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ASIA-PACIFIC INSTITUTE OF

MANAGEMENT

 

PROJECT REPORT ON FISCAL POLICY 

OF INDIA

 

SUBMITTED TO :

SUBMITTED BY:

Mr Jitender Bhandari 

Deepika [ib/08] Devkant [ib/09]

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 Fatik [ib/10]

 Gagan [ib/11]

 Gaganjeet [ib/12]

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 INDEX 

1. INTRODUCTION

2. OBJECTIVES OF FISCAL POLICY

3. TYPES OF FISCAL POLICY

4. COMPONENTS OF FISCAL POLICY

• Revenue budget

• Revenue receipt

• Capital receipts

• Expenditure budget

• Revenue expenditure

• Capital expenditure

5. CHANGE IN CUSTOM AND EXCISE DUTY

6. PLAN AND NON PLAN EXPENDITURES

7. EFFECTS OF FISCAL POLICY ON EMPLOYMENT

AND PRODCUTION

8. REVENUE DEFICIT

9. FISCAL DEFICIT

10. FRBM ACT

11. BIBLIOGRAPHY

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FISCAL POLICY 

OF INDIA

 

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  ACKNOWLEDGEMENT 

We express our profound gratitude to Mr. Jitender Bhandari; whoassigned us the project on FISCAL POLICY IN INDIA. We want to giveour sincere thanks for his kind advice and guidance. We are grateful tohim for his continuous support and encouragement throughout theproject.We have really appreciated and imbibed many of his sound

advices and it is largely due to his patience that we were able to achieveour goals successfully. We are greatly obliged to Asia Pacific Instituteof Management, Jasola, New Delhi for giving us an opportunity totake up this project and providing us a platform to learn and enhance ourprofessional skills.

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INTRODUCTION

Fiscal policy is the use of government spending and TAXATION to influence the economy. When the

government decides on the goods and services it purchases, the transfer payments it distributes,

or the taxes it collects, it is engaging in fiscal policy. The primary economic impact of any change

in the government budget is felt by particular groups—a tax cut for families with children, for 

example, raises their disposable income. Discussions of fiscal policy, however, generally focus on

the effect of changes in the government budget on the overall economy. Although changes in

taxes or spending that are “revenue neutral” may be construed as fiscal policy—and may affect

the aggregate level of output by changing the incentives that firms or individuals face—the term

“fiscal policy” is usually used to describe the effect on the aggregate economy of the overall levels

of spending and taxation, and more particularly, the gap between them.Fiscal policy refers to the

overall effect of the budget outcome on economic activity. Fiscal policy is an additional method to

determine public revenue and public expenditure. Fiscal policy is the means by which agovernment adjusts its levels of spending in order to monitor and influence a nation's economy. It

is the sister strategy to monetary policy with which a central bank influences a nation's money

supply. These two policies are used in various combinations in an effort to direct a country's

economic goals.

The idea of using fiscal policy to combat recessions was introduced by John Maynard

Keynes in the 1930s

According to Arther Simithies fiscal policy is a policy under which government uses its

expenditure and revenue programme to produce desirable effects and avoid undesirable effectson the national income, production and employment.

 

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OBJECTIVE OF FISCAL POLICIES

1. To achieve desirable price level:

The stability of general prices is necessary for economic stability. The maintenance of a

desirable price level has good effects on production, employment and national income.

Fiscal policy should be used to remove; fluctuations in price level so that ideal level is

maintained.

2. To Achieve desirable consumption level:

A desirable consumption level is important for political, social and economic consideration.

Consumption can be affected by expenditure and tax policies of the government. Fiscal

policy should be used to increase welfare of the economy through consumption level.

3. To Achieve desirable employment level:

The efficient employment level is most important in determining the living standard of the

people. It is necessary for political stability and for maximization of production. Fiscal policy

should achieve this level.

4. To achieve desirable income distribution :

The distribution of income determines the type of economic activities the amount of savings.

In this way, it is related to prices, consumption and employment. Income distribution shouldbe equal to the most possible degree. Fiscal policy can achieve equality in distribution of 

income.

5. Increase in capital formation :

In under-developed countries deficiency of capital is the main reason for under-

development. Large amounts are required for industry and economic development. Fiscal

policy can divert resources and increase capital.

6. Degree of inflation:

In under-developed countries, a degree of inflation is required for economic development.

After a limit, inflationary be used to get rid of this situation.

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TYPES OF FISCAL POLICIES

1. Reflationary Fiscal Policy :

Governments may choose to use reflationary fiscal policy in times of recession or a generaldownturn in economic activity. In this situation they will use their fiscal policy to give a boostto the economy. They may do this by lowering taxes in some form or by increasing the levelof government expenditure. This will encourage people to spend more. If they lower  indirect taxes then this will lower the prices of the taxed goods and encourage more demand.Alternatively they could lower direct taxes. This will raise people's disposable income (their take-home pay) and therefore encourage them to spend more. Either way the level of demand in the economy should rise and help encourage economic growth.

  Reflationary fiscal policies could therefore include:

• Cutting the lower, basic or higher rates of tax• Increasing the level of personal allowances• Increasing the level of government expenditure

2. Deflationary fiscal policy :

Deflationary fiscal policy is likely to be most appropriate in times of economic boom. If theeconomy is growing at above its capacity this is likely to cause inflation and balance of 

payments problems. To try to slow the economy down the government could either raisetaxes in some form or perhaps reduce government expenditure. Either of these will reducethe level of demand in the economy and therefore the level of economic growth. It mayincrease indirect taxes which will raise prices and deter people from spending so much, or itmay increase direct taxes, which will leave people with less money in their pockets and sostop them from spending so much.

  Deflationary fiscal policies include:

• Increasing the lower, basic or higher rates of tax• Reducing the level of personal allowances

• Reducing the level of government expenditure

3. Supply-side policies :

Supply-side  policies are policies that aim to increase the capacity of the economy toproduce. Fiscal policy usually acts on the level of demand in the economy and thedeflationary and reflationary policies are often known as demand-side policies.

Supply-side fiscal policies:

• Cutting the lower and basic rates of tax to open up the gap between earnings in and out of 

work and ensure people have an incentive to work• Increasing the level of personal allowances for the same reason• Reducing the top rate of tax to encourage enterprise, risk-taking and the incentive to work

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hard

 

Lags which influence the effectiveness of discretionary fiscal policy 

Discretionary fiscal policy is subject to the same lags that we discussed for monetary policy. It

takes some time for policy makers to realize that a recessionary or an inflationary gap exists—

the recognition lag . Recognition lags stem largely from the difficulty of collecting economic data

in a timely and accurate fashion. The current recession was not identified until October 2008,

when the Business Cycle Dating Committee of the National Bureau of Economic Research

announced that it had begun in December 2007. Then, more time elapses before a fiscal policy,

such as a change in government purchases or a change in taxes, is agreed to and put into effect

—the implementation lag . Finally, still more time goes by before the policy has its full effect on

aggregate demand—the impact  lag .

Changes in fiscal policy are likely to involve a particularly long implementation lag. A tax cut wasproposed to presidential candidate John F. Kennedy in 1960 as a means of ending the recessionthat year. He recommended it to Congress in 1962. It was not passed until 1964, three years after the recession had ended. Some economists have concluded that the long implementation lag for discretionary fiscal policy makes this stabilization tool ineffective. Fortunately, automatic stabilizersrespond automatically to changes in the economy. They thus avoid not only the implementationlag but also the recognition lag.

Key Takeways:

• Discretionary fiscal policy involves the same kind of lags as monetary policy. However, theimplementation lag in fiscal policy is likely to be more pronounced, while the impact lag islikely to be less pronounced.

• Expansionary fiscal policy may result in the crowding out of private investment and netexports, reducing the impact of the policy. Similarly, contractionary policy may “crowd in”additional investment and net exports, reducing the contractionary impact of the policy.

• Supply-side economics stresses the use of fiscal policy to stimulate economic growth.Advocates of supply-side economics generally favor tax cuts to stimulate economic growth.

 

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  Components of Fiscal Policy

1. Revenue budget :

The revenue budget primarily comprises Government revenue receipts like tax and expendituremet from the revenue. The tax revenues principally constitute yields of taxes and other dutiesimposed by the Government of India. 

Revenue Budget are classified into:

a. Revenue Receipt :

  Revenue receipts are those which neither decrease the asset nor increase the liability of thegovernment. Net revenue receipts of the Centre grew at an annual average of 18.7 per cent in thefive-year period ending 2007-08

Classification of Revenue Receipt

• Tax Revenue

• Non Tax Revenue

  Data on Tax Revenue and Non Tax Revenue for last five year:

7.17.

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Classification of Tax Revenue

1. Direct Tax :

When incidence and impact of tax falls on the same person.In other words direct tax is borneentirely by the entity that pays it, and cannot be passed on to another entity; for example,corporation tax,Personal Income tax.  In 2007-08, direct tax collections exceeded indirect taxcollections; and within direct taxes, the main contribution came from corporate income tax.

2. Indirect Tax :

When incidence and impact of tax can fall on different person.In other words Charge levied bythe State on consumption, expenditure, privilege, or right but not on income or property.E.g. saletax, import duty & excise duty.In indirect taxes, excise revenues remained less buoyant, customs

revenue grew somewhat steadily, and service tax emerged as the main driver of revenue growth.

1.61.8

2.62.8

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Changes in Custom and Excise duties

1. Custom Duties:

• Customs duty on nonagricultural products, reduced from 20% (2003-04)to 10%(2007-08)

• Duty on steel melting scrap and aluminum scrap reduced to Nil (from 5 per cent earlier).

• Customs duty on crude and non-refined sulphur reduced to 2% from 5% to boost domestic

fertilizers

• Customs duty on cigars, cheroots and cigarillos was increased from 30% to 60%.

2. Excise Duties:

• CENVAT rate on all goods from 16% to 14%

• Excise duty was reduced from 16% to 8% on all drugs

• In the automobiles sector, excise duties were reduced on small cars from 16% to 12%;

hybrid cars from 24% to 14%; electric cars from 8% to Nil

• In the food processing sector, excise duty was made fully exempt on packaged tender 

coconut water, paws, mudi  (puffed rice), milk containing edible nuts and tea/coffee pre-

mixes.

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b. Capital Receipt:

Receipt which either decreases the asset or increases the liability of the Government are knownas capital receipts.eg Recovery of loans, borrowing and other liabilities,disinvestment. The sharper decline budgeted in 2008-09 in non-debt capital receipts was also on account of the base effect in2007-08 of the accounting transfer of shares of the State Bank of India to the Government fromRBI accounts.In capital receipt borrowing and other Liablities is the major source and in the fig it is

clearly visible that borrowing are continuosly rising and the year ending 2008-09 it was around 6%.While Other receipts such as PSU Disinvestment and recovery of loan have a very minor shareof around 2.1% in 2004-05 and which was further reduced to 0.2%in 2008-09.

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2. Expenditure Budget:

Budget based on the cost of goods and services already received and paid for.

  Components of Expenditure Budget:

a. Revenue Expenditure:

Revenue Expenditure are those which neither increases the asset nor decreases the liability of the government. Revenue expenditure grew by 12.0 per cent and helped lower the deficit onrevenue account

 

b. Capital Expenditure:

Capital Expenditure those which either increases the asset or decreases the liability of theGovernment. The transfer of shares of the State Bank of India (SBI) to the Government of Indiafrom RBI in 2007-08.Adjusted for these, there is a decline in capital expenditure expressed as aproportion of GDP in the period 2003-04 to 2007-08.Capital Expenditure stood at 2.5 per cent of GDP in 2007-08 and was budgeted at 1.7 per cent of GDP in 2008-09

12.2 12.2

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Plan and Non Plan Expenditure

Plan Expenditure:

 These are the expenses that form a part of the government’s five year plan. For ex- salaries andpension. As a proportion of GDP, plan revenue expenditure had remained in the range of 2.3 per cent to 3.4 per cent in the period 1997-98 to 2006-07. It rose to reach 3.7 per cent of GDP in2007-08 and was budgeted at 3.9 per cent of GDP in 2008-09.

Non Plan Expenditure:

These are the expenses that don’t form a part of the government’s five year plan and include

defense expenses, subsidies, grants to the states.In the last five year. As a proportion of GDP,non-Plan expenditure was in the range of 9.5 per cent to 10.9 per cent in the period 1997-98 to2006-07 and was placed at 8.9 per cent in 2007-08.The Budget for 2008-09 envisaged it to godown to 8.4 per cent of GDP

4.23.

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 Effects of Fiscal Policies on Employment and Production

Undoubtedly, the fiscal policies have tremendous effects on individual behavior and everydaydecisions made by households as well as businesses. A change tax schedules has direct effect incost of production and the bottom-line for corporations or net income for individuals.

Fiscal Policies and Employment

One of fiscal policy component is taxation. An increase in taxes results in reduced net income.Organizations look into profitability factors and value of labor force in comparison to return oninvestment for use of technology or outsourcing tasks otherwise performed internally or domestically. Conversely, individuals may perceive an increase in tax as a form of punishment,which can lead to promotion of more black market labor (cash labor). Of course, a decrease intaxes may lead to further domestic hiring and lesser black market labor.

Equally, it is important to note that changes in taxation policies, as a part of the fiscal monetarypolicy, can have significant effects on the intensity of employment market, and overall efficiency

and productivity. The fiscal monetary policy of the government plays a crucial role on employmentfactors.

Fiscal Policies and Production

Interest rate is another component of the fiscal policy. Adjusting the interest rate can have adverseor favourable impact on production. To clarify, adverse in monetary policy is not negativeconnotation, and favourable is not a positive suggestion. In the monetary policy when market iscollapsing too fast the government may want to have an adverse result to bring the market under control.

Change in interest rates alters velocity of "cash." Meaning, when interest rates hike, cashbecomes scarce and credit tightens, as a result, monetary expansion becomes limited andproduction decreases. On the other hand, when interest rates decline, cash becomes moreavailable and credit loosens, as a result, monetary expansion becomes more vibrant andproduction increases.

 

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  Revenue Deficit

The difference between revenue expenditure and revenue receipt of the Government is known as

revenue deficit. Revenue deficit occurs when the actual amount of expenditure and actual

amount of received revenue do not tally with the anticipated expenditure and revenue figures.

Revenue deficit gives evidence of the deficit between revenue incomes and expenditures, which is

normally met by capital account surplus, or borrowings. Thus, the revenue deficit effectively

acquires the resources by preemption, which normally goes into capital investment. The revenue

deficit is causing a major concern to the Government of India. The Government of India expects

to eliminate revenue deficit in 2008-09 financial year and is determined to reduce fiscal deficit to 3

% of the GDP (Gross Domestic Product) by the end of 2008-09 financial year.As in the fig it is

clearly visible that the revenue deficit is following from 2004-05 to 2007-08 from 2.5% to 1.1% but

again in 2008-09 it agains reaches to high of 4.5 % due to economic slowdown.

Data on Revenue Deficit:

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Fiscal Deficit

Fiscal deficit is an economic phenomenon, where the Government's total expenditure surpassesthe revenue generated.It is the difference between the government's total receipts (excluding

borrowing) and total expenditure. Fiscal deficit gives the signal to the government about the totalborrowing requirements from all sources. The government accumulates this amount by currency emission or borrows the amount in order to compensate for the shortage or deficit in taxrevenues. Normally it is described as a percentage of GDP.As in the Fig it is Clearly visiblethat fiscal deficit had reduced from 4% in 2004-05 to 2.6% in 2007-08.But again in 2008-09 itreaches to 6.1% due to economic slowdown,sixth pay commission,maturity of oil bonds.

Data on Fiscal Deficit:

)

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Fiscal Responsibility and Budget Management Act

The FRBM Act was enacted by Parliament in 2003 to bring in fiscal discipline. It received the

President’s assent in August the same year. The United Progressive Alliance (UPA) government

had notified the FRBM Rules in July 2004.

FRBM Act has four main requirements:

1. It requires the Government to place before Parliament three statements each year along with

the Budget, covering Medium Term Fiscal Policy, Fiscal Policy Strategy and Macroeconomic

Framework.

2. The Act lays down fiscal management principles, making it incumbent on the Centre to "reduce

the fiscal deficit" (no target is mentioned in the Act, but the Rules prescribe 3 per cent of GDP)

and, more categorically, to "eliminate revenue deficit" by March 31, 2008.

3. In its most stringent provision, the Act prohibits the Centre from borrowing from the Reserve

Bank of  India that is, it bans `deficit financing' through Money creation

4. The Finance Minister is required to keep Parliament informed through quarterly reviews on the

implementation, and to take corrective measures if the reviews show deviations. The Act provides

that no deviation shall be permissible "without the approval of Parliament".

The FRBM Rules impose limits on fiscal and revenue deficit. Hence, it will be the duty of the Uniongovernment to stick to the deficit targets.

As per the target, revenue deficit, which is revenue expenditure minus revenue receipts, have to

be reduced to nil in five years beginning 2004-05. Each year, the government is required toreduce the revenue deficit by 0.5% of the GDP.

The fiscal deficit is required to be reduced to 3% of the GDP by 2008-09.It would meanreduction of fiscal deficit by 0.3 % of GDP every year 

The Rules have mid-year targets for fiscal and revenue deficits. The Rules required thegovernment to restrict fiscal and revenue deficit to 45% of budget estimates at the end of September (first half of the financial year).

In case of a breach of either of the two limits, the FM will be required to explain to Parliament the

reasons for the breach, the corrective steps, as well as the proposals for funding the additionaldeficit.

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Bibliography

http://www.bized.co.uk/virtual/economy/policy/advisors/fiscal4.htm

http://www.informationbible.com/FiscalPolicy.html

http://www.econlib.org/library/Enc/FiscalPolicy.html

http://indiabudget.nic.in/es2008-09/chapt2009/chap32.pdf 

www.finmin.nic.in

http://en.wikipedia.org/wiki/Fiscal_policy