Chapter

Fiscal Policy

Fiscal Policy
The sphere of state action on a country's budget is vast and all pervading. It includes "maintaining public services, influencing attitudes, shaping economic institutions, influencing the use of resources, influencing the distribution of income, controlling the quantity of money, controlling fluctuations, ensuring full employment, and influencing the level of investment."
W.A. Lewis and Philip V. Taylor give a more comprehensive definition when they say, "A budget is a master financial plan of the government. It brings estimates of anticipated revenues and proposed expenditures, employing schedule of activities to be undertaken towards the direction of national objectives. It is a device for consolidating various interest, objectives, desires and needs of people into a programme whereby they provide for their safety, convenience and comforts. Fiscal policy is the projected balance sheet of the country, prepared by the chief finance officer of the country i.e. the finance minister of the State.

Components of a Budget
Typically, a budget includes the following four components: a. A review of the economy b. Major policy announcements c. Expenditure proposal d. Tax proposal There are three major functions of a fiscal policy: The first is the function of allocation in the budget policy to make provisions for social goods. It is a process by which the total resources are divided between private and social goods and by which the mix of social goods is chosen. The Second is the distribution function of budget policy. This includes distribution of income and wealth in accordance with what the society considers a fair or just distribution. The third is the stabilisation function of a budget policy, that is marinating high employment, a reasonable degree of price stability, an appropriate rate of economic growth, with due considerations of its effects on trade and the balance of payment.

Revenue Budget
It consists of revenue receipts and revenue expenditure.
Revenue receipts: This includes tax revenue and other revenues: a. b. Tax revenue: These comprise of taxes and other duties levied by the Union government Other revenue: These receipts of the government mainly consist of interest and dividends on investment made by the government, fees and receipts for other services rendered by the government

Revenue Expenditure This includes expenditure for normal running of government departments and various services interest charges on debt incurred by the government, subsidies, etc. Expenditure which does not result in the creation of assets is treated as revenue expenditure.

Capital Budget
It consists of capital receipts and payments. Capital Receipts This includes loans raised by the government from the public called market loans, borrowings by the government from RBI and other parties through sale of treasury bills, loans received from foreign bodies and governments, and recoveries of loans granted by the union government to states and union territory governments and other parties.

Capital Payments
These payments consist of capital expenditure on acquisition of assets like land, buildings, machinery, equipment, infrastructure, as also investment in shares, etc. and loans and advances granted by the union government to state and union territory government companies, corporations and other parties.

Mobilisation of Resources
The primary sources of funds to finance development expenditure of a country can be grouped under following categories: 1. 2. 3. Taxation. Profits of the public sector (Price). Domestic non-monetary borrowing.

4.
5.

External borrowing.
Borrowing form the RBI (monetised borrowing).

Some minor sources of revenue are Fees, Fines, Forfeitures and Escheats,

Tributes, and Indemnities, Gifts, and Grants.

Expenditure of Central Government

Non Plan Expenditure: Non-Plan expenditure of the central government is divided into revenue expenditure and capital expenditure. Revenue expenditure includes: interest payment, defence revenue expenditure, major subsidies (export, food and fertilizer), interest and other subsidies, debt relief to farmers, postal deficit, police, pension and other general services, social service, economic service (agriculture, industry, power, transport, communications, science and technology, etc.) and grants to states and union territories, and to foreign governments. Capital non - plan expenditure includes such items such as defence capital expenditure, loans to public enterprises, loans to states and union territories and loans to foreign governments.
Plan Expenditure: Plan expenditure is meant to finance central plans drawn up for agriculture, rural development, irrigation and flood control, and industries like energy, minerals, transport, communications, science and technology, environment, social services and others. Plan expenditure also includes central assistance for plans of states and union territories.

Budgets of State Government

In India, each state government prepares its own budget of income and expenditure every year. State governments collect revenue from different sources to meet their expenditure. The important sources of revenue for states are VAT (earlier sales tax), grants, aid and other contributions from the centre, the states own non -tax revenue consisting of interest receipts, dividends, profits, general services (of which state lotteries are the most important), social services and economic services. Besides this, the state also collects taxes on income and commodities and imposes income tax on agriculture and other professions. It also receives income from taxes on property and capital transactions. The main sources are land revenue, stamps, and registration, and tax on urban and immovable property.
States also charge commodity taxes like motor vehicle tax, electricity duties, etc. The state is also empowered to impose taxes on alcoholic liquor, opium, Indian hemp, and other narcotics.

Financial Power of Central and State Governments

The constitution of India divides the functions and financial powers of the government between the Central and the State together with the concurrent areas. It also provides for sharing of taxes in various forms and the system of grants- in-aids. The Seventh Schedule of the Constitution of India divides the unctions and financial resources between the Centre and States. It contains three lists namely, List I or Union List, List II or State List, and List III or Concurrent List. List I: Union List. This comprises the following items: Tax Revenue The Union List contains of 97 items contains the following sources of tax revenues for the Central government: 1. 2. 3. Taxes on income other than agricultural income. Duties on customs including exports duties. Estate duty in respect of succession to property other than agricultural land.
Cont.

4.

5.

Duties of excise on tobacco and other goods manufactured or produced in India except (a) alcoholic liquors for human consumption and (b) opium, Indian hemp and other narcotic drugs and narcotics, but including medicinal and toilet preparations containing alcohol or any substance included this paragraph (entry 84). Corporation Tax.

6.

Taxes on the capital value of assets exclusively of agricultural land of individuals and companies, and taxes on the capital of companies. 7. Duties in respect of succession to property other than agricultural land. 8. Terminal taxes on goods or passengers carried by railways, sea, or air taxes on railways fares and freights. 9. Taxes on the sale stamp duties on transactions in stock exchanges and future markets. 10. Rates on stamp duty in respect of bills of exchange, cheque, promissory notes, bills of lading, letters of credit, policies of insurance, transfer of shares, debentures, proxies and receipts. Cont.

Non Tax Revenue Non - Tax revenue includes borrowings (both internal and external), income from various government undertakings and monopolies, income from government property, etc. List II: State List. Some of the financial resources as mentioned in constitution are: Tax Revenue 1. Land Revenue. 2. Taxes on agricultural income. 3. Taxes on land and buildings. 4. Duties of excise on the following goods manufactured or produced in the state and countervailing duties at the same or lower rates on similar goods manufactured or produced elsewhere in India: (a) alcoholic liquors for human consumption (b) opium, Indian hemp and other narcotic drugs and narcotics. 5. Taxes on the entry of goods into all local areas of consumption. 6. Taxes on electricity., Taxes on vehicles for use on roads and Tolls. Cont.

Non-Tax Revenue

1.

The state government can borrow on the security of their respective

consolidated funds, but only within the country, including loans from the Government of India.

2.

Income from government undertakings owned fully or partly by state governments.

3. 4. 5.

Income from public property owned by the state government. Grants-in-aid from the Central government. Other grants for the Central government.

Fiscal Policy and Economic Growth

Fiscal policy is a potent tool in the hands of the government for regulating economic growth. Deficit financing is an effective tool in the hands of the government to increase effective demand in recession. To fill the deficit the government borrows from the RBI, the market and even creates additional currency to increase the disposable income of people. This results in a conducive environment for investment. Role of Taxes in Economic Growth Taxation is an effective budgetary tool to influence the level of savings and investment in the country. Abolition and reduction of various taxes pushes the profits up and reduces the cost of production and prices. Lower prices are expected to increase demand production and employment, which in turn add to effective demand, and so on. Similar steps can be taken in the case of custom duties. Raising import duties diverts the domestic demand from imports to domestically produced goods. Reducing or abolishing export duties or providing export subsidies increases the demand for export and contributes towards recovery from depression.

Public Debt in India

Public debt in the Indian context refers to the borrowings of the Central and state governments. Gross public debt is the gross financial liability of the government. Net public debt is the gross debt minus the value of capital assets of the government and loans and advances given by the government to other sectors. Debt obligation can be of many types: Short term debts are those where maturity is less than one year at the time of issue and consists of items like the treasury bills. Some obligations may not have specific maturity but may be repayable subject to various terms and conditions. They are called Floating Debt like provident funds, small savings, reserve funds and deposits. Permanent funded debts are loans having a maturity of more than one year at the time of issue. Usually, their maturity is between three and thirty years. Some of them may even be non-terminable so that the government is only to pay the interest on such debt without ever repaying the principle amount. Obligations owed to foreigners--government institutions, firms and individuals are called external loans. Cont.

Public Debt and Inflation Public debt has an inflationary impact on the economy. It diverts the public savings, and sometimes public investment on consumption goods into that on capital goods. The capital goods industry has a longer gestation period, so in the meantime demand for consumption goods tends to exceed their supply. As the government invests public debt in infrastructure projects, etc., it increases demand as these provide employment to many. But production doesn not increase at the same pace, and therefore inflation rises. The Role of Public Debt in Regulating the Economy The variations in the volume, composition and yield rates of public debt can be used to regulate the economy's financial system. Government securities are highly liquid assets and their holders it can easily convert them into spendable purchasing power. So through various public debt policies, the government can influence the sum total of purchasing power or liquidity of the public debt.

Deficit Financing
Deficit Financing can be defined as "the financing of deliberately created gap between public revenue and public expenditure or a budgetary deficit, the

method of financing resorted to being borrowing of a type that results in a net

addition to national outlay or aggregate expenditure." Therefore, we can say it is deliberate unbalancing of the budget in such a way that government expenditure exceeds government revenue. In India, great reliance has been placed on deficit

financing for mobilising resources for the plans. Deficit financing in different
ways: a. b. c. Revenue Deficit Budget Deficit Fiscal Deficit
Cont.

Deficit Financing and Economic Growth Deficit financing can be used in accelerating economic growth. The government can use deficit spending for shifting productive resources of the economy into the capital goods sector, developing basic and key industries and providing necessary infrastructure. Deficit financing is a potent tool in the hands of the government for increasing effective demand. There are two forms of deficit financing which can be resorted to in combination: 1. The government may borrow from the market. This procedure is equivalent to transferring resources straight from the hands into those of the government. Market borrowings therefore, generally amount to loans from various institutions and this generally means diversion of investable funds from the private sector to the public sector.

2.

Deficit financing, i.e. resorting to the printing press amounts to taking away a portion of the private sector's resources and leaving it with extra money. This technique can be used for reallocation of the economy's resources and accelerating the pace of economic growth.

Impact of Fiscal Policy on Business

If there is any single document that has maximum impact on business, it is the Budget. Each years Budget brings opportunities and threats for business. Every budget improves the bottom line of some businesses, while some businesses go into the red. The recent budget, for instance, compelled organisations to work on their Compensation plan because of the Fringe Benefit Tax (FBT). Similarly, the budget of year 2005 gave a big impetus to mutual funds, and in turn to the stock market, by allowing tax rebate on investment in mutual funds. The introduction of VAT also has a big impact on the business. In early 1990s, the electronic industry was in great pressure as market growth rate was very low. Understanding this, the then finance minister Dr. Manmohan Singh reduced the excise on electronics, especially CTVs, which resulted in decrease in prices and rise in sales. Taxes on intermediary goods, corporate tax and dividend tax have an obvious impact on business. One of the reasons that gave rise to the Indian consumer industry is the relaxation in fiscal policy.

Some Technical Terms of Budget

Revenue Budget Tax Revenue Other Revenue Revenue Expenditure Capital Budget Capital Receipts Capital Payment Fiscal Deficit Primary Deficit Balance of Payment Capital gain tax Convertibility Countervailing Duty National Debt Public Debt Tax Avoidance

Demands for Grants

Finance Bill Performance Budget Appropriation Bill

Tax Evasion
Treasury Bill Annual Financial Statement

Budget deficit