Fiscal Policy

Meaning Of Fiscal Policy

The fiscal policy is concerned with the raising of government revenue and incurring of government expenditure. To generate revenue and to incur expenditure, the government frames a policy called budgetary policy or fiscal policy.

Or

“It refers to a policy concerning the use of state treasury or the government finances to achieve the macro-economic goals”

Or

“Government policy of changing its taxation and public expenditure programs intended to achieve its objective”.

Or

“Government uses its expenditure and revenue program to produce desirable effects on National Income, production and employment”.

Counter Cyclical Fiscal Policy

Fiscal or Budgetary Policy: Are the Revenue and Public Expenditure Policy

It is based on the relationship between them

It generates additional purchasing power during depression

Contracts purchasing power during expansion

Importance of Fiscal Policy

Government activities are enlarged.

Tax- Revenue and Expenditure accounts for large proportion of GNP.

Government effects the Economic activities through gap between government receipts and borrowings.

It indicates the level of overall borrowings by the government.

It is the indicator of fiscal health of the economy.

Objectives of Fiscal Policy

1. Development by effective Mobilization of Resources2. Efficient allocation of Financial Resources3. Reduction in inequalities of Income and Wealth4. Price Stability and Control of Inflation5. Employment Generation6. Balanced Regional Development7. Reducing the Deficit in the Balance of Payment8. Capital Formation9. Increasing National Income10. Development of Infrastructure11. Foreign Exchange Earnings

Objectives of Fiscal Policy Cont…Development by effective Mobilization of Resources

The principal objective of fiscal policy is to ensure rapid economic growth and development. This objective of economic growth and development can be achieved by mobilization of Financial Resources

The central and the state governments in India have used fiscal policy to mobilize resources.

The financial resources can be mobilized by :-

Taxation : Through effective fiscal policies, the government aims to mobilize resources by way of direct taxes as well as indirect taxes because most important source of resource mobilization in India is taxation.

Public Savings : The resources can be mobilized through public savings by reducing government expenditure and increasing surpluses of public sector enterprises.

Private Savings : Through effective fiscal measures such as tax benefits, the government can raise resources from private sector and households. Resources can be mobilized through government borrowings by ways of treasury bills, issue of government bonds, etc., loans from domestic and foreign parties and by deficit financing.

Objectives of Fiscal Policy Cont…Efficient allocation of Financial Resources

The central and state governments have tried to make efficient allocation of financial resources. These resources are allocated for Development Activities which includes expenditure on railways, infrastructure, etc. While Non-development Activities includes expenditure on defense, interest payments, subsidies, etc.

But generally the fiscal policy should ensure that the resources are allocated for generation of goods and services which are socially desirable. Therefore, India's fiscal policy is designed in such a manner so as to encourage production of desirable goods and discourage those goods which are socially undesirable.

Reduction in inequalities of Income and Wealth

Fiscal policy aims at achieving equity or social justice by reducing income inequalities among different sections of the society.

The direct taxes such as income tax are charged more on the rich people as compared to lower income groups. Indirect taxes are also more in the case of semi-luxury and luxury items, which are mostly consumed by the upper middle class and the upper class. The government invests a significant proportion of its tax revenue in the implementation of Poverty Alleviation Programs to improve the conditions of poor people in society.

Objectives of Fiscal Policy Cont…Price Stability and Control of Inflation

One of the main objective of fiscal policy is to control inflation and stabilize price. Therefore, the government always aims to control the inflation by Reducing fiscal deficits, introducing tax savings schemes, Productive use of financial resources, etc.

Employment Generation

The government is making every possible effort to increase employment in the country through effective fiscal measure. Investment in infrastructure has resulted in direct and indirect employment. Lower taxes and duties on small-scale industrial (SSI) units encourage more investment and consequently generates more employment. Various rural employment programs have been undertaken by the Government of India to solve problems in rural areas. Similarly, self employment scheme is taken to provide employment to technically qualified persons in the urban areas.

Balanced Regional Development

Another main objective of the fiscal policy is to bring about a balanced regional development. There are various incentives from the government for setting up projects in backward areas such as Cash subsidy, Concession in taxes and duties in the form of tax holidays, Finance at concessional interest rates, etc.

Objectives of Fiscal Policy Cont…Reducing the Deficit in the Balance of Payment

Fiscal policy attempts to encourage more exports by way of fiscal measures like Exemption of income tax on export earnings, Exemption of central excise duties and customs, Exemption of sales tax and octroi, etc.

The foreign exchange is also conserved by Providing fiscal benefits to import substitute industries, Imposing customs duties on imports, etc.

The foreign exchange earned by way of exports and saved by way of import substitutes helps to solve balance of payments problem. In this way adverse balance of payment can be corrected either by imposing duties on imports or by giving subsidies to export.

Capital Formation

The objective of fiscal policy in India is also to increase the rate of capital formation so as to accelerate the rate of economic growth. An underdeveloped country is trapped in vicious (danger) circle of poverty mainly on account of capital deficiency.

In order to increase the rate of capital formation, the fiscal policy must be efficiently designed to encourage savings and discourage and reduce spending.

Objectives of Fiscal Policy Cont…Increasing National Income

The fiscal policy aims to increase the national income of a country. This is because fiscal policy facilitates the capital formation. This results in economic growth, which in turn increases the GDP, per capita income and national income of the country.

Development of Infrastructure

Government has placed emphasis on the infrastructure development for the purpose of achieving economic growth. The fiscal policy measure such as taxation generates revenue to the government. A part of the government's revenue is invested in the infrastructure development. Due to this, all sectors of the economy get a boost.

Foreign Exchange Earnings

Fiscal policy attempts to encourage more exports by way of Fiscal Measures like, exemption of income tax on export earnings, exemption of sales tax and octroi, etc. Foreign exchange provides fiscal benefits to import substitute industries. The foreign exchange earned by way of exports and saved by way of import substitutes helps to solve balance of payments problem

Tools of Fiscal Policy

Tools of Fiscal Policy

Public Revenue

Revenue Receipt

Tax

Direct Tax Indirect Tax

Non- Tax

Capital Receipt

Public Expenditure

Revenue Expenditure

Capital Expenditure

Public Expenditure (Payments)

Revenue Expenditure

Interest Payments Major Subsidies Defense

Capital Expenditure

Expense on administration Repayment of Loans Extension of fresh loans to

the state govt by the central Loans to public enterprise Expense on Irrigation

project Sectoral development

Public Revenue (Receipts)

Revenue Receipts

Tax

Non- Tax Receipts Fines and Penalties Fees Profits of PSU Govt Interest Grants and Gifts

Capital Receipts

Recovery of Govt loans Disinvestment of PSU Market Borrowings –

Internal and International sources

Public Revenue (Receipts)

Direct Tax

Income Tax Corporate Tax Wealth Tax Gift Tax

Indirect Tax

Sales Tax Excise Tax Custom Service Tax

Effect of Public Expenditure on the Economy

Public Expenditure

An increase in PE raises the level of GNP. PE increases the purchase of goods and services

Increases household incomes Increases Govt Indirect tax revenues

Increase the flow of funds in the economy Increases private Income and thereby the Private Expenditure

Effect of Public Revenue on the Economy

Public Revenue

Total amount received. Taxation is a measure of transferring funds from private

purses to the public coffers. Withdrawal of funds from the private use. Has a deflationary impact on GNP Reduces Disposable income and reduces private expenditure

Concept of Deficit

Deficit: Total government expenditure is more than government receipts.

Budgetary Deficit: Total Expenditure – Total Revenue

Revenue Deficit: Revenue Expenditure – Revenue Receipts

Fiscal Deficit: Total Expenditure – Total Revenue (Excluding Govt. Borrowing)

Primary Deficit: Fiscal Deficit – Interest Payments

What is Fiscal Deficit?

Fiscal deficit:Is the difference between what the government spends and what it earns.

It is expressed as a percentage of GDP.

India's fiscal deficit target for year 2015-16 is 3.9 %.

The government has promised to cut the deficit further to 3% of GDP in

the coming three years.

What causes deficit?

Increase in subsidies

Payment of interest

Defense expenditure

Poor performance

of public sector

PensionsTax evasion

Weak revenue

mobilization

Huge borrowings

Unproductive expenditure

by govt.

Fiscal Deficit over the years

Budgeted Expenditure of the central Govt 2015-16

Budgeted Receipts of the Central Govt 2015-16

Kinds of Fiscal Policy

Fiscal Policy

Discretionary Fiscal Policy

Anti- RecessionaryFiscal Policy

Anti – Inflationary Fiscal Policy

Non- Discretionary / Automatic

Fiscal Policy

Anti- RecessionaryFiscal Policy

Increase In GovtExpenditure

Reduction In Taxes

Anti-InflationaryFiscal Policy

Reducing GovtExpenditure

Increase In Taxes

Implication of Large Fiscal Deficit

1) Borrow from within and outside the country Leads to increase in public debt and its burden

2) Financing through Deficit financing Leads to creation of Money and may lead to rise in prises or Inflation

3) Adversely effects Economic Growth Due to large revenue deficit a smaller amount are left for productive

investment in Infrastructure and social capital (education and health)

More borrowing by Government leaves less resources for Private sector Investment.

What should Govt. do?

In India, to reduce Fiscal Deficit the Govt has been curtailing Capital Expenditure.

But it effects the Economic Growth

The Govt needs to cut Revenue Expenditure and raise Revenue receipts ( mobilising Taxation)

Fiscal Policy strategy for 2015-16

Target a growth rate of 7.4 percent in current financial year on back of new optimism and decisive policy environment

Budget 2015-15 has adopted a fiscal deficit target of 3.9 percent.

Rationalization of administered pricing policies in petroleum and natural gas

Removing bottlenecks in land acquisition bill

Revival of manufacturing sector in India with focus on the “Make in India”.

Liberalization of foreign direct investment

Push to financial inclusion program for inclusive growth

Fiscal Policy strategy for 2015-16 Cont…

Delayed Financial Consolidation for 1 year.

Creating appropriate foreign currency reserves to counter adverse situation, Our currency reserves hit a record high of $353.88 billion as of May 15.

Public spending needs to be stepped up in core sectors to tap the growth potential.

Increasing state’s share in taxes from 32% to 42% (increase states share by 1.5 lakh crores)

Increase PPF limit to 1.5 lakh to increase saving under govt. scheme.

Push for GST bill

Financial Inclusion

Even after 60 years of independence, a large section of Indian population still remain unbanked.

In the recent years the government and Reserve Bank of India has been pushing the concept and idea of financial inclusion.

Financial inclusion is the delivery of financial services at affordable costs to vast sections of disadvantaged and low income groups.

Why is financial inclusion needed in India?

Steps taken by RBI to promote financial inclusion

• Initiation of no-frills account – These accounts provide basic facilities of deposit and withdrawal to accountholders makes banking affordable by cutting down on extra frills that are no use for the lower section of the society.

• Banking service reaches homes through business correspondents – The banking systems have started to adopt the business correspondent mechanism to facilitate banking services in those areas where banks are unable to open brick and mortar branches for cost considerations.

• EBT – Electronic Benefits Transfer – To plug the leakages that are present in transfer of payments through the various levels of bureaucracy, government has begun the procedure of transferring payment directly to accounts of the beneficiaries

Steps taken by current government to promote financial inclusion• Micro Units Development Refinance Agency (MUDRA) Bank: MUDRA Bank will

refinance Micro-Finance Institutions through a Pradhan Mantri Mudra Yojana. In lending, priority will be given to SC/ST enterprises. These measures will greatly increase the confidence of young, educated or skilled workers who would now be able to aspire to become first generation entrepreneurs; existing small businesses, too,  will be able to expand their activities.

The MUDRA Bank would primarily be responsible for –1)       Laying down policy guidelines for micro/small enterprise financing business2)       Registration of MFI entities3)       Regulation of MFI entities4)       Accreditation /rating of MFI entities5)       Laying down responsible financing practices to ward off indebtedness and ensure proper client protection principles and methods of recovery.6)       Development of standardized set of covenants governing last mile lending to MSME7)       Promoting right technology solutions for the last mile8)       Formulating and running  a Credit Guarantee scheme for providing guarantees to the      loans which are being extended to micro enterprises9)       Creating  a good architecture of Last Mile Credit Delivery to micro businesses under the scheme of Pradhan Mantri Mudra Yojana

Steps taken by current government to promote financial inclusion• Financial Inclusion through Pradhan Mantri Jan Dhan

Yojana

1. The Pradhan Mantri Jan Dhan Yojana (PMJDY), the biggest financial inclusion initiative in the world, has surpassed original target of opening bank accounts for 7.5 crore uncovered households in the country by 26th January, 2015, with banks already opening 11.50 Crore accounts by 17th January 2015

2. Out of the accounts opened, 60% are in rural areas and 40% are in urban areas.

3. Share of female account holders is about 51%.The Rupay cards have been issued to more than 10 crore beneficiaries who will get a benefit of personal accidental insurance of Rs. 1.00 Lac under the Yojana. In addition there is a life insurance cover of Rs.30, 000 for eligible beneficiaries

Steps taken by current government to promote financial inclusion• Financial Inclusion through Pradhan Mantri Suraksha

Bima Yojana and alikes

1. Covers accidental death risk of Rs.2 lakh for a premium of just Rs.12 per year. Similarly, the Atal Pension Yojana, will provide a defined pension, depending on the contribution, and its period

2. To encourage people to join this scheme, the Government will contribute 50% of the beneficiaries’ premium limited to Rs 1,000 each year, for five years, in the new accounts opened before 31st December, 2015

3. The third Social Security Scheme is the Pradhan Mantri Jeevan Jyoti Bima Yojana which covers both natural and accidental death risk of Rs.2 lakhs.  The premium will be Rs.330 per year, or less than one rupee per day, for the age group 18-50. 

Fiscal Consolidation

Fiscal Consolidation refers to the policies undertaken by Governments (national and sub-national levels) to reduce their deficits and accumulation of debt stock. Key deficits of government are the revenue deficit and the fiscal deficit.

Steps taken for fiscal consolidation

• Cut down subsidies.• Stop leakages in subsidies.• Reform the tax structure (implement GST). • Improve the performance of PSUs.• Recover black money• Control wasteful Government expenditures. (= take austerity measures)• Policy reforms such as FDI (to create environment conductive for economy =

that will automatically increase productivity and tax collection.)

Fiscal Consolidation as per budget 2015-16

• As per the current budget presented by Arun Jaitley, the government has delayed the current financial consolidation plan by one year by keeping the fiscal deficit at 3.9 % as opposed to the earlier projected 3.6% as per the earlier roadmap.

• As per the government, “The rationale behind postponing fiscal consolidation is to “maintain a fine balance between the need to continue with policy of fiscal rectitude to provide sufficient space for monetary policy easing on one hand, the need to adequately provide for social and welfare programmes and to increase public spending in core sectors to give a fillip to growth”.

• Government on the other hand has taken several measures in this direction like Stop leakages in Subsidy through EBT and Jan DhanYojana ; Commitment to introduce GST from April 2016 ; Disinvestment in various non performing PSU’s ; Initiatives like Make in India and Skill India to promote industry.