Fiscal Policy

Agenda
o Introduction
o Fiscal Policy & Macroeconomic Goals
o Overview of Indian system of Fiscal policy
o Budget 2009-10
Definition & Meaning Of Fiscal Policy
The word fisc means state treasury and fiscal policy refers to
policy concerning the use of state treasury or the govt. finances
to achieve the macroeconomic goals.

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

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

Fiscal policy is also called Budgetary Policy.
The government receipts are inflows and expenditures are
outflows of money.
Fiscal Policy & Macroeconomic Goals
Fiscal policy for economic growth

To achieve desirable employment level

To achieve desirable price level

To achieve desirable consumption level

To achieve desirable income distribution

Fiscal policy for stabilization

Fiscal policy for external balance


Fiscal Policy - Tools
Tools Of Fiscal
Policy
Government
Expenditure

Taxation
Public
Borrowing
Government Expenditure
Government spending or government expenditure is classified by
economists into three types :
Government Consumption :

Government purchases of goods & services for current use

Government Investment :

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

Transfer Payments :

Government expenditures that are not purchases of goods &
services, and instead just represents transfer of money such as
pensions,subsidies,social security payments etc.
Government Expenditure Estimate 09-10
Budget estimate provide for a total expenditure of
Rs.10,20,838 cr. consisting of Rs.6,95,689 crore under
Non-Plan and Rs.3,25,149 crore under plan registering an
increase of 37 % in non-plan and 34 % in plan expenditure
over 2008 2009.
Increase in Non-Plan expenditure is manly due to
Implementation of central Sixth Pay Commission
recommendations, increased food subsidy,higher interest
payment arising out of larger fiscal deficit in 2008-09
Additional amount of Rs.430 crore provided to
modernize police machinery in the States

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

Outlay for Defence up from Rs.1,05,600 cr.in 2008-09
to Rs.1,41,703 cr in 2009-2010.
Methods Of Funding
Governments spend money on a wide variety of things, from
the military and police to services like education,healthcare,as
well as transfer payments.
The expenditure can be funded in number of different ways :

Taxation

Public Borrowings

Consumption of fiscal reserve

Sale of assets (eg. Land)
Taxation
Purpose and Effect

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

Taxation has four main purposes or effects :
Revenue,Redistribution & Reprising
Revenue : Taxes raise money to spend on schools, hospitals,
roads and on more government indirect functions like market
regulation or legal systems.

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

Reprising : Taxes are levied to address externalities : tobacco is
taxed, for example, to discourage smoking
Taxation
The major tax enactment in India is The Income Tax Act 1961 passed
by the parliament, which imposes a tax on income from individuals and
corporations. The act imposes a tax on income under the following
heads :

Direct Taxes

Income from Salaries

Income from house and property

Income from business and profession

Income in the form capital gains

Income from other sources
Taxation
Indirect Taxes

Custom Duty : duty on goods
imported In India

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

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

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

Transaction Tax : tax on
transactions of sale of securities
Taxation
Other major taxation enactment passed by State Legislatures :

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



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

This is commonly known as Deficit Financing .

Sources of funding:

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

External Borrowings
Foreign government
International org. World Bank and IMF
Fiscal Policy - Instruments
Instruments Of
Fiscal Policy
Budgetary
Policy
Compensatory
Policy
Deficit-
budget
Policy
Surplus-
budget
Policy
Balanced-
budget
Policy
Discretionary
Policy
Built
In
Stabilizers
Budgetary Policy
Its also known as the Contra cyclical Fiscal Policy
1) Budget Deficit - Fiscal Policy During Depression


When government expenditure exceeds the receipts
Expansionary effect of budget deficit
Two ways : Increasing Government expenditure and keeping tax intact
or Decreasing Tax and keeping government expenditure intact
C+I+G= Consumption +Investment+ Government Expenditure
E= Equilibrium Point
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Budgetary Policy
2) Surplus Budget - Fiscal Policy During Boom


When government revenue exceeds the expenditure
To control the inflationary pressure within economy
Increasing Taxation and Decreasing Government expenditure
Income
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3) Balance Budget Multiplier
Increase in the Taxes and Government
Expenditure equally
Leads to increase in the net national
income.
Compensatory Policy
The compensatory fiscal policy aims at continuously compensating the
economy against tendencies towards inflation and deflation by
manipulating public expenditure and taxes.

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

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

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

2) Discretionary Fiscal Policy:
This requires the deliberate change from government
i) Changing taxes with government expenditure constant
ii) Changing government expenditure with taxes constant
iii) Variations in both expenditures and taxes simultaneously

This is depend upon the proper timing and accurate forecasting
Lags In Effect Of Policy
1) Recognition Lag:
Refers to time between the development and recognition of
need of action by the Monetary and Fiscal authorities
Its difficult to identify the turning points of the business cycle
Past experience with Federal Reserve Bank (US) states that it
recognize the need for action after Three months from Trough
and Six months after Boom is started

2) Administrative Lag:
Refers to authorities recognize the need for action and
actually collects the relevant data
Length of this lag depends on which type of policy is being
implemented
This lag is short in duration compare to other lags
Inside Lags
Lags In Effect Of Policy
1) Operation Lag:
Refers to time between the adaption of the policy and its final
effect on economic activities.
It is divided in two types:

a) Intermediate Lag:
Refers to the time period between the moment at which action
is been taken by authorities till the moment at which economy
is faced with change in interest rates, money supply, taxes,
public expenditure.

b) Outside Lag:
Refers to time involve between interest rates,, total reserves,
credit rationing and their effects on aggregate spending,
income and output of the economy
Outside Lags
Fiscal Responsibility And Budget
Management (FRBM)
Enacted by parliament in 2003 to bring fiscal discipline.

The FRBM Rules impose limits on fiscal and revenue deficit.
Hence, it will be the duty of the government to stick to the
deficit targets.
It aimed at:
1. Reducing revenue deficit
2. Reducing gross fiscal deficit
3. Reducing the Public debt
4. No Borrowing from the RBI

Advantages Of Fiscal Policy

Emphasis on overall economic growth
Management of revenue and expenditure
Helps in planning
Easy to target specific sector
For the social welfare
Disadvantages Of Fiscal Policy
Requires accurate forecasting, which is essential to judge the
stage of cycle through which economy is passing.

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

Execution Lags : Once the decision is taken,delay in executing
the same
Fiscal Deficit The Biggest Challenge
The fiscal deficit is the difference between the government's
total expenditure and its total receipts . When the governments
expenditure exceeds the receipts it is called fiscal deficit or
the deficit budget policy.

Fiscal deficit = Total Govt. Expenditure > Total Govt. Revenue
MEANING
The biggest challenge before the Finance Minister, will lie in
the area of containing the governments fiscal deficit. If
the deficit of States & off-budget liabilities (such as petroleum
and fertilizers bonds) taken into account, the combined fiscal
deficit will be almost 11 per cent of the GDP
Trends In Fiscal Deficit Of India
Where The Rupee Comes From
2008-09
Non Tax Revenue
10%
Non - Debt
Capital
Receipt
1%
Borrowings
19%
Corporation Tax
21%
Income Tax
13%
Customs
12%
Excise
17%
Service & Other
Taxes
7%
Where Does The Rupee Goes To
Other Non
Planned
Expenditutre
11%
Subsidies
7%
Defense
12%
Interest
20%
Central Plan
20%
Planned State
Asisstance
7%
Non Planned
State Asisstance
5%
States Share To
Taxes & duties
18%
Budget Deficit Or Surplus In FY 2002
-6 -4 -2 0 2 4
Italy
Sweden
Canada
United Kingdom
France
United States
Ireland
Norway
Japan
Source: Organization for Economic Development and Cooperation
India's per capita income is
$440

In India 30-40% population
is below poverty line


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



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

China's per capita income
stood at $990

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

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

China received FDI of $52.7
billion in 2002
Fiscal Policy Case Study India vs China
India China
India & fiscal Deficit
Budget At Glance
2008-09

Government
of India
Key Features Of Budget 09-10
To lead economy to high GDP growth rate of
9% per annum at the earliest

To deepen and broaden the agenda for
inclusive development

To improve delivery mechanism of the
Government
CHALLENGES
Overview Of Economy
Growth rate of GDP dipped from an average of over
9 % in the previous years to 6.7 % during 2008-
09.
WPI rose to nearly 13 % in August, 2008 and had an
equally sharp fall to zero per cent in March, 2009.
The structure of Indias economy changed over the last ten years
with contribution of the services sector to GDP at well over 50 %
and share of merchandise trade doubling to 38.9 % of GDP in 2008-
09
Recognizing economic recovery and growth as co-operative effort of
the Central and State Governments, meeting with Finance Ministers of
States held as part of preparation of the Budget. This is intended to
become an annual feature.
Estimates 2009-10
Gross tax receipts budgeted at Rs.6,41,079 crore in 2009-
2010 compared toRs.6,87,715 crore in 2008 2009.

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

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

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

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