Impact of Fiscal Policy in India

“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.
Fiscal policy also shows effect 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. The government needs to borrow from domestic or foregin
sources, draw upon its foreign exchange reserves or print an equivalent amount of money to
meet the additional expenditures. 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.1
The impact of India’s fiscal policy can be assessed in terms of whether it has been successful
in completing the objectives before it. Some of the objectives can be –
1) To promote saving and capital formation;
2) To reduce economic inequalities
3) To bring about domestic stability, specially to curb inflationary
tendencies in the economy

One of the main objectives of Fiscal policy is to increase saving and capital formation and to
mobilize these as agents of economic development. Relationship between saving and capital
formation is taken to be direct and simple. Taxation reduces disposable income of all sections
of society and thus reduces their conspicuous consumption, the tax revenue as a result of this
will give a boost to public sector savings. Going by this assumption, taxation has been used to
mobilize resources for increasing domestic savings. The tax structure of the country has also
changes in this process of mobilization of huge amounts of additional taxes. Research has
indicated that though additional taxes have had some positive impact on government savings,
it was not substantial. This shows that the fiscal strategy which was formulated to mobilize
additional taxes seeking to boost governmental savings for the purpose of development has
only achieved little success. This result is further supported by the performance of the public
sector in the area of capital formation. As increasing the public sector savings was one of the
main objectives of taxation, the increase in capital formation in public sector was the main
objective of public expenditure. Research has indicated that this unsatisfactory performance
of the public sector in capital formation has continued to exist. The reasons attached to this
unfruitful growth are that the economic performance of the public sector as a whole has been
disappointing not only in generating surplus but also in its efficiency, the attitude of some
sections of public sector employees is not helpful for attaining the targeted aims of the public
sector and all the funds that have bee invested in the public sector have gone to increase

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JAGRAN JOSH, https://www.jagranjosh.com/general-knowledge/fiscal-policy-of-india-meaning-objectives-and-
impacts-on-the-economy-1448705973-1 ( Last visited September 15, 2018).
capital formation. As a result of this, the physical assets of the public sector are not of the
required standard and quality. This has been reflected by the Capital-Output ratio.
The combined effect of the abovementioned is that even after decades of economic planning,
our country is drenched of resources for public investment.

Fiscal Policy and Income Inequalities

The achievement of equity has been one of the most crucial objective of direct taxes. The
effectiveness of these taxes in reducing the inequality of income and wealth depends on the
progressive structure of the tax rates. The studies and evidence at hand show that the only tax
that has been progressive is income tax and even that too, not significantly. All the other
direct taxes have been mostly proportional. This can be attributed to the low effective tax
rates owing to exemptions, rebates and deductions even though the nominal tax rates have
been very progressive, The nitty-gritties of tax laws and procedure of assessment have been
used for tax avoidance wherever tax rebates and deductions are possible and Tax evasion is
evident particularly at higher slabs of income and wealth as the average marginal effective
tax rates become lower at higher levels of income and wealth.
The estimates of the Jha committee, in the case of indirect taxes, has indicated that these are
proportional with reference to the levels of consumer expenditure. There has been a failure in
absorbing the rise in costs due to taxation and other factors as a result of increase in
productivity. Added to the burden of cost imposed by high prices, scarcities, poor living
conditions and lack of employment opportunities, the tax system and changes in it in the
process of time have given rise to social discontent and a sense of grievance against public
authority.
Thus, there is still much left to be desired as regarding the administration of the tax system. A
failure in properly administering the tax systems poses a threat to the ideal of equity because
full payment of taxes is then made only by those whose conscience will not permit them to do
otherwise. It may further give rise to tax evasion as the large amount of tax evasion erodes
the morale of honest tax payers.

Fiscal Policy and Inflation

A main lapse of the fiscal policy has been on the price front, its ability to reduce inflation.
Both direct and indirect taxation, and public expenditure have given rise to inflationary forces
in the country. Public expenditure gives force to the demand-pull inflation, whereas taxation,
specifically indirect taxes, contribute to the price rise by the process of shifting. It is generally
believed that as soon as the rates of union excise duties and sales tax are raised, it will
consequently give rise to the price of these commodities. This is belief is based on good
reasons as the actual practice of businessmen where manufacturers, wholesalers and retailers
take no time to shift the increased amount of tax in the form of higher prices of goods.
Another crucial source of inflation in the budget is deficit financing. Deficit financing was
strongly defended as a source of financing government investment to produce productive
capacity. The assumption that gave rise to this argument was that all the funds obtained by
this mechanism of deficit financing were invested to create productive capital assets. This
assumption is not supported by the development experience of the last few decades of
panning. Many empirical studies have indicated the crucial association between price level
and deficit financing in the country.
In a nutshell, the shortcomings of fiscal policy have been a lot, almost in every way. But one
of its most important achievement has been that it has been effectively used as a means to
give rise to a lot of additional resources necessary for both investment and consumption
purposes.

Evaluation of Fiscal Policy

Government of India’s fiscal policy has been creating a huge impact on the economy of the
country. There has been a significant rise in the rate of taxation, public expenditure and
public debt. There has also been a sizeable expansion in the Public sector of the country.

The country has been able to achieve substantial development of its industrial and
infrastructural sector. But the burden of taxation in our country is comparatively heavy and
thereby it has been affecting the saving capacity of the people.

Moreover, the extent of inequality in the distribution of income and wealth has been failed to
be checked by the fiscal policy of the and has also failed to solve the problem of
unemployment and poverty even after 50 years of planning. The stability in price level of the
country has also been failed to be maintained by th fiscal policy of our country.2

Shortcomings of Fiscal Policy of India

1. Instability

Stability has been failed to be achieved by India’s fiscal policy in various areas. The problem
of inflationary rise in price level has been given rise to by deficit financing’s growing
volume. There has also been a change in the external stability of the country caused due to
disequilibrium in its balance of payments.

2. Defective Tax Structure

There has been a failure to provide for a necessary tax structure for our country by the fiscal
policy. There has been no rise in the productivity of direct taxes and much reliance has been
placed on the indirect taxes. Thus, for the poor of the country, the tax structure is nothing but
burdensome.

3. Inflation

There has also been a failure on the part of the fiscal policy to check the inflationary rise in
price level. The increase in the volume of public expenditure regarding non developmental
heads and deficit financing has given rise to demand-pull inflation. Cost push inflation is also
a result of the high rate of indirect taxes. In addition to this, a failure to check the growth of
black money by direct taxes has increased the inflationary spiral in the level of prices.

4. Negative Return of the Public Sector

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YOUR ARTICLE LIBRARY, http://www.yourarticlelibrary.com/india-2/fiscal-policy/fiscal-policy-of-india-definition-
objectives-and-evaluation/63282 (Last visited September 15, 2018).
Another serious problem for the government is the negative return on capital invested in the
public sector units. Although there is a huge total investment on Public sector units, there has
constantly been a negative return on investment. Huge amount of budgetary provisions need
to be kept by the government to maintain these public sector units. This in turn creates a huge
drainage of the meagre resources of the country.

5. Growing Inequality

There has been a failure to check the growing inequality in the income and wealth
distribution through the length and breadth of the country. The tax machinery has been
rendered ineffective by the increasing trend of evasion on tax. The tax structure has been
rendered regressive by the increasing reliance on indirect taxes

Recent Fiscal Policy Reforms in India – Budget 2018

The Union budget of this year has been guided by it’s mission to give more power to
agriculture, rural development, health, education, employment, MSME and infrastructure
sectors.

As regarding the Fiscal reforms, the fiscal deficit has been pegged at 3.5% and projected ar
3.3% for 2018-19. More concession will be given to Interational Financial Services Centre,
for the promotion of trade in stock exchanges of IFSC. For the control of cash economy,
payments in the excess of Rs. 10000 in cash done by institutions and trusts will be restricted
and tax would need to be paid. There would be taxation at the rate of 10% on Long term
capital gains exceeding Rs 1 Lakh. There is also a proposal for the increasing of cess on
corporate and personal income tax from 3% to 4%. E-assessment will be released throughout
the county for the elimination of person to person contact and for an increased efficiency and
transparency in the collection of direct tax.3

In addition to this, as regarding salaried professionals, personal income tax slabs will remain
unchanged and for senior citizens, no TDS will be charged on interest from FD upto Rs
50,000 and exemption limit regarding medical expenditure for some critical illnesses has
been raised to Rs. 1,00,000 from Rs. 60,000.4

Thus, in conclusion, it can be said that since 2001-02, a prudent fiscal policy is being
followed by the Central Government comprising balanced tax structure of direct and indirect
tax system with moderate tax rates and exepmtions at the minimum which covers a wider
section of tax payers and an expenditure policy that aims to restrict growth in non-
developmental expenditure and provides for more important social and infrastructure needs
of the developing economy adequately.5

3
THE HINDU BUSINESS LINE, https://www.thehindubusinessline.com/economy/budget/budget-2018-
highlights/article22620084.ece (Last visited on 23 September 2018).
4
CLEARTAX, https://cleartax.in/s/union-budget-2018-highlights (Last visited on 23 September 2018).
5
ECONOMIC DISCUSSION, http://www.economicsdiscussion.net/fiscal-policy/reforms/reforms-in-indias-fiscal-
policy-and-its-performance/10975 (Last visited on 23 September 2018).