Fiscal Policy

What Is Fiscal Policy

It is concerned with raising the revenue.

Most important instrument of government
intervention in the country.
Taxation, Expenditure and Borrowing by the
government.
It operates through budget.
 Objectives of Fiscal Policy

■ In a developing countries it play’s a

very important role in accelerating
economic development.
■ Several peculiar characteristics, which
necessitate the adoption.
■ vast and diverse resources human and
material, which are lying underutilized.
■ Weak infrastructure.
 To overcome these handicaps…

 To mobilize resources.
 To promote economic growth in the private sector.
 To ensure price stability by restraining inflationary
forces.
 To ensure equitable distribution of income and
wealth
 Role Of Fiscal Policy

■ Instrument to measure the Deficit.

■ The consumers would not like to be

told directly to curtail their
consumptions.

■ Help stabilize short-run fluctuations in

the economy.
 FISCAL POLICY

Discretionary
Non-Discretionary
policy
Policy

Personal Income
To cure Recession To Control Inflation
taxes

Increase in Govt Raising Taxes to

Transfer Payments
Expenditure Control Inflation

Disposing of Budget Corporate Income

Reduction of taxes
Surplus taxes

Corporate Dividend
policy
 Discretionary Policy

 Deliberatechange in Government Exp.

And Taxes.
 Aims at managing aggregate demand.

 Divided into 2:-

 Fiscal Policy to Cure Recession.
 Fiscal policy to Control Inflation.
 Fiscal Policy To Cure Recession

Increase In Government expenditure:

■By starting public works,such as building
roads, dams, telecommunication links,
irrigation of new areas.
■The effect if both DIRECT & INDIRECT.
■Direct effect is increase in incomes of those
who sell and supply labour and RM.
■Indirect is those who earn more income and
spend as per their MPC.
How large should be the increase in expenditure so that
equilibrium is established at full level of output??

45o

C+I2+G2
E2
E
X H
P C+I1+G1
E
N
D Deflationary Gap
I
T E1
U
Y= G 1
R Potential 1-MPC
E output
450

Y1 YF

NATIONAL INCOME
 Non-Discretionary

■ Automatic stabilizer.

■ No deliberate change is made by the

Government.

■ Automatically cures the recession and

controls the Inflation.
 Cont…

■ Personal Income:
✦ ProgressiveRate
✦ More income = more rate of Tax

■ Transfer Payments:
✦ Unemployed Compensation / Welfare benefits.
✦ Recession increases = Unemployment
increases.
 Cont…

■ Corporate Income Taxes:

✦ Corporate/ companies pays the Income tax as
per the percentage of profit earned.
✦ More Profit = more income tax

■ Corporate Dividend Policy:

✦ Profitdepends on economic fluctuation
✦ Follow a fairly stable dividend policy.
 EFFECTIVENESS OF FISCAL POLICY

Keynesians theory
Large expansionary effect of national
income =
2. Government increases its
expenditure, without raising its taxes
3. When Government reduces taxes
without changing expenditure
 INSTRUMENTS

■ Budget
■ Taxation
■ Public Expenditure
■ Government Borrowing
■ Deficit Financing
 Budget

FRBMA
■ notified on July 2nd & came into force
on July 5th 2004.
■ Reduction of fiscal deficit & elimination
of revenue deficit by March 09
 Budget

Provisions of FRBMA
■ Revenue deficit should be down by
0.5%
■ Fiscal deficit should be reduced by
0.3% every year and brought down to
3% by 07-08
■ The total liabilities of the Union Govt.
should not rise by more than 9%p.a
■ The Union Government shall not give
guarantee to loans raised by PSUs and
State governments for more than
0.5% of GDP in the aggregate;
 TAXATION

■ A non quid pro quo payment by the people to

the government
■ Types - personal and corporate tax, VAT &
royalties
■ Sound tax system, with moderate rates and a
broad base, is an integral part of the prudent
fiscal policy. The expansion in the tax base is
sought to be achieved through expansion in
the scope of taxes, specifically service tax,
removal of exemptions and improvement in
tax administration
 TAXATION - REFORMS
■ Domestic Co. 40% – 30%
■ Foreign Co. 55%– 40%
■ Special tax benefits to power sector,
SEZ & shipping Ind.
■ Dematerialization of TDS cert.
■ Widening of service tax base
■ Introduction of state – level VAT for
achieving a self-enforcing &
harmonized commodity taxation regime
 PUBLIC EXPENDITURE

■ Plan expenditure – govt. plans to incur on a

scheme to be implemented in a given year.
■ Non-plan expenditure is generally an
outcome of plan expenditure
■ Return generated should be greater than the
cost of capital, but cannot always work on
profit motive
■ Expected to release a summary of their
monthly receipts and exp to public.
 Government Borrowing

■ Borrowing is the quickest Mode of

raising funds. To finance schemes of
economic devt.
■ Market loans – Govt. sells securities &
treasury bills to public
■ Small savings – RDB, Postal accounts
■ To meet the uncovered gap between
total expenditure and total non-debt
receipts
 DEFICIT FINANCING

DEFICIT = Government expenditure -

Government receipts from the public.

■ Expenditure < Income = Surplus

■ Expenditure > Income = Deficit
 Cont…

■ Deficit financing means the creation of

new currency.

■ Monetization of government debt.

 NEED FOR DEFICIT FINANCING

■ The developing countries keen to

promote rapid economic growth;
 Cont…

■ The resources required for

development far exceeds the amount
which can be raised by normal means
of resource mobilization, viz., taxation,
borrowing, surpluses from public
enterprises, etc.

■ The uncovered gap is made up by

deficit financing.
TRENDS IN FISCAL DEFICITS

Gross Fiscal Fiscal Revenue Revenue Primary Primary

Deficit
Year Deficit as Deficit Deficit as Deficit Deficit as
% of
(Rs.crs) GDP (Rs.crs) % of GDP (Rs.crs) % of GDP
1996-97 56242 4.1 32654 2.4 -3236 -0.2
1997-98 73204 4.8 46449 3.1 7567 0.5
1998-99 89560 5.1 66976 3.8 11678 0.7

1999-00 104717 5.3 67596 3.5 14468 0.7

2000-01 118816 5.6 85234 4.0 19502 0.9
2001-02 140955 6.2 100162 4.4 33495 1.5
2002-03 145072 5.9 107880 4.4 27268 1.1
2003-04 123272 4.5 98262 3.6 -816 0.0

2004-05 125202 4.0 78338 2.5 -1732 -0.1

2005-06 (RE) 146175 4.1 91821 2.6 16143 0.5

2006-07 (BE) 148686 3.8 84727 2.1 8863 0.2

2006-07 108201 - 84483 - 20258 -

(Provisional upto November)

RE= Revised Estimates BE= Budget Estimates

Source: Ministry of Finance and Controller General of Accounts..
DEBT POSITION OF THE CENTRE (INTERNAL DEBT)

Amount Outstanding at the end of March (Rs.crores)

DEBT 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07

(RE) (BE)

Internal debt (Total) 803698 913061 1020689 1141706 1275971 1355943 1522031

I) Market Loans 428793 516517 619105 707965 758995 867368 984645

II) Others 374905 396544 401584 433741 516976 488575 537386

As % of GDP 38.1 40.0 41.7 41.4 40.7 39.9 38.9

RE= Revised Estimates BE= Budget Estimates

Source: Ministry of Finance and RBI
Comparison from 1997 - 2007