxRegressive Tax

Proportional TaxProportional Tax


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Fiscal Policy and Efficiency IssuesFiscal Policy and Efficiency Issues

Fiscal policy also influences growth performanceFiscal policy also influences growth performance

of an economy through its effects on allocation ofof an economy through its effects on allocation of

resources and how far they are efficientlyresources and how far they are efficientlymanaged.managed.

Among the various aspects of efficiency issues,Among the various aspects of efficiency issues,

the level of Incremental Capital Outputthe level of Incremental Capital Output RatioRatio

(ICOR) is an important issue for any economy.(ICOR) is an important issue for any economy. The development of an economy is dependentThe development of an economy is dependent

upon ICOR.upon ICOR.


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Fiscal Policy and StabilizationFiscal Policy and Stabilization

Even without understanding Public FinanceEven without understanding Public Finance

anyone is aware of the fact that theanyone is aware of the fact that the

Government is having tremendous powers in itsGovernment is having tremendous powers in itshands to influence the purchasing power of thehands to influence the purchasing power of the

consumer, through affecting his disposableconsumer, through affecting his disposable

income.income.

Stabilization policies are the policiesStabilization policies are the policiesundertaken by the government authorities toundertaken by the government authorities to

maintain full employment and a reasonablymaintain full employment and a reasonably

stable price level.stable price level.


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Automatic StabilizersAutomatic Stabilizers

Every economy suffers from cyclical fluctuations in output,Every economy suffers from cyclical fluctuations in output,

employment and prices.employment and prices.

Automatic stabilizers are features of the governmentAutomatic stabilizers are features of the governmentbudget that automatically adjust net taxes to stabilizebudget that automatically adjust net taxes to stabilize

aggregate demand as the economy expands or contracts.aggregate demand as the economy expands or contracts.


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Fiscal Policy and Economic GrowthFiscal Policy and Economic Growth

The role of fiscal policy in securing stability and growth inThe role of fiscal policy in securing stability and growth in

the less developed countries (LDCs) is of fundamentalthe less developed countries (LDCs) is of fundamental

importance.importance. Fiscal policy should be so employed that while promotingFiscal policy should be so employed that while promoting

consumption and investment to the level of optimumconsumption and investment to the level of optimum

utilization of the available resources of the economy.utilization of the available resources of the economy.


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Government RevenueGovernment Revenue

The Central Government levies four major categories ofThe Central Government levies four major categories of

taxes, viz., personal income tax, corporation tax,taxes, viz., personal income tax, corporation tax,

customs duties and union excise duties for mobilizationcustoms duties and union excise duties for mobilizationof resources.of resources.

These taxes account for almost total tax revenues of theThese taxes account for almost total tax revenues of the

government.government.


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Budget Deficit and the Government Debt15

Government ExpenditureGovernment Expenditure

With the expansion of the government activitiesWith the expansion of the government activities

during the planning period, there has been aduring the planning period, there has been a

spectacular rise in government spending.spectacular rise in government spending. However, the finances of the government haveHowever, the finances of the government have

expenditure far exceeding the revenue income.expenditure far exceeding the revenue income.

Among the various components of revenueAmong the various components of revenue

expenditure, the increase in nonexpenditure, the increase in non--plan expenditureplan expenditure


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Budget DeficitBudget Deficit

The annual budget is a financial plan.The annual budget is a financial plan.

It gives estimates of how the government proposed toIt gives estimates of how the government proposed to

spend that year both as part of the five year plan (i.e.spend that year both as part of the five year plan (i.e.plan expenditure) and outside the plan (i.e. nonplan expenditure) and outside the plan (i.e. non--planplan

expenditure) and how that expenditure is to be financed.expenditure) and how that expenditure is to be financed.


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Basic DefinitionsBasic Definitions

Revenue DeficitRevenue Deficit It is the difference between Governments revenue expenditure andIt is the difference between Governments revenue expenditure and

revenue receipts whereas capital deficit is the difference betweenrevenue receipts whereas capital deficit is the difference between

capital expenditure and capital receipts.capital expenditure and capital receipts.

Gross Fiscal DeficitGross Fiscal Deficit It is equal to borrowings and other liabilities.It is equal to borrowings and other liabilities.


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High Fiscal Deficits: ImplicationsHigh Fiscal Deficits: Implications Money Supply GrowthMoney Supply Growth InflationInflation CrowdingCrowding--out of Private Investmentout of Private Investment CrowdingCrowding--out of Essential Public Expenditureout of Essential Public Expenditure

Monetized DeficitMonetized Deficit It is the increase in net RBI credit to the CentralIt is the increase in net RBI credit to the Central

Government, comprising the net increase in theGovernment, comprising the net increase in theholdings ofTreasury Bills of the RBI and itsholdings ofTreasury Bills of the RBI and itscontribution to the market borrowings of thecontribution to the market borrowings of theGovernment.Government.


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Primary DeficitPrimary Deficit It is calculated by deducting the interest payments of theIt is calculated by deducting the interest payments of the

government from the gross deficit.government from the gross deficit.


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Public DebtPublic Debt

Growth of public debt is now a major concern inGrowth of public debt is now a major concern in

India.India.

Repayment of external debt has already createdRepayment of external debt has already createda balance of payments crisis in 1991.a balance of payments crisis in 1991.

Growth of internal debt as yet has not attractedGrowth of internal debt as yet has not attracted

as much public attention, as it ought to have,as much public attention, as it ought to have,

mainly because unlike external debt, internalmainly because unlike external debt, internaldebt can be repaid by monetization.debt can be repaid by monetization.


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Measurement of Public Debt in IndiaMeasurement of Public Debt in India

As per the current Indian budgetary practice there areAs per the current Indian budgetary practice there are

three sets of liabilities which constitute centralthree sets of liabilities which constitute central

government public debt via..government public debt via.. Internal debtInternal debt External debtExternal debt

Other liabilitiesOther liabilities


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Public Debt: Problems and IssuesPublic Debt: Problems and Issues

Public debt in India has grown tremendouslyPublic debt in India has grown tremendouslyover the planning period as massiveover the planning period as massive

investments were made in th fields ofinvestments were made in th fields ofdevelopment infrastructure and setting up ofdevelopment infrastructure and setting up ofheavy capital goods industries.heavy capital goods industries.

Problems that have risen in the context ofProblems that have risen in the context ofrising public debt in India are:rising public debt in India are: The Burden of Public DebtThe Burden of Public Debt The Inflationary PotentialThe Inflationary Potential Increasing Cost of BorrowingsIncreasing Cost of Borrowings

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Fiscal Policy- PP - IBE-12