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    Fiscal Management and Financial Administration

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    rel FISCAL POLICY 111 Meaning 11.2 Functioning ® 11.3. Objectives * 11.4 Constituents 115 Limitations 11.1 MEANING | oe Fiscal polcyis the part of government policy that deals with raising revenue through tax and non-tax sources and deciding on the eve and pattern of public expenditure. icy is composed of several parts. These include, tax policy, investment or disinvestment strategies and debt or surplus management. Fiscal policy is an important constituent of the overall economic framework of a country andis therefore intimately linked with its general economic polit} strategy.'In most modern economies, governments deal with fiscal the central bank is responsible for monetary policy: Fiscal a 1. Samuelson, P.A. and Nordhaus, W.D.. Economics (McGraw-Hill, New You Mic. jat the government mie 1936s, ban oe os momy and its activities shoutg pe ticant rile to pin dealin ee al services to the os tothe eon ee justice, fet meme 430s inthe United stat Peer en al cere OM iS Own, it en owed that ita pression iF mt would not be abi? fail and cause pression through efforts ofthe private sect i (0 recover from for the government to step in and take er Need Was Hegomy on the path of recovery, The mesg stu © Pu the etme were based onthe wore of) measures initiated during : ohn Maynard Keynes, ¢ measures included social s ‘ ecurit ; owing counter-cyclical budgetary iy epee ‘Bat ‘e and some essenti ing countries, besides tradit i developing countries tional functions, st cmon ema een jal policy is used as an important instrument to bring about qeation of economic and social infrastructure, employment aeration, poverty reduction and improvement in income Gstribution. 11.2 FUNCTIONING OF FISCAL POLICY SE eee cording to Keynesian economists, the primary objective of fiscal is to maintain high level of aggregate demand through iables like disposable income, public and private investment, ‘onsumption expenditure, net exports and government purchases. Ahigh level of aggregate demand will result in higher production, exployment and ensure better standard of living. A change in any «ve of the policy variables affects all other variables as they are all iterrelated., s-IV (S.Y.B.Com, ss Economic Business SEMay . as follows: / 48 rip can be explained is interrelations! ‘This interrel apecei+ Gt &™) AD aggregate demand “ = consumption expenditure = investment expenditure X= exports M-= imports Inthe short run, C= (4) and M =f) Yy2Y-t¥+TR where, Y = gross income Y4 = disposable income (income left with people fo; @ spending) TR = transfer payments (e.g. pension, subsidies, unemployment benefits) t= tax rate (direct tax is imposed as a proportion of income Y) By using fiscal policy measures, the government can influence aggregate demand (AD) as follows: (@)_Ccan be increased by reducing t and increasing TR as this will raise the level of disposable income. (©) Imposition of import duties will reduce M and subsidies and tax incentives to exports will increase X. (©) can be raised throu; Producers 'gh tax exemptions as well as subsidies to (A) G can be increased through government purchases. OBJECTIVES OF FISCAL POLIcy a policy is formulated with specific | jective in developed countries is to achi wi maintain high aggregate demand, indeveloping countries the goal is to achieve economt | nd development. Sonomic growth determines how funds are allocated to different heads of exp. enses. The policy of public (xPenditure is used by the government to directly undertake Tesource allocation for different sectors. On the other hand, the government can use taxation and subsidies to indirectly influence resource allocation. For ‘example, tax incentives given 5. EM, tance of fiscal policy ag ent: TRE iM Por uring the Great Depress” ountries Were suffering jo™ Per a objective of fiscal po} aa wn gall employment For this the fg ent of fp te evel OF a8BTegatedemany rromies government €xPenditur gp romaructre 'S used tO generar jon of the economy is anothe, a policy, especially in develope ores business cycles. The cyclical nar, pe economies causes fluctuations in variable, vestment and employment xs ‘When growth periods end, they are sae en cl a ed by conta lutuations. This known as count ismeantt0 cou ey. Acounter-cyclical fiscal policy is adopted oe of recession and depression by following . «brings about an increase in government oar consumprion and investment. On the other hand, during flation, government expenditure and tax rates are lowered to reduce aggregate demand and prices. A surplus budge is wed. ofthe market in e income, output, in 4, Increasing the Rate of Investment and Capital Formation: In ~~ developing, countries the problem is of mass and structural unemployment. Fiscal policy in such countries is aimed at increasing the rate of capital formation through investment This can be done by giving tax incentives and subsidies to OF tis ‘encourage private sector investment. Also, in many developing. | countries | formation Encouraging Socially Optimum Pattern of Investment: In developing countries fiscal policy can direct investment in those that are Most desirable ple, fiscal incentiy ucture developme; pete am ota from s, °5 to me £9 sma ‘cial point of I-scale industri les: Fiscal tribution POUCY can be effect and Public eon of maton thom or i ture poli inegual Policies are used . Progress: itfuare on social infreucrtich than the neve cuest han the poor. Publi 1g, health and education help eee Subsidies on a luce income inequ seas Unemployment and Underempl f expenditure an Py an important role in tie lent: Public works ProBTé af nes can be initiated tocreatee "gard. Public to absorb surplus labour from areas of unde eta tepecially in developing counties, stemployment \derem ling Inflation: Developi if ae fionncing in order ees need to resort to industrialization and infrastructure building Sot inflationary conditions in the economy as 7 mien creates js bound to rise with deficit financing. In order teerey inflation, the ideal fiscal respon: me pookrel n 'se would be reduction: " expenditure. But this is unlikely to take place ina aan country and hence the fiscal response should be inthe fora encouraging supply of goods and services though : igh appropriate incentives. As supply increases, the inflation: likely to be on the decline ela 114 CONSTITUENTS OF FISCAL POLICY Tete are four constituents of fiscal pol |. The Budget: The budget is an estimate of the government's expenditure and revenue for a fiscal year. It is an important instrument of fiscal policy used by most modem governments ‘ofulfil objectives of economic growth, reduction of inequalities, generation of employment and economic stability. The budget 'Sused to allocate and divert resources to the desired sectors. in th te on deficit budget shou’ snplus budget shoud & be rev stant sources of evenyey, mm a sty payments evied on in 2 Pend on production, saleg ang iret te) sites 0 comma. revenue t0 the ZOVerTMEn,y me inequality (redistribute la onary ive, proportional ary income tax, are base} reduce income inequal ef are used tO to pay a ‘Taxes have wide rangin, on ability t0 Pay Pr essve innate aging Indie onsumption, investment and saving, action effects on pre icy isthe iblic expenditure policy is the eng 3. bli Expendits say Government spending is classified objective of fiscal ert The primary objective of public revenue and api Pron welfare, Public expenditures are oper ugh taxand non axsources of revenue as Wells financec public borrowing i vernments finance their expenditure Frat oe Nn en he tx anc other Sources of evens re be inadequate Publi debts are classified on the bass Of ime period, productive oF unproductive, voluntary or compulsory. One of the most important classifications of public Public debt cause burden of inincome redistribut wentioned constituents of fiscal policy are discussed ferent chapters in this book. the outcomes of fiscal 'ptions, However, real More complex. Certain Not be presen i pales wipe economy is NOt increase i Also, fiscal poli ancing icy satan} POU. * avery 7 Siables include national inc ome, ployment, consumption and inves output, price level, tment. Forecasting is a sis which is difficult in developed economies, function of data collection and analy developing economies. Even in forecasting has not been foolproof, «Multiplier: The effects of fiscal measures economy through the workir ' investment multiplier, tax mi For example, the effect ofan induced government investment on infrastructure will lead to an increase in income and consumption theough the multiplier process. The exact impact of such an investment would depend on the investment multiplier coefficient. Fi icult to estimate the values ofthe multiplier coefficients le to leakages and uncertainties, Secondly, in the working of the mult are transmitted tothe f various multiplier sconomic conditions may have changed in such a way that Tequires another contrary fiscal decision than the previous one. For example, the government may decide to increase ®Ppenditure in order to boost economic growth. This can lead th al te on. OBJECTIVE 101 iy Gere wn 80 JAFBE aS to force, and revenue expenditure i ex briefly: = th. asst fiscal policy gain signi i Bo qpin case of discretionaty fiscay lig wean fiscal po r Pood to . These lags OF taken by the government, jf tak) |! HOM Goes fiscal policy help in allocation of Tesources? ain Eee eee tne pote legge | HOM Goes fiscal Policy help to reduceineones inequality? ee Fa more Thess |, HOM js the role of fiscal policy in control \B inflation in di a auetoide lag isin the form of time taken fe |g ies? in developing in ne policy to be felt: These lags reduce 4 cay governENt EOTTOW Ng considered animportany art of fiscal EF the policy | pases of fiscal policy : effect" rnomies: Fiscal Measures, as yw, ra are the practical difficulties ini r underdeveloped Eco! : Implementation offs t very effecn vat are the time lags involved in fiscal policy? S<*! Policy? Meas ES ae ears like, Tost in |g WHE AN al policy measures nota ; monetary policy conomies due factors like, low taxable why are ery effect ein underdeveloped underdeveloped ¢°0""Tjsed and nion-monetised, financjg) |* economies? | lange nels and corruption. pefine the following concepts: low inco rey? lic th ce: While monetary policy isundler the cena) |; FCAPS staves 6. Pol cal Inftnen al policy is implemented by the government OTe eet le bank's conte) Ite an autonomous institution, relatively ges |, public buds influence. This is not true of the fiscal policy. Th, |, Disposable income state whether the following statements are True or False with " yeasons: ~ val s |1. Real policy isthe part of government policy that deals with money increase subsidies and other expenditures to gain public |' Supply and interest rate, be support. This can increase fiscal deficit and cause harm tothe |; Fiscal policy is an important constituent of the ‘overall economic te economy in the long run. Thus, short run political gains can_| framework of acountry compromise log run economic goals of fiscal policy. |. Indeveloping economies fiscal policy is primarily used to counter n | the effects of business cycles, 4 Ccan be increased by increasing t and reducing TR. REVIEW QUESTIONS |5. Allocation of resources depends upon the: collection of taxes and the 7) aes steer |) govemmen expenditure L Full employment is one of the main objectives of fiscal policy. e 1. Define fiscal policy. Explain how fiscal policy functions. During recession a surplus budget is followed, 2. Discuss the objectives of fiscal pol “ |& Inorder to control inflation the ideal fiscal response is expansion of 3. Discuss the cor public expenditure. r 4. Whatare the | ‘ Ataxis a compulsory payment. It Fiscal policy is free from p. influence. Time lags limit the impact of fiscal policy. jected by ts decisions areal ive in ca ply es are very Ot Uunderdeya " 13, Fiscal policy * economies is Fase; Reason: Refer Section 5. wat Introduction jon 11.5. 11. True; Reason: Refer Section 12, True; Reason: Refer Section 11.5. og 1a. False; Reason : Refer Section 11.5, os the comectanswer and rewrite the statement; does not directly deal with, jxation (b) Public debt (¢) Money supply: (4) Public expenditure 5v— “Aggregate demand is comprised of Cunptonentue () Invetmentexpondinne 9 INTRODUCTION Government purchases (d). Allthe above : isposable income is al V. Choose 25 Types of Fiscal Policy n Income before tax fal policy deals with government policy i ranser payments are added enue through taxation and other meany and dene oes Casini sland pattern of publcexpndiueiscposedattphy nme ofhouseholds after deduction of direct taxes and addition pblicexpenditure policy, investment or disin es ster payments ibudget management. ee t a characteristic of a tax? hreeent history, fiscal policy has been a very important component \ scopy me ‘goverment policy. But until the Great Depression of 1985, he Soinpseds ely fremment’s role was concentrated on traditional functions like fvision of defence, law and order and civic amenities. It was co that the government need not use fiscal policy to interfere tkmarket mechanism, since the marke is ecient enough to ra tself, in case it failed at times, This was known as the Nciple of sound finance. Most classical and neo-classical “Stomists advocate sound finance policy. a ion, But after the Depressi donot yyment an lif Unemplo t laisse: the people. UnemP OY" therefore, most 2 faire forthe comm perso tnemselves into welfare States insform' ints expanded to inchs "sy, of the government Include 5. Yeh heal ties lke reduction of inequi Prove ne puilding economic infrastructure ang ‘using polices to reduce the impact of busines Moy nts began to use fiscal policy to avoig ants orion, control inflation and keep aggregate demang its oe sal policy was used se nentcacyelical Measure Ky me fuse offal policy to bring about desired changes’ aw 3 ny is known as functional finance. The main Avoca ot it type o fiscal policy was John Maynard Keynes, A major problem of fiscal policy is finding a balance betigen, a short run stabilization objectives and long run goals of ae and development. At times, the short run policies adopteg®® Z with eylical fluctuations like inflation and recession may config ith long run goals of the economy. the goals of fis Tevo conflicting views on how to achieve the gc ca po are represented by the following principles: ly (a) The Principle of Sound (0) The Principle of Functional Finance ‘The discussion below involves the basic economic, political and Sociological basis for arguments for and against sound finance wi ance. In the analysis, the classical school includes the economic thoughts of economists like Adam Smith, David Ricard JB. Say, John Stuat Mill and Thomas Malthus, The term ‘modent used in the context here refers to denote economists who challenged and opposed the classical principle of sound finance. They include John Maynard Keynes, A.C. Pigou, Edgeworth and mos significantly, Abba P. Lerner, an economic system formed the bag classic economic thoughts, In, Such a syste femment Was expected to be restrciay ote ce, law and order, justice, yore most ZOVernment spend pes areas. The classical economis argued that restricted to a limit that was sufcint for meee ssefands for performing its traditional unctiong The role ofthe tuigetand fiscal policy did notextend: beyond raising funds through satin and spending on traditional functions The primary belief hat the size of the government's budget should be sm, igbsdget should balance, Thene tulle frm Bs bof sinciple of sound finance. Ttefollowing are some of the features of sound finance: Say’s Law: Like many other classical principles, the of sound finance is also based on Say's La most social event eradkation medi Psd 2 ey bring re and taxation shoulg ginal social cost ang the primary foxy, margin of function been severely criticises following functional inane sa advanced countries began sez fre capitalism by promoting ablicexPe re on welfare measure, “Frade and capital movement ‘This resulted in Pade and capital movement Thi ingeconomies ike ndiaand Chi feepulation resulted in mull ved a major financial crisis Jof unemployment. The ted the world economy, Prop different versions ‘and reiucing| ‘th globalisation ded ih of market derepul expand their budgets and stimulus to their economies, thus reviving the po the emerging had to expand their budgets to r lev riences of fol Rae ae of toning sound and func gt oe acl oles to suit the ee Ss Most madre scram ol sone ce et finance in deciding on their fiscal vein of a orm economies the primary obj al pe opt etal fe of economic ef yi are some of the types of fiscal policies used: swt? . sect ett daa me seein nein Oa ne eckngea train ca atic Stabilisers she national income rises and the economy experiences Jad inflation takes place. During such times, taxrevene nes ke fa ily increases and government expenditure on social ity lke ‘unemployment benefits reduces as less people are serpoyed. This Keeps effective demand under control and slows sen the growth oF aggregate demand preventing inflation. athe other Rand, during recession, public expenditure on Me inployment benefits and other soc security measures eatcally go up while taxrevene falls, Due tothis the growth egregate demand increases, Production rises, unemployment iikand this prevents the economy fom going ito depression. thse changes in tax revenue and government expenditre take place tomatically due to the bu in the fiscal system. is leads to automatic stabilization of the economy. s workonly under certain conditions, They will se of cost push inflaton or inflaton caused due : the economy is ie worldwide recession, automatic stabilises 166 Bus Sky, they are not applicable to developing e-OMOMIES Whey, flexibility in the fiscal system is very limited. 2. Discretionary Fiscal Policy: ype of fiscal policy, the government makes det; tte le acs St, some targets. Changes are made in tax rates and structure, Sing VE composition of public expenditure and debt. Changes jn Seeang addition or abolition of taxes, result in changing the sh, income of people and bring about the desired changes in age demand. Bate iscretionary changes in government expenditure take th caer) reduction in the size of expenditure, chang mot composition and sources ofinancngchangesin transfer po he like pensions, unemployment benefits etc, surplus or defer ings budget and methods of financing deficit. All these changes han the impact on aggregate demand through consumption and jaye’ —e expenditure. Discretionary fiscal policy is effective only when it is use run corrections in the economy. For long run structuy there should be effective automatic stabilisers. Besides, timely recognising a particular problem and imple m discretionary policy measure reduce the impact of the for shor, ral change Sin enting the Policy, 3. Contraylial Fiscal Policy or Compensatory Fiscal Policy The main objective of contra-cyclical fiscal policy is to achieve economic stability. The purpose is to counter the phases of business cycle and minimise their negative impact on the economy, Such a fiscal policy is discretionary in nature and consists of deliberate budgetary action taken to manipulat fe aggregate demand. The budget is the primary instrument of compensatory fiscal policy, A. Fiscal Policy during Recession and Depression: recession and depression the level of aggregate spending is very low. People reduce their consumption spending and businesses reduce their investment spending. Many resources remain unutilised During V(S.Y.B.Com, ; rise Policy ine goverment has tg then paing the eCOMOMY oye os suche late asc 6 Sit ‘al Polic g depression, defic; Nation iy that puri Fi dg “t Spend 7 Spend. coP°°Ple’s, ing. Tax massive expenditure on pubig es, rate employment and trang YS pr ‘Uunderta en aster moe PPOBTam ke taxes eee lowered to Bivebenan tothe Peon Order tp and emP OY PEOPIE. A.cut in conse “EP therm prod’ lower spencourage investment, "Pte income Me come taxis inpublic expenditure poo, done she government can use the fot (i) Pump- priming: The te, of America in 1932. fj (i) Compensatory spending: This kind of Spending is adopted to compensate the decline in Private investment during recession and depression, Such expenditures ate in te form of government investment in infrastructure building and introducing new social security measures Compensatory spending should be carried out only aslong as private sector investment is low and should be ne cal ain sin ate ith are seal ate 168 Business Ec cSIV(SY.B.Com, q e governments are not able to time the beginnin, My a, =: gemand and also to sh , he contro} wefore may begin compensatory s — dese on ROUSING, to specu , and tera become Serious. Secondly, cersing sion ee ae specified amounts of interest. This gives rise to public gee Pay deficit may alo be nance borrowing rom the Cental ge, Te the country. This may give rise to increase in the money suppinct the country. Thus, budget deficit causes the aggregate dent? the economy to rise and even lead to inflation. But deficits newt be incurred during recession to increase aggregate demang, °°“ to The important types of deficits are the following ; N Tevenue Ue receipt, S from Ton. ividend ang expenditure exceeds revenue receipts. The reven; come from both direct and indirect taxes as well a tax sources like interest received on loans given, q Pro of public enterprise, eset. They represent tran’ Purchasing power from individuals to government Fevenue expenditures consists of interest payments ons, deb civil administration, defence subsidies on food, epee = ete. and social services —e, e education, health, etc, The deficit or surplus in the revenue budget is carried the capital budget. Generally, a prudent pub management should give rise to surplus in the tev reni Iwhich could be used for financing development a However, in India for the I < Homers ast several years, there has been of the government’. financed by borrowing, over to finance the difference betw ‘een all recei rnment, both reve 4 ‘this deficit adds to money supply in the economy and, srerefore it cam be a major cause of inflationary rise in pice ‘his concept isnot used by the governmentin the recent years, fiscal Deficit: Fiscal deficit is the excess of experiditure (both revenue and capital) over rev ‘and non-borrowing capital receipts, like recov proceeds from disinvested government ass, comprehensive measurement of the budge measures the entire short-fall in the government. government /enue receipts ery of loans, sale els, It is the most tary imbalance. It operations of the Fiscal De borrowings it = Total Expenditure ~ Total Receipts net of Fiscal deficit is financed by borrowing both internally and externally and incurring other liabilities like draw-down of cash balances with the central bank. However, according to the provisions of the Fiscal Responsibility and Budget Management Act 2003, the RBI is not to lend to the Government of India by subscribing to primary issues of the Central Government securities since 2006-07. The fiscal deficit of the Union Government of India was %5,33904 crore or 3.5 percent of GDP in 2016-17. Primary Deficit : The fiscal deficit may be decomposed into primary deficit and interest payments. The primary deficit is obtained by deducting interest payments from the fiscal deficit. deficit is equal to fiscal deficit less interest payments. It indicates the real position of the government a in a finances as it excludes the interest burden of the loans taken in. the past. Primary deficit = Fiscal deficit - Interest Payments Primary deficit of the Union Government of India in 2016-17 was @ 41,234 crore or 0.3 percent of GDP. A. State whether the followin, 1 2 3 4, yovernment tothe: Les cor rese in money iy. This concept is also 1, ore year. ose by the recent Y reates equivalent increa, in RB ve money in the economy ay high 2nd hens enue Deficit: This concept Was intfod, fective Re" Budget Proposal for 2011-19 <4 by | Gy sore 7 ae waite ren lasts Terevenveerpenditre gies Sr creation of ft jvento states forthe creation of capita, pS includes By ding grants forthe creation of ca ital assets fre ‘we get the concept of effective revenue deft fective revenue de 216-17 was @ 187175 crore or 1.2 percent of GDP. Inthe Union Budget governme fective rever deficit. (see Table 13.1) the Union Government of went uses 4 concepts of deficits ni mue deficit, fiscal deficit and ran*) Primary REVIEW QUESTIONS 1 2 3. Explain the structure o 4 1e Union Government of India’s Discuss the types of deficit. budget, OBJECTIVE QUESTIONS j reasons: Budget cannot be used to Economic growth can be aci 1g statements are true or false with A public budget should always balance, of resources isthe primary objective ofa budget ingeconomic stability ieved through budgetary provisions. of Budget and Concepts of Deficit a we ‘The budget is always balanced in zero-based budget. Performance and programme budgets are v Executive budget is more e ve than legislat Narrower than functional budget. the excess of total expenditure over revenue receipts and non-borrowing capital receipts, 10. Revenue deficits the most comprehensive: in, Effective revenue defi creation of capital assets, 42, Primary deficits fiscal deficit minus borrowings. 43. The Union Budget gives details for 3 consecutive years. ; For Reasons : Refer Section 13.2. a For Reasons : Refer Section 13.2 3. False; For Reasons : Refer Section 13.2. 4. True; For Reasons : Refer Section 13.2. 5. False; For Reasons : Refer Section 13.3. 6 7. 8 ‘True; For Reasons : Refer Section 13.3. ; For Reasons : Refer Section 13.3. “or Reasons: Refer Section 13:3. ‘or Reasons: Refer Section 13.5. ‘or Reasons : Refer Section 13.5. 11. True; For Reasons : Refer Section 13.5. 12. False; For Reasons : Refer Section 13.5. 13, True; For Reasons : Refer Section 13.4 Choose the correct answers and rewrite the statements: ‘Which of the following refers to the excess of revenue expenditure over revenue receipts ? (@) Revenue deficit Fiscal deficit 2. Which ofthe following deficit budgetary imbalances ? a more comprehensive measure of (&) Budgetary: (@) Fiscal deficit (0) Budgetary deficit ay is ma vn (0). Traditional budge mt (@)_ Programme budgey objective ofthe budgets jebudget ich of the following is not jon ofemployment Reduction of poverty Manipulating the rate of interest 14.1 Introduction 142 Fiscal Federalism i 143 Fiscal Decentral 144 Centre-state_ nancial Relations in India ——————— 14.1 INTRODUCTION, Governments can be classified governments, 0 unitary and federal (a) Unitary Government: In a unitary government set-up, all the affairs of the entire country are conducted by a single government. Most or all the governing powers are with the ‘Some of the examples ly and China. Maj | countries in the world have unitary form of government. | (0) Federal Government: In a federal form of government, the | affairs of the country are conducted by the authorities of different levels of government. The governing powers shared | between the national or central government and state or | provincial governments. Some of the major countries that follow the federal form of government are India, the USA, = 14.2 FISCAL FEDERALISM Meaning of Fiscal Federalism different vertical layers of administration According to Joseph E. St the division of economic responsi Feder ge lems faced repalance BetWeen central i ministrative Power ang resources comes state and local governments. It is concerned with understa which functions and instruments are best centralised ang nding are best placed inthe sphere of decentralised levels of go iscal federalism is cone ies between the federal) government and the states and local covers issues that go beyond economics. and regional j by fedetal gover SSS =< the study ofhow expenditures and revenues are allocated, Central sovernmen® which Wvernment ered with Central (op governments Key Issues under Fiscal Federalism i issues : Who pays for the programmes? Joseph 6. Stgh ts: Economic London, 3rd Edition 2ogg, N °f Peblic Sector, W.W, ) [ee ties and Resources: 1 of fiscal federalism are concerned with tl ies and resources between the cent and the states and local governments. There ar The main issues he division of tral government re two important (Who makes the decisions about the Programmes ? and Nortan & Company, 1 en athe nang dors Fiscal R 1 e central gov ally ictatesall the terms and the states simply ate ‘ne programmes. gust a there isa division of responsi government and state and local governments, there is also a division of responsibilities between the state governments and Jocal governments. The division is complicated one, involving inancing, regulation and administr ren the central According to the tra have the basic responsibility for the macroeconomic stabilisation function and for income redistribution. In addition to these functions, the central government must provide certain national public goods like defence that provide services to the entire population of the country. The state and local governments should be concerned with the provision of goods and services whose consumption is limited to their own jurisdictions, Regulation: The constitution restricts the laws that states can_ pass. Similarly, state and local governments may also be subject regulations that apply. to private firms and individuals. Sometimes the central government has mandated that state and local governments provide certain service without providing the requisite funds. Al these may give rise to problems in the federation. Incentives for Resource Transfer: Sometimes the central yy requirements for grants and loans, etc. This leads to disparity in the allocation of grants to states. The intention of central government aid to local government is to encourage local spending on particular public services. The central government uses this power to transfer resources to enforce national rules and standards. ‘Tax Expenditures: One of the important ways that the central government affects state and local expenditures is through the as 5. i National and Local Public Goods: One o! the importang fa influencing fiscal fed difference between public goods ancl local public goods. In the case of ational public goods benefits accrue t0 everyone the na ear eack defence. In contrast, the benefits f local publ pecrut tothe residents ofa particular locality, ©. traffic ‘ete, While some argue that the ce fire prot govemment should provide certain Ft - argue for assigning grea! yy for the providien™® public goods atthe local le M of ‘tere isa presumption tat the central government provide aac goods. The question is whee provision of local public goods should be left to state and Tocal Ponts isargued that competion amang oman ra cal governments suppivingand producing lca services i 6, Tax Competition: Ifthe local governments use tax incentives toattract! businesses and to increase employment opportunities, sate are partly at the expense of losses gains in one locality or s Beivper localities or states. But the competition © attract, businesses results in lower taxes for businesses. ‘Thus, at the end businesses are the ultimate beneficiaries. ‘Tax subsidies lead to increased expenditures goods and increase ments. At the same time, ‘al governments by state and local govern int way of subsiising state and loc due to following reasons : accrues to wealthy investors rather (i) Some of the benefits ies. than to the commu! isinesses and not efits is passed on to the b fents of the communities. (ii) Some of th to the resi 193 in favour of hi 0 have ighvincome provided goods. & strong preference for publicly _ginancial Imbalance: One ofthe : l main issue inthe f - pis the financial imbalances Financia bane ear ck Gt harmony between functions and finan ean ‘The sources of revenue assigne should be adequate roenabie hen pee loved fo them. It is very likely that the needs and resources ofeach government will not be balanced Therefore, itis necessary to ‘evolve mechanisms which can be used to even 0 the shortages nd surpluses. One such mechanism is fiscal decentralisation. 14.3 FISCAL DECENTRALIZATION ecentralisation in general, is an ongoing and gradual process i hereby, politcal, administrative an fiscal powers are transferred from the central government tothe state and Jocal governments Fiscal decentralization refers to the transfer ‘of taxing and ravers from the control of central government expenditure P government authorities at sub-nati nal levels (state and local goverment), The main PUrPOS® of decentralization is improved aeinistration, better accountability ABE participa ‘Femocratc proces by peopleand ultimate generation ofeconomic welfare. centralization are: Components of fiscal dec nt in a federal ities to the as unique such expendite vat, State governme’ “and other economi 194 d by local taxes, user ernment grants, vied by the central gover ransferred to the state govern ™ent tenure, when cae es °y col on. In India, the nec tral 3d corporate income tg e government. The monje" country. In some coungs, jects taxes and shares the ws ‘estate or regional governments ater deca ection, In some cases the taxes are shareq contribution to tax generny n. The mode of tax sharat®® we and undergoes changes wher ® flexi wes ar reviewed from time n faired, Thisis necessary for brining in decentralization process. In India, constituted periodically to examine Supplementary Levies: Supplementary levies are imposed oy, and above a main tax. Cess and surcharges are examples of Such levies. These are imposed by the central government ay proceeds are distributed to the lower level governments, Local Taxes: These local governments have the power to impose and collect taxes usually on property, sale of goods and service ‘movement of goods, and in some cases even on income. Such are apart of fiscal decentralization, Collection of these ‘es provides greater autonom governments to carry 5. User Charges: In many cases, local governments supplement their tax collection by charging user charges and fees from the people for use of local infrastructure, Examples of these are road folls, fees fe ales 22 wing Public spaces like parks, museums, a 6. Inter-Governmental Transfers of Grants: Grants-in-aid are Provided by the central government to the state governments eee C 195 services they have to ) outright or untargeted "9" ge the gap between current revenues and te government and there are no conditions a id to these grants, and (b) targeted or conditional grants meet specific expenditures, like provision of primary al education oF primary health care, Grants are given in order to n Syoid the imposition of state tax burden on the people. They sre provided to reduce regional imbalances which are common indeveloping economies, Backward and underdeveloped states geta larger share of grants in order to bring them on par with ther states. This benefits the nation. Some states have ywer capacity to generate revenue through taxes due to lower level of economic activities. Such fiscal gap between different states are sought to be filled through grants. Loans are necessary to finance large capital expenditure. Large infrastructure related expenditure cannot be funded through revenue receipts. The central governments provide loans to the state government to meet such expenditures either fully or partially. Such loans are expected to be used for productive purposes so that they are self-liquidating, th they generate income to repay the loans. The rates of interest ‘on such loans are usually lower than the market rates. 14.4 CENTRE-STATE FINANCIAL RELATIONS IN INDIA ea a respons powers t local bodies. A. Division of Functions Se The princi ing the division of functions assigns countrywide tasks to the centre and state/ region, Similarly the tasks - poe. ‘os usness Bo J signed (0 of local panchaya sons: The several fUNCtIONS Of the, ef into developmental ang ™ opmental functions are the Nn- ‘d welfare of the people, fore proche te gro aervices (education, public health, 9/0 ofsexi and contour and employment et.) economic semi an rina i series, ecstry and minerals, ryan ere manications, foreign trade etc.)-and grants in aid tg staat for developmental purposes. = tions include maintenat if I Non-developmental functions inch se of aw and (police, defence) ‘maintenance of external relations; grants tg ee for non-developmental purposes. ates State Government Functions : The various responsibilities of states are also grouped under two categories : developments non-developmental. Developmental functions include: socigy services; economic services etc. val and lopment which promote growth Non-developmental functions include administrative s, 7 ‘payment of pensions, interest payments on loans, "vices, Justification for the Division The above mentioned division of functions : Poem s is justified on the (Defence and communication services are to be provided ide uniformly throughout the countr responsibility of the centre. Y and thus should be the (ii) Benefits accrue due to ecoi i momies of scale in the provision of vices due tothe large size of the county. (ii) Critical areas such as fo Which requirea reign investment and forei a n tr ional agenda, are with thecentree (9) Further, services which differ from re 'sriculture, are assigned to the states 'gion to region like ns 87 “prea g division of functioy eos nctions has the following problems rere is over lapping of functions in im areastike | 1 qducation and health, ns in important areas lik Many of the centrally sponsored schemes do not provide the sequited freedom and autonomy to the regions in respect to their designing and implementation and thus do not benefit the targeted groups, g. Division of Resource Raising Powers sree omeet the expenditures involved in the performance of functions, the governments at different levels have been assigned powers to raise resources. Receipts of Central Government : There are various sources of receipts of the central government classified into revenue receipts and capital receipts. Among the revenue receipts the most important is the tax revenue. A part of the tax receipts is statutorily transferred tothe states as per the recommendations of the Finance Commission. The various types of taxes allotted to the centre may be listed under three categories: ‘¢ Taxes on income and expenditure, which include income tax, corporation tax and expenditure tax. ¢ Taxes on property and capital transactions which cover estate duty, wealth tax ete Taxes on commodities: A major change in the indirect tax structure was made with the implementation of The Goods and Services Tax (GST) on 1 July 2017. Since GST is a destination based tax, an end user consuming any goods or services is liable toppay it. The tax is received by the State in which the goods or services are consumed and not by the state in which such goods are manufactured. (i) Central GST (CGST) is a tax levied on intra-state supplies of both goods and services by the central government and governed by the CGST Act. QQ. 10s sass Eononto-!VS.¥B.Com, spy 1s Maly) (ii) State GST (6GST) will also be levied on the same intra.” sve, but wll be governed EY the state governmony Site int » Hhat both the Central and the State soveramenty st i their levies with an appropriay te pr between them. Proportion agree on combining for revenue shaving ga tax levied on all inter-st Integrated GST (IGST) ist statesue, (Hoga and services and willbe governed by the cats of goods shared between central and state governmengs

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