Fiscal Policy

- Dr Vighneswara Swamy

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Coverage
1. Fiscal Policy
2. Objectives of Fiscal Policy
3. Types of Fiscal Policy
4. Discretionary Vs. Non-discretionary Fiscal Policy
5. Expansionary Vs. Contractionary Fiscal Policy
6. Fiscal instruments-Taxes, Public expenditure, Public borrowings.
7. Tax structure- Direct and Indirect tax.
8. Impact of GST on the Indian economy.
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Coverage..
9. Role of Fiscal Policy during inflation and deflation
10.Laffer curve
11.Fiscal Policy and stabilization
12.Types of deficits
13.Public debt
14.Crowding-out effect.

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Fiscal Policy
•Fiscal policy is the use of government taxes and spending to alter
macroeconomic outcomes.
•It is the manipulation of government purchases, transfer payments,
taxes, and borrowing in order to positively influence the economy
•Keynes argued that fiscal policies may be necessary to bring about full
employment
•Post World War experiences showed that government stimulus
package can work
•Examples of Fiscal policies are (i) Government purchases; (ii) Transfer
payments; (iii) Taxes
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Objectives of Fiscal Policy
Fiscal Policy is designed to:
1) Achieve full-employment
2) Control inflation
3) Encourage economic growth

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Goal #1 of Fiscal Policy: raise potential GDP
Supply-side economics
▪ taxes entail welfare loss
▪  tax rates on K and L incomes  enhanced incentives to invest and work
Implication: growth of permanent GDP= supply side phenomenon
 tax rates to be lowered to favor growth
Yet most people think that tax elasticity of investment and work
effort is rather low. If this correct, then fiscal policy left with goal #2

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Goal #2: GDP stabilization
If supply-side effects are not there or small, then goal of fiscal policy is:
stabilize GDP
when economy overheated, fiscal policy should simply cool it down (by
G and T)
when in recession, fiscal policy should sustain GDP by either T or G
In both cases, fiscal policy meant to affect aggregate demand (by shifting
AD curve)
◦ By how much? It depends on the multiplier
Big issue: does fiscal policy really stabilize GDP?

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Fiscal Policy..
Fiscal Policy can
◦ boost the level of economic activity if there is a shortage of
demand which is causing a deflationary gap (reflationary policy).
◦ reduce the level of economic activity if too much demand in the
economy is causing an inflationary gap (deflationary policy).
◦ Be used to improve incentives, e.g. through income tax cuts, or
to improve the quality of resources, such as increased
government expenditure on health and education and subsidies
to key areas (supply-side policy).

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Expansionary Fiscal Policy Contracationary Fiscal Policy

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Expansionary Fiscal Policy
▪To stimulate the economy when unemployment is greater than the
natural rate
▪An increase in government purchases, decrease in net taxes, or some
combination of the two aimed at increasing aggregate demand
▪A typical Keynesian policy during recession is to use discretionary fiscal
policies to stimulate the economy to a full employment equilibrium
▪It seeks to stimulate production (and consumption)
▪Directly (expenditures ↑)
▪Indirectly (taxes ↓ to encourage household spending or investment
spending)
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Expansionary Fiscal Policy..
Expansionary $5 billion Recessions
increase in
Fiscal policy is spending
Decrease AD

used during a AS
recession to: Full $20 billion

Price level
1. Increase increase in
aggregate demand
government P1
spending
2. Decrease taxes
3. Combination of AD1
both AD2
4. Create a deficit $490 $510
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Real GDP (billions)
Contractionary Fiscal Policy
A decrease in government purchases, increase in net taxes, or some
combination of the two aimed at reducing aggregate demand
A response to inflation (economy is operating above full employment and
prices are rising)
It is used to slow down the economy when inflation is more than desired
It leads to reduction in interest rates
It seeks to reduce production (and consumption)
◦ Directly (expenditures ↓)
◦ Indirectly (taxes ↑ to discourage household or investment spending)
A politically difficult phenomenon

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Contractionary Fiscal Policy..
$3 billion initial
Used during demand- decrease in
spending
pull inflation AS
1. Decrease
government spending

Price level
Full $12 billion
2. Increase taxes P2
d c b decrease in
aggregate demand
3. Combination of both a
P1
4. Create a surplus
AD4
AD
AD3 5

$502 $510 $522

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Real GDP (billions)
Discretionary Vs. Non-discretionary Fiscal Policy
Discretionary
1. Policymakers change tax policies
or spending programs in
response to fluctuations in the
business cycle (at their
discretion)
2. Government policies that require
ongoing decisions by policy
makers
3. Discretionary policy often has
limited impacts on the economy.
Automatic Stabilizers
1. Implemented without any deliberate action
from policymakers
2. Found in the tax system and spending
programs
3. Taxes are linked to economic activity
a) Progressive income tax rates (individual
and corporate)
b) Payroll taxes
c) Sales and excise taxes
4. Recessions → automatic “tax cut”
5. Expansion → automatic “tax increase”
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Automatic or Built-In Stabilizers
Tax System
1. Taxes are linked to economic
activity
a) Progressive income tax rates
(individual and corporate)
b) Payroll taxes
c) Sales and excise taxes
2. Recessions → automatic “tax
cut”
3. Expansion → automatic “tax
increase”
Spending
1. Government spending responds
to the business cycle
a) Unemployment insurance
benefits
b) Welfare benefits
c) School lunch programs
d) Other income-support
programs
2. Recessions → more spending
3. Expansion → less spending
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Automatic or Built-in Stabilizers
▪Structural features of
government spending and
taxation smooth out
fluctuations in booms and
busts
▪Example of automatic
stabilizers are
▪(i) Unemployment
payments;
▪(ii) Welfare;
▪(Iii) Other govt. programs

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Built-In Stability
T

Government expenditures, G,
▪Automatic stabilizers
▪ Taxes vary directly with GDP

and tax revenues, T

▪ Transfers vary inversely with
GDP Surplus
G
▪Reduces severity of business Deficit
fluctuations
▪Tax progressivity
◦ Progressive tax system
◦ Proportional tax system
◦ Regressive tax system
GDP1 GDP2 GDP3
Real domestic output, GDP

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Discretionary Fiscal Policy
1. Do lag effects influence discretionary fiscal policies?
Answer: Yes, they weaken fiscal policies as a tool of economic
stabilization
2. Is there an effect of politics?
Answer: There is always the danger that politicians can use
discretionary fiscal policies to suit their short term political goals

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Fiscal Policy Instruments
Taxes Subsidies Government Crowding
Expenditure Out
1. Can be targeted 1. Research and 1. Can be targeted: During periods of
2. Reduces overall development welfare for full employment
consumption 2. Activities corporations or for the government
3. Stabilize economy that provide the poor? can borrow
4. Can have positive 2. Public goods or money that
important impact externalities:
private goods? What otherwise would
on scale 'subsidize
offers highest be spent or
goods, not
bads' marginal benefits? invested
3. Investments in
human made vs.
natural
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Government Expenditure
▪Government expenditure, also known as government spending, refers to the
resources a government allocates to achieve its strategic objectives and satisfy
the needs of the members of the nation.
▪Governments spend money on health care, education, Social Security benefits,
infrastructure and defence activities.
▪Annual government budgets specify the breakdown of funds for a fiscal year.
▪Total government expenditure includes federal government expenditure, as well
as state and local government expenditure.
▪Economists classify government expenditure into two main types: transfer
payments and purchase of services and goods.

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Types of Government Expenditure
Government final Capital Expenditures or Fixed Capital Transfer payments
consumption Formation
expenditure
Current Expenditures Capital Expenditures or fixed capital Transfer payments -
or Government final formation (or government investment) - spending that does not
consumption government spending on goods and services involve transactions of
expenditure on goods intended to create future benefits, such goods and services, but
and services for current as infrastructure investment in transport instead represent
use to directly satisfy (roads, rail airports), health (water collection transfers of money, such
individual or collective and distribution, sewage systems, as social security
needs of the members communication (telephone, radio and tv) and payments, pensions and
of the community research spending (defence, space, genetics). unemployment benefit.

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Public Expenditure

Public Expenditures

Government
Transfers (Tr)
Expenditures (G)

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Public Expenditure..
Current expenditure Capital Expenditure
1. Current expenditure is expenditure on goods 1. Capital expenditure
and services consumed within the current measures the value of
year.
purchases of fixed assets,
2. Current expenditure includes final
consumption expenditure, property income i.e. those assets that are
paid, subsidies and other current transfers used repeatedly in
(e.g., social security, social assistance, production processes for
pensions and other welfare benefits). more than a year.
3. Goods And Services 2. The value is at full cost
4. Interest Payments
price.
5. Subsidies
6. Transfers 3. Sales of fixed assets are not
deducted.
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Crowding Out Effect
▪Crowding out effect is a situation when increased interest rates lead to a
reduction in private investment spending such that it dampens the initial
increase of total investment spending.
▪When the government adopts an expansionary fiscal policy stance and
increases its spending to boost the economic activity, it leads to an increase in
interest rates. Increased interest rates affect private investment decisions. A
high magnitude of the crowding out effect may even lead to lesser income in
the economy.
▪With higher interest rates, the cost for funds to be invested increases and
affects their accessibility to debt financing mechanisms. This leads to lesser
investment ultimately and crowds out the impact of the initial rise in the total
investment spending.

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Crowding Out Effect
The tendency of
expansionary fiscal policy
to cause a decrease in
planned investment or
planned consumption in
the private sector; this
decrease normally results
from the rise of interest
rates.
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Crowding Out Effect
▪ Private sector spending is
‘crowded-out’ by the
government’s deficit spending.
▪ The crowding out effect refers
to a situation of high
government expenditure
supported by high borrowing
causes decrease in private
expenditure. Or in other
words, when the government
is increasing its expenditure,
private expenditure comes
down.
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The Crowding-Out Effect, Step by Step

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 Crowding Out and IS-LM curve
▪ Economy is at equilibrium at point E1.
▪ The corresponding income-interest rate combination is r1 – Y1.
▪ An increase in government spending shifts the IS1 curve to IS2,
shifting the equilibrium point to E2.
▪ Consequently, income rises to OY1 from OY, (a full multiplier
effect of government spending).
▪ But the economy is out of equilibrium: goods market is in
equilibrium (since planned expenditure equals aggregate
output), but money market is out of equilibrium. This is because
higher income causes money demand to rise.
▪ This excess demand for money (in the money market) then pulls
up the interest rate, leading to a fall in aggregate demand as it
squeezes out some private investment, tending to reduce the
size of the multiplier effect on income.
▪ Final equilibrium (determined by the IS-LM intersection) now
occurs at point E3 and aggregate output declines to OY3.

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 Crowding Out and AD/AS
Deficit Fiscal Policy AD shifts to AD1 when G increases
The tendency Then shifts back to AD2 as I falls due to
Real ir SLF (Private Savings) Price the increase in interest rates.
of
expansionary Level
SRAS
fiscal policy to
cause a
r1 Pl1
decrease in
planned
investment or Pl2
r
planned PL AD1
consumption (C+I+G1)
in the private
DLF1 (Private
sector; this +
decrease Government) AD2
(C+(I-I1)+G1)
normally DLF
results from (Private
Demand)
the rise of AD
interest rates. QLF QLF1 Y Y2 Y1
(C+I+G)

Quantity of Loanable Funds Real Gross Domestic Product

Barro-Ricardo Effect
▪The Barro-Ricardo Effect is feedback caused by a Crowding Out
effect.
▪Higher interest rates associated with Crowding Out cause individuals
to save more of their incomes.
▪The rise in savings increases the supply of loanable funds, thereby
reducing the real interest rate.
▪The B-R effect has a smaller impact and usually doesn’t fully
negate a crowding out effect.
 Illustrating the Crowding-out Effect
Interest rates paid by private borrowers in a nation are a primary determinant of the
levels of savings, investment, and consumption. The market in which private interest
rates is illustrated is called the loanable funds market.

The Loanable Funds Market: A nation's loanable funds market represents

the money in commercial banks that is available to be loaned out to firms
and households to finance private investment and consumption.
• The price of loanable funds is the real interest rate
• The market shows relationships between real returns on savings and
real price of borrowing and the private sector's willingness to save and
invest.
• The supply curve represents household savings
➢ At higher interest rates, households save more
➢ At lower rates, households save less

• The demand curve represents investment

➢ At higher interest rates, firms invest less
➢ At lower interest rates, firms invest more
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 Crowding-out Effect in the Loanable
Funds Market
When a government borrows in order to finance a budget deficit, it must increase
the interest rates on its bonds in order to attract more lenders.
• Higher rates on government debt will lead households to take their savings
out of private banks and lend it to government instead

• This causes the supply of loanable funds to decrease, leading to

higher borrowing costs in the private sector.
➢ Before the expansionary fiscal policy, the level investment was
Qpr.
➢ Higher interest rates on government bonds cause the supply of
loanable funds to decrease to S1.
➢ Less money in banks leads to higher interest rates. The quantity
funds demanded for private investment falls to Qp.
➢ Overall spending increases to Qg, but there is a decrease in
private investment of Qp-Qpr
Private sector spending is ‘crowded-out’ by the government’s deficit
spending. This means AD will not increase by as much as the spending
multiplier would predict. 32
Crowding-out Effect in the AD/AS Model
Let us say a government increases spending by $100
million, without raising taxes. This money must be
borrowed. Assume the multiplier is 4.
The fiscal policy should lead to an increase in AD of $400
million. However…
• If the government’s borrowing reduces the supply of
funds available to the private sector, then higher interest
rates might cause private investment to fall, therefore,
• The total increase in AD will be less than that which was
predicted by the multiplier.
➢ To reach full employment, AD would have to
increase to AD1.
➢ But due to crowding-out, it only increases to AD2.
A much larger stimulus would be needed than the multiplier
predicts, further increasing national debt!
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Evaluating the Crowding-out Effect
During deep recessions: During mild recessions:
Crowding-out is unlikely to occur; private sector Crowding-out is more likely to occur; resources are close
investment is already deeply depressed. There is very to being fully-employed, and private sector spending is
little spending to crowd out, and government should be relatively high. Government will have to offer higher
able to borrow without raising interest rates by much rates to attract lenders, which could cause private
investment to fall
LRAS SRAS
LRAS PL
PL SRAS

Pfe
Pfe
P2

AD1
P2 AD1
AD2

$100 million
$500 million AD2
Y2 Yfe real GDP
Y2 Yfe real GDP
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Fiscal Policy Lag Effects
1. Recognition lag
The time required to gather information about the current state of the
economy
2. Decision lag
The time required to take a decision after recognizing the current state of the
economy
3. Action lag
The time required between recognizing an economic problem and putting
policy into effect
4. Effect Time lag
The time it takes for a fiscal policy to affect the economy
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Three Pillars of Keynesian Economics
1. Liquidity Trap:
A lack of borrowing keeps money bottled up in savings institutions. A
Keynesian solution to a liquidity trap is that Government borrows the
money that consumers and business do not borrow.
2. Balanced Budget Multiplier:
When the government taxes and spends the money there is a multiple
effect because of no savings
3. Paradox of thrift:
The more people save, the less will be demand, which leads to slow
growth
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How fiscal policy affects business?
▪Businesses directly experience the effects of fiscal policy whether it's in the form
of spending or taxation.
▪Businesses can foresee investment opportunities from government spending as
well as private investment. This commonly happens during an expansionary policy,
when more money is flowing into the economy from the government and from
other sources since taxation is also low.
▪When a balance between price and demand are met, then businesses can expect
to thrive and grow.
▪A contractionary financial policy may kick in to prevent inflation when that
balance is broken and demand and prices fall. Businesses typically reign in their
growth due to rising taxes and take measures to stay in the black with less money
flowing through the economy.
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How effective are fiscal policies?
▪Automatic or built-in stabilizers are more effective than are
discretionary fiscal policies
▪The stronger and more effective the automatic stabilizers
are, the less need there is for discretionary fiscal policies

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Does fiscal policy really stabilize GDP?
Three possible reasons for why this may not be
the case
1. Political delays
2. Ricardian equivalence
3. Crowding out

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Reasons why fiscal policy may not stabilize GDP?
Political delays Ricardian equivalence Crowding Out
‘Right’ fiscal policy Robert Barro Suppose G to counteract recession; expect
stance hardly If T temporary, effects on AD very large effect on AD (shift of AD)?
No, if other AD items ‘crowded out’
delivered when small How is G financed? Suppose G financed by
needed. Approval Why? DEF
takes time If tax cut is “temporary”, then people  DEF  price of T-bonds and interest rates
 I (private investment)
When tax cuts to would save additional income overall effect on AD dampened
sustain GDP obtain from tax cut, rather than By how much, it depends on how responsive
Parliament consume it investment and savings are to interest rates
With today’s high K mobility, only if large
approval, it may be If G has not been cut in parallel, I economy (e.g USA, Euroland or OECD) runs
too late expect taxes up tomorrow & a large DEF will it have an impact on world
save to meet future tax interest rates; unlikely to work for small
If approved and economies in isolation
obligations
implemented late, if G financed by T: T  C, effect on AD
risk of GDP de- Hence AD stays where it is dampened either
stabilization If Barro is right, changing tax rates If crowding out important, stabilizing role of
does not stabilize GDP fiscal policy may not be there

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Ricardian Equivalence
▪Ricardian equivalence suggests that when a government tries to
stimulate an economy by increasing debt-financed government
spending, demand remains unchanged.
▪Aggregate Demand (AD) remains unchanged due to the fact that the
public saves its excess money to pay for expected future tax increases
that will be used to pay off the debt.
▪Ricardian Equivalence holds if taxation and government borrowing
both have the same effect on spending in the private sector.
▪Ricardian equivalence theory was developed by David Ricardo in the
19th century but was revised by Harvard professor Robert Barro into a
more elaborate version of the same concept.
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Two arguments for Fiscal Policy
Efficiency
Efficiency refers to the
collective well being of
an economy.
Can we use fiscal policy to
increase aggregate income?
Equity
Equity refers to the
distribution of well being
across individual in an
economy.
Can we use fiscal policy to
redistribute income in a “fair”
way?
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Fiscal Policy - Challenges
1. Political factors
2. Time lags
a) Time required to create and pass legislation
b) Time required to implement legislation
3. Supply side impacts
4. Forecasting difficulties
5. Monetary policies may reinforce or offset fiscal policies

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Taxes
▪A tax may be defined as a "pecuniary burden laid upon
individuals or property owners to support the
government, a payment exacted by legislative
authority.”
▪A tax "is not a voluntary payment or donation, but an
enforced contribution, exacted pursuant to legislative
authority".
▪Taxes: Direct and Indirect
Direct Taxes are Income Tax; Corporation Tax; Property
Tax; Inheritance (Estate) Tax; Gift Tax.
Indirect Taxes are Goods and Services Tax; Customs Duty
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Tax structure- Direct and Indirect tax
Direct Taxes
1. A Direct tax is a kind of charge,
which is imposed directly on the
taxpayer and paid directly to the
government by the persons (juristic
or natural) on whom it is imposed.
2. A direct tax is one that cannot be
shifted by the taxpayer to someone
else.
3. The some important direct taxes
imposed in India are as under:
Income Tax; Corporation Tax;
Property Tax; Inheritance (Estate)
Tax; Gift Tax.
Indirect Taxes
1. An indirect tax is a tax collected by an
intermediary (such as a retail store) from the
person who bears the ultimate economic
burden of the tax (such as the customer).
2. An indirect tax is one that can be shifted by the
taxpayer to someone else.
3. An indirect tax may increase the price of a good
so that consumers are actually paying the tax
by paying more for the products.
4. The some important indirect taxes imposed in
India are as under: Goods and Services Tax;
Customs Duty
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Nature of Taxes
Regressive
• % of income paid in taxes ↓ as income ↑

Progressive
• % of income paid in taxes ↑ as income ↑

Proportional
• % of income paid in taxes is fixed as income
changes
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Benefits of GST
1 Reduction in Cascading of Taxes
Decrease in
2 Overall Reduction in Prices Inflation

3 Common National Market

Ease of Doing
4 Benefits to Small Taxpayers Business

5 Self-Regulating Tax System

Decrease in “Black”
Non-Intrusive Electronic Tax System Transactions
6
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Benefits of GST ..
7 Simplified Tax Regime
More informed
8 Reduction in Multiplicity of Taxes consumer

9 Consumption Based Tax

Poorer States
10 Abolition of CST to Gain

11 Exports to be Zero Rated

Make in India
12 Protection of Domestic Ind. - IGST

48
 Central Taxes
Multiple State Taxes Single Tax-GST
Tax Multiple State Tax
Administrations Single Tax
Administrations Administration
CEx/ST Act & Rules Multiple Acts & Rules
Uniform law
Procedures Multiple procedures
Computerized
uniform procedures
Pre-GST Indirect tax structure in India

GST
GST

CGST
CGST SGST/UTGST
SGST/UTGST IGST
IGST

GST Structure in India

Goods and Services Tax
▪“Goods and services tax” means any tax on supply of goods, or services or both
except taxes on the supply of the alcoholic liquor for human consumption. (w.e.f 1
July, 2017)
▪GST includes Central Excise duty, Duties of Excise (medicinal and toilet preparations),
Additional Duties of Excise (goods of special importance), Additional Duties of Excise
(textile and textile products), Additional Duties of Customs, Special Additional Duties
of Customs, Service Tax, and Central surcharges and cesses.
▪The State taxes subsumed under GST include State VAT, Entry Tax, Central Sales Tax,
Entertainment and Amusement Tax, Luxury Tax, Purchase Tax, Taxes on
advertisements.
▪GST have been categorised under four tax slabs, viz. 5%, 12%, 18%, and 28%.

50
Benefits of GST
1 Reduction in Cascading of Taxes
Decrease in
2 Overall Reduction in Prices Inflation

3 Common National Market

Ease of Doing
4 Benefits to Small Taxpayers Business

5 Self-Regulating Tax System

Decrease in “Black”
Non-Intrusive Electronic Tax System Transactions
6
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Benefits of GST ..
7 Simplified Tax Regime
More informed
8 Reduction in Multiplicity of Taxes consumer

9 Consumption Based Tax

Poorer States
10 Abolition of CST to Gain

11 Exports to be Zero Rated

Make in India
12 Protection of Domestic Ind. - IGST

52
What is Laffer Curve?
▪The Laffer Curve describes the relationship between the tax rate and the tax
revenue it generates
▪The Laffer Curve implies there is an “optimal” tax rate, a tax rate that
maximizes tax revenue.
▪The Laffer curve is the graphical representation of the relationship
between tax rates and absolute revenue these rates generate for the
government.
▪The principle thought behind the Laffer curve is that a zero tax rate would
produce zero revenue and a 100% tax rate would also generate zero revenue,
as there would be no incentive to work. This means there must be an optimal
tax rate that will yield maximum revenue for the government.
▪The Laffer curve gets its name from economist Arthur Laffer
53
Laffer curve
A curve that shows that
starting from zero an
increase in taxes will
raise revenue but beyond
a point an increase will
lower revenues

54
Laffer Curve..
What is the case in India?
Although the current rate of taxes in India is considered moderate, it is felt that
lowering the tax rate will increase compliance further, particularly in the case of
individuals.
What is the case around the world?
A recent paper of the European Central Bank says that the US could increase tax
revenues by as much as 30% by raising labour taxes or tax on income and 6% by
raising capital income taxes or tax on business.
For a select 14 countries of the EU, the benefit from rate hike can be only 8% and 1%,
respectively.
The study notes that Denmark and Sweden are on the wrong side of the Laffer curve
for capital income taxation.

55
Measuring Fiscal Policy’s Effects
▪Effects are not limited to the initial dollar value of the change in
policy
▪The eventual effects may be larger or smaller, depending on:
1. Multiplier effect
2. Crowding-out effect
Fiscal operations
Fiscal operations are actions taken by the government to
implement budgetary policies, such as revenue and expenditure
measures, as well as issuance of public debt instruments and
public debt management.
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Budget Lingo
Balanced budget
• Revenues = Expenditures

Budget deficit
• Revenues < Expenditures
Budget surplus
• Revenues > Expenditures
Government debt
• Sum of all deficits – Sum of all surpluses

57
Budget Glossary
Revenue Receipts:
The earnings made by the government which neither create liabilities or reduce assets
of the government. For example, receipts from tax collections, interest on investments,
dividend earnings and earnings from services provided.
Capital Receipts:
The earnings made by the government which creates liabilities (borrowing from the
public in form of PPF and small saving deposits, National Pension Scheme etc. ) or
reduce assets (divesting stake in a particular company, called disinvestment or
recovering loans made to state governments.)
Non-debt Capital Receipts
These are capital receipts which do not create debt for the government such as
recovery of loans made and selling a stake in a public company.

58
Budget Glossary..
Revenue expenditure:
It is the expenditure made by the government on a recurring basis such as
administrative expenses, interest payments on loan taken by the
government, pensions, subsidies etc.
Capital expenditure:
It is a productive, asset-creating (or liability reducing) long-period, non-
recurring expenditure of the government. For example; expenditure on
creating the infrastructure (roads, electricity dams etc.), loans made to
state governments and repayment of loans by the central government
(reducing liability).

59
Budget Glossary…
Gross Fiscal Deficit (GFD):
GFD of the government is the difference between the total expenditure incurred and the
total non-debt capital receipts (total receipts minus the earnings from borrowing) of the
government. GFD indicates the total borrowing requirements (incl. the need for interest
payments) of the government.
Revenue Deficit (RD):
RD is the difference between the revenue receipts and the revenue expenditure of the
central government. RD indicates the excess amount of expenditure by the government to
fund current consumption needs rather than for productive asset-creation.
Gross Primary Deficit (GPD):
GPD is the difference between the fiscal deficit of the current year and the interest
payments on the previous borrowings made by the government. GPD indicates how much
of the government borrowing is going to meet expenses other than interest payments.
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Gross Budgetary Support
▪The government’s support to the Central plan is called Gross Budgetary Support.
▪The Central plan forms the annual expenditure of the government and is
incurred keeping the objectives of 5-year plans in mind.
▪Budgetary Support is earmarked for meeting the planned outlays of the Central
government during the financial year.
▪Plan outlays are incurred for development of heterogeneous sectors like
agriculture and allied activities, rural areas, irrigation and flood control, energy,
industry and minerals, transport, communications, science, technology and
environment, social services like education, mid day meal scheme, Sarva Shiksha
Abhiyan, health, housing, police, justice administration etc.

61
Fiscal Deficit
▪Fiscal Deficit is the difference between total revenue and total expenditure of the government.
▪Fiscal Deficit is an indication of the total borrowings needed by the government.
▪While calculating the total revenue, borrowings are not included.
▪The gross fiscal deficit (GFD) is the excess of total expenditure including loans net of recovery over
revenue receipts (including external grants) and non-debt capital receipts. The net fiscal deficit is the
gross fiscal deficit less net lending of the Central government.
▪Generally fiscal deficit takes place either due to revenue deficit or a major hike in capital expenditure.
Capital expenditure is incurred to create long-term assets such as factories, buildings and other
development.
▪A deficit is usually financed through borrowing from either the central bank of the country or raising
money from capital markets by issuing different instruments like treasury bills and bonds.
▪Fiscal consolidation is a policy aimed at reducing government deficits and debt accumulation.
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Fiscal Deficit - classification
Gross Fiscal Deficit (GFD) Net Fiscal Deficit
The gross fiscal deficit (GFD) is The net fiscal deficit is the gross
the excess of total expenditure fiscal deficit less net lending of
including loans net of recovery the Central government.
over revenue receipts (including
external grants) and non-debt
capital receipts.

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 Deficit Types
Deficit Types

Revenue deficit = Fiscal deficit =

Primary deficit =
Total revenue Total expenditure – Total Fiscal deficit-Interest
expenditure – Total receipts excluding payments
revenue receipts borrowings

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India - Budget at a Glance
India Budget at a Glance (In INR crore)
2016-2017 2017-2018 2017-2018 2018-2019
Actuals Budget Estimates Revised Estimates Budget Estimates
1Revenue Receipts 1374203 1515771 1505428 1725738
2. Tax Revenue 1101372 1227014 1269454 1480649
(Net to Centre)
3. Non-Tax Revenue 272831 288757 235974 245089
4Capital Receipts 600991 630964 712322 716475
5. Recovery of Loans 17630 11933 17473 12199
6. Other Receipts 47743 72500 100000 80000
7. Borrowings and Other Liabilities 535618 546531 594849 624276
8Total Receipts (1+4) 1975194 2146735 2217750 2442213
9Total Expenditure (10+13) 1975194 2146735 2217750 2442213
10On Revenue Account 1690584 1836934 1944305 2141772
of which
11Interest Payments 480714 523078 530843 575795
12Grants in Aid for creation
of capital assets 165733 195350 189245 195345
13On Capital Account 284610 309801 273445 300441

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India Budget –Deficits at a Glance
(In INR crore)
2016-2017 2017-2018 2017-2018 2018-2019
Actuals Budget Estimates Revised Estimates Budget Estimates

Revenue Deficit 316381 321163 438877 416034

-2.1 -1.9 -2.6 -2.2
Effective Revenue Deficit 150648 125813 249632 220689
-1 -0.7 -1.5 -1.2
Fiscal Deficit 535618 546531 594849 624276
-3.5 -3.2 -3.5 -3.3
Primary Deficit 54904 23453 64006 48481
-0.4 -0.1 -0.4 -0.3
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India – Deficit Trends
▪ Gross Primary Deficit is Gross Fiscal Deficit
less interest payments.
▪ Net Primary Deficit is Net Fiscal Deficit minus
net interest payments.
▪ Net interest payment is interest paid minus
interest receipt.
▪ While fiscal deficit is the difference between
total revenue and expenditure, primary deficit
can be arrived by deducting interest payment
from fiscal deficit.
▪ Interest payment is the payment that a
government makes on its borrowings to the
creditors
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Deficit
▪Deficit occurs when government spending (purchases &
transfers) exceeds tax receipts
▪Primary deficit is one of the parts of fiscal deficit.
▪While Fiscal Deficit is the difference between total
revenue and expenditure, Primary Deficit can be arrived
by deducting interest payment from fiscal deficit.
▪Interest payment is the payment that a government
makes on its borrowings to the creditors
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Budget Deficit and Debt
• Budget deficit (DEF) = G + Ig + Tr + iD-1– T
• DEF goes up in recessions and down in booms
▪ Why? In recession: Tr and T (why?)
▪ Hence: in recession, DEF. The opposite during
booms
▪ Structural DEF computed as if GDP were at its
potential
• Balanced budget: DEF=0, G + + Ig Tr + iD-1 = T
• Primary deficit = (G + Ig + Tr – T)
• Deficit is not debt: debt = sum of current and past
deficits
▪G = Govt purchases of goods and
services (for education, justices,
defense)
▪Ig = public investment (for roads,
highways)
▪Tr = transfers (pensions, assistance
to the poor). Tr  G or Ig: doesn’t
have to do with provision of goods
and services
▪iD-1 = interest payments on
outstanding debt (another type of
transfers)
▪T = indirect taxes (e.g. VAT) + direct
taxes (personal & corporate taxes) +
social security contributions
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India
Deficit Financing

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Deficit
▪Deficit occurs when government spending (purchases &
transfers) exceeds tax receipts
▪Primary deficit is one of the parts of fiscal deficit.
▪While Fiscal Deficit is the difference between total
revenue and expenditure, Primary Deficit can be arrived
by deducting interest payment from fiscal deficit.
▪Interest payment is the payment that a government
makes on its borrowings to the creditors
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Fiscal Consolidation
▪Fiscal consolidation is a process where government’s fiscal health is getting
improved and is indicated by reduced fiscal deficit.
▪Improved tax revenue realization and better aligned expenditure are the
components of fiscal consolidation as the fiscal deficit reaches at a
manageable level.
▪Fiscal consolidation is a reduction in the underlying fiscal deficit. It is not
aimed at eliminating fiscal debt
▪In India, fiscal consolidation or the fiscal roadmap for the centre is
expressed in terms of the budgetary targets (fiscal deficit and revenue
deficit) to be realized in successive budgets.
▪The Fiscal Responsibility and Budget Management (FRBM) Act gives the
targets for fiscal consolidation in India.
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Fiscal Consolidation
▪Fiscal consolidation is a process where government’s fiscal health is getting
improved and is indicated by reduced fiscal deficit.
▪Improved tax revenue realization and better aligned expenditure are the
components of fiscal consolidation as the fiscal deficit reaches at a
manageable level.
▪Fiscal consolidation is a reduction in the underlying fiscal deficit. It is not
aimed at eliminating fiscal debt
▪In India, fiscal consolidation or the fiscal roadmap for the centre is
expressed in terms of the budgetary targets (fiscal deficit and revenue
deficit) to be realized in successive budgets. The Fiscal Responsibility and
Budget Management (FRBM) Act gives the targets for fiscal consolidation in
India.
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What is FRBM Act?
▪The Fiscal Responsibility and Budget Management (FRBM) Act was enacted in
2003.
▪FRBM sets targets for the government to reduce fiscal deficits.
▪The targets were put off several times.
▪In May 2016, the government set up a committee under NK Singh to review the
FRBM Act.
▪The committee recommended that the government should target a fiscal deficit
of 3 per cent of the GDP in years up to March 31, 2020 cut it to 2.8 per cent in
2020-21 and to 2.5 percent.

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Public Debt
▪Public debt are the external obligations of the government and
public sector agencies.
▪Public external debt is the external debt obligations of the public
sector.
▪Government debt (also known as public interest, public debt,
national debt and sovereign debt) is the debt owed by a
government.
▪By contrast, the annual "government deficit" refers to the difference
between government receipts and spending in a single year.

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Role of Fiscal Policy during inflation
During Inflation the following is the Fiscal policy approach:
◦ Inflation can be reduced by policies that slow down the growth of Aggregate
Demand (AD) and/or boost the rate of growth of Aggregate Supply (AS).
◦ To control inflation there is a need to control aggregate demand. If the
government believes that AD is too high, it may choose to ‘tighten fiscal
policy’ by reducing its own spending on public and merit goods or welfare
payments
◦ It can choose to raise direct taxes, leading to a reduction in real disposable
income
◦ The consequence may be that demand and output are lower which has a
negative effect on jobs and real economic growth in the short-term.

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Role of Fiscal Policy during deflation
During Deflation, the following Fiscal policy is adopted:
◦This involves increasing AD.
◦Therefore the government will increase spending (G)
and cut taxes (T).
◦Lower taxes will increase consumers spending because
they have more disposable income (C)
◦This will tend to worsen the government budget deficit,
and the government will need to increase borrowing.

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Key words
Fiscal Policy
Discretionary Fiscal Policy Primary Deficit
Non-discretionary Fiscal Policy Revenue Deficit
Direct Tax Laffer Curve
Indirect Tax Crowding out effect
GST Public Debt
Budget
Budget Deficit

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