Fiscal Policy

Agenda

o Introductiono Fiscal Policy & Macroeconomic Goalso Overview of Indian system of Fiscal policyo Budget 2009-10

Definition & Meaning Of Fiscal Policy

• The word fisc means ‘state treasury’ and fiscal policy refers to policy concerning the use of ‘state treasury’ or the govt. finances to achieve the macroeconomic goals.

• Arthur Smithies defined fiscal policy as “a policy under which government uses its expenditure and revenue programs to produce desirable effects and avoid undesirable effects on national income,production and employment.”

• Fiscal Policy is the government programme of making discretionary changes in the Pattern and level of its expenditure, taxation and borrowings in order to achieve Intended economic growth,employment,income equality,and stabilization of the Economy on a growth path

Fiscal policy is also called Budgetary Policy. The government receipts are inflows and expenditures are outflows of money.

Fiscal Policy & Macroeconomic Goals

Fiscal policy for economic growth

To achieve desirable employment level

To achieve desirable price level

To achieve desirable consumption level

To achieve desirable income distribution

Fiscal policy for stabilization

Fiscal policy for external balance

Fiscal Policy - Tools

Tools Of Fiscal

Policy

Government

ExpenditureTaxation

Public

Borrowing

Government Expenditure

Government spending or government expenditure is classified by economists into three types :

Government Consumption :

Government purchases of goods & services for current use

Government Investment : Government purchases of goods and services intended to create future benefits such as infra-structure investment, research spending etc

Transfer Payments :

Government expenditures that are not purchases of goods & services, and instead just represents transfer of money such as pensions,subsidies,social security payments etc.

Government Expenditure Estimate 09-10

• Budget estimate provide for a total expenditure of Rs.10,20,838 cr. consisting of Rs.6,95,689 crore under Non-Plan and Rs.3,25,149 crore under plan registering an increase of 37 % in non-plan and 34 % in plan expenditure over 2008 – 2009.

• Increase in Non-Plan expenditure is manly due to Implementation of central Sixth Pay Commission recommendations, increased food subsidy,higher interest payment arising out of larger fiscal deficit in 2008-09

• Additional amount of Rs.430 crore provided to modernize police machinery in the States

• Construction of fences,roads,Flood lights on International boarders with additional amount of Rs.2,284 cr. over 2009-2010

• Outlay for Defence up from Rs.1,05,600 cr.in 2008-09 to Rs.1,41,703 cr in 2009-2010.

Methods Of Funding

Governments spend money on a wide variety of things, from the military and police to services like education,healthcare,as well as transfer payments.

The expenditure can be funded in number of different ways :

Taxation

Public Borrowings

Consumption of fiscal reserve

Sale of assets (eg. Land)

Taxation

Purpose and Effect

Funds provided by taxation have been used by states and their functional equivalents throughout history to carry out many functions

Taxation has four main purposes or effects : Revenue,Redistribution & Reprising

Revenue : Taxes raise money to spend on schools, hospitals, roads and on more government indirect functions like market regulation or legal systems.

Redistribution : Transferring wealth from richer sections of society to poorer sections

Reprising : Taxes are levied to address externalities : tobacco is taxed, for example, to discourage smoking

Taxation

The major tax enactment in India is The Income Tax Act 1961 passed by the parliament, which imposes a tax on income from individuals and corporations. The act imposes a tax on income under the following heads :

Direct Taxes

• Income from Salaries

• Income from house and property

• Income from business and profession

• Income in the form capital gains

• Income from other sources

Taxation

•Indirect Taxes

• Custom Duty : duty on goods imported In India

• Central Excise Duty : duty of excise on goods manufactured or produced in India

• Service Tax : tax on the services provided by the service provider

• Central Sales Tax : tax on goods sold in inter-state trade or commerce in India

• Transaction Tax : tax on transactions of sale of securities

Taxation

Other major taxation enactment passed by State Legislatures :

• Excise duties ,on tabacco,alcohol and narcotics• Sales tax, on sales of goods within the state• Stamp duties, on sale of properties within the state• Entertainment tax

Public Borrowing

When resource mobilization through ‘tax means’ are inadequate, the government resort to borrowings to finance the expenditures.

This is commonly known as Deficit Financing .

Sources of funding:

• Internal Borrowings• Issuance of government bonds and treasury bills• Borrowing from central bank (Monetizing deficit financing)

• External Borrowings • Foreign government• International org. World Bank and IMF

Fiscal Policy - Instruments

Instruments Of

Fiscal Policy

Budgetary Policy

Compensatory Policy

Deficit-budget Policy

Deficit-budget Policy

Surplus-budget Policy

Surplus-budget Policy

Balanced-budget Policy

Balanced-budget Policy

DiscretionaryPolicy

DiscretionaryPolicy

Built In

Stabilizers

Built In

Stabilizers

Budgetary Policy

Its also known as the Contra cyclical Fiscal Policy

1) Budget Deficit - Fiscal Policy During Depression• When government expenditure exceeds the receipts• Expansionary effect of budget deficit• Two ways : Increasing Government expenditure and keeping tax intact or Decreasing Tax and keeping government expenditure intact

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Budgetary Policy

2) Surplus Budget - Fiscal Policy During Boom• When government revenue exceeds the expenditure• To control the inflationary pressure within economy• Increasing Taxation and Decreasing Government expenditure

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3) Balance Budget Multiplier

• Increase in the Taxes and Government Expenditure equally• Leads to increase in the net national income.

Compensatory Policy

• The compensatory fiscal policy aims at continuously compensating the economy against tendencies towards inflation and deflation by manipulating public expenditure and taxes.

•When there are deflationary tendencies in the economy the government should increase its expenditure through deficit budgeting and reduction in taxes.

• When there are inflationary tendencies the government should reduce the expenditure by having surplus budget and raising taxes in order to stabilize the economy.

1)Built in Stabilizers: Automatic adjustment of the expenditure and taxes in relation to cyclical upswings and downswings within the economy without any deliberate action from the government. Stabilizers include: Corporate profit tax, Income tax, Excise tax, Old age, survivors and unemployment insurance and unemployment relief payments.

Compensatory Policy

2) Discretionary Fiscal Policy: This requires the deliberate change from government

i) Changing taxes with government expenditure constant ii) Changing government expenditure with taxes constant iii) Variations in both expenditures and taxes simultaneously

This is depend upon the proper timing and accurate forecasting

Lags In Effect Of Policy

1) Recognition Lag:• Refers to time between the development and recognition of

need of action by the Monetary and Fiscal authorities• Its difficult to identify the turning points of the business cycle• Past experience with Federal Reserve Bank (US) states that it

recognize the need for action after Three months from Trough and Six months after Boom is started

2) Administrative Lag:• Refers to authorities recognize the need for action and actually

collects the relevant data• Length of this lag depends on which type of policy is being

implemented• This lag is short in duration compare to other lags

Inside LagsInside Lags

Lags In Effect Of Policy

1) Operation Lag:• Refers to time between the adaption of the policy and its final

effect on economic activities.• It is divided in two types:

a) Intermediate Lag:Refers to the time period between the moment at which action is

been taken by authorities till the moment at which economy is faced with change in interest rates, money supply, taxes, public expenditure.

b) Outside Lag:Refers to time involve between interest rates,, total reserves,

credit rationing and their effects on aggregate spending, income and output of the economy

Outside LagsOutside Lags

Fiscal Responsibility And Budget Management (FRBM)

• Enacted by parliament in 2003 to bring fiscal discipline.

• The FRBM Rules impose limits on fiscal and revenue deficit. Hence, it will be the duty of the government to stick to the deficit targets.

• It aimed at:1. Reducing revenue deficit2. Reducing gross fiscal deficit3. Reducing the Public debt4. No Borrowing from the RBI

Advantages Of Fiscal Policy

Emphasis on overall economic growth Management of revenue and expenditure Helps in planning Easy to target specific sector For the social welfare

Disadvantages Of Fiscal Policy

Requires accurate forecasting, which is essential to judge the stage of cycle through which economy is passing.

Time Lags :The time required in studying the problem & taking the decision involves too long time.

Execution Lags : Once the decision is taken,delay in executing the same

Fiscal Deficit – The Biggest Challenge

The fiscal deficit is the difference between the government's total expenditure and its total receipts . When the government’s expenditure exceeds the receipts it is called fiscal deficit or the deficit – budget policy.

Fiscal deficit = Total Govt. Expenditure > Total Govt. Revenue

MEANINGMEANING

The biggest challenge before the Finance Minister, will lie in the area of containing the government’s fiscal deficit. If the deficit of States & off-budget liabilities (such as petroleum and fertilizers bonds) taken into account, the combined fiscal deficit will be almost 11 per cent of the GDP

Trends In Fiscal Deficit Of India

Where The Rupee Comes From 2008-09

Where Does The Rupee Goes To

Budget Deficit Or Surplus In FY 2002

-6 -4 -2 0 2 4

Italy

Sweden

Canada

United Kingdom

France

United States

Ireland

Norway

JapanSource: Organization for Economic Development and Cooperation

• India's per capita income is $440

• In India 30-40% population is below poverty line

• India is trying to catch up with China in terms of foreign direct investment (FDI)

• In the case of India, the FDI figure stood at $4.67 billion in 2002.

• China's per capita income stood at $990

• In China, 3% of the population is below the poverty line

• China opened up its economy before India & could therefore attract foreign investment . Since the opening up of the economy in 1978, China enjoyed a steady flow of FDI.

• China received FDI of $52.7 billion in 2002

Fiscal Policy Case Study – India vs China

IndiaIndia ChinaChina

India & fiscal Deficit

Budget At Glance 2008-09

Government of India

Key Features Of Budget 09-10

• To lead economy to high GDP growth rate of 9% per annum at the earliest

• To deepen and broaden the agenda for inclusive development

• To improve delivery mechanism of the Government

CHALLENGESCHALLENGES

Overview Of Economy

Growth rate of GDP dipped from an average of over 9 % in the previous years to 6.7 % during 2008-09.

WPI rose to nearly 13 % in August, 2008 and had an equally sharp fall to zero per cent in March, 2009.

The structure of India’s economy changed over the last ten years with contribution of the services sector to GDP at well over 50 % and share of merchandise trade doubling to 38.9 % of GDP in 2008-09

Recognizing economic recovery and growth as co-operative effort of the Central and State Governments, meeting with Finance Ministers of States held as part of preparation of the Budget. This is intended to become an annual feature.

Estimates 2009-10

• Gross tax receipts budgeted at Rs.6,41,079 crore in 2009-2010 compared toRs.6,87,715 crore in 2008 – 2009.

• Non- tax receipts estimated at Rs.1,40,279 crore in 2009 -2010 compared to Rs.95,785 crore in 2008 – 2009.

• Tax proposals on direct taxes to be revenue neutral.On indirect taxes, estimated net gain to be Rs.2,000 crore for the full year .

• Revenue deficit projected at Rs.4.8 per cent of GDP in 2009 – 2010 compared to 1 per cent in 2008 – 2009.

• Fiscal deficit as a percentage of GDP is projected at 6.8 per cent compared to 2.5 per cent in 2008 – 2009 and 6.2 per cent as per provisional accounts 2008- 2009

Thank You !

“We need faster growth because, at our level of incomes, there can be no

doubt that we must expand the production base of the economy if we

want to provide broad-based improvement in the material conditions of

living of our population, ..........

But growth alone is not enough if it does not produce a flow of benefits

that is sufficiently wide-spread. We, therefore, need a growth process that

is much more inclusive, .......... and which also ensures access to

essential services such as health and education for all sections of the

community”.-Dr. Manmohan Singh,

Prime Minister