Final Draft: Economics

Topic: Fiscal Policy Of India

SUBMITTED TO: SUBMITTED BY:

Dr. Mitali Tiwari, Rishabh Bhandari,

Assistant Professor (Economics), B.A. L.L.B. (Hons.) {Sem II},

Dr. Ram Manohar Lohiya NLU, Lko. Dr. Ram Manohar Lohiya NLU, Lko.
 Acknowledgement

This project consumed huge amount of work, research and dedication. Still, implementation
would not have been possible if I did not have a support of many individuals and organizations.
Therefore I would like to extend my sincere gratitude to all of them.

I am very thankful to my Economics professor, Dr. Mitali Tiwari, for her valuable help.

I would also like to thank my friends, who often helped and gave me support at critical junctures
during the making to this project.

Rishabh Bhandari.

Roll No - 112

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 Table of Contents
Acknowledgement............................................................................................................................i

Chapter 1: Introduction....................................................................................................................1

[I] Background.............................................................................................................................1

[II] Research Questions...............................................................................................................1

[III] Objectives.............................................................................................................................2

[IV] Research Methodology........................................................................................................2

[V] Analysis and Interpretation...................................................................................................2

[VI] Conclusion...........................................................................................................................3

Chapter 2: Meaning and Objective..................................................................................................4

Development by effective allocation of Resources.................................................................4

Expenditure of Financial Resources........................................................................................5

Reduction of Income and Wealth inequalities.........................................................................5

Price Stability and Control of Inflation...................................................................................6

Employment Generation..........................................................................................................6

Balanced Regional Development............................................................................................7

Reducing the Deficit in the Balance of Payment.....................................................................7

Capital Formation....................................................................................................................7

Increasing National Income.....................................................................................................8

Development of Infrastructure.................................................................................................8

Chapter 3: Fiscal Policy’s role in Economic Development.............................................................9

Chapter 4: Tools of Fiscal Policy..................................................................................................12

Chapter 5: Conclusion...................................................................................................................14

Bibliography...................................................................................................................................iii
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Books:.........................................................................................................................................iii

Online Sources:..........................................................................................................................iii

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 Chapter 1: Introduction

[I] Background
In economics and political science, fiscal policy is the use of government revenue collection

(mainly taxes) and expenditure (spending) to influence the economy. According to Keynesian

economics, when the government changes the levels of taxation and governments spending, it
influences aggregate demand and the level of economic activity. Fiscal policy can be used to

stabilize the economy over the course of the business cycle.

The two main instruments of fiscal policy are changes in the level and composition of taxation
and government spending in various sectors. These changes can affect the
following macroeconomic variables, amongst others, in an economy:

 Aggregate demand and the level of economic activity;

 Savings and Investment in the economy
 The distribution of income

Fiscal policy can be distinguished from monetary policy, in that fiscal policy deals with taxation
and government spending and is often administered by an executive under laws of a legislature,
whereas monetary policy deals with the money supply, lending rates and interest rates and is
often administered by a central bank.

[II] Research Questions

1. What are the various objectives of Fiscal Policy?
2. What is the role of Fiscal Policy in the economic development of India ?
3. What are the tools of Fiscal Policy ?

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[III] Objectives
 This research is an attempt to highlight the meaning of Fiscal Policy and bring to the light
the role of Fiscal Policy in the economic development.
 The basic idea is to define the tools of Fiscal Policy and analyse how they bring an
impact to an economy’s functioning.

[IV] Research Methodology

The research is strictly doctrinal, the sources being exhaustive and limited to the internet, books,
journals, and newspaper articles, although reference to all of the aforementioned sources may not
be necessarily made.

[V] Analysis and Interpretation

The three main stances of fiscal policy are:

 Neutral fiscal policy is usually undertaken when an economy is in

equilibrium. Government spending is fully funded by tax revenue and overall the budget
outcome has a neutral effect on the level of economic activity.
 Expansionary fiscal policy involves government spending exceeding tax revenue, and is
usually undertaken during recessions. It is also known as reflationary fiscal policy.
 Contractionary fiscal policy occurs when government spending is lower than tax
revenue, and is usually undertaken to pay down government debt.
However, these definitions can be misleading because, even with no changes in spending or tax
laws at all, cyclic fluctuations of the economy cause cyclic fluctuations of tax revenues and of
some types of government spending, altering the deficit situation; these are not considered to be
policy changes. Therefore, for purposes of the above definitions, "government spending" and
"tax revenue" are normally replaced by "cyclically adjusted government spending" and

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"cyclically adjusted tax revenue". Thus, for example, a government budget that is balanced over
the course of the business cycle is considered to represent a neutral fiscal policy stance.

[VI] Conclusion
Tax policy, expenditure policy, investment or disinvestment strategies and debt or surplus
management is the core basis of the Fiscal policy. Fiscal policy is the policy of the government
which includes taxation, public expenditure and public borrowings. Fiscal policy is an vital part
of the economic framework of a country and so it is closely linked with its overall economic
policy strategy. In contemporary economic scenario the government is in trusted t deals with
fiscal policy while the central bank is held responsible for monetary policy. In underdeveloped
countries the importance of fiscal policy is very high. The state is loaded with responsibility in
order to play active role for allocating the revenue and expenditure properly. Hence, fiscal policy
is a powerful tool in the hands of government with the help of which it can attain the objectives
of development. Fiscal policy help government to create a balance between revenue generated
and revenue expend. Surplus occurs when the government receives more than what it spends.
Likely when he government expenditure turns to be more than what it receives it runs into a
deficit. So while formulation of fiscal policy government see it neither run into deficit nor have
surplus. Planning is made to achieve best use of received revenue.

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 Chapter 2: Meaning and Objective

Fiscal policy is an vital part of the economic framework of a country and so it is closely linked
with its overall economic policy strategy. Tax policy, expenditure policy, investment or
disinvestment strategies and debt or surplus management is the core basis of the Fiscal policy. It
is the policy of the government which particularly aims for nation's development.

The Indian Constitution gives the balanced fiscal policy framework for the country. India
constitutes federal form of government which is having divided responsibility of imposing taxes
and spending between the central and the state governments. The Indian constitution provides for
the formation of a Finance Commission (FC) every five years which provides medium term
guidance on all the fiscal matters. It is with help of report of the FC that the central taxes are
delegated to the state governments. The Constitution also says that for every financial year, the
government shall prepare its proposal of taxation and spending execution and place them before
the legislature for legislative debate and approval. This is known as the Budget. Both the central
and the state governments have their own budgets. The various objectives of Indian fiscal policy
are as follows-

Development by effective allocation of Resources

The primary objective of fiscal policy is to produce rapid and sustainable economic growth and
development. By Mobilization of Financial Resources this objective of economic growth and
development can be attained. Both the central and the state governments in India have been
empowered to mobilize financial resources in order to bring effective financial planning and its
uses. In India financial resources are mobilized by following three means :-

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Taxation : Through fiscal policies, the government generated revenue. It aims to allocate
resources by means of direct taxes as well as indirect taxes. Direct taxes involves income tax
which each working citizen of India pays form his salary.

Public Savings : By reducing government expenditure and increasing surpluses of public sector
enterprises is one of the emerging tool of fiscal policy. Hence financial resources can be
mobilized well through public savings. 

Private Savings : With the help of effective fiscal policy such as tax benefits, the government
can bring resources from households and private sector. Resources can be allocated and managed
through government borrowings by means of loans from domestic and foreign parties, treasury
bills, issue of government bonds, deficit financing etc.

Expenditure of Financial Resources

The central and state governments have worked to make efficient allocation of financial
resources. These resources are utilized mainly to increase production of necessary and desirable
goods and discourage socially undesirable goods. The central theme of fiscal policy includes
development Activities which are expenditure on railways, infrastructure, etc. While other part
of non-development activities includes expenditure on interest payments defense, subsidies, etc.
Planning is made systematically at end of every financial year and action is taken accordingly.

Reduction of Income and Wealth inequalities

Fiscal policy by reducing income inequalities among different sections of the society leads to
strive equity or social justice. The direct taxes play crucial role in this, income tax are charged on
all salaried person which is directly proportion to the income of the person. More the person
earns more he is entitled to pay tax. Hence direct tax applied more on the higher income groups
as compared to lower income groups. Likely indirect taxes are also more in the case of semi-
luxury and luxury items than that of necessary consumable items. In this way government

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generates good amount of revenue which is on significant proportion is implemented on Poverty
Alleviation Programmes which improves the conditions of poor people in society and
consequently leads to reduction of income and wealth inequalities.

Price Stability and Control of Inflation

One of the major objective of fiscal policy is to have stabilize price and control inflation.
Inflation and price instability have hazardous impact on over all economy. If inflation increses at
high rate in any country then it can finally lead to overall collaspe of country. Hence, the
government being particular about this and always tries to control the inflation by various means
such as bringing reduction in fiscal deficits, introduction of tax savings schemes, induce correct
use of financial resources, etc.

Employment Generation

The government is inducing every possible effort for increasing employment throughout the
country with help of effective fiscal measure. Direct and indirect employment are one of the
outcome of various investments in infrastructure of the country. Small-scale industrial (SSI)
units are encouraged to bring in more investment by providing lower taxes and duties which
consequently creates more employment. Government of India in order to solve problems in rural
areas initiated various rural employment programmes to generate employment and cope up with
increasing poverty. Likely, self employment schemes have been taken up in order to generate
employment for persons in the urban areas who are technically qualified. 

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Balanced Regional Development

Balanced regional development is very important for any nation. Government key responsibility
is to see that all states and its sub units whether urban or rural develop equally and no part of
country be away from development. So fiscal policy planning occupies larger portion for
regional development. Government in order to accomplish its aim provides various incentives
such as Finance at concessional interest rates, Cash subsidy, Concession in taxes and duties in
the form of tax holidays etc for setting up projects in backward areas.

Reducing the Deficit in the Balance of Payment

Fiscal policy aims to encourage more exports by means of various fiscal measures such as
exemption of central excise duties and customs, exemption of income tax on export earnings,
exemption of sales tax etc. The foreign exchange is also protected by giving import substitute
industries fiscal benefits, applying customs duties on imports etc. The problem of balance of
payment is solved since foreign exchange received by means of exports and saved by way of
import substitutes. With the help of this method the adverse balance of payment is rectified either
by applying duties on imports or by providing subsidies to export.

Capital Formation

The aim of fiscal policy in India is also to improve and increase the rate of capital formation so
as to increase the overall economic growth. An underdeveloped country is badly trapped with the
problem of increasing poverty which is mainly an outcome of capital deficiency. In order to
defeat poverty and increase the capital formation generation, the fiscal policy must be
systematically prepared to encourage savings and decrease spending.

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Increasing National Income

National income growth of any country shows its efficiency and overall development. Any
activities of development closely have impact on national income. If production and services
within a country increases the overall national income also increases. National income is
calculated by addition of contribution from all the sectors in a country. So government with the
help of fiscal policy tries to increase capital formation which in turn increases GDP, per capita
income and national income of the country.

Development of Infrastructure

Development of infrastructure is the core element that is seen in fiscal policy. Infrastructure
development benefits is enormous, it help to provide boost in all the sector of the economy. So
government always see which area needs new or further infrastructural development and
accordingly investment is put in from the revenue to bring desired result.

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 Chapter 3: Fiscal Policy’s role in
Economic Development

The budgetary provisions made in the budgets when read together, bring out the guiding

philosophy of the new fiscal policy and the objectives that the government intends to achieve.

(i) Restoring Fiscal Equilibrium:

A very important feature of the government’s efforts is to attain a match between the revenue

receipts and revenue expenditure with the ultimate aim of securing surpluses on revenue account

for capital expenditure.

Towards this end, three types of measures have been taken. The first concerns expenditure. This

has been to slow-down the growth-rate in it despite increase in the absolute amounts. Second

concerns tax-revenues.

The aim is to increase it, but unlike in the past when high taxes prevailed the policy now is to

seek larger tax receipts through moderately low rates of taxes on a wider base. Third the

government has made efforts to raise profits of the public sector undertakings.

(ii) Reforming Tax-structure:

The approach towards the tax system is to design it in such a manner that it becomes growth

elastic and gets in line with the tax-systems of other fast-growing and developed countries. To

ensure better compliance and less incentive for tax-evasion, the government has lowered the tax

rates both in respect of direct taxes and indirect taxes.

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At the same time schemes have been introduced to widen the base of the tax. These together with

lower tax and a wider base are very likely to raise the yield of taxes. And with growth in the

activities and income of the economy, the tax receipts will increase.

This approach is totally different from the one pursued so far on the premise of a high tax-rate on

a narrow base. The new tax-regime will reduce and if pursued further eliminate the difference

between the domestic tax-rates and the tax rates in the foreign country.

This will help in integrating the Indian economy with the world economy. The benefits to the
country will be an increase in exports and a larger inflow of foreign direct investment. The

competitive strength and efficiency of the Indian economy will also improve.

(iii) Promoting Socially Desirable Activities:

The Government in the new fiscal policy has also provided larger expenditure, tax concessions

and other incentives for the expansion of socially important sectors. These are the sectors which

are normally the responsibility of the government. The development of infrastructure is one such

field of key significance for the economy.

While most of it is to be undertaken by the Government, several incentives have been extended

to seek private sector’s involvement in some areas like power to ensure that the supply of

infrastructural services becomes adequate.

Tax concessions in the form of tax holiday have been given to encourage the private sector to set

up industries in the backward regions. Similar incentives have also been given to industries

producing pollution-control equipment.

Provision has also been made for the development of R&D (Research and Development) to

upgrade the technological base of the economy. Besides public expenditure, tax concessions

have been given to the private sector for this purpose.

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(iv) Market-Oriented Development:
The new fiscal policy in line with the new economic policy aims at promoting allocation of

resources largely in terms of the market prices. The government has already dismantled a

significant part of state- intervention and enlarged the field for the private sector. The fiscal

policy has carried this process further by offering money incentives through lower tax-rates and

tax-concession to the private sector.

Supply constraints in the market have also been caused by several fiscal measures. Reduction in

custom duties on the import of capital goods to modernise domestic production is one such
measure to step-up the supply of goods and services.

The lowering of the rates of indirect taxes on the consumer goods including luxury items like

electronics goods, cars, etc., will encourage a growth-pattern largely based on the expansion of

consumer goods industries.

The market orientation of development is also sought to be promoted by providing a demand

stimulus to the economy. How direct taxes will mean larger disposable income with the people.

Low indirect taxes will result in lower prices. Both of these will increased demand.

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 Chapter 4: Tools of Fiscal Policy

The government has two primary fiscal tools to influence the economy. They are revenue tools
and spending tools. Let’s look at each of these tools.

Revenue tools

Revenue tools refer to the taxes collected by the government in various forms. The taxes can be
direct or indirect. Direct taxes are taxes levied on the income or wealth individuals and firms.
This includes income tax, wealth tax, estate tax, corporate tax, capital gains tax, social security
tax, etc.

Indirect taxes are taxes levied on goods and services. This includes sales tax, value added tax,
excise duty, etc.

Spending Tools

Spending tools refer to increasing or decreasing government spending/expenditure to influence

the economy. Government spending can be in the form of transfer payments, current spending
and capital spending.

Current spending includes expenditure on essential goods and services such as health, education,
defense, etc.

Capital spending is the public investment in infrastructure such as roads, hospitals, schools, etc.

The above two also include subsidy or direct provision of merit goods and public goods, which
would otherwise be underprovided.

Transfer payments are the redistribution of income from taxpayers to those requiring support, for
example, unemployment benefits. It also includes interest payments on government debt.

Fiscal policy tools have several advantages.

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Spending tools enable services such as defense to benefit everyone in the country and build
infrastructure that propels growth. Spending tools also ensure a minimum standard of living for
the residents. Subsidies in research and development also help in future economic growth.

Taxes help government in meeting their fiscal needs. By levying high indirect taxes, the
government can also discourage use of items such as tobacco, and alcohol.

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 Chapter 5: Conclusion

The fiscal policy is the first step towards efficient and profound nation. It is a jest and planning
of all the sect oral development along with it carter the need of common people and inducing the
social justice. It’s a great tool in the hands of government and if effective fiscal policy is applied
then the growth of any nation is inevitable. The proper investment in different program and
policy can bring great results in the long terms. In context of developing nation the importance of
fiscal policy is just too much because a developing nation have limited resources and many
responsibility and needs that require urgent attention. So mobilization of recourses towards most
urgent requirement is the prerequisite of any developmental action. India has achieved to utilize
benefit with help of fiscal policy but certain gaps in the implementation is still exists which need
a corrective measure to bring over all sustainable economic growth.

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 Bibliography

Books:

 B Sudhakara, Reddy, Economics Reforms in India and China, Sage Publications, New
Delhi,2008.
 Dr.Deepashree, Economic Development and Policy in india Part 1, ISBN
9789382209218, Scholar Tech Press.
 Reddy, Y.V., Economic Policies and India’s Reform Agenda, ISBN 9788125050513,
Orient Black Swan Publication.

Online Sources:
 http://www.kcgjournal.org/ss/issue11/dharini.php
 http://www.indiastudychannel.com/resources/161774-Role-of-fiscal-policy-in-India.aspx
 http://www.yourarticlelibrary.com/policies/fiscal-policy-and-objectives-of-indian-
government/23470/
 http://www.economicsdiscussion.net/fiscal-policy/5-major-instruments-of-fiscal-
policy/4696

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