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
or
Government 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 Policy

Fiscal 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

Tools of
Fiscal Policy

Public Revenue

Revenue
Receipt

Tax

Direct Tax

Capital
Receipt

Non- Tax

Indirect Tax

Public
Expenditure

Revenue
Expenditure

Capital
Expenditure

Public Expenditure (Payments)

Revenue Expenditure

Interest Payments
Major Subsidies
Defense

Capital Expenditure

Expense on administration
Repayment of Loans
Extension of fresh loans to
the state govt by the central
Loans to public enterprise
Expense on Irrigation
project
Sectoral development

Public Revenue (Receipts)

Revenue Receipts

Tax

Capital Receipts

Non- Tax Receipts

Fines and Penalties

Fees
Profits of PSU
Govt Interest
Grants and Gifts

Recovery of Govt loans

Disinvestment of PSU
Market Borrowings
Internal and International
sources

Public Revenue (Receipts)

Direct Tax

Income Tax
Corporate Tax
Wealth Tax
Gift Tax

Indirect Tax

Sales Tax
Excise Tax
Custom
Service 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 incomes
Increases Govt Indirect tax revenues
Increase the flow of funds in the economy
Increases 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 GNP
Reduces 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.No

Item

1996-97

1997-98

1998-99

Revenue Receipts

1,26,279

1,33,886

1,49,510

a)

Tax Revenue

93,701

95,672

1,04,652

b)

Non- Tax Revenue

32,578

38,214

44,858

Revenue Expenditure

1,58,933

1,80,336

2,17,419

a)

Interest Payments

59,478

65,637

77,882

b)

Major Subsidies

14,041

18,248

21,269

c)

Defence Expense

20,977

26,174

29,861

Revenue Deficit (1-2)

32,564

46,450

67,909

Capital Receipt

50,872

82,435

1,06,824

Recovery of Loan

7,540

8,310

10,633

Other Receipt ( PSU disinvestment)

455

912

5,874

Borrowing and Other Liabilities

42,877

73,205

90,922

Capital Expenditure

31,403

35,985

38,920

Total Receipts ( 1+ 4)

Total Expenditure

Fiscal Deficit ( 1 + 4a + 4b 7)

Budget Deficit ( 6 -7)

13,185

Nil

Nil

10

Primary Deficit ( 8- 2a)

Q2 Receipts & Expenditure of the central Govt

S.No

Item

2004-05

2005-06

Revenue Receipts

a)

Tax Revenue

2,24,857

2,73,466

b)

Non- Tax Revenue

80,330

77,734

Revenue Expenditure

3,84,745

4,46,512

a)

Interest Payments

1,26,540

1,33,945

b)

Major Subsidies

44,633

46,358

c)

Defence Expense

43,967

48,625

Revenue Deficit (1-2)

Capital Receipt

1,93,261

163,144

Recovery of Loan

60,862

12,000

Other Receipt ( PSU disinvestment)

4,424

Capital Expenditure

1,13,703

67,832

Total Receipts ( 1+ 4)

Total Expenditure

Fiscal Deficit

10

Primary Deficit ( 8- 2a)

Calculate Revenue Receipt, Revenue Deficit, Fiscal Deficit?

Kinds of Fiscal Policy

Fiscal Policy

Discretionary
Fiscal Policy

Anti- Recessionary
Fiscal Policy

Non- Discretionary /
Automatic
Fiscal Policy

Anti Inflationary
Fiscal Policy

Discretionary Fiscal Policy

1. Anti Recessionary Fiscal Policy
Aggregate Demand Decreases
Private Investment Fall

Deflationary Gap

Anti- Recessionary
Fiscal Policy

Increase In Govt
Expenditure

Reduction In Taxes

a) Increase In Govt Expenditure

How does Govt increase Expenditure?
1. Public Works
Building roads, dams, ports, telecommunication links, irrigation
works, 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 Effect
Increase in Income of suppliers and sellers
Increase in demand for capital good
b) Indirect Effect
Consumption Increases
Increase in demand for consumer goods
Expansion in output
Generates 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) Borrowing
1) Market Loans and Borrowings
2) Small Savings
Govt Borrowing is anti - inflationary
Borrow from the public
Govt competes with the businessman ( private investment)
Govt demand will raise the demand for loans
Raise the rate of interest
Will reduce pvt investment
b) Creation of New Money- Deficit Financing
Will not reduce pvt investment
Full 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 Income

Increase in Consumption
Employment will increase
National Income and output

Lead to increase in Budget Deficit

Need to be financed by Borrowing or Creation of Money.

Deficit Financing and Inflation

Countries (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 NECESSARY
If the supply of output (Consumer goods) is also increasing with demand
But 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 Option
What 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 Increases

Private Investment Rises

Inflationary Gap

Anti-Inflationary
Fiscal Policy

Reducing Govt
Expenditure

Increase In Taxes

a) Reducing Govt Expenditure

How does Govt reduce Expenditure?

Reducing expenditure on non-development or unproductive

heads like Defense, Subsidies, transfer payments
Decrease in income
Reduces excess demand

b) Increasing Taxes
Whats going to happen?

Increase in Taxes (income, wealth, corporate)

Reduces the disposable income
Consumption reduces
Aggregate demand reduces

Leads to increase in Budget Surplus

Disposing Of Budget Surplus

1) Retiring Public Debt
Pay back the outstanding debt
Would weaken its anti-inflationary effect
Add money supply to the public
Public will spend money
Increase consumption demand
Expansion of money supply would lower rate of interest
2) Impounding of Public Debt
Surplus to be kept idle

Non- Discretionary Fiscal Policy

Taxes 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 Taxes

Direct relationship in between tax revenue and level of income

Higher 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 Taxes

Companies 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 Policy

3) 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 demand
In prosperity phase, transfer payments decreases, reduces demand
and inflation.

4) Corporate Dividend Policy

Corporate follow a stable dividend policy

Permits individual to spend more during recession
Less 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 Deficit

Borrow from within and outside the country Leads to increase in
public debt and its burden

1)

2)

Financing through Deficit financing Leads to creation of Money and

may lead to rise in prises or Inflation

3)

Adversely effects Economic Growth

Due 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 Management

Fiscal Deficit 2008-09 : 6.4%

Revenue Deficit 08-09: 4.5%