Fiscal Policy

Meaning Of Fiscal Policy

It refers to a policy concerning the use of state treasury or the government finances to achieve the macro-economic goals

orGovernment policy of changing its taxation and public expenditure programmes intended to achieve its objective.

or

Government uses its expenditure and revenue program to produce desirable effects on National Income , production and employment.

Counter Cyclical Fiscal PolicyFiscal or Budgetary Policy: Are the Revenue and Public Expenditure Policy

It is based on the relationship between them

It generates additional purchasing power during depression

Contracts purchasing power during expansion

Importance of Fiscal Policy

Government activities are enlarged.

Tax- Revenue and Expenditure accounts for large proportion of GNP.

Government effects the Economic activities through gap between government receipts and borrowings.

It indicates the level of overall borrowings by the government.

It is the indicator of fiscal health of the economy.

Objectives of Fiscal Policy

To mobilise resources for Economic Growth

To promote growth in Private Sector

Equitable distribution of Income and wealth

Restrain inflationary forces in the Economy

Tools of Fiscal Policy

Public Expenditure (Payments)Revenue Expenditure

Interest PaymentsMajor SubsidiesDefenseCapital Expenditure

Expense on administrationRepayment of LoansExtension of fresh loans to the state govt by the centralLoans to public enterpriseExpense on Irrigation projectSectoral development

Public Revenue (Receipts)Revenue Receipts

Tax

Non- Tax ReceiptsFines and PenaltiesFeesProfits of PSUGovt InterestGrants and Gifts

Capital Receipts

Recovery of Govt loansDisinvestment of PSUMarket Borrowings Internal and International sources

Public Revenue (Receipts)Direct Tax

Income TaxCorporate TaxWealth TaxGift TaxIndirect Tax

Sales TaxExcise TaxCustomService Tax

Effect of Public Expenditure on the Economy Public Expenditure

An increase in PE raises the level of GNP.PE increases the purchase of goods and services Increases household incomesIncreases Govt Indirect tax revenuesIncrease the flow of funds in the economyIncreases private Income and thereby the Private Expenditure

Effect of Public Revenue on the Economy Public Revenue

Total amount received. Taxation is a measure of transferring funds from private purses to the public coffers.Withdrawal of funds from the private use.Has a deflationary impact on GNPReduces Disposable income and reduces private expenditure

Concept of Deficit

Deficit:Total government expenditure is more than government receipts.Budgetary Deficit: Total Expenditure Total Revenue

Revenue Deficit: Revenue Expenditure Revenue Receipts

Fiscal Deficit: Total Expenditure Total Revenue (Excluding Govt Borrowing) Primary Deficit: Fiscal Deficit Interest Payments

What is Fiscal Deficit? Fiscal deficit:Is the difference between what the government spends and what it earns. It is expressed as a percentage of GDP.

India's fiscal deficit was brought down to 3.17% (Rs 1,43,653 crore) of the gross domestic product in 2007-08 from 3.8% in 2006-07.

The government has promised to cut the deficit further to 2.5% of GDP (Rs 1,33,287 crore) by the end of 2008-09,

Q1 Receipts & Expenditure of the central Govt

S.NoItem1996-971997-981998-991 Revenue Receipts1,26,2791,33,8861,49,510a)Tax Revenue93,70195,6721,04,652b)Non- Tax Revenue32,57838,21444,8582Revenue Expenditure1,58,9331,80,3362,17,419a)Interest Payments59,47865,63777,882b)Major Subsidies14,04118,24821,269c)Defence Expense20,97726,17429,8613Revenue Deficit (1-2)32,56446,45067,9094Capital Receipt50,87282,4351,06,824ARecovery of Loan7,5408,31010,633BOther Receipt ( PSU disinvestment)4559125,874cBorrowing and Other Liabilities42,87773,20590,9225Capital Expenditure31,40335,98538,9206Total Receipts ( 1+ 4)7Total Expenditure8Fiscal Deficit ( 1 + 4a + 4b 7)9Budget Deficit ( 6 -7)13,185NilNil10Primary Deficit ( 8- 2a)

Q2 Receipts & Expenditure of the central GovtCalculate Revenue Receipt, Revenue Deficit, Fiscal Deficit?

S.NoItem2004-052005-061 Revenue Receiptsa)Tax Revenue2,24,8572,73,466b)Non- Tax Revenue80,33077,7342Revenue Expenditure3,84,7454,46,512a)Interest Payments1,26,5401,33,945b)Major Subsidies44,63346,358c)Defence Expense43,96748,6253Revenue Deficit (1-2)4Capital Receipt1,93,261163,144ARecovery of Loan60,86212,000BOther Receipt ( PSU disinvestment)4,42405Capital Expenditure1,13,70367,8326Total Receipts ( 1+ 4)7Total Expenditure8Fiscal Deficit10Primary Deficit ( 8- 2a)

Kinds of Fiscal Policy

Discretionary Fiscal Policy1. Anti Recessionary Fiscal Policy

Aggregate Demand DecreasesPrivate Investment Fall

Deflationary Gap

a) Increase In Govt Expenditure

How does Govt increase Expenditure?

1. Public WorksBuilding roads, dams, ports, telecommunication links, irrigationworks, electrification of new areas etc 2. Govt buys various types of goods and materials

3. Employ Labour

What is going to be the effect?

a) Direct EffectIncrease in Income of suppliers and sellersIncrease in demand for capital good

b) Indirect EffectConsumption IncreasesIncrease in demand for consumer goodsExpansion in outputGenerates Employment and Income

How large should be the increase in expenditure?

Magnitude of GNP gap caused by the deflationary gap.

How to finance Govt Expenditure or Budget Deficit ?a) Borrowing1) Market Loans and Borrowings2) Small SavingsGovt Borrowing is anti - inflationaryBorrow from the publicGovt competes with the businessman ( private investment)Govt demand will raise the demand for loansRaise the rate of interestWill reduce pvt investment

b) Creation of New Money- Deficit FinancingWill not reduce pvt investmentFull expansionary rise in govt expenditure can be realised

Monetisation of Budget deficit

b) Reduction in Taxes

What is going to be the effect? Increase in the Disposable IncomeIncrease in ConsumptionEmployment will increaseNational Income and output

Lead to increase in Budget DeficitNeed to be financed by Borrowing or Creation of Money.

Deficit Financing and InflationCountries (Developing) need to promote Economic Growth.Resources required for development exceeds the amount which can be raised by normal ways: taxation, borrowing, surpluses etc.Economic development can be achieved by Investment.For Investment Govts needs to resort to Deficit Financing.

Does Deficit Financing leads to Inflation?NOT NECESSARYIf the supply of output (Consumer goods) is also increasing with demandBut in short run it might turn inflationary in developing economies as there is dearth of capital and long term Investment projects does not add to supply of consumer goods.

Policy OptionWhat is better Govt Expenditure or Taxes for stabilization?

Depends on the Role of Public Sector.If Public sector can overcome the failure of free market system.However Public sector are inefficient and involves waste of scarce resources then Taxation are better options.Also depends upon the magnitude of effect of Expenditure and Tax Multiplier.

2. Anti Inflationary Fiscal Policy

Aggregate Demand IncreasesPrivate Investment Rises

Inflationary Gap

a) Reducing Govt ExpenditureHow does Govt reduce Expenditure?

Reducing expenditure on non-development or unproductive heads like Defense, Subsidies, transfer paymentsDecrease in incomeReduces excess demand

b) Increasing Taxes

Whats going to happen?

Increase in Taxes (income, wealth, corporate)Reduces the disposable incomeConsumption reducesAggregate demand reduces

Leads to increase in Budget Surplus

Disposing Of Budget Surplus

1) Retiring Public DebtPay back the outstanding debtWould weaken its anti-inflationary effectAdd money supply to the publicPublic will spend moneyIncrease consumption demandExpansion of money supply would lower rate of interest

2) Impounding of Public DebtSurplus to be kept idle

Non- Discretionary Fiscal PolicyTaxes and Expenditure vary automatically with changes in National Income.With built in stabilizers recession and inflation will be shorter and less intense.

1) Personal Income TaxesDirect relationship in between tax revenue and level of incomeHigher National Income, citizen have to pay higher taxes, which reduces the disposable income and the consumption demand.Fall in national income in recession, lower taxes but aggregate demand does not fall.

2) Corporate Income TaxesCompanies pay percentage of profits as tax.Revenue rises during inflation which reduces aggregate demand.Revenue falls in recession which tend to offset the decline in demand.

Non- Discretionary Fiscal Policy3)Transfer Payments ( Unemployment & Welfare benefits, subsidies,)

Its a fiscal instrument which redistributes income in favor of poor.In recession Transfer Payments increases, Govt Expenditure increases and increases aggregate demandIn prosperity phase, transfer payments decreases, reduces demand and inflation.

4)Corporate Dividend Policy

Corporate follow a stable dividend policyPermits individual to spend more during recessionLess during prosperity phase

Success of this largely depend upon tax compliance, honest declaration of income, a stable dividend policy and transparent economic system.

Implication of Large Fiscal DeficitBorrow from within and outside the country Leads to increase in public debt and its burden

2) Financing through Deficit financing Leads to creation of Money and may lead to rise in prises or Inflation

3)Adversely effects Economic GrowthDue to large revenue deficit a smaller amount are left for productive investment in Infrastructure and social capital (education and health)

More borrowing by Government leaves less resources for Private sector Investment.

What should Govt do?In India, to reduce Fiscal Deficit the Govt has been curtailing Capital Expenditure.

But it effects the Economic Growth

The Govt needs to cut Revenue Expenditure and raise Revenue receipts ( mobilising Taxation)

FRBM Fiscal Responsibility and Budget ManagementFiscal Deficit 2008-09 : 6.4%Revenue Deficit 08-09: 4.5%