Fiscal Policy FINAL

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Fiscal policy its objectives

Definition of Fiscal Policy. Fiscal policy

involves the Government revenue and

Government Spending in order to

influence Aggregate Demand (AD) and

therefore the level of economic activity.


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Objectives

Growth and employment by increasing

aggregate demand

Redistribution of income and wealth

Allocation of resources in desired

directions

Stabilization of the economy External Balance


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Fiscal Stance:

This refers to whether the govt is increasing AD ordecreasing AD

Expansionary (or loose) Fiscal Policy. This involves increasing AD,

Therefore the govt will increase spending (G)and cut taxes. Lower taxes will increase consumers

spending because they have more disposable income(C)

This will worsen the govt budget deficit Contractionary (or tight) Fiscal Policy

This involves decreasing AD

Therefore the govt will cut govt spending (G)

And or increase taxes. Higher taxes will reduceconsumer spending (C) This will lead to animprovement in the government budget deficit

Fine Tuning : This involves maintaining a steady rate ofeconomic growth through using fiscal policy. Howeverthis has proved quite difficult to achieve precisely.


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Instruments of fiscal policy

Taxes

Public Expenditure

Public debt or borrowings Deficit financing


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TYPES OF TAXES When it is said Indian Government, it can

be classified into Central Government andthen into state government.

Taxes imposed on citizens of India can be

broadly classified into two categories:1. Direct Taxes and

2. Indirect Taxes

Progressive Regressive

Proportional


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Taxes can be distinguished by the effect they have on the

distribution of income and wealth.

A proportional tax is one that imposes the same relativeburden on all taxpayersi.e., where tax liability and

income grow in equal proportion.

A progressive tax is characterized by a more than

proportional rise in the tax liability relative to the increasein income, and

A regressive tax is characterized by a less than

proportional rise in the relative burden. Thus, progressive

taxes are seen as reducing inequalities in income

distribution, whereas regressive taxes can have the effect

of increasing these inequalities.


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Public Expenditure

Government Expenditure = (revenue +capital

exp.) and Transfer payments

Revenue Expenditure: is recurring spending or,

in other words, spending on items that are

consumed and only last a limited period of time.They are items that are used up in the process

of providing a good or service. In the case of the

government, revenue expenditure would include

wages and salaries and expenditure onconsumables - stationery, drugs for health

service and so on.


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Capital Expenditure: by contrast, capital

expenditure is spending on assets. It isthe purchase of items that will last and will

be used time and time again in the

provision of a good or service. In the case

of the government, examples would be the

building of a new hospital, the purchase of

new computer equipment or networks,

building new roads and so on.


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The breakdown between these two types of

spending is very important. Capital expenditure

has a lasting impact on the economy and helpsprovide a more efficient, productive economy. A

new hospital, for example, will be much more

efficient and allow more patients to be treated for

many years into the future. revenue expenditure,

however, doesn't have such a lasting impact.

Once the money is spent, it is gone and the

effect on the economy is simply a short-termone.


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Public Debt Over the years, the public debt of the India's Central

and that of State government has increasedconsiderably during the planning period. The

Government borrows funds by way of public debt to

meet the various development and non-development

expenses.

Internal Debt: The various internal sources from which the government borrows include

individuals, banks, business firms, and others. The various instruments of

internal debt include market loans, bonds, treasury bills, ways and meansadvances, etc.

Internal debt is repayable only in domestic currency. It imply a redistribution

of income and wealth within the country & therefore it has no direct money

burden.


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External Debt

External loans are raised from foreign countries

or international institutions. These loans arerepayable in foreign currencies. External loans

help to take up various developmental

programmes in developing and underdeveloped

countries. These loans are usually voluntary.

An external loan involves, initially a transfer of

resources from foreign countries to the domestic

country but when interest and principal amountare being repaid a transfer of resources takes

place in the reverse direction


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Flexibility of Fiscal policy

Discretionary Fiscal Policy

Non Discretionary Fiscal

Policy: Automatic

stabilizers or built in

stabilizers


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Automatic Fiscal Stabilizers

If the economy is growing, people will

automatically pay more taxes ( VAT and Income

tax) and the Government will spend less on

unemployment benefits. The increased T andlower G will act as a check on AD.

In a recession the opposite will occur with tax

revenue falling but increased government

spending on benefits, this will help increase AD


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Discretionary Fiscal Stabilizers

This is a deliberate attempt by the govt to affect AD andstabilize the economy, e.g. in a boom the govt will increasetaxes to reduce inflation

Injections (J): This is an increase of expenditure into thecircular flow, it includes govt spending(G), Exports (X) andInvestment (I)

Withdrawals (W): This is leakages from the circular flowThis is household income that is not spent on the circularflow. It includes: Net savings (S) + Net Taxes (T) + NetImports (M).

Fiscal Policy was particularly used in the 50s and 60s tostabilize economic cycles. These policies were broadlyreferred to as 'Keynesian' In the 1970s and 80sgovernments tended to prefer monetary policy forinfluencing the economy.

There are many factors which make successful

implementation of fiscal Policy difficult .


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Budget and various concepts of

budget deficits

The budget of the government of India, for any year ,

gives a complete picture of the estimated receipts and

expenditure of the govt on the on the basis of the figures

of the two previous year . Every budget , for instance

gives three sets of figures . For example, the budgetestimates for the year 2008-09 contains :

Actual or account for the year 2006-07.

Budget and revised figures for the year 207-08.

Budget estimates for 2008-09


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Receipts and Expenditure of central government1.REVENU RECEIPTS (a+b) (net)

a. Tax Revenue

b.Non Tax Revenue2.Revenue Expenditure of which

a. Interest payments

b. Major subsidies

c. Defense expenditure

3. Revenue Deficits (2-1)4. Capital Receipts of which

a. Recovery of loans

b. Other Receipts ( mainly PUS disinvestment )

c. Borrowing and other liabilities

5. Capital Expenditure

6. Total Expenditure ( 2+5= 6(a)+6(b) of whicha.Plan Expenditure

b. Non plan Expenditure

7.Fiscal Deficit( (6-1-4 (a)-4(b)

8.Primary deficit( 7-2(a)


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Budget DeficitsBasic Definitions -

Revenue Deficit= Revenue Receipts Revenue

Expenditure

Budget Deficits = Total Receipts( Revenue

Receipts + Capital Receipts ) Totalexpenditure

Fiscal Deficit = Revenue Receipts + (Capital

Receipts Borrowing and other liabilities )

Total Expenditure

Primary Deficit= Fiscal Deficit Interest

Payments


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Burden of deficits and Debt and monetized public debt

Implications of high fiscal deficits

Money Supply growth rate

Inflation

Crowding out of private investment

Crowding out of essential publicexpenditure

The following data are extracted from the quarterly report Jan The


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The following data are extracted from the quarterly report, Jan The

following estimates are extracted from the Union Budget for the

year 1998-99.CalculateRs. in crore

Tax revenue 1,16857

Non-tax revenue 45,137

Recoveries of loans 9,908

Other capital receipts 5,000

Borrowings/other liabilities 91,025

Non plan expenditure

On revenue account

(of which interest payment is Rs.75,000

crore)

1,66301

On capital account 29,624

Plan expenditure

On revenue account 43,761

On capital account 28,241


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You are required to compute

Revenue Receipts

Capital Receipts

Revenue Expenditure

Capital Expenditure

Revenue Deficit

Fiscal Deficit

Primary Deficit


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Documents

Fiscal Policy FINAL