12/29/2020

 Nothing arouses as much controversy as

the role of government in the economy.
 Government can affect the macro
economy in two ways:
• Fiscal policy is the manipulation of government
spending and taxation.
• Monetary policy refers to the behavior of the
Federal Reserve regarding the nation’s money
supply.
Union Budget
 Who prepares the budget ?
 Dept. of Economic Affairs, Ministry of
Finance.
 Along with the budget, economic survey is
presented.
 Budget is for the next year and Economic
Survey is for the previous years.
 Fiscal policy is the deliberate manipulation of
government purchases, transfer payments, taxes, and
borrowing in order to influence macroeconomic
variables such as employment, the price level, and the
level of GDP
 changes in government expenditure and taxation designed
to influence the pattern and level of activity.
 Fiscal policy means the use of taxation and public
expenditure by the government for stabilization or
growth of the economy.
 Fiscal policy refers to the government actions affecting its
receipts and expenditures which ordinarily as measured by
the government’s receipts, its surplus or deficit The
government may change undesirable variations in private
consumption and investment by compensatory variations of
public expenditures and taxes.

Fiscal policy is the guiding force that helps the government
decide how much money it should spend to support the
economic activity, and how much revenue it must earn from
the system, to keep the wheels of the economy running
smoothly.
12/29/2020
Importance of Fiscal Policy in India

➢ Fiscal policy plays a key role in elevating the rate of

capital formation (that part of country's current output and
imports which is not consumed or exported during the
accounting period, but is set aside as an addition to its stock
of capital goods) both in the public and private sectors.
➢ Through taxation, the fiscal policy helps mobilise
considerable amount of resources for financing its
numerous projects.
➢ Fiscal policy also helps in providing stimulus to elevate
the savings rate.
➢ The fiscal policy gives adequate incentives to the private
sector to expand its activities.
➢ Fiscal policy aims to minimise the imbalance in the
dispersal of income and wealth.
12/29/2020
To attain an economic development in the country,
the fiscal policy of the country has adopted two
objectives:

1. To raise the rate of productive investment of both

public and private sector of the country.

2. To enhance the marginal and average rates of

savings for mobilising adequate financial resources
for making investment in public and private sectors of
the economy.

The fiscal policy of the country is trying to attain both

these two objectives during the plan periods.

12/29/2020
 Revenue budget:
The revenue budget contains details relating to the current
revenues and the current expenditure of the government.
 Revenue Receipts/ current revenue
It is government income through tax revenue (direct and
indirect taxes) and non- tax revenue (interest receipts,
dividends and profits, external grants, etc).
 Revenue Expenditure/ current expenditure
The expenditure which meets the consumption needs of the
government is called revenue expenditure. The purpose of
this expenditure is not to build up any assets in the
economy. This type of expenditure is necessary to keep
the government machinery running and to enable the
government meet its liabilities.

Normally, the government expenditure is classified into two

categories:
 i. Plan expenditure; and
 ii. Non- plan expenditure.

The overall expenditure of the government can also be

classified in two groups:
 i. Developmental expenditure; and
 ii. Non- developmental expenditure.
Capital budget
Capital budget contains details relating to the
capital receipts and capital expenditure of the
government.
Capital Receipts
It refer to all those sources of inflows to the
government account which have any one of the
following features:
▪ These involve a liability of repayment such as loans
and borrowings
▪ These involve a recovery of loans earlier extended by
the government
▪ These involve selling of an asset of the government,
for example, disinvestment of the equity of the public
sector undertakings.
Capital Expenditure
Expenditure incurred by the government on
such items as have a life of more than one year. This
type of expenditure adds to the capital stock of the
economy.

Capital expenditure is also classified into two

categories:
i. Plan expenditure; and
ii. Non- plan expenditure.
The sum total of the revenue receipts and the capital receipts
constitutes the total receipts of the government. i. e.,

revenue receipts + capital receipts = total receipts

The sum total of the revenue expenditure and capital

expenditure constitutes the total expenditure of the
government. i. e.,

revenue expenditure + capital expenditure = total

expenditure
 Surplus budget is a situation in which the
revenue earned by the government exceeds its
expenditure. The surplus might occur either due
to decrease in spending and increased taxation
or due to growth in revenue gaining activity.

A budget deficit occurs when expenses

exceed revenue, and it is an indicator of
financial health. The government generally
uses this term in reference to
its spending rather than business or
individuals. Accrued government
deficits form the national debt.

A balanced budget is a budget in which

revenues are equal to expenditures. Thus,
neither a budget deficit nor a budget surplus
exists.
Principles of good tax structure
 Equity objective
• Every tax payer should contribute his fair share to the cost of
government, though there is no such agreement about how the fair
share should be defined
 Benefit principle
• Different person should be taxed in the proportion of the benefit
they received from the various public services.
 Ability to pay principle
• Calls for people with equal capacity to pay the same, and people
with greater capacity to pay more.

Neither approach is easy to interpret or implement.

None of these can be said to deal with the entire function of tax policy

What are the requirements of a good tax

structure?
The central government levies four major
categories of taxes
 Personal income tax
 Corporation tax
 Customs duties
 Union excise duties
Tax rate structure

 Progressive tax
• Higher the level of income greater will be the volume
of tax burden.

 Regressive tax
• People with lower levels of income are imposed with
higher taxes.

 Proportional tax
• When the tax imposed is of a particular percentage of
income irrespective of his income slab.“flat taxes”
 It describes the relationship
between tax rates and total tax
revenue, with an optimal tax rate
that maximizes total government
tax revenue.
 If taxes are too high along the
Laffer Curve, then they will
discourage the taxed activities,
such as work and investment,
enough to actually reduce total
tax revenue. In this case, cutting
tax rates will both stimulate
economic incentives and
increase tax revenue.
 The Laffer Curve was used as a
basis for tax cuts in the 1980's
with apparent success, but
criticized on practical grounds
on the basis of its simplistic
assumptions, and on economic
grounds that increasing
government revenue might not
always be optimal.
The tax structure in India is divided into direct and indirect taxes

▪ Direct taxes are levied on taxable income earned by individuals and

corporate entities, the burden to deposit taxes is on the
assesses themselves.
▪ Indirect taxes are levied on the sale and provision of goods and
services respectively and the burden to collect and deposit taxes is on
the sellers instead of the assesses directly.

The taxation system in India is such that the taxes are levied by
the Central Government and the State Governments. Some minor taxes
are also levied by the local authorities such as the Municipality and the
Local Governments.

This has consequently lead to India’s meteoric rise to the top 100 in the
World Bank’s Ease of Doing Business (EoDB) ranking in 2019 as India
jumps 79 positions from 142nd (2014) to 63rd (2019) in 'World Bank's
Ease of Doing Business Ranking 2020'.

The Goods & Services Tax (GST) reform is one such reform to ease the
complex multiple indirect tax regime in India.
Deficit financing
 It is the budgetary situation where expenditure is higher
than the revenue. A practice adopted for financing the
excess expenditure with outside resources. The
expenditure revenue gap is financed by either printing
of currency or through borrowing.

 Governments in the developed and developing world

are having deficit budgets and these deficits are often
financed through borrowing.

 Fiscal deficit is the ideal indicator of deficit financing.

Various indicators of deficit in the budget

 Budget deficit = total expenditure – total receipts

 Revenue deficit = revenue expenditure – revenue receipts
 Fiscal Deficit = total expenditure – total receipts except
borrowings
 Primary Deficit = Fiscal deficit- interest payments
 Effective revenue Deficit-= Revenue Deficit – grants for the
creation of capital assets
 Monetized Fiscal Deficit = that part of the fiscal deficit
covered by borrowing from the RBI.

https://www.firstpost.com/business/union-budget-2019-20-what-does-budget-
deficit-mean-three-types-of-deficits-on-basis-of-receipts-and-expenditures-
6859861.html
Effects of Fiscal Deficits on an Economy
 A government experiences a fiscal deficit when it
spends more money than it takes in from taxes and
other revenues excluding debt over some time period.
 This gap between income and spending is
subsequently closed by government borrowing,
increasing the national debt.
 An increase in the fiscal deficit, in theory, can boost a
sluggish economy by giving more money to people who
can then buy and invest more.
 Long-term deficits, however, can be detrimental for
economic growth and stability.
Fiscal policy and stabilization
Discretionary fiscal policy and Non-discretionary fiscal policy of
automatic stabilisers.
 Discretionary policy is the deliberate change in the Government
expenditure and taxes to influence the level of national output and
prices. Fiscal policy generally aims at managing aggregate
demand for goods and services.
 Non-discretionary fiscal policy is a built-in tax or expenditure
mechanism that automatically increases aggregate demand when
recession occurs and reduces aggregate demand when there is
inflation in the economy without any special deliberate actions on
the part of the Government.

Fiscal Policy to Cure Recession

 The recession in an economy occurs when aggregate demand
decreases due to a fall in private investment. Private investment
may fall when businessmen become highly pessimistic about
making profits in future, resulting in decline in marginal efficiency
of investment.
 As a result of fall in private investment expenditure, aggregate
demand curve shifts down creating a deflationary or recessionary
gap. It is the task of fiscal policy to close this gap by increasing
Government expenditure, or reducing taxes.
 At the time of recession the Government increases its expenditure
or cuts down taxes or adopts a combination of both.
Public debt

In the Indian context, public debt includes the total

liabilities of the Union government that have to be paid
from the Consolidated Fund of India.

The term is also used to refer to the overall liabilities of

the central and state governments. However, the Union
government clearly distinguishes its debt liabilities from
those of the states.

It calls overall liabilities of both the Union government

and states as General Government Debt (GGD) or
Consolidated General Government Debt.
Sources of Public Debt
• Treasury Bills or T-bills
• Dated government securities or G-secs.
• External Assistance
• Short term borrowings
• Public Debt definition by Union Government
• The Union government describes those of its liabilities as
public debt, which are contracted against the Consolidated
Fund of India. This is as per Article 292 of the Constitution.
Importance of Public Debt Management in India
As per Reserve Bank of India Act of 1934, the Reserve Bank is
both the banker and public debt manager for the Union
government.
The RBI handles all the money, remittances, foreign exchange
and banking transactions on behalf of the Government.
The Union government also deposits its cash balance with the
RBI.
However, of late, there is a demand for creating a specialized
agency for managing public debt as exists in some advanced
economies. For instance, the Niti Aayog has advocated the
creation of a separate public debt management agency (PDMA).
Public Debt versus Private Debt

 Public Debt is the money owed by the Union

government, while private debt comprises of all the
loans raised by private companies, corporate sector
and individuals such as home loans, auto loans,
personal loans.

Public Debt as a percentage of GDP

 The Union government’s liabilities account for a little

over 46% of the country’s GDP.
 If the public debt is calculated as general government
liabilities, which also includes the liabilities of states
then it goes up to 68% of the country’s GDP.
Types of Public debt
The government of India can take loans from both inside and
outside the country.
 Internal loan
• The loan which is taken within the country itself, is called an
internal loan. This loan is taken from commercial banks,
insurance companies, Reserve Bank of India, corporate houses,
and mutual fund companies etc.

 External debt
• The loan is taken from outside the country is called an external
loan. This loan is taken from friendly countries, international
institutions, and NRIs, etc.
The Department of Economic Affairs of the Ministry of Finance
released a report in April 2020 titled; Status Report on Government
Debt for 2018-19. It has been reported in this report that the total
public debt of the country has increased to 68.6% of the gross
domestic product by March 2019, in other words, it is Rs.13
trillion or Rs. 1.3 crores.
How much debt on India during the Modi government since 2014?
 India's external debt was about 85 billion dollars in 1991, which increased to
US$446 billion in 2014 and US$ 564 billion of GDP by the end of December
2019. It means; since the Narendra Modi has taken oath as the Prime
Minister of India; external debt on the country has been increased by 118
billion dollars.
 An increase in the external debt is not a good sign because the county needs to
repay this debt in foreign currency, i.e. dollars and other foreign currencies.
Internal debt on India
 Having internal debt over the country is not as dangerous as foreign debt. That
is why; the Government of India raises about 80% of its total debt within the
country with the help of the Reserve Bank and the governments of the Indian
states have taken about 94% of their total debt from internal sources.
 The biggest sources of internal loans to the Government of India are
commercial banks (40% of the total internal debt), 24% by insurance
companies, and 15% by the Reserve Bank of India.
What is the comfortable limit of Debt
 According to the World Bank estimates, countries that have external debt more
than 77% of its GDP faces problems in the long run. If the external debt
increases one more percent after the limit of 77% of GDP; it reduces the GDP
growth rate of that country by 1.7%.
Today, Japan is the largest debt-ridden country in the world. It has taken
loans equal to 238% of its GDP, followed by 106% by the US, 68.5% by
Brazil and 66.8% by India.
Fiscal and Monetary Policies and IS-LM
Curve Model

IS-LM model shows the effect of

expansionary fiscal policy of increase in
Government expenditure on level of
national income.
Increase in Government expenditure
which is of autonomous nature raises
aggregate demand for goods and
services and thereby causes an outward
shift in IS curve
The horizontal distance between the two
IS curves is equal to the increase in
government expenditure times the
government expenditure multiplier (ΔG x
1/1-MPC) which shows the increase in
national income equal to the horizontal
distance (EK)that occurs in Keynes’
multiplier model.
However, in IS-LM model actual increase
in national income is not equal to EK
caused by the working of Keynesian
multiplier.
 The rightward shift in IS curve rate of
interest also rises which causes
reduction in private investment.
 With the LM curve remaining
unchanged, the new IS2 curve
intersects LM curve at point B.
 In IS-LM model with the increase in
Government expenditure (ΔG), the
equilibrium moves from point E to B
and with this the rate of interest rises
from r1 to r2 and income level from
Y1 to Y2.
 Income equal to CK has been wiped
out because of rise in interest
causing a decline in private
investment.
 CK represents crowding-out effect of
increase in government expenditure
Thus, IS-LM model shows that
expansionary fiscal policy of
increase in Government expenditure
raises both the level of income and
rate of interest.
Expansionary Fiscal Policy
Reduction in Taxes
 In the Keynesian multiplier model,
the horizontal shift in the IS curve
is determined by the value of tax
multiplier times the reduction in
taxes (ΔT), that is, ΔT x MPC/1-MPC
and causes level of income to
increase by EH.
 In the IS-LM model, with the shift of
the IS curve from IS1 to
IS2 following the reduction in taxes,
the economy moves from
equilibrium point E to D and rate of
interest rises from r1 to r2 and level
of income increases from Y1 to Y2.
Income equal to LH has been
wiped out because of crowding-out
effect on private investment as a
result of rise in interest rate.
How Fiscal Policy Relates to the AD-AS
Model

Expansionary policy shifts the aggregate

demand curve to the right, while
Contractionary policy shifts it to the left.
The multiplier calculation
 Government expenditure multiplier
• 1(1−MPC)

 Tax multiplier
• MPC(1−MPC)

 where MPC is the marginal propensity to consume (the change in

consumption divided by the change in disposable income)
 The government spending multiplier is always positive.
 The tax multiplier is always negative. This is because there is an inverse
relationship between taxes and aggregate demand. When taxes decrease,
aggregate demand increases.
 The multiplier effect of a tax cut can be affected by the size of the tax cut, the
marginal propensity to consume, as well as the crowding out effect.
 The crowding out effect occurs when higher income leads to an increased
demand for money, causing interest rates to rise. This leads to a reduction in
investment spending, one of the four components of aggregate demand,
which mitigates the increase in aggregate demand otherwise caused by
lower taxes.
The crowding out effect suggests rising
public sector spending drives down
private sector spending.

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.
 FP
Y
 Imports….
 Tradedeficits…..
 Expansionary fiscal policy
 FP
I … - exchange rate …
 Y … - exchange rate …
 P … - exchange rate …
 It is unclear what is the effect of
expansionary or Contractionary fiscal
policy will have on exchange rates.
Thank you