A Study of Fiscal Policy of India . (Debasis)

“A STUDY OF FISCAL POLICY OF INDIA”
Project Report On
A STUDY OF FISCAL POLICY OF INDIA
A Project Submitted to
University of Mumbai for partial completion of the degree of
Bachelor in Commerce (Accounting and Finance)
Under the Faculty of Commerce
Submitted By
MR. DEBASIS SATYAM KULIA
ROLL ON :37
Under the Guidance of

PROF. FLORENCY D’Souza
SHRI G. P. M DEGREE COLLEGE

MAHATMA GANDHI ROAD, VILE PARLE (E), MUMBAI - 400057
MARCH , 2018-2019
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SHRI G. P. M DEGREE COLLEGE

MAHATMA GANDHI ROAD, VILE PARLE (E), MUMBAI - 400057
Certificate
This is to certify that Mr. Debasis Satyam Kulia has worked and duly
completed his Project Work for the degree of Bachelor in Commerce
(Accounting & Finance) under the Faculty of Commerce in the subject of
Accounting and Finance and his project is entitled, “A Study Of Fiscal

Policy Of India ” under my supervision.
I further certify that the entire work has been done by the learner under my
guidance
and that no part of it has been submitted previously for any Degree or
Diploma of any University.
It is his own work and facts reported by his personal findings and
investigations.
Signature of Guiding Teacher
Prof. Florency D’Souza
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Date of submission:
Declaration by learner
I the undersigned Mr. Debasis Satyam Kulia here by,
declare that the work embodied in this project work titled “A Study Of
Fiscal Policy Of India ”,
forms my own contribution to the research work carried out under the
guidance of Prof. Florency D’Souza is a result of my own research work and
has
not been previously submitted to any other University for any other Degree/
Diploma to this or any other University.
Wherever reference has been made to previous works of others, it has been
clearly indicated as such and included in the bibliography.
I, here by further declare that all information of this document has been
obtained and
presented in accordance with academic rules and ethical conduct.
Signature of the learner
Mr. Debasis kulia

Certified by
signature of the Guiding Teacher
Prof. Florency D’Souza
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Acknowledgment
To list who all have helped me is difficult because they are so numerous and
the depth is so enormous.
I would like to acknowledge the following as being idealistic channels and

fresh dimensions in the completion of this project.
I take this opportunity to thank the University of Mumbai for giving me

chance to do this project.
I would like to thank my Principal, Dr. Vijay Singh for providing the
necessary facilities required for completion of this project.
I take this opportunity to thank our Coordinator Prof. Namrata palekar , for
her moral support and guidance.
I would also like to express my sincere gratitude towards my project guide
Prof. Florency D’Souza whose guidance and care made the project
successful.
I would like to thank my College Library, for having provided various

reference books and magazines related to my project.
Lastly, I would like to thank each and every person who directly or
indirectly helped me in the completion of the project especially my Parents
and Peers who supported me throughout my project.
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Mr. Debasis Kulia
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Abstract
Fiscal policy is a policy of government’s actions and reactions .Every country does not want to grow only
but develop also. In other words increase in National income and per capita income along with increased
welfare of masses.
For this the govt. Needs a sound fiscal policy which can help them to achieve desired objectives. This essay
reviews the trends and trajectory of India’s fiscal policy with a focus on historical trends, fiscal discipline
frameworks, and fiscal responses to the global financial crisis and subsequent return to a fiscal consolidation
path.
The initial years of India’s planning strategy were featured by a conservative fiscal policy whereby deficits
were kept under control. The tax system was geared to transfer resources from the private sector to finance
the large public sector driven industrialization process and also cover social welfare schemes.
However, growth was hampered and the system was prone to inefficiencies. In the 1980s some attempts
were made to reform particular sectors. But the public debt increased, as did the fiscal deficit.
India’s balance of payments crisis of 1991 led to economic liberalization. The reform of the tax system
commenced. The fiscal deficit was controlled. When the deficit and debt situation again threatened to go out
of control in the early 2000s, fiscal discipline legalizations were instituted.
The deficit was brought under control and by 2007-08 a benign macro-fiscal situation with high growth and
moderate inflation prevailed. During the global financial crisis fiscal policy responded with counter-cyclical
measures including tax cuts and increases in expenditures.
The post-crisis recovery of the Indian economy is witnessing a correction of the fiscal policy path towards a
regime of prudence. In the future, the focus would probably be on bringing in new tax reforms and better
targeting of social expenditures.
This essay examines the trajectory of India‟s fiscal policy with a focus on historical trends, fiscal discipline
frameworks, fiscal responses to the global financial crisis and subsequent return to a fiscal consolidation
path.
The initial years of India‟s planned development strategy were characterised by a conservative fiscal policy
whereby deficits were kept under control. The tax system was geared to transfer resources from the private
sector to fund the large public sector driven industrialization process and also cover social welfare schemes.
However, growth was anaemic and the system was prone to inefficiencies. In the 1980s some attempts were
made to reform particular sectors. But the public debt increased, as did the fiscal deficit. India‟s balance of
payments crisis of 1991 led to economic liberalisation.
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The reform of the tax system commenced. The fiscal deficit was brought under control. When the deficit and
debt situation again threatened to go out of control in the early 2000s, fiscal discipline legalisations were
instituted.
The deficit was brought under control and by 2007-08 a benign macro-fiscal situation with high growth and
moderate inflation prevailed.
During the global financial crisis fiscal policy responded with counter-cyclical measures including tax cuts
and increases in expenditures. The post-crisis recovery of the Indian economy is witnessing a correction of
the fiscal policy path towards a regime of prudence.
In the future, the focus would probably be on bringing in new tax reforms and better targeting of social
expenditures
1.INTRODUCTION OF FISCAL POLICY IN INDIA
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In economics and political science , fiscal policy is the use of government revenue collection (mainly taxes )
and expenditure (spending) to influence the economy. According to Keynesian economics , when the
government changes the levels of taxation and government spending, it influences aggregate demand and the
level of economic activity. Fiscal policy is often used to stabilize the economy over the course of
the business cycle. .
Changes in the level and composition of taxation and government spending can affect the
following macroeconomic variables, amongst others:
 Aggregate Demand and the level of economic activity;
 Saving and investment ;
 Income distribution .
Fiscal policy can be distinguished from monetary policy , in that fiscal policy deals with taxation and
government spending and is often administered by an executive under laws of a legislature, whereas
monetary policy deals with the money supply and interest rates and is often administered by a central bank.
Fiscal is a powerful instrument in the hands of the government to achieve a number of socio-economic
objectives. Through fiscal policy the government can influence production, distribution, consumption and
resources allocation. Fiscal policy is formulated and implemented by the government to achieve certain pre-
determined objectives. Fiscal policy is concerned with public revenue, public expenditure and public debt.
The government mainly uses the budget policy to bring about desirable changes in the economy. Through
taxation, the government mobilise resources to meet its ever increasing expenditure. At the same time taxes
reduce private spending. When the government incurs public expenditure, it leads to more employment,
higher level of output – and income. Along with taxation and public expenditure, public debt also serves as a
useful weapon to the government to mobilise more resources and also to bring about economic stability.
Thus, through fiscal policy economic growth and development can be accelerate.
Fiscal policy is pursued by modern government to achieve certain objectives. The objectives differ from
country to country depending upon their own economic condition and priorities.
1.1Methods of funding:
Governments spend money on a wide variety of things, from the military and police to services like
education and healthcare, as well as transfer payment such as wealfer benefits. This expenditure can
be funded in a number of different ways:
 Taxation
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 Seigniorage , the benefit from printing money

 Borrowing money from the population or from abroad
 Consumption of fiscal reserves
 Sale of fixed assets (e.g., land)
It should be noted that even though printing has not been mentioned above, some countries have actually
used it, an example is Zimbabwe and Germany . The method is however inflationary .
Borrowing
A fiscal deficit is often funded by issuing bonds , like treasury bills or consolesand gilt-edged securities. .
These pay interest, either for a fixed period or indefinitely. If the interest and capital requirements are too
large, a nation may default on its debts, usually to foreign creditors. Public debt or borrowing refers to the
government borrowing from the public.
Consuming prior surpluses
A fiscal surplus is often saved for future use, and may be invested in either local currency or
any financial instruments that may be traded later once resources are needed.
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1.2Economic effects
Keynesians argue that expansionary fiscal policy should be used in times of recession or low economic
activity as an essential tool for building the framework for strong economic growth and working towards full
employment. In theory, the resulting deficits would be paid for by an expanded economy during the boom
that would follow; this was the reasoning behind the New Deal .
Governments can use a budget surplus to do two things: to slow the pace of strong economic growth, and to
stabilize prices when inflation is too high. Keynesian theory posits that removing spending from the
economy will reduce levels of aggregate demand and contract the economy, thus stabilizing prices.
But economists still debate the effectiveness of fiscal stimulus . The argument mostly centers on crowding
out.: whether government borrowing leads to higher interest rates that may offset the stimulative impact of
spending. When the government runs a budget deficit, funds will need to come from public borrowing (the
issue of government bonds), overseas borrowing, or monetizing the debt. When governments fund a deficit
with the issuing of government bonds, interest rates can increase across the market, because government
borrowing creates higher demand for credit in the financial markets. This causes a lower aggregate demand
for goods and services, contrary to the objective of a fiscal stimulus. Neoclassical economists generally
emphasize crowding out while Keynesians argue that fiscal policy can still be effective especially in
a liquidity trap where, they argue, crowding out is minimal.
Some classic and neoclassical economists argue that crowding out completely negates any fiscal stimulus;
this is known as the treasury view ,] which Keynesian economics rejects. The Treasury View refers to the
theoretical positions of classical economists in the British Treasury, who opposed Keynes' call in the 1930s
for fiscal stimulus. The same general argument has been repeated by some neoclassical economists up to the
present.
In the classical view, the expansionary fiscal policy also decreases net exports, which has a mitigating effect
on national output and income. When government borrowing increases interest rates it attracts foreign
capital from foreign investors. This is because, all other things being equal, the bonds issued from a country
executing expansionary fiscal policy now offer a higher rate of return. In other words, companies wanting to
finance projects must compete with their government for capital so they offer higher rates of return. To
purchase bonds originating from a certain country, foreign investors must obtain that country's currency.
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Therefore, when foreign capital flows into the country undergoing fiscal expansion, demand for that
country's currency increases. This causes the currency to appreciate, reducing the cost of imports and making
exports from that country more expensive to foreigners. Consequently, exports decrease and imports
increase, reducing demand from net export. .
Some economists oppose the discretionary use of fiscal stimulus because of the inside lag(the time lag
involved in implementing it), which is almost inevitably long because of the substantial legislative effort
involved. Further, the outside lag between the time of implementation and the time that most of the effects of
the stimulus are felt could mean that the stimulus hits an already-recovering economy and exacerbated the
ensuing boom rather than stimulating the economy when it needs it.
Some economists are concerned about potential inflationary effects driven by increased demand engendered
by a fiscal stimulus. In theory, fiscal stimulus does not cause inflation when it uses resources that would have
otherwise been idle. For instance, if a fiscal stimulus employs a worker who otherwise would have been
unemployed, there is no inflationary effect; however, if the stimulus employs a worker who otherwise would
have had a job, the stimulus is increasing labor demand while labor supply remains fixed, leading to wage
inflation and therefore price inflation.
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1.3Feature of Fiscal Policy of India
The following are the main features of fiscal policy of India
 Rationalization of Product Classification codes:

A very welcome change brought about for administrative convenience is the adoption of a
rationalized standard product code structure for indirect taxes. The change has resulted in reduced
disputes and litigation about product classification.
 Common Accounting Year of Income Tax:

Taxation policy has adopted standard accounting year (April-March) for the purpose of income tax.
The change is intended to reduce the malpractices and raise tax revenues.
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 Long-term Fiscal Policy:

Since 1986 budget, the government of India has introduced long-term fiscal policy to provide greater
certainties in its budgetary policies and to improve the over all environment of business.
 Impact on Rural Employment:

Generation of employment has been an important objective of fiscal policy. The Government of India
has introduced new employment schemes like integrated Rural development program or national
rural employment program.
 Black money:
Unaccounted money has been a constant feature of India’s economy. Fiscal measures have generally
failed to reduce the creation of black money. Schemes like voluntary disclosure, bearer bonds
or eager vikas patra have had marginal impact on the incidence and growth of black money.
 Reliance on Indict taxes:

The tax policy is increasingly becoming regressive in nature by large dependence on indirect taxes
like excise duty or custom duty as compared to that on direct taxes like income taxes, corporation
tax, capital gains tax, etc.
 Inadequate Public Sector contribution:

Contrary to repeated assertion by the government of India, public sector continues to be a drain on
the eagre resources of the government. Plan schemes of finance have expected sizable contribution
from public sector, which has not meterialised in most cases.
 Introduction of MODVAT:
In 1986 the introduction of MODVAT has helped to reduce the cumulative impact of indirect taxes on
manufactured products. Under MODVAT the manufacturer while charging full rate of excise duty on
his output, gets credit for tax paid on inputs. This reduces the cascading effect of excise duty.
 Inflationary Potential:
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With large budget deficits, indirect taxes, shortages, black money and rising money incomes,
inflationary trend in economy has been remarkable. The fiscal policy instead of being a cure of
inflation has become the cause of inflation.
1.4ADVANTAGE OF FISCAL POLICY
 Unemployment Reduction – When unemployment is high, the government can employ an

expansionary fiscal policy. This involves increasing spending or purchases and lowering taxes. Tax
cuts, for example, can mean people have more disposable income, which should lead to increased
demand for goods and services. To meet the growing demand, the private sector will increase
production, creating more job opportunities in the process.
 Budget Deficit Reduction - A country has a budget deficit when its expenditures exceeds revenue.
Since the economic effects of this deficit include increased public debt, the country can pursue
contraction in its fiscal policy. It will, therefore, reduce public spending and increase tax rates to raise
more revenue and ultimately lower the budget deficit.
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 Economic Growth Increase - The various fiscal measures a country employs facilitate expansion of
the national economy. For example, when the government reduces tax rates, businesses and
individuals will have a greater incentive to invest and steer the economy forward. To boost the U.S.
economy during the Great Recession in 2008, for instance, the government enacted the Economic
Stimulus Act of 2008, which provided a range of fiscal measures, including tax incentives to
encourage business investment.
1.5LIMITATION OF FISCAL POLICY
Some of the major limitations of fiscal policy are as follows:
Although fiscal policy gained prominence during world depression of 1930’s, yet its practical application has
a number of problems or limitations.
In view of such a situation, let us understand fully problems and limitations which are associated with a
fiscal policy.
They are:
 Policy Lags:
During the recent times, there is not much argument about the desirability or otherwise of a discretionary
fiscal policy. The burning question in this context is related with the timing of the fiscal measures. Unless the
variations in taxes and public expenditure are neatly timed, the desired counter-cyclical effects can not be
realized.
There is generally some interval between the time when a particular action is needed and the time when a
fiscal measure has its impact felt. The duration of this interval determines the extent to which a specific
fiscal measure can be effective. This time interval comprises of three types of lags-recognition lag,
administrative lag and operational lag.
(а) Recognition Lag:

This is the interval between the time when action is needed and when it is recognized that action is needed.
This lag may exist when a change in the economy and a report concerning the change do not coincide. Such
a lag has a duration of 3 months. It can be reduced if the forecasting is satisfactory.
(b) Administrative Lag:
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This is the interval between the time when need of an action is recognized and the time when the action is
actually taken. This is perhaps the most difficult lag to deal with. Even when the need of action has been
recognized, the sanction from legislature and executive must take some time and that may involve about 1 to
15 months of time.
In order to reduce such a lag and to minimize the legislative and executive red-taps, it is important to keep a
shelf of public works in readiness. The recognition and administrative lags together determine the inside lag
of the fiscal policy and its length, according to Willes, is 4 to 18 months.
(c) Operational Lag:

The time interval between when action is taken and when it has its impact on income and employment is
known as the operational or the outside lag. Albert Ando and E.C. Brown have pointed out that the change in
personal income taxes produce significant changes in disposable money income and consumption within a
month or two; changes in the corporate tax structure produce changes in corporate spending in about 3 or 4
months. Willes was of the view that the outside lag of fiscal policy has a short duration of 1 to 3 months
only. J.G. Ranlett, however, considers that these estimates need modification.
On the basis of U.S. income tax data of 1960’s, he emphasized that the valuation in income tax rates affected
changes on consumption spending with a lag of about 3 to 9 months. Even this estimate of outside lag of
fiscal policy is much lower than that of the monetary policy.
 Forecasting:
Another most serious limitation of fiscal policy is the practical difficulty of observing the coming events of
economic instability. Unless they are correctly observed the amount of revenue to be raised, the amount of
expenditure to be incurred or the nature and extent of budget balance to be framed cannot be suitably
planned. In fact, success of fiscal measures depends on the accurate predictions of various economic
activities. In its absence, it proves to be a little bit erratic.
 Correct Size and Nature of Fiscal Policy:

The most important necessity on which the success of fiscal policy will depend is the ability of public
authority to frame the correct size and nature of fiscal policy on the one hand and to foresee the correct
timing of its application on the other. It is, however, too much to expect that the government would be able
to correctly determine the size, nature of composition and appropriate execution-time of fiscal policy.
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 Fiscal Selectivity:
When monetary policy is general in nature and impersonal in impact, the fiscal policy, in contrast, is
selective. The former permits the market mechanism to operate smoothly. The latter, on the contrary,
encroaches directly upon the market mechanism and gives rise to an allocation of resources which may be
construed as good or bad depending upon one’s value judgements. A particular set of fiscal measures may
have an excessively harsh impact upon certain sectors, while leaving others almost unaffected.
 Inadequacy of Fiscal Measures:

In anti-depression fiscal policy, the expansion of public spending and reduction on taxes are always
important elements. The question arises naturally, whether a specific variation in public spending or taxes
will bear the desired results or not. In case the injections or withdrawals from the circular flow are more or
less than what are required, the system will fail to move in the desired direction. This results in exaggeration
of instability in the economy.
 Adverse Effect on Redistribution of Income:

It is felt that fiscal policy measures redistribute income, the actual effect will be uncertain. If income is
redistributed in favour of the low-income classes whose marginal propensity to consume is high, the effect
will be increase in total demand. But the fiscal action will be contractionary if larger part of the additional
income goes to people having higher marginal propensity to save.
 Self-offsetting Effect:
The compensatory fiscal policies of the government may discourage private investment, since the private
entrepreneurs have to face a competition from public enterprises in securing labour, raw materials and
finances. Moreover, increased involvement of the government in economic activity at the onset of recession
strengthens the pessimistic expectations of the private entrepreneurs. The expansion of public spending may
be associated with a curtailment of private spending. Consequently, the fiscal measures may be self-
offsetting.
 Reduction in National Income:

Balanced budget multiplier as a fiscal weapon can be gainfully applied during depression is conditioned by
the fact of marginal propensity to spend of the recipients of public expenditure being larger than or, at least,
equal to that of the taxpayers. In case it becomes smaller than the taxpayers, the fiscal programmes under
balanced budget will bring about reduction in the national income.
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2.OBJECTIVES OF FISCAL POLICY IN INDIA
Fiscal policy means the use of taxation and public expenditure by the government for stabilization or growth
of the economy. According to Culbertson, “By fiscal policy we refer to government actions affecting its
receipts and expenditures which ordinarily as measured by the government’s receipts, its surplus or deficit.”
The government may change undesirable variations in private consumption and investment by compensatory
variations of public expenditures and taxes.
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Fiscal policy also feeds into economic trends and influences monetary policy. When the government receives
more than it spends, it has a surplus. If the government spends more than it receives it runs a deficit. To meet
the additional expenditures, it needs to borrow from domestic or foreign sources, draw upon its foreign
exchange reserves or print an equivalent amount of money. This tends to influence other economic variables.
On a broad generalization, excessive printing of money leads to inflation. If the government borrows too
much from abroad it leads to a debt crisis. Excessive domestic borrowing by the government may lead to
higher real interest rates and the domestic private sector being unable to access funds resulting in the
“crowding out” of private investment. So it can be said that the fiscal deficit can be like a double edge
sword, which need to be tackled very carefully.
Main Objectives of Fiscal Policy in India
Before moving on the discussion on objectives of India’s Fiscal Policies, firstly know that the general
objective of Fiscal Policy.
 General objectives of Fiscal Policy are given below:
1. To Full Employment
2. To Development by effective mobilisation of resources
3. To Reduction in inequalities of income and wealth
4. To Price stability and control of inflation
5. To Employment Generation
6. To Balanced regional development
7. To Reducing the deficit in the balance of payment
8. To Increase national income
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Fiscal policy of India always has two objectives, namely improving the growth performance of the economy
and ensuring social justice to the people.
The fiscal policy is designed to achieve certain objectives as follows:-
 Full Employment:
The first and foremost objective of fiscal policy in a developing economy is to achieve and maintain full
employment in an economy. In such countries, even if full employment is not achieved, the main motto is to
avoid unemployment and to achieve a state of near full employment. Therefore, to reduce unemployment
and under-employment, the state should spend sufficiently on social and economic overheads. These
expenditures would help to create more employment opportunities and increase the productive efficiency of
the economy.
In this way, public expenditure and public sector investment have a special role to play in a modern state. A
properly planned investment will not only expand income, output and employment but will also step up
effective demand through multiplier process and the economy will march automatically towards full
employment. Besides public investment, private investment can also be encouraged through tax holidays,
concessions, cheap loans, subsidies etc.
 Development by effective Mobilisation 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 Mobilisation of Financial Resources. The central
and state governments in India have used fiscal policy to mobilise resources.
The financial resources can be mobilised by:-
a. Taxation: Through effective fiscal policies, the government aims to mobilise resources by way of direct
taxes as well as indirect taxes because most important source of resource mobilisation in India is taxation.
b. Public Savings: The resources can be mobilised through public savings by reducing government
expenditure and increasing surpluses of public sector enterprises.
c. Private Savings: Through effective fiscal measures such as tax benefits, the government can raise
resources from private sector and households. Resources can be mobilised through government borrowings
by ways of treasury bills, issuance of government bonds, etc., loans from domestic and foreign parties and
by deficit financing.
 Reduction in inequalities of Income and Wealth:
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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 Programmes to improve the
conditions of poor people in society.
 Price Stability and Control of Inflation:

One of the main objectives 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 measures. 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 generate more
employment. Various rural employment programmes 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:

there are various projects like building up dams on rivers, electricity, schools, roads, industrial projects etc.
run by the government to mitigate the regional imbalances in the country. This is done with the help of
public expenditure.
 Reducing the Deficit in the Balance of Payment:

some time government gives export incentives to the exporters to boost up the export from the country. In
the same way import curbing measures are also adopted to check import. Hence the combine impact of these
measures is improvement in the balance of payment of the country.
 Increases National Income:
it’s the strength of the fiscal policy that is brings out the desired results in the economy. When the
government want to increase the income of the country then it increases the direct and indirect taxes rates in
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the country. There are some other measures like: reduction in tax rate so that more peoples get motivated to
deposit actual tax.
2.1TECHNIQUES OF FISCAL POLICY IN INDIA
Here we detail about the four important techniques of fiscal policy of India,
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 Policy of Taxation of Government of India:
One of the important sources of revenue of the Government of India is the tax revenue. Both the direct and
indirect taxes are being levied by the Government of India. Direct taxes are progressive by nature and most
of indirect taxes are regressive in nature. Taxation plays an important role in mobilizing resources for plan.
During the First, Second and Third Plan, additional taxation alone contributed nearly 12.7 per cent, 22.8 per
cent and 34 per cent of public sector plan expenditure respectively. The same shares during the Fourth, Fifth,
Sixth and Seventh Plan were 27 per cent, 37 per cent, 22 per cent and 15 per cent respectively. Total tax
revenue collected by the Government of India stands at 72.13 per cent of the total revenue of the
government. Mobilisation of taxes by the government stands around 15 to 16 per cent of the national income
of the country during recent years.
main objective of taxation policy in India includes:

(i) Mobilisation of resources for financing economic development;
(ii) Formation of capital by promoting saving and investment through time deposits, investment in
government bonds, in units, insurance etc.;
(iii) Attainment of equality in the distribution of income and wealth through the imposition of progressive
direct taxes; and
(iv) Attainment of price stability by adopting anti-inflationary taxation policy.
 Public Expenditure Policy of Government of India:
Public expenditure is playing an important role in the economic development of a country like India. With
the increase in responsibilities of the government and with the increasing participation of government in
economic activities of the country, the volume of public expenditure in a highly populated country like India
is increasing at a galloping rate.
In 1992-93, the public expenditure as percentage of GDP was around 30 per cent. Public expenditure is of
two different types, i.e., developmental and non-developmental expenditure. Developmental expenditure of
the government is mostly related to the developmental activities viz., development of infrastructure, industry,
health facilities, educational institutions etc. The non-developmental expenditure is mostly a maintenance
type of expenditure and is related to maintenance of law and order, defence, administrative services etc. The
public expenditure incurred by the Government of India has been creating a serious impact on the production
and distribution pattern of the economy.
The following are some of the important features of the policy of public expenditure formulated by the
Government of India:
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(i) Development of infrastructure: Development of infrastructural facilities which include development of

power projects, railways, road, transportation system, bridges, dams, irrigation projects, hospitals,
educational institutions etc. involves huge expenditure by the government as private investors are very much
reluctant to invest in these areas considering the low rate of profitability and high risk involved in it.
(ii) Development of public enterprises: Developments of heavy and basic industries are very important for
the development of underdeveloped country. But the establishment of these industries involves huge
investment and a considerable proportion of risk. Naturally private sector cannot take the responsibility to
develop these industries.
Development of these industries has become a responsibility of the Government of India particularly since
the introduction of Industrial Policy, 1956. A significant portion of public expenditure has been utilized for
the establishment and improvement of these public enterprises.
(iii) Support to Private Sector :Providing necessary support to the private sector for the establishment of
industry and other projects is another important objective of public expenditure policy formulated by the
Government of India.
(iv) Social Welfare and Employment Programmes: Another important feature of public expenditure
policy pursued by the Government of India is its growing involvement in attaining various social welfare
programmes and also on employment generation programmes.
 Policy of Deficit Financing of Government of India:
Following the policy of deficit financing as introduced by J.M. Keynes, the Government of India has been
adopting the policy for financing its developmental plans since its inception. The deficit financing in India
indicates taking loan by the government from the Reserve Bank of India in the form of issuing fresh dose of
currency.
Considering the low level of income, low rate of savings and capital formation, the government is taking
recourse to deficit financing in increasing proportion. Deficit financing is a kind of forced savings.
Accordingly, Dr . V.K.R.V. Rao observed, “Deficit financing is the name of volume of those forced savings
which are the result of increase in prices during the period of the government investment. Thus deficit
financing helps the country by providing necessary funds for meeting the requirements of economic growth
but at the same time it also create the problem of inflationary rise in prices. Thus the deficit financing must
be kept within the manageable limit .”During the First, Second, Third and Fourth Plan deficit financing as
percentage of total plan resources was to the extent of 17 per cent, 20 per cent, 13 per cent and 13.5 per cent
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respectively. But due to adverse consequence of deficit financing through inflationary rise in price level, the
extent of deficit financing was reduced to only 3 per cent during the Fifth Plan. But due to resource
constraint, the extent of deficit financing again rose to 14 per cent and 16 per cent of total plan resources
respectively .Thus knowing fully the evils of deficit financing, planners are still maintaining a high rate of
deficit financing in the absence of increased tax revenue due to large scale tax evasion and negative
contribution of public enterprises. But considering the present inflationary trend in prices, the government
should give lesser stress on deficit financing.
 Public Debt Policy of the Government of India:
As the taxation has got its limit in a poor country like India due to poor taxable capacity of the people, thus
the government is taking recourse to public debt for financing its developmental expenditure. In the post-
independence period, the Central Government has been raising a good amount of public debt regularly in
order to mobilize a huge amount of resources for meeting its developmental expenditure. Total public debt of
the Central Government includes internal debt and external debt.
Internal Debt:
Internal debt indicates the amount of loan raised, by the government from within the country. The
Government raises internal public debt from the open market by issuing bonds and cash certificates and 15
years annuity certificates. The government also borrows for a temporary period from RBI (Treasury bills
issued by RBI) and also from commercial banks.
External Debt:
As the internal debt is insufficient thus the government is also collecting loan from external sources, i.e.,
from abroad, in the form of foreign capital, technical know-how and capital goods. Accordingly, the Central
Government is also borrowing from international financing agencies for financing various developmental
projects. These agencies include World Bank, IMF, IDA, IFC etc. Moreover, the government is also
collecting inter-governmental loans from various developed countries of the world for financing its various
infrastructural projects.
The volume of public debt in India has been increasing at a considerable rate i.e. from Rs. 204 crore during
the First Plan to Rs. 2,135 crore during the Fourth Plan and then to Rs. 1,03,226 crore during the Seventh
Plan. During the Eighth Plan, the volume of internal debt of the Central Government was amounted to Rs.
1,59,972 crore and that of external debt was to the extent of Rs. 2,454 crore. At the end of the second year of
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the Ninth Plan, i.e., in 1998-99 (BE), total outstanding loan (liabilities) of the Central Government stood at
Rs. 8,68,206 crore.
2.2TOOLS OF FISCAL POLICY
The government possesses two major fiscal tools that it employs in the economy. These tools can be divided
into spending tools and revenue tools. Revenue tools refer to taxes collected by the government. On the other
hand, spending tools refer to the overall government spending.
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1.Government Spending Tools
(a). Capital Expenditure: Capital expenditure refers to what the government spends on amenities such as
schools, roads, and hospitals. This spending adds to a country’s capital stock and also affects the productivity
capabilities of the country. Moreover, as the government increases its spending on such facilities, it increases
the capital stock of the country. Since such facilities highly encourage investment, the total productivity of a
country also increases due to an increase in investments.
(b).Current Government Spending: Current government spending includes goods and services which it
provides regularly and on a recurring basis. Such services include defense , health, and education.
Consequently, this is aimed at improving the country’s labor productivity.
(c).Transfer Payments: These are payments that are made by the government through the social security
systems. Transfer payments ensure a minimum level of income for low-income individuals. Also, they
provide ways in which the government can change the distribution of income in the society. Therefore, they
comprise unemployment benefits and child benefits. Such benefits include state pensions, housing benefits,
income support, and tax credits. It should be stated that such payments are not included in calculating the
GDP because they are not a reward to any factor of production.
Justification of Government Spending
 To provide services like defense for the benefit of all citizens
 For enhancing infrastructure in the form of capital spending
 To assure the less-wealthy individuals a certain minimum income level
 To influence low inflation and high employment.
Advantage of Spending Tools
 Subsidies in development and research can aid in a country’s economic growth.
 An increase in government expenditure causes an increase in aggregate demand.
 Reduces unemployment rate: An increase in government expenditure increases aggregate demand

and the need for companies to employ more workers so as to be able to meet up with the growing
demand for goods and services.
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Disadvantages of using Spending Tools
 Capital spending strategies tend to take time. Formulating and implementing capital spending may
take several years.
 Too much spending on recurrent projects depletes the reverse of the economy.
2.Government Revenue Tools
(a).Indirect Taxes:Indirect taxes refer to taxes spent on specific goods like cigarettes, alcohol and fuel, and
services like VAT. Health and education can be excluded from indirect taxes.
(b).Direct Taxes:Levies on profits, incomes, and wealth are direct taxes. Taxes charged on a deceased
property can both raise revenue and distribute wealth. They include capital gains taxes, national insurance
taxes, and other corporate taxes.
Advantages of Using Fiscal Tools
 Raising taxes helps in discouraging alcoholism and drug abuse. This is made possible by increasing
taxes on tobacco and alcoholic drinks.
Disadvantages of Using Fiscal Tools

 Raising and creating taxes is unpopular and can be politically challenging to impose and implement.
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2.3TYPES OF FISCAL POLICY
There are two types of fiscal policies. Both of these policies work well for the overall growth of the
economy. But the government use one of them at times when one is required more than the other.
Let’s talk about both of these.
1. EXPANSIONARY FISCAL POLICY:
This policy is quite popular among the people of the country because through this, consumers get more
money in their hands and as a result their purchasing power increases drastically. The government uses this
by two ways. Either they spend more money on public works, provide benefits to the unemployed, spend
more on projects that are halted in between or they cut taxes so that the individuals or businesses don’t need
to pay much to the government. You may think which one is more prudent! People who favour the
government spending prefer it over cutting taxes because they believe that if the government spends more,
the unfinished projects would be completed. On the other hand, individuals who prefer cutting taxes talk
about it because they believe that by cutting taxes the government would be able to generate more cash into
consumers’ hands. Expansionary policy isn’t easy to apply for state government because state government is
always on a pressure to keep a budget that is balanced. As it becomes impossible at local levels,
expansionary fiscal policy should be mandated from the central government.
2. CONTRACTIONARY FISCAL POLICY:
As you can expect, a contractionary fiscal policy is just the opposite of the expansionary fiscal policy. That
means the objective of the contractionary policy is to slow down the economic growth. But why a
government of a country would like to do that? The only reason for which contractionary fiscal policy can be
used is to flush out the inflation. However, it is a rarest thing and that’s why government doesn’t use
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contractionary policy at all. The nature of this sort of policy is just the opposite. In this case, the government
spending is cut as much as possible and the rate of taxes is increased so that the purchasing power of the
consumer gets reduced. Taking away money from the hands of the consumers can be dangerous because that
means businesses will not be able to sell off goods and services and as a result, the economy will take a sure-
shot hit which only can be reversed by taking the expansionary fiscal policy
2.4INSTRUMENT OF FISCAL POLICY
Some of the major instruments of fiscal policy are as follows: A. Budget B. Taxation C. Public
Expenditure D. Public Works E. Public Debt.
A. Budget:
The budget of a nation is a useful instrument to assess the fluctuations in an economy.
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Different budgetary principles have been formulated by the economists, prominently known as:
(1) Annual budget,
(2) cyclical balanced budget and
(3) fully managed compensatory budget.
Let us briefly explain them:
 Annual Balanced Budget:

The classical economists propounded the principle of annually balanced budget. They defended it with force
till the deep rooted crisis of 1930’s.
The reasons for their reacceptance of this principle are as under:

(i) They maintained that there should be balance in income and expenditure of the government;
(ii) They felt that automatic system is capable to correct the evils;
(iii) Balanced budget will not lead to depression or boom in the economy;
(iv) It is politically desirable as it checks extravagant spending of the state;
(v) This type of budget assures full employment without inflation;
(vi) The principle is based on the notion that government should increase the taxes to get more money and
reduce expenditure to make the budget balanced.
However, this principle is subject to certain objections.
These objection are as under:

(i) Classical version that balanced budget is neutral is not well based. In practice, a balanced budget can be
expansionary.
(ii)The assumptions of full employment and automatic adjustment are too untenable in a modern economy.
(iii)Some economists also argue that annually balanced budget involves lesser burden of the taxes.
 Cyclically Balanced Budget:
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The cyclical balanced budget is termed as the ‘Swedish budget’. Such a budget implies budgetary surpluses
in prosperous period and employing the surplus revenue receipts for the retirement of public debt. During the
period of recession, deficit budgets are prepared in such a manner that the budget surpluses during the earlier
period of inflation are balanced with deficits.
The excess of public expenditure over revenues are financed through public borrowings. The cyclically
balanced budget can stabilize the level of business activity. During inflation and prosperity, excessive
spending activities are curbed with budgetary surpluses while budgetary deficits during recession with
raising extra purchasing power.
This policy is favored on the following account:

(i) The government can easily adjust its finances according to the needs;
(ii)This policy works smoothly in all times like depression, inflation, boom and recession;
(iii) Cyclically balanced budget simply ensures stability but gives no guarantee that the system will get
stabilized at the level of full employment.
 Fully Managed Compensatory Budget:

This policy implies a deliberate adjustment in taxes, expenditures, revenues and public borrowings with the
motto of achieving full employment without inflation. It assigns only a secondary role to the budgetary
balance. It lays down the emphasis on maintenance of full employment and stability in the price level. With
this principle, the growth of public debt and the problem of interest payment can be easily avoided. Thus, the
principle is also called ‘functional finance.’
The fully managed compensatory budget has been criticized on the following grounds:
(i) It considers that the government should give blanket guarantee against unemployment.
(ii) This policy is not automatic.
(iii) It brings political upheavals as it delays the implementation of appropriate fiscal measures.
(iv) A country is burdened with debt in the long run period.
(v) This policy is a prolonged lag which in practice has a disturbing effect on the economy.
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B. Taxation:
Taxation is a powerful instrument of fiscal policy in the hands of public authorities which greatly effect the
changes in disposable income, consumption and investment. An anti- depression tax policy increases
disposable income of the individual, promotes consumption and investment. Obviously, there will be more
funds with the people for consumption and investment purposes at the time of tax reduction.
This will ultimately result in the increase in spending activities i.e. it will tend to increase effective demand
and reduce the deflationary gap. In this regard, sometimes, it is suggested to reduce the rates of commodity
taxes like excise duties, sales tax and import duty. As a result of these tax concessions, consumption is
promoted. Economists like Hansen and Musgrave, with their eye on raising private investment, have
emphasized upon the reduction in corporate and personal income taxation to overcome contractionary
tendencies in the economy.
Now, a vital question arises about the extent to which unemployment is reduced or mitigated if a tax
reduction stimulates consumption and investment expenditure. In such a case, reduction of unemployment is
very small. If such a policy of tax reduction is repeated, then consumers and investors both are likely to
postpone their spending in anticipation of a further fall in taxes. Furthermore, it will create other
complications in the government budget.
Anti-Inflationary Tax Policy:

An anti-inflationary tax policy, on the contrary, must be directed to plug the inflationary gap. During
inflation, fiscal authorities should not retain the existing tax structure but also evolve such measures (new
taxes) to wipe off the excessive purchasing power and consumer demand. To this end, expenditure tax and
excise duty can be raised.
The burden of taxation may be raised to the extent which may not retard new investment. A steeply
progressive personal income tax and tax on windfall gains is highly effective to curb the abnormal
inflationary pressures. Export should be restricted and imports of essential commodities should be liberated.
The increased inflow of supplies from origin countries will have a moderate impact upon general prices. The
tax structure should be such which may impose heavy burden on higher income group and vice versa.
Therefore, proper care must be taken that the government policies should not bring violent fluctuations and
impede economic growth. To sum up, despite certain short-comings of taxation, its significance as an
effective anti-cyclical and growth inducing investment cannot be forfeited.
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C. Public Expenditure:
The active participation of the government in economic activity has brought public spending to the front line
among the fiscal tools. The appropriate variation in public expenditure can have more direct effect upon the
level of economic activity than even taxes. The increased public spending will have a multiple effect upon
income, output and employment exactly in the same way as increased investment has its effect on them.
Similarly, a reduction in public spending, can reduce the level of economic activity through the reverse
operation of the government expenditure multiplier.
(i) Public Expenditure in Inflation:

During the period of inflation, the basic reason of inflationary pressures is the excessive aggregate spending.
Both private consumption and investment spending are abnormally high. In these circumstances, public
spending policy must aim at reducing the government spending. In other words, some schemes should be
abandoned and others be postponed. It should be carefully noted that government spending which is of
productive nature, should not be shelved, since that may aggravate the inflationary dangers further.
However, reduction in unproductive channels may prove helpful to curb inflationary pressures in the
economy. But such a decision is really difficult from economic and political point of view. It is true, yet the
fiscal authority can vary its expenditure to overcome inflationary pressures to some extent.
(ii) Public Expenditure in Depression:

In depression, public spending emerges with greater significance. It is helpful to lift the economy out of the
morass of stagnation. In this period, deficiency of demand is the result of sluggish private consumption and
investment expenditure. Therefore, it can be met through the additional doses of public expenditure
equivalent to the deflationary gap. The multiplier and acceleration effect of public spending will neutralize
the depressing effect of lower private spending’s and stimulate the path of recovery.
D. Public Works:
Keynes General Theory highlighted public works programme as the most significant anti-depression device.
There are two forms of expenditure i.e., Public Works and ‘Transfer Payments. Public Works according to
Prof. J.M. Clark, are durable goods, primarily fixed structure, produced by the government.
They include expenditures on public works as roads, rail tracks, schools, parks, buildings, airports, post
offices, hospitals, irrigation canals etc. Transfer payments are the payments such like interest on public debt,
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subsidy, pension, relief payment, unemployment, insurance and social security benefits etc. The expenditure
on capital assets (public works) is called capital expenditure.
Keynes had strong faith in such a programme that he went to the extent of saying that even completely
unproductive projects like the digging up of holes and filling them up are fully admissible.
Public works are supported as an anti-depression device on the following grounds:

(i) They absorb hitherto unemployed workers.
(ii) They increase the purchasing power of the community and thereby stimulate the demand for
consumption goods.
(iii)They help to create economically and socially useful capital assets as roads, canals, power plants,
buildings, irrigation, training centres and public parks etc.
(iv) They provide a strong incentive for the growth of industries which are generally hit by the state of
depression.
(v) They help to maintain the moral and self respect of the work force and make use of the skill of
unemployed people.
 Difficult Forecasting:
The effectiveness of public works programmes always rests upon accurate forecasting of the depression or
boom. But prediction of accurate forecasting is very difficult.
 Timing of Public Works:
Another serious problem relates to the timing of public works with the moment of cycle. Due to lack of
accurate forecasting, proper timing is neither feasible nor possible. Thus this factor along undermines the
significance of public works as an instrument of stabilization.
 Delay in starting:
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Public works programmes are not something which can be started immediately. Actually, it is a long term
programme which requires proper planning with regard to the finance and engineering. In this way, delay is
the natural cause. Dernburg and McDougal have rightly noticed, “public works are, in short, clumsy and
slow moving requiring time to get ready and time to turn off.”
 Scarcity of Resources:
The undertaking of public works programme may pose a serious threat due to non-availability of resources.
It is likely that scarcity of resources may further aggravate the crisis instead of giving the pace of
smoothness.
 Limited Scope of Employment:

The public works programme is not capable of assuring job to all cadres of unemployed workers. Such
works are only started to absorb unskilled and semi-skilled workers and not the specialised.
 Misallocation of Resources:
As the slump gets deepened, there is wide spread unemployment of manpower and equipment. Generally,
public works are located in only few selected areas. Thus, they may prove to be inadequate to cope with the
requirements. Again, immobility in factors of production may also prevent the economic utilization of
available resources. As a result, they reduce the efficiency of public works programme.
 Burden of Public Debt:

The public works programme, generally, are financed through borrowing during depression. This will saddle
the country with a heavy burden of repayment of principle amount and interest therein.
 Cost Price Maladjustments:

The public works programme may perpetuate cost price maladjustments in heavy industries where public
expenditure is concentrated. During the period of boom, wages and prices in construction industries have a
strong upward tendency while in recession or depression, prices move downward, wages and costs remain
sticky relatively. In short, such distortion in cost price structure brings more instability in the economy.
 Effect on Private Enterprise:
In certain areas, the construction programmes undertaken by the public agencies may complete with private
investment. As a result, the later is driven out of business. In such a case, public works will prove to be self-
off setting and the aggregate demand will possibly fail to increase.
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 Control over Public Works:

The success of public works mostly depends on the nature of control over them. If public works are
controlled by the central authority, delay is likely to arise in selected projects.
 Political Considerations:
Public works are often started in democratic countries in certain areas not on account of economic reasons,
but the political pressures at national, state and local levels sway the government decisions. Consequently,
the economic utility of such public works remains very limited.
E. Public Debt:
Public debt is a sound fiscal weapon to fight against inflation and deflation. It brings about economic
stability and full employment in an economy.
The government borrowing may assume any of the following forms mentioned as under:
(a) Borrowing from Non-Bank Public:
When the government borrows from non-bank public through sale of bonds, money may flow either out of
consumption or saving or private investment or hoarding. As a result, the effect of debt operations on
national income will vary from situation to situation. If the bond selling schemes of the government are
attractive, the people induce to curtail their consumption, the borrowings are likely to be non inflationary.
When the money for the purchase of bonds flows from already existing savings, the borrowing may again be
non-inflationary. Has the government not been borrowing, these funds would have been used for private
investment, with the result that the debt operations by the government will simply bring about a diversion of
funds from one channel of spending to another with the similar quantitative effects on national income.
If the government bonds are purchased by non bank individuals and institutions by drawing upon their
hoarded money, there will be net addition to the circular flow of spending. Consequently, the inflationary
pressures are likely to be created. But funds from this source are not commonly available in larger quantity.
Its main implication is that borrowings from non bank public is more advantageous in an inflationary period
and undesirable in a depression phase. In short, the borrowing from non bank public are not of much
significant magnitude whether it comes out of consumption, saving, private investment or hoarding.
(b) Borrowing from Banking System:
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The government may also borrow from the banking institutions. During the period of depression, such
borrowings are highly effective. In this period, banks have excessive cash reserves and the private business
community is not willing to borrow from banks since they consider it unprofitable.
When unused cash lying with banks is lent out to government, it causes a net addition to the circular flow
and tend to raise national income and employment. Therefore, borrowing from banking institution have
desirable and favourable effect specially in the period of depression when the borrowed money is spend on
public works programmes.
On the contrary, borrowing from this source dry up almost completely in times of brisk business activities
i.e. boom. Actually, demand is very high during inflation period, since profit expectation is high in business.
The banks, being already loaded up and having no excess cash reserves. Find it difficult to lend to the
government. If it is done, it is only through reducing their loans somewhere else.
This leads to a fall in private investment. As the government spending is off-set by a reduction in private
investment, there will be no net effect upon national income and employment. In nut shell, borrowing from
banking institutions have desirable effect only in depression and is undesirable or with a neutral effect during
inflation period.
(c) Drawing from Treasury:

The government may draw upon the cash balances held in the treasury for financing budgetary deficit. It
demonstrates dishoarding resulting in a net addition in the supply of money. It is likely to be inflationary in
nature. But, generally, there are small balances over and above what is required for normal day to day
requirements. Thus, such borrowings from treasury do not have any significant result.
(d) Printing of Money: Printing of money i.e. deficit financing is another method of public expenditure for
mobilizing additional resources in the hands of government. As new money is printed, it results in a net
addition to the circular flow. Thus, this form of public borrowing is said to be highly inflationary.
3.IMPORTANCE OF FISCAL POLICY IN ECONOMIC DEVELOPMENT
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Importance of Fiscal Policy in the Economic Development.

The attitude of economists and government regarding the role of fiscal policy has radically changed owing to
the Keynesian impact.
The old conception of “neutrality” of public finance has yielded place to a new one namely functional
finance,” public finance with its fiscal measures has been assigned a positive and dynamic role for the
promotion and acceleration of the rate of economic development.
The Keynesian analysis of fiscal policy is however, applicable to the advanced and well-to-do countries of
Europe and it has little relevance to underdeveloped economies.
The problem of developed countries is to stabilise the rate of economic growth by maintaining effective
demand at a high pitch and for that fiscal policy aims at reducing the savings of the people and increasing
their propensity to consume, The problem of under-developed countries is however different.
They need more savings so as to increase the rate of capital formation and thereby achieve higher rate of
economic development. But in these countries the general level of incomes of the people is low and their
propensity to consume is high and hence the rate of savings is small. The fiscal measures in these countries,
therefore, should aim at raising the rate of capital formation by reducing consumption and encouraging
propensity to save.
Our analysis of the problems connected with voluntary savings indicated that the per capita incomes and
savings are extremely low and as such capital formation in underdeveloped economies cannot be left to
voluntary savings.
According to an expert UN study, the annual per capita incomes in the Middle East, in Asia and in Latin
America are less than 200 US dollars or less than one-seventh of the US level and one-fourth of the
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Canadian level. It was revealed in the I.M.F. “staff papers” that in India savings contributed only 2½ percent
of the national income for development purpose.
The crucial determinant of economic growth is the rate of savings and, therefore savings cannot be left to
themselves to grow automatically. On the contrary, fiscal measures have to be adopted to increase the
savings of the people and to mobilise them for productive purpose. In the words of Nurkse, “fiscal policy,
assumes a new significance in the face of the problem of capital formation in under-developed countries.
The backward countries are caught in the vicious circle of low income, high consumption, low savings, and
low rate of capital formation and therefore, low incomes. To get out of this vicious circle of poverty, the
fiscal policy can play a constructive and dynamic role for the economic development of the underdeveloped
countries.
“To break out of this circle, apart from foreign aid,” observes an expert UN study “calls for vigorous taxation
and government development programmes.” Thus in poor countries, the importance of fiscal policy lies in
raising the rate and volume of savings and to divert them into the desired channels.
In this connection, the UN report on Taxes and Fiscal Policy says, “Fiscal policy is assigned the central task
of wresting from the pitifully low output of under-developed countries sufficient savings to finance
economic development programmes and to set the stage for more vigorous private and public investment
activity.”
The limitations and ineffectiveness of monetary policy in securing an accelerated rate of economic growth
has further added to the importance of fiscal policy. Fiscal policy was designed to supplement monetary
policy but now it seems to have supplanted monetary policy altogether.
The role of fiscal policy in economic development cannot be overemphasized. The importance of fiscal
policy as an instrument of economic development was first envisaged by Keynes in his General Theory
wherein he showed that the total national income was an index of economic activity and brought out the
relation of economic activity of total spending.
The direct and indirect effects of fiscal policy on aggregate spending in the community were clearly
established and as a result the budgetary policy of the government as a weapon of economic control and
development came into prominence.
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The fiscal policy can affect the rate of economic development in a variety of ways such as by increasing the
rate of saving and investment, affecting the allocation of resources, controlling inflation, promoting
economic stability. We now discuss them in detail.
To Increase the rate of saving and Investment:
Shortage of financial resources is the main obstacle in the way of economic development of under-
developed countries. There are certain forces operating in these countries which increase consumption and
reduce savings. The first among them is the population pressure.
Besides, the high income groups spend much of their income on conspicuous consumption and their
propensity to consume is further reinforced by the ‘demonstration effect’. According to “Still-worse,” a large
part of the meager savings is dissipated in unproductive channels—real estate, hoarding, gold, jewellery,
speculation etc.
The fiscal policy can be employed effectively to divert savings of the people into productive channels. It
should aim at raising the incremental saving ratio through taxation and forced loans and make funds
available for investment purposes in the public and private sectors of the economy.
This can be done by checking conspicuous consumption and preventing the flow of funds for unproductive
purposes. For this, high taxes on personal and corporate incomes and commodity taxation on articles of
widest use and conspicuous consumption should be imposed to check the actual and potential consumption
of the people.
In this connection, report of the Taxation Enquiry Commissions, Government of India, observes, “A tax
system, which on the whole, promotes capital formation in is two aspects of saving and investment fulfills an
essential desideration”.
It should be borne in mind that the purpose of taxation should not be merely to transfer funds from private to
public use but to enlarge the total volume of savings available for investments. This requires that the general
emphasis should be on curtailing and restraining consumption and thereby increasing the volume of saving
in the community.
In Japan, for example, agricultural productivity was doubled between 1885 and 1915 and the instruments of
taxation was used effectively and much of the increase was taken away from the farmers by imposing on
them higher rents and taxes and the resources thus collected were channelled into productive investments.
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Forced loans were also imposed on the business community to mop up surplus funds for economic
development. In USSR also, collective farms were heavily-taxed and agricultural surplus were siphoned off
by raising the prices of manufactures relating to farm products.
The Economic Bulletin for Asia and the Far East States observes, “Taxation, therefore, remains as the only
effective financial instruments for reducing private consumption and investment and transferring resources
to the government for economic development.”
It will be essential for the purpose to relay on both direct and indirect taxes. Their form and magnitude
should be determined in the light of the requirements of development.
We may discuss the role of Fiscal policy, in this connection, after Prof. Kurihara regards Fiscal policy as a
“desiderate for underdeveloped countries, lacking in private initiative, private voluntary saving and private
innovation.” He discusses the fiscal roles of government as an additional saver, an investor, an innovator and
an income-redistributors.
As an additional saver, the government should, “maintain a persistent budgetary surplus through (a) a
decrease in the government average propensity to spend, (b) an increase in the average propensity to tax, or
(c) a decrease in the government average propensity to make transfer payments”. Prof. Kurihara observes,
“As for as under-developed economy is concerned, budgetary surplus is the relevant position to be achieved
and maintained. For it is as supplementing deficient private saving that the fiscal role of government as a
saver is to be contemplated.”
As an additional investor, the government can increases the productive capacity of the economy and secure
an accelerated rate of economic growth by changing the pattern of investments and laying emphasis on
capacity creating rather than on income-generating aspects; by decreasing government consumption and
thereby increasing government investment and by raising the tax-rate which “has the effects of decreasing
private consumption expenditure and hence of increasing that part of real income which is available for
government investment.”
As an innovator, the Government should spend on research and experimentation and stimulate innovations
and new techniques of production. This will reduce the costs of production and encourage investment.
Besides, the Government can encourage innovations by giving subsidies and tax-relief to those firms and
industries which may introduce them of their own.
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The government has an important role to play as an income redistributors and for that fiscal measures can go
a long way in reducing economic inequalities. A broad-based and sleepy progressive tax structure can serve
as a potent weapon in the hands of the state to secure equitable distribution of income and wealth.
However, there is a limit to which taxation can be carried for resource mobilisation. If the taxes are
excessive they will adversely affect people’s desire and ability to work, save and invest. This will obviously
retard the pace of economic development. To avoid such a situation, the gap in resources required for
economic development may be covered by mobilising savings through voluntary loans.
Financing of economic development through borrowings is not harmful it loans are used for productive
projects. Further, unlike taxes, borrowing is not harmful if loans are the public, does not adversely affect
people’s desire to work, save and invest as lending is voluntary and the lenders not only get back the amount
lent but also earn interest on it. Instead Public borrowing may add to the incentive of the people to save and
invest more as the lure of interest is there.
However, public borrowing is beset with certain limitations in under-developed countries and as such much
reliance cannot be placed on it. The general masses are poor and their propensity to consume is very high
and hence they have no lending capacity. The rich generally do not like to lend to the government but instead
divert their invisible resources into speculative channels as they can earn more from there.
Besides, the absence of organised money and capital markets inadequate banking facilities and lack of
confidence in the financial and political stability in the governments of most of the underdeveloped countries
are some of the other obstacles in the way of public borrowing programme.
Therefore, steps may be taken to remove these and other obstacles and all out efforts must be made to
educate people and persuade them to save more in the wider interest of the community.
But if inspite of all this, adequate resources are not forthcoming, the government may resort to compulsory
borrowing. For financing economic development. In this connection, Nurkse says, since individuals are
interested not only in their consumption but also in the size of their asset holdings, there is a case for forced
loans as an alternative to taxation.
They may be little more than tax receipts and yet make a difference to the incentive to work and to produce
as was found during the war period when the un-spendable cash reserves accumulated as a result of rationing
made consumers feel much better off. Forced loans in place of taxation would be a method of forced saving
in form as well in substance.
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Those people who spend the major portion of their income on conspicuous consumption and divert their
resources into unproductive channels or those who stand to be benefitted from particular development
projects may be forced to invest in government bonds.
But it may be noted that no democratic government can rely on forced loans except for a short period and for
certain specified projects. Ultimately, it is the voluntary lending by the people that matters and the
Government must be prepared to increase its domestic borrowing when the income and saving of the people
increase as a result of economic development and make public borrowing an important tool of resource
mobilisation.
Under the policy of Laissez. Faire when state was regarded as police state, the role of public expenditure in
the economic life of the people and community remained neglected. Its effects on production and
distribution were not take notice of and it was held that public expenditure should be kept at the minimum
level. But today, the pendulum has moved to the other side.
Public expenditure is one the most potent weapons in the hands of the state to secure economic development
of the underdeveloped. In underdeveloped countries, there is lack of basic facilities such as transport, power,
irrigation, education etc. and also of basic and key industries.
The availability of such facilities and provides by the private sector for want of resources and entrepreneurial
ability. Thus, public expenditure should aim at creating basic facilities and establishing basic and key
industries and encourage the development of agriculture and industry by giving loans, grants, subsidies etc.
Thus a carefully and wisely planned public expenditure by creating social and economic overheads can go a
long way in creating necessary environment for the growth of the economy. But public expenditure can
achieve its wider objective of development only it conforms to certain well-defined principles of public
expenditure.
The expenditure on the armed forces must not be overdone and other wasteful and excessive expenditure on
administration must be avoided. Public enterprises must conform to the principle of economic efficiency so
that costs fall and profits increase.
Care should be taken that public expenditure does not adversely affect people’s desire to work, save and
invest and for that people should not be provided with direct money help but with goods and services in the
form of free education, free medical facilities etc. This will go a long way in increasing the efficiency and
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productive capacity of the people. Thus public expenditure can play an important role in economic
development.
Dr. R.N. Tirpathy, in his book, Public Finance in Under-developed Countries has suggested the following
methods which the government may adopt to increase the volume of domestic savings to meet the financial
requirements of economic development:
(i) Direct physical controls.
(ii) Increase in the rate of existing taxes.
(iii) Imposition of new taxes.
(iv) Surplus from public enterprises.
(v) Public borrowing of a non-inflationary nature.
(vi) Deficit financing.
The process of economic development inevitably leads to inflationary pressures in the economy because it
generates additional effective demand without an immediate and corresponding increase in the production of
consumption goods.
Direct physical controls can be used most effectively to curtail consumption and check socially undesirable
investment and thereby releasing resources for economic development.
Though direct physical controls are not compatible with maintenance of democratic freedom and may be
difficult to administer in an underdeveloped economy yet they are a necessary adjunct to a developmental
fiscal policy.
To meet the financial requirements of economic development, the imposition of a new variety of taxes both
direct and indirect becomes indispensable in absence of sufficient voluntary savings. In some countries
profits made in public enterprises bring the government closer to economic realities and enable it to measure
the efficiency and taxpaying capacity of their counterparts and in the private sector.
It is desirable that the government herself starts highly profitable enterprises and utilises the surplus from
them for economic development. But the scope for any large surplus from public enterprises in under
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developed countries is limited due to high cost of production, in the initial stages of economic development
and also because of limited number of such enterprises.
A mild dose of deficit financing is very useful for the employment of unemployed economic resources but its
scope is limited in underdeveloped countries because of its inflationary impact resulting from the lags in the
supply of consumer goods.
Similarly, public borrowing cannot be expected to bring in adequate resource in the absence of properly
developed capital markets in most of the underdeveloped countries. Besides a vigorous programme of public
borrowing may push up interest rates and affect investments adversely.
Of all methods, therefore, main reliance has to be placed on taxation for the mobilisation of resources for
economic development. Besides, “fiscal policy in the shape at fiscal concessions such as investment and
depreciation allowances, provisions of finance and foreign exchange, tax-holiday, development rebates
subsides etc., can contribute materially to the growth of investment in the private sector of the economy”.
Thus the first role of fiscal policy is to make available for economic development maximum resources
consistent with minimum current consumption.
3.1Optimum Pattern of Investment:
An underdeveloped country can ill-afford the diversion of her limited resources into socially undesirable
channels. The fiscal measure can be used to secure the pattern of investment which is in conformity with the
criteria of social marginal productivity.
High taxes on land value increments on capital gains and other windfalls should be imposed to prevent the
flow of funds into unproductive channels such as land, buildings, inventories and other investments of
speculative nature.
The tax system can provide positive inducement to productive and socially desirable investment in the
private sector. This can be done by differential rates of taxation and the grant of tax exemption in selected
cases.
Investment in economic and social overheads, viz. transport, power, soil conservation, education public
health, technical training facilities etc., is of vital importance for attaining optimum pattern of investment
because the provision of these basic facilities is essential for speeding up development.
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Such an investment widens the extent of the market; helps reduce cost of production and raise productivity
by creating external economies. Private enterprise cannot be expected to provide such basic facilities as the
investment involved in them is very huge and they are low yielding and slow yielding projects.
Therefore, Governments of under-developed countries should take upon themselves the responsibilities to
the execution of these basic facilities. However, such projects should be financed through taxation and not
with borrowed funds because they do not yield direct returns necessary for the repayment of these debts.
The raising of collective compulsory saving through taxation for such development programmes is now
widely recognised. Thus fiscal measures should be directed to secure the optimum pattern of investment so
as to accelerate the pace of economic development of the underdeveloped countries.
3.2To Counteract Inflation:
The process of economic development in underdeveloped countries inevitably leads to inflationary pressures
as a result of the imbalances between the demand for and supply of real resources.
The pressure of wages on prices, structural rigidities of their economic systems, market imperfections and
bottle- necks impede the supply of goods and services and prices start rising. Inflation feeds on itself and if it
goes out of control, it ruins the entire economy and all progress comes to standstill.
That is why economic growth and stability are regarded as joint objectives for underdeveloped countries to
pursue. Today the choice is not between economic growth and stability “but only over the inter-relations ups
between them and over the policies necessary to achieve them.”
The fiscal measures should be used to counter act the inflationary pressures by reducing over a effective
demand for the attainment of this objective. The tax structure should be so devised that it mops up a major
portion of the rise in money income.
For that, greater reliance should be placed on progressive direct taxes and commodity taxes, the yield of
which changes more than in proportion to changes in tax base. Special anti-inflationary taxes on excess
profits, capital gains and other windfalls including taxes on articles of conspicuous consumption may be
imposed.
Besides, the fiscal policy of the Government should extend to the removal of structural rigidities, market
imperfections and imposition of physical controls including subsidies and protection to essential consumer
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goods industries. However, if inflationary pressures go on mounting, capital levy on cash balances and liquid
assets may be imposed.
3.3Alternative Fiscal Policies for Curbing Inflation:
The inflationary situation may basically be caused by the condition of excess demand, when the spending on
consumption and investment goods and the foreign spending on the goods of home country, aggregate
together, exceed the full employment output. This implies that true inflation starts only after full
employment. But actually, inflationary pressure are felt even before full employment on account of the bottle
necks and rigidities of factor supply and the pushes of wages, profits and costs.
3.4The fiscal remedies of inflation are discussed below:

(i) Reduction in Government Spending and no Change in Tax Rates:
Such a fiscal policy will give rise to budget surplus and drain out the purchasing power of the people. Tins
will set a reverse process of government expenditure multiplier in motion and bring about a contraction in
national income and employment and a consequent mitigation of inflationary phenomenon.
(ii) Reduction in Government Spending and Increase in Tax Rates:
This set of fiscal measures is likely to be made effective than the previous one since an increase in tax rates
coupled with a reduction in government spending will create a larger budget surplus and consequently a
larger reduction will be affected in national income and employment.
(iii) Rigid Government Spending and Increasing Tax Rates:
Sometimes the Government spending is rigid as for instance during the period of war the reduction in
aggregate spending can be affected. In this case, only through an increase in tax rates.
This results, in a reduction in private disposable incomes and hence private consumption and investment
expenditures fall which can check inflation. It was through such a policy that the United States during the
period of Second World War could siphon of purchasing power by a measure sufficient to finance more than
48 percent of the cost of war out of tax proceeds.
(iv) Reduction in Government Spending and an Equivalent Reduction in Taxes:
Just as an increase in government expenditure and an equivalent increase in tax revenues raises the national
income through the operation of the balanced budget multiplier, similarly a decrease in government spending
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and equivalent decrease in tax revenue brings about a reduction in national income and expenditure on
account of its reverse operation.
If these fiscal changes result in a redistribution of income between the beneficiaries of government
expenditure and tax payers in such a way that it results in reduction in government expenditure. A balanced
budget multiplier greater than unity will in this situation have an anti-inflationary impact upon the economy.
This discussion clearly brings out the fact that variation in taxes is the most crucial instrument of an anti-
inflationary fiscal policy. There is a controversy about the relative anti-inflationary impact of income-tax and
consumption tax of an equal yield.
The latter is sometimes conceived as more effective, since it results entirely in reducing consumption. The
income tax, on the contrary, falls partly upon consumption and partly upon savings, to the extent income-tax
reduces savings, if will not help in curtailing inflationary pressure.
To Promote Economic Stability:
The underdeveloped countries are susceptible to economic instability resulting from deficiency of effective
demand in the short-run and fluctuations in demand for their products in the world market. Underdeveloped
countries mainly export agricultural and mineral products the demand for which is generally less elastic.
On the other hand these countries import capital goods and finished manufactured articles, the demand for
which is elastic. When the prices of export goods fall in the international markets the terms of trade becomes
unfavourable, foreign exchange earnings decline and national income falls which produces depression
effects on the economy.
The under-developed countries cannot push their, exports to take advantage of the fall in prices because their
capacity to produce more is limited. Similarly, when the prices of the exports rise due to the boom conditions
in the world-markets, the increase in export earnings does not lead to increased output and employment but
instead it is dissipated in conspicuous consumption and speculative investment which further generate
inflationary pressure in the economy.
Fiscal measures can be used to offset the effects of international cyclical fluctuations in the prices of exports.
For example, in booms heavy export and imports duties may be imposed export duties to neutralise the
windfall gains arising from the rise in world market prices and import duties to discourage conspicuous
consumption.
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The earnings from such export and import duties should be used for capital formation. In periods of
depression on the other hand, subsidies may be given to encourage exports and government should directly
intervene to maintain the level of effective demand through public work programmes etc.
Thus, contra-cyclical fiscal policy should be followed to mitigate the effects of international cyclical
movements and all out efforts should be made to develop all sectors of the economy so as to reduce an
excessive dependence on the primary sector alone. Hence a well-devised fiscal policy can go a long way in
promoting economic stability.
4.Reforms in India’s Fiscal Policy and Its Performance
Fiscal policy is a critical component of the policy framework pursued since the initiation of economic
reforms in India in 1991 to achieve the objectives of economic growth, price stability and equity.
To achieve these objectives, it was necessary to raise more resources through taxation and restrain the
growth of unproductive and non-plan expenditure.
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During the mid-nineties there was set back in this policy when Fifth Pay Commission’s recommendations of
sharp hike is wages and salaries were accepted resulting in large increase in non-plan government
expenditure and consequently rise is fiscal deficit.
4.1But since 2001-02, the Central Government has continued to follow prudent fiscal policy
comprising:
(i) Balanced tax structure of direct and indirect taxation based on moderate tax rates with minimum
exemptions covering a wider class of tax payers and
(ii) An expenditure policy that aims to restrain the growth in non-developmental expenditure and adequately
provide for pressing social and infrastructure needs of a developing economy.
In the last some budgets, especially the budgets for the years 2005-06,2006-07, 2007-08,2010-11, 2011-12
and 2012-13 the fiscal strategy for achieving the above stated objectives has been primarily revenue led
without expenditure compression. However, within the limits of fiscal deficit set under Fiscal Responsibility
and Budget Management (FRBM) Act passed in 2003-04, there has been reprioritization of public
expenditure along with revenue-ted strategy of fiscal consolidation.
To raise more revenue for achieving growth with macroeconomic stability, tax-GDP ratio has been sought to
be raised. As a result of tax effort made for mobilisation of tax-GDP ratio rose to 12.6 per cent (for both the
centre and states combined) in 2007-08. For this purpose various tax reforms both in the spheres of direct
and indirect taxes have been carried out. It is felt that while the policy of moderate tax rate; have to be
followed, the base of taxation has to be broadened.
With this end in view the tax reforms undertaken since the beginning of nineties have sought to bring about a
compositional shift in the structure of the tax system away from the excessive dependence on regressive
indirect taxes to progressive direct taxes for raising resources for accelerating economic growth with
stability. Besides, to ensure competitiveness of the products of Indian industry excise duties and custom
duties have been reduced so that rapid growth of Indian exports is possible.
Moreover customs duties were reduced to open up the Indian economy and to obtain gain from free trade. To
compensate for this and realizing that more than per cent of India’s GDP came from services, service tax was
levied which has now become an important source of Government revenue. In 2013-14 service tax was
expected to yield Rs. 1.30 lakh crore (BE).
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4.2 Cent’s fiscal position table
(As per cent of GDP at current market price)
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Particular 2001 2004- 2005- 2006- 2007 2008- 2009- 2010 2011- 2012-
-02 05 06 07 -08 09 10 -11 12 13
Reverse receipts(a+b) 8.8 9.6 9.4 10.1 11.0 9.7 8.8 10.1 8.4 9.3
(a) Tax revenue 5.9 6.9 7.3 8.2 8.8 7.9 7.0 7.3 7.0 7.7
(net of sales
share)
(b) Non-tax 3.0 2.5 2.1 1.9 2.1 1.7 1.8 2.8 1.4 1.6
revenue
Revenue expenditure 13.2 11.9 11.9 12.0 11.9 14.2 14.1 13.4 12.7 12.8
(a) Interest 4.7 3.9 3.6 3.5 3.5 3.4 3.3 3.0 3.0 3.2
payments
(b) Major 1.3 1.4 1.2 1.2 1.4 2.2 2.1 2.1 1.6 1.8
subsidies
(c) Defence 1.7 1.4 1.3 1.2 1.1 1.3 1.4 1.2 1.1 1.1
expenditure
Revenue deficit (2-1) 4.4 2.4 2.5 1.9 1.1 4.5 5.1 3.2 4.3 3.5
Capital receipts (a+b+c) 7.1 5.9 4.3 3.5 3.4 6.2 7.0 5.2 6.0 5.5
(a) Recovery of 0.7 1.1 0.3 0.1 0.1 0.1 0.1 0.2 0.2 0.1
loan
(b) Other receipt 0.2 0.1 0.0 0.0 0.8 0.0 0.4 0.3 0.2 0.3
(mainly put
disinvestment)
© Borrowing and other 6.2 3.9 4.0 3.3 2.5 6.0 6.5 4.8 5.7 5.1
liabilities
Capital expenditure 2.7 3.5 1.8 1.6 2.4 1.6 1.7 2.0 1.8 2.0
Total expenditure
Total expenditure 15.9 15.4 13.7 13.7 14.3 15.8 15.8 15.4 14.5 14.9
(2+5=6(a)+6(b) of which
(a) Plan 4.4 4.1 3.8 4.0 4.1 4.9 4.7 4.9 4.6 5.2
expenditure
(b) Non-plan 11.4 11.3 9.9 9.6 10.2 10.9 11. 1 10.5 9.9 9.7
expenditure
Fiscal deficit 6.2 3.9 4.0 3.3 2.5 6.0 6.5 4.8 5.7 5.1
[6-1-4(a)=8(a)+8(b)]
Primary deficit 1.1 0.0 0.4 -0.2 -0.9 2.6 3.2 1.8 2.8 1.9
[7-2(a)=8(a)+8(b)]
(a) Primary deficit 1.6 0.0 0.0 -0.7 -1.6 1.7 _ _ _ _
consumption
(b) Primary deficit -0.1 0.0 0.4 0.5 0.7 0.8 _ _ _ _
investment
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However, as stated above, to achieve fiscal consolidation (i.e., reduction of fiscal deficit) for controlling
inflation and ensuring release of resources for economic growth and employment generation, raising revenue
from taxation has been given priority along with improving the quality of public expenditure (that is,
restraining the growth of non-developmental expenditure and raising plan expenditure).
Since, much of public expenditure is of committed nature such as interest payments for servicing past public
debt, expenditure on defence, pensions and wages and salaries of government employees, there is very little
room for compression of expenditure in the short run, the objective of accelerating growth and employment
generation have to be achieved by raising revenue and improving the quality of expenditure.
However, in the financial year 2012-13 in order to contain fiscal deficit, Finance Minister, Mr. Chitambram
reduced planned expenditure by Rs. 90,000 crore which worked to reduce rate of economic growth. In what
follows we first explain the reforms in both direct and indirect tax systems that have been undertaken in the
last two decades.
Reforms in Direct Taxation:
It is important to note that over the last two decades, there has been a significant reform in the tax system so
that it can make larger contribution to resource mobilisation for economic growth and at the same time
serves the objective of achieving equity as well. First, in the sphere of direct taxation rate of income and
corporation taxes have been lowered to moderate levels.
With lower tax rates revenue buoyancy from these taxes can be achieved through better compliance and
minimal exemptions. Until the early eighties, direct tax rates were exorbitant, evasion of these taxes was
rampant which gave birth to the enormous black money in the Indian economy.
It was realised that moderate rates of these taxes would yield more revenue by increasing tax compliance.
Lower rates of direct taxes also provide incentives to work more, save more and invest more as lower rates
increases after-tax returns on work, saving and investment. Long-term fiscal policy announced in 1985
rightly emphasised that “a broader base of taxation combined with moderate rates of taxes and strict
enforcement, can yield better revenue results”.
Acting on the long-term fiscal policy V.P. Singh in his 1985-86 budget cut the maximum marginal rate of
income tax to 50 per cent and reduced personal income tax slabs from eight to four. Seven years later Dr.
Manmohan Singh reduced the maximum marginal income tax rate to 40 per cent in his budget for 1992-93
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and reduced the personal income tax slabs to only three. Mr. Chidambaram in his dream budget 1997-98
further reduced top marginal rate of income tax to 30 per cent. Moreover, education cess of 3 per cent has
been levied on both income tax and corporation tax.
As regards corporation tax, acting on the Chilliah Committee recommendations Dr. Manmohan Singh
attempted rationalisation of corporate taxation and cut the corporation tax rate to 40 per cent and reduced
exemptions in 1994-95 budget to broaden the base of the tax. Three years later Mr. Chidambaram further
reduced corporation tax to 35 percent in his budget for 1997-98 and again as Finance Minister in UPA
Government he further reduced the corporation tax rate to 33 per cent in 2004-05 budget.
However, to broaden the base of corporation tax so as to increase tax revenue he lowered the depreciation
allowance from 25 per cent to 15 per cent in 2007-08. Besides, to raise revenue from corporate taxation,
fringe benefit tax (FBT) was levied payable by corporate employee.
Besides, Minimum Alternate tax (MAT) which was fixed at 7.5 per cent to 10 of book profits of the
corporate companies has now been raised to 18.5 per cent in 2011-12 budget and long-term capital gains
have been included in the book-profits. Further, securities transaction tax (STT) has been levied on the sale
and purchase of shares/securities.
It is thus evident from above that in the last over two decades, efforts have been made to move to moderate
direct tax rates and broaden the base of direct taxation by withdrawing certain exemptions. This has
improved the compliance to pay taxes and resulted in increase in revenue from direct taxes. However, there
is still a vast potential for revenue buoygency of direct taxes since there are still a large number of
exemptions, for example, in case of various types of financial savings and exports.
As recommended by the Task Force headed by R. Vijay Kelkar, more resources can be mobilized from direct
taxes if a large number of existing exemptions which have outlived their utility are withdrawn and direct tax
system is simplified and made transparent. It is now proposed to implement direct tax code without much
exemptions which is now awaiting the approval of parliament.
An important outcome of fiscal policy pursued after 2002-03 was decline in fiscal deficit till 2007-08 which
helped to keep inflation rate at around 5 per cent per annum as measured by WPI of all commodities. It will
be seen from Table 33.1 that fiscal deficit which was 6.2 per cent of GDP in 2001 -02 fell to 2.5 per cent in
2007-08, but again rose to 6.5 percent in 2009-10 due to fiscal stimulus package adopted to prevent
slowdown of the Indian economy due to global financial crisis. High fiscal deficit of the order of 6 per cent
and more is bad and against fiscal prudence.
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Fiscal deficit can be either financed by the Government monetisation, that is, printing of new money by RBI
or by borrowing from the market. Monetisation of fiscal deficit is avoided as it leads to inflation in the
economy. The excessive Government borrowing is also had because it causes increase in public debit which
raises the burden on future generations. Besides, excessive Government borrowing from the banks dries up
banking resources for the private sector, that is, reduces the availability of credit for the private sector.
Further, Government borrowing from the market tends to raise interest rate. Higher interest rate causes
increase in cost of credit for the private sector which impinges on their profit margins. Therefore, on the
recommendation of IMF, Fiscal Responsibility and Budget Management (FRBM) Act was passed in 2003-
04.
After this, fiscal deficit consistently declined to 4.0 per cent of GDP in 2005-06 and to 2.6 per cent in the
year 2007-08. This decline in fiscal deficit in these years was achieved by reducing revenue deficit from 4.4
percent of GDP in 2001-02 to 2.5 percent in 2005-06 and further to 1.1 per cent in 2007-0& on the one hand
and restraining the growth of expenditure (See Row 6 of Table 33.1), especially non-plan expenditure.
Under Fiscal Responsibility and Budget Management Act (FRBMA) it was planned to eliminate revenue
deficit completely by 2008-09 and fiscal deficit to be reduced to 3 per cent of GDP in 2008-09. This was
expected to release more resources for economic growth and social sector development.
However, fiscal deficit rose to 6.0 per cent of GDP in 2008-09 and to 6.5 per cent of GDP in 2009-10. This is
because to fight economic slowdown following the intensification of global financial crisis in 2008, the
Central Government came out with fiscal stimulus programmes wherein Government expenditure had to be
increased and indirect taxes reduced to keep the momentum of economic growth.
However, it was reduced by the 4.8 per cent in 2010-11 and to 4.6 per cent of GDP in 2011 -12, but it again
rose to 5.7% of GDP in 2011 -12 and 5.1 % in 2012-13. In his budget for 2013-14, the Finance Minister has
set the target of fiscal deficit for 2013-14 at 4.8% of GDP.
Changes in Taxation Structure: Increase in Share of Direct Taxes:
It is interesting to note that tax-GDP ratio which rose to 11.9 per cent in 2007-08 declined to 10.8% and 9.6
per of GDP in 2008-09 and 2009-10 respectively due to lowering of indirect taxes in 2008-09 and 2009-10 to
prevent large economic slowdown. Besides, there has been also improvement in the taxation structure (See
Table 33.2). While there has been decline in the share of regressive and resource-distorting indirect taxes in
the revenue of the Central Government, there is rise in the share of direct taxes.
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Thus, as will be seen from Table 33.2, whereas the share of direct taxes as per cent of GDP rose from 2.8%
in 1995-96 to 5.9 percent in 2007-08, the share of indirect taxes (customs duties, excise duties and service
tax) as per cent of GDP fell from 6.4 per cent in 1995-96 to 5.6 per cent in 2007-08 and further to 3.8% in
2009-10 but for 2012-13 it was budgeted to rise to 5% of GDP. On the other hand, the share of direct tax as
percentage of GDP which was 3% of GDP rose to 5.6 per cent of GDP in 2012-
4.3 Share of Direct and Indirect taxes in central government’s Revenue :
Tax Revenue as percent of GDP
Taxes 1995- 2001- 2004- 2006- 2007- 2008- 2009- 2010- 2011- 2012-
96 02 05 07 08 09 10 11 12 13
Direct (a) 2.8 3.0 4.1 4.3 5.9 5.7 5.7 5.6 5.5 5.6
Personal 1.3 1.4 1.5 1.5 2.1 1.9 1.9 1.8 1.9 1.9
income tax
Corporation 1.4 1.6 2.6 2.6 3.9 3.8 3.8 3.8 3.6 3.7
tax
Indirect (b) 6.4 5.1 5.3 5.4 5.6 4.8 3.8 4.4 4.4 5.0
Customs 3.0 1.8 1.8 1.8 2.1 1.8 1.3 1.7 1.7 1.9
Excise 3.4 3.2 3.1 3.0 2.5 1.9 1.6 1.8 1.6 1.9
Service tax 0.1 0.1 0.4 0.6 0.9 1.1 0.9 0.9 1.1 1.2
Gross tax 9.4 8.2 9.4 9.9 11.1 11.9 10.8 10.2 9.9 10.7
revenue
1. Direct taxes also include taxes pertaining to expenditure, interest, wealth, gift and estate duty.
2. The ratios to GDP at current market price are based on the CSO’s National Accounts 2004-05 series.
This change in tax structure a creditable achievement of mobilising resources from direct taxes, as this has
been done despite the fact that rates of both personal income tax and corporation tax have been substantially
reduced. This will also ensure equitable distribution of burden of overall tax among the people.
Reforms in the Indian Indirect Tax System:
The Indian indirect tax system as it existed in the early nineties had several drawbacks. First, the excise
duties and sales tax were levied on inputs which had a cascading effect on raising prices of final products. In
a way, there is ‘a tax on tax’. As regards sales tax which is levied by State governments, a uniform value
added tax (VAT) is proposed to be levied. VAT tax will replace different rates of sales tax levied by the state
governments. Legislation has already been enacted but its implementation was deferred due to protest by
traders and due to general elections in April 2004.
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Now, as per decision of UPA government VAT has come into effect from April 1, 2005. Implementation of
VAT will eliminate the cascading effect of sales tax and also help in achieving price stability. The experience
of Haryana and Delhi which have implemented VAT shows that government revenue increased when VAT
was introduced.
Reforms in Excise Duty:

To rationalise the indirect tax system at the centre by removing distortion in the structure there is a need to
remove multiplicity of tax rates of central excise duties on various goods and services. With tax reform
initiated since 1991, this has been now achieved with few exceptions.
Now, there is a single excise duty called CENVAT (which is in the form of value added tax) at the rate of 16
per cent on all products which enter a production chain. The argument for a single 16 per cent CENVAT is
that it will remove the distortions in the tax system as a result of multiplicity of rates of excise duties.
This is of course a correct approach in general but in the view of the present author the final consumption
goods of the nature of income-elastic luxuries such as cars and air conditioners should be taxed at a much
higher rate than CENVAT.
This will enable the government to raise more revenue without harming production incentives and will thus
serve well the equity objective. To simplify the indirect tax system, it is now planned to introduce Goods and
Services Tax (GST) in near future. This GST will replace the service tax Central CENVAT and states VAT
and a uniform rate of GST by all states will be fixed.
Revenue Mobilisation through Service Tax:

While the revenue from existing three sources, namely, direct, excise and customs taxes, is expected to
increase by ensuring greater tax compliance and withdrawal of exemptions, the government seeks to collect
more revenue from service tax by bringing more services under its net. Over the last four decades there has
been a structural change in the Indian economy with relative contribution of agriculture to GDP significantly
decreasing and of services sector sharply increasing to 54 per cent of GDP.
With more services which have been brought within the service tax net in the last four budgets for the years,
2004-05, 2005-06, 2006-07, 2007-08 the total number of services on which service tax is levied has risen to
more than 100. In the year 2013-14 service tax was expected to bring in about Rs. 1.80 lakh crore (BE).
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It is now well recognized that for more revenue mobilisation as well as for achieving equity and price
stability there is a need to look at the whole value addition chain covering both goods and services from the
viewpoint of taxation. Government intends to expand the scope of taxation of services by not only bringing
additional services within the tax net, but also covering a larger number of assesses under the service tax.
Reforms in Customs Duties:

Since the early nineties revenue from customs duties as a percentage of GDP has been falling due to the
reduction in customs duty rates following the policy of trade liberalisation. Dr. Manmohan Singh, the
Finance Minister in his five budgets between 1991 and 1996 reduced India’s absurdly high customs duties.
He reduced peak tariff rates from over 200 per cent to 50 per cent and the import weighted average tariff rate
from over 80 per cent to below 30 per cent. Since 1996, successive finance ministers further reduced the
peak trifurcate (i. e. customs duty) first to 35 per, and then to 20 per cent in Jan. 2004.
The peak rate of customs duty has been further reduced to 15 per in 2005-06 and to 12.5 per cent in 2006-07
and to 10 per cent in 2007-08. But there are several exceptions to this peak rate. It is now planned to reduce
the peak customs duties to the ASEAN level. Though India is committed to reduce tariff duties under trade
liberalisation agreement of WTO, we should try to provide effective protection to some of our crucial
industries such as textiles and agriculture by fixing higher customs rates than peak customs duty making a
cause for their exceptional treatment.
It is quite surprising to note that Kelkar Task Force on implementation of Fiscal Responsibility and
Budgetary Management Act (FRBMA) proposed a shift to a three rate structure on customs duties consisting
of 5 per cent, 8 per cent and 10 per cent. In our view this is going too far in trade liberalisation. This will
involve not only a loss of tax revenues but will also reduce effective protection to Indian industries.
Changes in Quality of Expenditure:
Changes in pattern of expenditure is also worth mentioning. It will be seen from Table 33.4 that prior to
2007-08 through the adoption of prudent fiscal policy the Government had been able to reduce total
expenditure both revenue and capital, which as percentage of GDP fell from 17.3 per cent in 2001-02 to 15.4
per cent in 2004-05 and further fell to 13 .6 per cent in 2006-07, and rose marginally to 14.1% in 2007-08.
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As compared to plan-expenditure which as a percent of GDP rose from 3.8 per cent in 2005-06 to 4.9% in
2008-09 and 5.3% in 2009-10 non-plan expenditure fell sharply from 12.3 per cent of GDP in 2002-03 to
9.7% in 2006-07 and to 10.3 per cent in 2007-08. It is only in 2008-09 and 2009-10 that due to need of
increasing public expenditure to overcome recession or slowdown of the Indian economy and to keep the
growth momentum that non-plan expenditure slightly increased to 10.9% and 11.3% in 2008-09 and 2009-10
respectively (See Row 6 (a) and 6 (b) of Table 33.1.
Further, as seen from Table 33.4 that Government has succeeded in restraining the growth of non-
development expenditure incurred on interest payments, major subsidies and defense till 2007-08. It is only
in 2008-09 and 2009-10 under well-designed contra-cyclical policy that Government increased its
expenditure and borrowed heavily for this purpose to fight slowdown of the Indian economy and to keep the
growth
Type of 1990- 2001- 2002- 2003- 2004- 2005- 2006- 2007- 2008- 2009- 2010- 2011-
expenditure 91 02 03 04 05 06 07 08 09 10 11 12
Total public 17.3 15.9 16.3 15.5 15.4 13.6 13.6 14.4 15.7 15.8 15.4 14.5
expenditure
Interest 3.8 4.7 4.8 4.5 3.9 3.6 3.5 3.5 3.4 3.3 3.0 3.0
payments
Major 1.7 1.3 1.7 1.6 1.4 1.2 1.2 1.4 2.2 2.1 2.1 1.6
subsidies
Defence 1.9 1.7 1.7 1.6 1.4 1.3 1.2 1.1 1.3 1.4 1.2 1.1
revenue
expenses
momentum.
This resulted in increase in expenditure on interest and subsidies. As plan expenditure represents
development expenditure and non-plan expenditure represents non-development expenditure, the changes
witnessed in the pattern of expenditure therefore show improvement in the quality of expenditure.
4.4 Public Expenditure On Some Important Items
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achieving 8 per cent rate of growth in GDP on a sustained basis, it is necessary to step-up public investment
expenditure on agriculture and infrastructure. This requires to effect a shift in the composition of total
expenditure in favour of capital expenditure. This can be done only if revenue deficit is bridged by raising
more resources through taxation on the one hand and cutting non-plan expenditure on the other.
One of the major objectives of Fiscal Responsibility and Budget Management (FRBM) Act, 2003 was to
eliminate revenue deficit by the year 2008-09. With revenue deficit reduced to zero, But in 2008-09 partly
due to fiscal stimulus in which tax cuts were made and government expenditure increased to maintain the
growth momentum and partly due to the populist programme such as waiving loans of farmers to the time of
Rs.70,000 crore the target of zero revenue deficit was not achieved.
As a result revenue deficit which was lowered to 1.1 per cent of GDP in 2007-08 went up to 4.6 per cent in
2008-09. Therefore, the expectation that with zero revenue deficit, the government would be able to increase
capital expenditure for investment in agriculture, industry and infrastructure was not realised. Large revenue
deficit is quite bad because large expenditure incurred on revenue account does not lead to creation of
durable assets which are essential to sustain growth.
Thus, what is a matter of concern is the decline in capital expenditure which mostly represents investment
expenditure in physical assets. As a proportion of GDP, fall in total government expenditure from a level of
17.1 percent in2003-04 to 14.4 per cent in 2007-08 was largely driven by the steep fall in capital expenditure
with revenue expenditure remaining almost steady between 2004-05 and 2007-08 (see rows 5 and 6 in Table
33.1).
It may be however noted that revenue expenditure includes some expenditure on social sector (mainly
elementary education and literacy) under Sarv Shiksha Abhiyan and Mid-day Meals; health and family
welfare (National Rural Health Mission), rural employment, and physical infrastructure including rural roads
which are also of developmental nature. Even accounting for these the fact remains that fall in capital
expenditure is disturbing and must be reversed.
As regards expenditure on subsidies, the government’s recent policy is to make them targeted to the poor and
weaker sections of the society. To ensure that benefits of expenditure on subsidies are not usurped by those
not intended be the beneficiaries of these subsidies. Delivery mechanism for providing these subsidies
should be improved and made more efficient.
Under NCMP, Government is committed to control inefficiencies that increase the food subsidy burden and
to target all subsidies sharply at the poor and the truly needy like small and marginal farmers, farm labour
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and the urban poor. To reduce expenditure on subsidies government has raised the price of cooking gas and
restricted its use by a family to 9 cylinders per year. Besides, it has decontrolled petrol and raising price of
diesel by 50 paise every month. However, due to enactment of Food Security Bill, its expenditure on food
subsidy will rise.
Reduction in Fiscal Deficit:
A large fiscal deficit has been a major macro-economic problem. It is persistent large fiscal deficits in the
nineteen eighties that landed the Indian economy in a state of severe economic crisis reflected in the acute
balance of payments problem.
This acute economic crisis compelled us to approach IMF for help to tide over the crisis. Fiscal deficit is the
difference between the total government expenditure on revenue and capital accounts and the total sum of
revenue receipts and non-debt capital receipts. Thus fiscal deficit measures the total borrowing from the
market, net borrowing from the Reserve Bank of India (i.e. monetisation of deficit), small savings and
external assistance (i.e. borrowing from abroad at concessional rate of interest).
For the achievement of macroeconomic stability, fiscal deficit should not exceed 3 per cent of GDP. Fiscal
Responsibility and Business Management (FRMB) Act 2003 has prescribed to achieve the target of fiscal
deficit to 3 per cent of GDP by the year 2008-09. This is generally called fiscal consolidation. But how this
fiscal consolidation, that is, reduction in fiscal deficit is to be achieved so as to achieve economic growth
with stability and equity. Thiscan be done by raising tax-GDP ratio on the one hand and reducing non-plan
expenditure on the other.
Tax-GDP ratio can be raised by widening the base of direct taxes, especially personal income tax and
corporation tax. One important way of broadening the base of the direct taxes is to withdraw many of such
exemptions which have outlived their utility and are merely used to evade these taxes.
As result of these exemptions, the effective rate of corporation tax is much smaller. Economic Survey 2005-
06 found that 40 per cent of corporate companies pay only 10 per cent or less corporation tax as against 30
per cent levied on them. This has also been found by Task Force headed by Vijay Kelkar.
It is interesting to note that because of these exemptions Reliance Industries which made huge profits
throughout its career did not pay any corporation tax for several years. Similarly, many other profitable
companies also took advantage of these exemptions and did not pay any tax for several years. Therefore, the
Central government enacted’ Minimum Alternative Tax (MAT) according to which these profitable
companies which did not pay corporation tax would have to pay this minimum alternative tax.
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The efforts have been to raise more resources through levying new taxes in order to reduce fiscal deficit. The
introduction of service tax in 1994-95 ushered in a major change in indirect taxes in the (BE) form of wider
base and facilitated the process of rationalization of excise duties resulting in lower tax burden on productive
sectors. Over the years, the number of services subject to service tax has increased and now stands at around
114. However, a further reform in the indirect tax system in the form of Goods and service tax (GST) is to be
introduced from April 2012.
It is also worth noting that long-term capital gains from shares has been exempted in the budget w. e .f.
2004-05 and has been replaced by Securities Transaction Tax. Along with it, short-term capital gains tax was
reduced from 20% to 10%. This is quite contrary to broadening the tax base. Indeed, there is good economic
case for imposing a tax on long-term capital gains on shares, its rate may be kept lower than the general
income tax rate because of the risk involved in investing funds in equity capital.
The total abolition of capital gains tax on equity capital will introduce large distortions (relative to capital
gains from other assets) and also results in loss of revenue for the government. This loss is unlikely to be
made up by levying a small securities transaction tax.
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5. The Fiscal Policy Overview, Budget and government Role
External Affiars and Finance Minister Pranab Mukherjee on Monday said the government cannot indulge in
'reckless borrowing' and did not have Parliamentary mandate to tweak taxes.
The following is the government's fiscal policy strategy statement that the finance minister announced in
Parliament.
5.1 Fiscal Policy Overview
1. The Union Budget 2008-09 was presented in the backdrop of impressive growth in the Indian economy
which clocked about 9 per cent of average growth in the last four years.
This striking performance coupled with significant improvement in fiscal indicators, during the Fiscal
Responsibility and Budget Management (FRBM) Act, 2003 regime definitely put the country on a higher
growth trajectory inspiring confidence in the medium to long term prospects of the economy. The process of
fiscal consolidation during these years has resulted in improvement in fiscal deficit from 5.9 per cent of GDP
in 2002-03 to 2.7 per cent of GDP in 2007-08. During the same period, revenue deficit has declined from 4.4
per cent to 1.1 per cent of GDP.
In tune with the philosophy of equitable growth, the process of fiscal consolidation was taken forward
without constricting the much-required social sector and infrastructure related expenditure.
This improvement in the state of public finances was achieved through higher revenue buoyancy, driven by
efficient tax administration and improved compliance which is evident from increase in the tax to GDP ratio
from 8.8 per cent in 2002-03 to 12.5 per cent in 2007-08.
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2. Riding on the path of fiscal consolidation, the Union Budget 2008-09 was presented with fiscal deficit
estimated at 2.5 per cent of GDP and revenue deficit at 1 per cent of GDP.
However after the presentation of the Union Budget in February 2008, the world economy was hit by three
unprecedented crises -- first, the petroleum price rise; second, rise in prices of other commodities; and third,
the breakdown of the financial system.
The combined effect of these crises of these orders are bound to affect emerging market economies and India
was no exception. The first two crises resulted in serious inflationary pressure in the first half of 2008-09.
The focus of the monetary as well as fiscal policy shifted from fuelling growth to containing inflation, which
had reached 12.9 per cent in August, 2008.
Series of fiscal measures both on tax revenue and expenditure side were undertaken with the objective of
easing supply side constraints. These measures were supplemented by monetary initiatives through policy
rate changes by the Reserve Bank of India, and contributed to the softening of domestic prices.
Headline inflation fell to 4.39 per cent in January, 2009. However, the fiscal measures undertaken through
tax concessions and increased expenditure on food, fertiliser and petroleum subsidies along with increased
wage bill for implementing the Sixth Central Pay Commission recommendations significantly altered the
deficit position of the Government.
3. The global financial crisis in the second half of the financial year which heralded recessionary trends the
world over, also impacted the Indian economy causing the focus of fiscal policy to be shifted to providing
growth stimulus.
The moderation in growth of the economy and the impact of the fiscal measures taken to stimulate growth
can be seen reflected in the estimates for gross tax revenue which stand reduced from Rs 6,87,715 crore in
B.E.2008-09 to Rs 6,27,949 crore in R.E.2008-09.
Additional budgetary resources of Rs.1,50,320 crore provided as part of stimulus package and various
committed liabilities of Government including rising subsidy requirement, provision under NREGS,
implementation of Central Sixth Pay Commission recommendations and Agriculture Debt Waiver and Debt
Relief Scheme for Farmers contributed to the higher fiscal deficit of 6 per cent of GDP in RE 2008-09 as
compared to 2.5 per cent of GDP in B.E.2008-09.
4. The Country is facing difficult economic situation, the cause of which is not emanating from within its
boundaries. However, left unattended, the impact of this crisis is going to affect us in medium to long term.
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The Government had two policy options before it. In view of falling buoyancy in tax receipts, the
Government could have taken a decision to cut expenditure and thereby live within the estimated deficit for
the year.
The second option was to increase public expenditure, even with reduced receipts, to stimulate economy by
creating demand and maintain the growth trajectory which the country was witnessing in the recent past.
The Government took the second option of adopting fiscal measures to increase public expenditure to boost
demand and increase investment in infrastructure sector.
Ensuring revival of the higher growth of the economy will restore revenue buoyancy in medium term and
afford the required fiscal space to revert to the path of fiscal consolidation.
5.2. Fiscal Policy for the ensuing financial year
The Interim Budget 2009-2010 is being presented in the backdrop of uncertainties prevailing in the world
economy. The impact of this is seen in the moderation of the recent trend in growth of the Indian economy in
2008-09 which at 7.1 per cent still however makes India the second fastest growing economy in the World.
The measures taken by Government to counter the effects of the global meltdown on the Indian economy,
have resulted in a short fall in revenues and substantial increases in government expenditures, leading to a
temporary deviation from the fiscal consolidation path mandated under the FRBM Act during 2008-09 and
2009-2010.
The revenue deficit and fiscal deficit for R.E.2008-09 and B.E.2009-2010 are, as a result, higher than the
targets set under the FRBM Act and Rules.
The grounds due to which this temporary deviation has taken place, are detailed in the Fiscal Policy
Overview above and also in the Macro-economic Framework Statement being presented in the Parliament.
The fiscal policy for the year 2009-2010 will continue to be guided by the objectives of keeping the
economy on the higher growth trajectory amidst global slowdown by creating demand through increased
public expenditure in identified sectors.
However, the medium term objective will be to revert to the path of fiscal consolidation at the earliest, with
improvement in the economic situation.
Tax Policy
5.3Indirect Taxes
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During the first half of the fiscal year, the global spurt in commodity prices (crude petroleum, food items
and metals) led to increases in domestic prices of essential items and industrial inputs, putting a severe
inflationary pressure on the economy.
Hence, the Government took several measures after the presentation of the Union Budget 2008-09,
particularly on the Customs side, to contain the rising inflation, as detailed below:-
5.4Customs
 On 21.3.2008, to curb the inflationary trends in the economy arising out of a rise in prices of food items,
a sharp reduction was effected in the import duty rates on various food items such as semi-milled or wholly
milled rice (70% to nil) and crude and refined edible oils (from 40%-75% to 20%-27.5%). On 01.04.2008, a
further reduction was effected in the import duty rate- on all crude edible oils duty was reduced to nil, and on
refined edible oils duty was reduced to 7.5%.
 Export duty of Rs 8,000 PMT was imposed on exports of Basmati rice with effect from 10.5.2008.
 With effect from 10.5.2008, import duties on crude petroleum was reduced to nil and on petrol and diesel
to 2.5% (earlier 7.5%). Customs duty on other petroleum products was reduced from 10% to 5% on
04.06.2008.
 Import duties were reduced to nil on many iron and steel items as well as on specified inputs for this
sector (zinc, ferro-alloys, metcoke) on 29.4.2008. Further, in order to increase the domestic availability and
bring about moderation in prices, export duties were imposed on many items in the iron and steel sector @
15% ad valorem on pig iron, sponge iron, iron and steel scrap, iron or steel pencil ingots, semi finished
products and HR coils/sheets, etc.
 On 08.07.2008, raw cotton was also fully exempted from customs duties so as to contain the prices of raw
cotton and augment the domestic supply.
Excise
 With effect from 04.06.2008, excise duty on unbranded motor spirit (MS) was reduced from Rs 6.35 per
litre to Rs 5.35 per litre and on unbranded high speed diesel (HSD), excise duty was reduced from Rs 2.6 per
litre to Rs 1.6 per litre. In the post-October stage, while the inflationary pressures on the economy were
subdued, the global meltdown and resultant slowdown of the Indian economy required review of the existing
policy in favour of maintaining the growth momentum and retaining export markets. As such, the following
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policy changes were effected which would be reviewed in the ensuing financial year in the light of the
macroeconomic situation particularly the growth of the manufacturing sector:
Excise
 With effect from 07.12.2008, a fiscal stimulus package was implemented.
 As part of this package, Government implemented an across-the board reduction of 4 percentage points in
the ad valorem rates of excise duty on non-petroleum items, with a few exceptions. Thus the three major ad
valorem rates of Central Excise duty viz. 14%, 12% and 8% have been reduced to 10%, 8% and 4%,
respectively.
 The specific rates of duty applicable to cement and cement clinker were also reduced proportionately.
Customs
 Export duties on iron and steel items were withdrawn w.e.f. 31.10.2008.
 Aviation turbine fuel was fully exempted from basic customs duty for the benefit of the aviation industry
w.e.f. 31.10.2008.
 In addition, to provide a level playing field to the domestic industry, some customs duty exemptions
provided earlier to combat inflation, on iron and steel items, zinc and ferro-alloys, were withdrawn w.e.f.
18.11.2008.
 As an incentive to the infrastructure sector, the CVD and Special CVD exemption granted to imports of
cement has been withdrawn w.e.f. 2nd January, 2009 to provide a cushion to domestic cement industry and
boost demand.
 In the power sector, customs duty on naphtha used for generation of electricity by electrical generating
stations has been fully exempted w.e.f. 2nd January, 2009 till the end of this financial year.
5.5Service Tax
 The refund of service tax paid by exporters on various taxable services attributable to export of goods has
been further extended to include clearing and forwarding agents services.
 The upper limit of refund of service tax paid by exporters on foreign commission agent services has been
enhanced from 2% of FOB value to 10% of FOB value of export goods.
 Drawback benefit can now be availed of simultaneously with refund of service tax paid in respect of
exports.
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 In order to mitigate the genuine hardships of goods transport agencies, eight specified services which are
provided to goods transport agency have also been fully exempted from service tax.
5.6Direct Taxes
1.Over the last five years, widespread reforms have been ushered in the area of direct taxes. The reform
strategy comprises the following elements: -
 Minimizing distortions within the tax structure by expanding the tax base and rationalizing the tax rates.
 Enabling the tax administration to provide quality taxpayer services and also enhance deterrence levels.
Both these objectives reinforce each other and have promoted voluntary compliance.
 Re-engineering business processes in the Income-tax Department through extensive use of information
technology, viz., e-filing of returns; issue of refunds through ECS and refund bankers; selection of returns
for scrutiny through computers; e-payment of taxes; establishing a Centralized Processing Centre and an
effective taxpayer information system. These measures have substantially enhanced the direct tax revenue
productivity from 3.81 per cent of GDP in 2003-04 to an estimated 6.35 per cent of GDP in 2008-09.
Further, the share of direct taxes in the Central tax revenues is now significantly higher than the share of
indirect taxes resulting in a substantial improvement in the equity of the tax system. Therefore, the reform
strategy in the medium term is to consolidate the achievements of the past.
2. Since there is no change in the tax base and rates, the prospects of growth in direct tax collection in the
ensuing financial year will remain unchanged vis-a-vis the revised estimate for the financial year 2008-09.
5.7Contingent and other Liabilities
1.The FRBM Act mandates the Central Government to specify the annual target for assuming contingent
liabilities in the form of guarantees. Accordingly the FRBM Rules prescribe a cap of 0.5 per cent of GDP in
any financial year on the quantum of guarantees that the Central Government can assume in the particular
financial year.
The Central Government extends guarantees primarily on loans from multilateral/bilateral agencies, bond
issues and other loans raised by various Public Sector Undertakings/Public Sector Financial Institutions.
The stock of contingent liabilities in the form of guarantees given by the government has reduced from Rs
1,07,957 crore at the beginning of the FRBM Act regime i.e. 2004-05 to Rs 1,04,872 crore at the end of
2007-08. As a percentage of GDP, it has reduced from 3.4 per cent in 2004-05 to 2.3 per cent in year 2006-
07 and further to 2.2 per cent for the year 2007-08.
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The disclosure statement on outstanding Guarantees as prescribed in the FRBM Rules, 2004 is appended in
the Receipts Budget as Annex 3 (iii).
2. Assumption of contingent liability in the form of guarantee by the sovereign helps to leverage private
sector participation in areas of national priorities. In the current situation, wherein a large number of
infrastructure projects are being cleared for implementation under the Public Private Partnership (PPP)
mode, difficulties are being faced in reaching financial closure due to the current uncertainties in the global
financial market.
Within the given fiscal constraints and with a view to supporting financing of above mentioned PPP projects,
the India Infrastructure Financing Company Limited (IIFCL) has been authorized to raise Rs 10,000 crore
through Government guaranteed tax free bonds, by the end of 2008-09 and additional Rs 30,000 crore on the
same basis as per requirement in the next financial year.
The capital so raised will be used by IIFCL to refinance bank lending of longer maturity to eligible
infrastructure projects. This initiative of the government is expected to result in leveraging of bank financing
to PPP programmes of about Rs one lakh crore.
The likely assumption of contingent liability in the form of guarantee for 2008-09, including the above
mentioned Rs 10,000 crore for IIFCL, will amount to Rs 36,606 crore which will be 0.67 percentage of GDP
during 2008-09, higher than the target of 0.5 per cent of GDP set under the FRBM Rules.
This deviation has been necessiated in the larger interest of re-invigorating the economy in the background
of the current economic scenario, to stimulate demand and increase investment in infrastructure sector
projects. In the medium term while this may not have a potential budgetary impact, the additional demand
thus created will help restore the economy to its higher growth path and contribute to higher revenue
buoyancy which has shown a slump in the current financial year due to moderation in the growth in
economy.
5.8Government Borrowings, Lending and Investments
1. The Government policy towards borrowings to finance its deficit continues to remain anchored on the
following principles namely (i) greater reliance on domestic borrowings over external debt, (ii) preference
for market borrowings over instruments carrying administered interest rates, (iii) elongation of the maturity
profile and consolidation of the debt portfolio and (iv) development of a deep and wide market for
Government securities to improve liquidity in secondary market.
2. In the first half of the current financial year, the government borrowing was in line with the indicated
auction calendar decided upon in consultation with the Reserve Bank of India.
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However, due to the need to provide the fiscal stimulus to counter the situation created by the effects of the
global financial crisis, the borrowing calendar of the government had to be revised in the second half of the
current financial year.
The gross and net market borrowings (dated securities and 364- day Treasury Bills) of the Central
Government during 2008-09 (up to February 9, 2009) amounted to Rs 2,40,167 crore and Rs 1,68,710 crore,
respectively. As part of policy to elongate maturity profile, Central Government has been issuing securities
with maximum 30--year maturity.
The weighted average maturity of dated securities issued during 2008-09 (up to February 9, 2009) was 14.45
years which was marginally lower than 14.90 years during the corresponding period of the previous year.
The weighted average yield of dated securities issued during 2008-09 (up to February 9, 2009) was 7.91 per
cent and was lower than 8.12 per cent during the corresponding period of last year.
3. Consequent to the transition to the FRBM Act mandated environment, recourse to borrowing from RBI
under normal circumstances is prohibited. During the year 2008-09 (up to February 7, 2009) the Central
Government resorted to ways and means advance to meet the temporary mismatch in receipts and
expenditure for 77 days as compared with 91 days a year ago.
The daily average utilization of ways and means advance by the Central Government was Rs 7,383 crore as
compared with Rs 14,498 crore a year ago. The Central Government also availed of Overdraft (OD) for 24
days up to February 7, 2009. The daily average of OD was Rs.11,233 crore as compared with Rs 6,381 crore
a year ago.
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6.REVIEW OF LITERATURE
6.1 Introduction:
The impact of scale and extent of government activity on economic growth has been significant. It is a
subject of great interest and controversy in every nation. Different countries have tried to examine impact of
key fiscal variables like taxes, expenditure and deficits on performance of their economy.
Tax policy is one of the most frequently used economic tools. By careful adoption of alternative policies; the
government is able to exert significant influence on resource allocation decisions. It is a matter of
controversy and there are no unanimous views among the economist regarding impact of various fiscal
incentives on performance of industry as well as economy.
The review of literature helped to identify objectives of the study by identifying gaps in existing research
done on the subject and allows understanding of various tools used by other researchers. Literature in global
and Indian context on different aspects of and issues related to the subject was undertaken which has been
covered in present chapter.
The review of literature has been classified under broad areas of fiscal policy, fiscal deficit, fiscal
consolidation, fiscal incentives, fiscal policy and exchange rate, fiscal restructuring, fiscal transfer and
reforms, MSMEs and fiscal incentives, SEZs and fiscal incentives, fiscal policy and Gujarat; and are
extensively referred to get insight and find gaps in literature to decide objectives for the present study.
6.2 Fiscal Policy:
Fiscal policy is concerned with raising government revenue and incurring of government expenditure. It
affects tax rate, interest rates and government spending in an effort to control the economy. Main objectives
of fiscal policy are development by effective mobilization of resources, efficient allocation of financial
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resources, reduction in inequalities of income and wealth, price stability and control of inflation,
employment generation, capital formation and increasing national income.
7.DATA ANALYSIS AND INTERPRETATION
The survey included 20 Respondents Of The State . It included both male and female. The
survey was conducted on few selected number of Respondents . The Respondent were from
different age, occupations, religion. The Respondent included businessman, professionals,
self- employed, and serviceman.
The survey sheet or the questionnaire was held to Respondent who filled in the information.
The information was regarding their socio-economic activities and general awareness related
to fiscal policy which was the main motive behind to conduct the survey.
The questionnaire included 10 questions. The customers were supposed to tick any one of
them in each question as their answer.
Observations or findings were derived after carefully analyzing the questionnaire. This
survey will help us to find the Awareness of the people of Fiscal policy in india.
Followings are the analysis of the data collected from the survey conducted on various
Sectors Respondents .
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1. ARE YOU AWARE ABOUT FISCAL POLICY SYSTEM.
Awareness of fiscal policy
No; 30.00%
Yes
No
Yes; 70.00%
DIAGRAMATICAL
REPRESENTATION:
INTERPRETATION :
From the above pie chart it can be observed that out of 20 respondents, 14 are given positive
response to the question , and 6 of them are given a negative answer for the same.
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2. DO YOU THINK FISCAL POLICY IS HELPFUL AND IMPORTANT FOR OUR COUNTRY.
DIAGRAMATICAL REPRESENTATION:
Important of fiscal policy
No; 20.00%
Yes
No
Yes; 80.00%
INTERPRETATION :
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3.DO YOU THINK FISCAL POLICY NEED ANY CHANGES.
Need for changes
No; 40.00% Yes

No
Yes; 60.00%
DIAGRAMATICAL
REPRESENTATION:
INTERPRETATION :
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4.ACCORDING TO YOU IMPOSING TAX ON EQUITY MUTUAL FUNDS IS WORTH.
Tax on mutual funds is worth
No; 20.00%
Yes
No
Yes; 80.00%
INTERPRETATION :
P a g e 78 | 88
5.DO YOU THINK FISCAL POLICY GET AFFECTED BECAUSE OF INCREASE IN RATE OF
CORRUPTION.
Affected by corruption
Yes; 30.00%
Yes
No
No; 70.00%
INTERPRETATION :
response to the question , and 14 of them are give a negative answer for the same.
P a g e 79 | 88
6. DO YOU THINK THAT FISCAL POLICY IS A INSTRUMENT WHICH CAN ACHIEVE A

NUMBER OF SOCIO-ECONOMIC OBJECTIVES.
Achievement of objectives
30.00%
Yes
No
70.00%
INTERPRETATION :
P a g e 80 | 88
7.DO YOU THINK WITH THE HELP OF FISCAL POLICY GOVERNMENT CAN ACHIEVE
OPTIMUM ALLOCATION OF RESOURCES.
Optimum Allocation of Resources
Yes
No; 50.00% Yes; 50.00% No
DIAGRAMATICAL
REPRESENTATION:
INTERPRETATION :
P a g e 81 | 88
8.DO YOU THINK EXPANSIONARY FISCAL POLICY CAN REDUCE HIGH UNEMPLOYMENT
AT THE TIME OF RECESSION.
Reduce unemployment
No; 40.00% Yes

No
Yes; 60.00%
INTERPRETATION:
P a g e 82 | 88
9.DO YOU THINK IN THE NEXT 5 YEARS THE GOVERNMENT BRING.
 BALANCE BUDGET
 SURPLUS BUDGET
Government budget
Surplus budget ;
30.00% Bal a nce budget
Surpl us budget
Balance budget ;
70.00%
INTERPRETATION :
From the above pie chart it can be observed that out of 20 respondents, 6 are looking surplus
budget , and 14 of them are looking for a Balance budget.
P a g e 83 | 88
10.WHICH POLICY DO YOU PREFER.
Preference Of Policy
Monetary policy ; Fi s cal pol i cy

40.00% Monetary pol i cy
Fiscal policy ;
60.00%
DIAGRAMATICAL
REPRESENTATION:
INTERPRETATION :
From the above pie chart it can be observed that out of 20 respondents, 12 of respondents
are prefer fiscal policy and reaming 8 will go with monetary policy.
P a g e 84 | 88
8.Conclusion
This essay traced the major developments in India‟s fiscal policy from the early stages of planned
development in the 1950s, through the country‟s balance of payments crisis of 1991, the subsequent
economic liberalisation and rapid growth phase, the response to the global financial crisis of 2008 and the
recent post-crisis moves to return to a path of fiscal consolidation. India‟s fiscal policy in the phase of
planned development commencing from the 1950s to economic liberalisation in 1991 was largely
characterised by a strategy of using the tax system to transfer private resources to the massive investments in
the public sector industries and also achieve greater income equality. The result was high maximum marginal
income tax rates and the consequent tendency of tax evasion. The public sector investments and social
expenditures were also not efficient. Given these apparent inadequacies, there were limited attempts to
reform the system in the 1980s. However, the path of debt-induced growth that was pursued partly
contributed to the balance of payments crisis of 1991. Following the crisis of 1991, the government charted
out a path of economic liberalisation. Tax reforms focussed on lowering of rates and broadening of the tax
base. There were attempts to curb subsidies and disinvest the government holdings in the public sector
industries. While initially the fiscal deficit and public debt were brought under control, the situation again
started to deteriorate in the early 2000s. This induced the adoption of fiscal responsibility legislations at the
central and state levels. There were also reforms in the state level tax system with the introduction of VAT.
Consequently there were major improvements in the public finances. This probably contributed to the benign
macro-fiscal environment of high growth, low deficits and moderate inflation that prevailed around 2008.
The global financial crisis brought an end to this phase as the government was forced to undertake sharp
counter-cyclical measures to prop up growth in view of the global downturn. Measures included, excise duty
cuts, fiscal support to selected export industries and ramping up public expenditure.
The Indian economy weathered the global crisis rather well with growth going down to 5.8 percent in the
second half of 2008-09 and then bouncing back to 8.5 percent in 2009-10. In view of the recovery, a slow
exit from the fiscal stimulus was attempted in a manner whereby fiscal consolidation was achieved without
hurting the recovery process.
P a g e 85 | 88
Bibliography
Dasgupta, Dipak and Supriyo De. 2011. "Fiscal Deficit," in New Oxford Companion to Economics in India.
Kaushik Basu and Annemie Maertens eds. New Delhi: Oxford University Press.
Empowered Committee of State Finance Ministers. 2009. "First Discussion Paper on Goods and Services
Tax in India."
Fischer, Stanley and William Easterly. 1990. "The Economics of the Government Budget Constraint." The
World Bank Research Observer, 5:2 (July 1990), pp. 127-42.
Herd, Richard and Willi Leibfritz. 2008. "Fiscal Policy in India: Past Reforms and Future Challenges."
Organisation for Economic Co-operation and Development, Economics Department Working Paper No. 595.
Kumar, Rajiv and Alamuru Soumya. 2010. "Fiscal Policy Issues for India after the Global Financial Crisis
(2008-2010)." Asian Development Bank Institute, Working Paper No. 249.
Ministry of Finance. 2011. "Fiscal Policy Strategy Statement (Budget 2011-12)." Planning Commission.
2011. "Approach to the Twelfth Five Year Plan."
Rao, N. Govinda and R. Kavita Rao. 2006. "Trends and Issues in Tax Policy and Reform in India." India
Policy Forum, NCAER, www.ncaer.org/downloads/Journals/ipf0506-paper2.pdf.
Reserve Bank of India. 2011. "Database on the Indian Economy, http://dbie.rbi.org.in, date accessed 19th
October 2011."
Singh, Nirvikar and T. N. Srinivasan. 2004. "Fiscal Policy in India: Lessons and Priorities." Paper for the
NIPFP-IMF conference on Fiscal Policy in India, New Delhi.
P a g e 86 | 88
ANNEXTURE
QUESTIONERS :
1.ARE YOU AWARE ABOUT FISCAL POLICY SYSTEM.
 YES
 NO I
2.DO YOU THINK FISCAL POLICY IS HELPFUL AND IMPORTANT FOR OUR COUNTRY.
 YES
 NO
3.DO YOU THINK FISCAL POLICY NEED ANY CHANGES.
 YES
 NO
4. ACCORDING TO YOU IMPOSING TAX ON EQUITY MUTUAL FUNDS IS WORTH.
 YES
 NO
5 .DO YOU THINK FISCAL POLICY GET AFFECTED BECAUSE OF INCREASE IN RATE
OF CORRUPTION.
 YES
 NO
6. DO YOU THINK THAT FISCAL POLICY IS A INSTRUMENT WHICH CAN ACHIEVE A

NUMBER OF SOCIO-ECONOMIC OBJECTIVES.
 YES
 NO
7. DO YOU THINK WITH THE HELP OF FISCAL POLICY GOVERNMENT CAN ACHIEVE
OPTIMUM ALLOCATION OF RESOURCES.
 YES
 NO
P a g e 87 | 88
8. DO YOU THINK EXPANSIONARY FISCAL POLICY CAN REDUCE HIGH UNEMPLOYMENT

AT THE TIME OF RECESSION.
 YES
 NO
9. DO YOU THINK IN THE NEXT 5 YEARS THE GOVERNMENT BRING.
 BALANCE BUDGET
 SURPLUS BUDGET
10. WHICH POLICY DO YOU PREFER.
 FISCAL POLICY
 MONETARY POLICY
P a g e 88 | 88

A Study of Fiscal Policy of India . (Debasis)

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A Study of Fiscal Policy of India . (Debasis)

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“A STUDY OF FISCAL POLICY OF INDIA”

Under the Guidance of

SHRI G. P. M DEGREE COLLEGE

SHRI G. P. M DEGREE COLLEGE

(Accounting & Finance) under the Faculty of Commerce in the subject of

Accounting and Finance and his project is entitled, “A Study Of Fiscal

Signature of Guiding Teacher

Prof. Florency D’Souza

Mr. Debasis kulia

Prof. Florency D’Souza

I would like to acknowledge the following as being idealistic channels and

I take this opportunity to thank the University of Mumbai for giving me

I would also like to express my sincere gratitude towards my project guide

I would like to thank my College Library, for having provided various

Mr. Debasis Kulia

1.INTRODUCTION OF FISCAL POLICY IN INDIA

 Seigniorage , the benefit from printing money

Consuming prior surpluses

1.3Feature of Fiscal Policy of India

The following are the main features of fiscal policy of India

 Rationalization of Product Classification codes:

 Common Accounting Year of Income Tax:

 Long-term Fiscal Policy:

 Impact on Rural Employment:

 Reliance on Indict taxes:

 Inadequate Public Sector contribution:

1.4ADVANTAGE OF FISCAL POLICY

 Unemployment Reduction – When unemployment is high, the government can employ an

1.5LIMITATION OF FISCAL POLICY

Some of the major limitations of fiscal policy are as follows:

(а) Recognition Lag:

(b) Administrative Lag:

(c) Operational Lag:

 Correct Size and Nature of Fiscal Policy:

 Inadequacy of Fiscal Measures:

 Adverse Effect on Redistribution of Income:

 Reduction in National Income:

2.OBJECTIVES OF FISCAL POLICY IN INDIA

 General objectives of Fiscal Policy are given below:

 Development by effective Mobilisation of Resources:

The financial resources can be mobilised by:-

 Reduction in inequalities of Income and Wealth:

 Price Stability and Control of Inflation:

 Balanced Regional Development:

 Reducing the Deficit in the Balance of Payment:

2.1TECHNIQUES OF FISCAL POLICY IN INDIA

 Policy of Taxation of Government of India:

main objective of taxation policy in India includes:

(i) Development of infrastructure: Development of infrastructural facilities which include development of

 Public Debt Policy of the Government of India:

2.2TOOLS OF FISCAL POLICY

1.Government Spending Tools

Justification of Government Spending

 To provide services like defense for the benefit of all citizens

 For enhancing infrastructure in the form of capital spending

 To assure the less-wealthy individuals a certain minimum income level

 To influence low inflation and high employment.

Advantage of Spending Tools

 Subsidies in development and research can aid in a country’s economic growth.

 An increase in government expenditure causes an increase in aggregate demand.

 Reduces unemployment rate: An increase in government expenditure increases aggregate demand

Disadvantages of using Spending Tools

2.Government Revenue Tools