Fiscal Policy

Shyam Sreekumaran NairInstitute of Management Technology Nagpur

Public Revenue• Revenue receipts – Tax Revenue and Non tax revenue• Capital receipts – Public sector disinvestment proceeds,

recovery of loans, grants

Taxation“Compulsory levies (payment) on private individuals and

organisations made by government to raise revenue to finance expenditure on public goods and services, and to control the volume of private expenditure in the economy”

Incidence of taxation: “The ultimate distribution of the burden of tax”

Tax base: “the quantity or coverage of what is taxed”

Principles of good tax policy• Equity and fairness – horizontal and vertical equity• Certainty – certainty and stability to gauge tax liability• Convenience of payment – tax deduction at source – better

compliance• Economy of collection – administrative and compliance costs

Nature of taxes• Progressive Tax System – ability to pay• Regressive Tax system – “each tax payer, regardless of his or

her income, pays the same amount of tax”• Proportional Tax System – “tax payers are subject to fixed or

flat rates of tax”

Laffer Curve• “Relationship between tax rate and amount of tax revenue

generated”• “Thesis that there exists some optimal tax rate, which

maximises government tax revenue”• “Taxes above the optimal rate discourage production and

hence result in lower revenues”

Types of taxes• Direct tax – capital gains tax, corporate tax, inheritance tax,

income tax, wealth tax, retirement tax• Indirect tax* – countervailing duty, custom duty, excise duty,

sales tax, stamp duty, VAT **

* “A tax collected by an intermediary (such as a supplier) from the economic agent who bears the formal incidence of the tax (such as the customer)”

** “An indirect tax levied on goods and services as a percentage of their value added”

Non Tax Revenue• Commercial revenue• Administrative revenue – fines and penalties, license fee,

forfeitures, escheat, special assessment, gifts and grants

Capital Receipts• Disinvestment of public sector units• Recoveries of loans• Grants

Public Expenditure• Revenue account and capital account Revenue account – affects money balance, but does not

create assets – expenditure on goods, services and transfer payments

Capital account – variations in physical and financial assets of government – infrastructure development – adds to growth and have long term implications

Canons of expenditure• Economy – resources used more efficiently and judiciouly• Sanction – resources should not be used without proper

authorisation• Benefit – collective maximisation of social benefits• Surplus – meet expenditure from revenue earned

Measurement of Deficit• Fiscal Deficit: [(Revenue expenditure + capital expenditure) –

(revenue receipts + capital receipts)]• Revenue Deficit: Revenue expenditure – revenue receipts• Primary deficit: Gross fiscal deficit – Interest payments• Net fiscal deficit: Gross fiscal deficit – (Domestic lending -

Recoveries)• Net primary deficit: Gross primary deficit – (Loans and

Advances - Recoveries)

Concepts of deficit estimated independently

• Monetized deficit• Cyclical deficit• Structural deficit