Group-6 FISCAL DEFICIT AND ITS

IMPLICATIONS

Group Members
Sai Kumar K - 132
Anand Kumar S - 136
Divya Shree R C - 148
Ashutosh Tiwari - 158
Vikalp Agrawal - 161
Satish K Reddy - 162
Abhilasha Jha - 174
Submitted to
Dr.C.S.Adhikari
Dean Academics
 FISCAL DEFICIT
• It is a phenomenon where governments total
expenditure surpasses the total revenue
generated.
• In simple terms it is the difference between
governments total receipts and total expenditure.
• Total receipts doesn’t include governments
borrowing from external sources.
• Normally fiscal deficit termed as a percentage of
GDP.
• It is a clear indication of the level which
government should borrow.
• Fiscal deficit takes place due to either revenue
deficit or a major hike in capital expenditure.
 COMPONENTS OF FISCAL DEFICIT
• Revenue expenses: Revenue expenses are the day-to-day
expenses
– salaries payable to the government employees
– the expenses incurred in running various government
departments, and so on

• Capital expenses: Capital expenses include what is incurred

for creating new factories and improving infrastructure.
• Revenue Receipts

Revenue receipts consist of tax collected by the government

and other receipts consisting of interest and dividend on
investments made by Govt., fees and other receipts for
services rendered by Govt.

• Capital Receipts:

Capital Receipts include Recoveries of Loans and

disinvestment of Govt.’s equity holdings in Public enterprises,
etc.
• Revenue Deficit
It is an economic phenomenon, where the net amount received fails to meet the
predicted net amount to be received.

• Plan expenditure

These are the expenses that form a part of the government’s five year plan.

• Non plan expenditure

It is an outcome of planned expenditure like maintenance of national highways,

subsidies to states.
• Revenue expenses: Revenue expenses are the day-to-day
expenses:
– salaries payable to the government employees
– the expenses incurred in running various government
departments, and so on

• Capital expenses: Capital expenses include what is incurred

for creating new factories and improving infrastructure.
 Where Does the Money Come From??

3%
6% Non debt capital
receipts
29% 9%
Service tax and other
taxes
Customs
9%
Income tax
Union excise duties
Non tax revenues
10%
Corporation tax
23% Borrowings and other
11% liabiliies
 Where is Our Money Going??

Non plan assistance to state

and UT Govts
4%
7% Plan assistance to state and
21% UT
9%
Subsidies

Defence

11% Other non plan expenditure

19% States' share of taxes and

duties

13% Interest paymaent

16% Central plan

TRENDS AND PATTERNS IN FISCAL VARIABLES IN INDIA
1.8

1.6

1.4

1.2

1 Subsidies
Food
0.8 Fertilizer
Petroleum
0.6

0.4

0.2

0
2003-04 2004-05 2005-06 2006-07 2007-08

SUBSIDIES AS % OF
90
80
70
60
50
40 Gross Fiscal
Deficit
30 Column1
20
10
0
2010 2011 2012 2013 2014 2015
-11 -12 -13 -14 -15 -16

PROJECTIONS(AS % OF GDP)
19
60

0
2
4
8
10
12
-6

6 5.6
19 1
62

5.1
-6
19 3
64
-6

5.8 6 6
19 5
66

6.7
-6

7.3
19 7
68

5.5
-6

4.4
19 9
70

3.8
-7

4.6
19 1
72
-7

5.35.2
19 3
74
-7

4.34.1
19 5
76

4.6
-7

5.4
19 7
78

4.9
-7
19 9 5.7
80
6.5

-8
8.1

19 1
82
6.7

-8
7.3

19 3
84
8.1

-8
9.7

19 5
86
9.3

-8
19 7
10.9

88
10

-8
9.4

19 9
90
-9
10.4

6.6

19 1
92
-9
4.74.8

19 3
94
6.4

-9
4.7

19 5
96
-9
4.24.1

19 7
98
4.8

-9
5.1

20 9
00
5.4

-0
20 1
02
6.2

-0
5.7 5.9

20 3
04
-0
4.1

20 5
FISCAL DEFICIT IN TERMS OF % OF GDP

06
4.5 4.3

-0
3.5

20 7
08
2.7

-0
9
6.1
 REDUCING FISCAL DEFICIT BY EFFECTIVE
FISCAL POLICY
• Fiscal policy is a policy in which government
uses its expenditure and revenue programs to
produce desirable effect on national income
and employment.
 TYPES OF FISCAL POLICY
• REFLATIONARY FISCAL POLICY
• Policy aims to boost the economy by decreasing the
taxes which will lower the prices of taxed goods and
encourage more demand.
• This will make people to spend the disposable income
which will trigger the growth.
• Government will increase its expenditure.
• These policy will be adopted during economic slow
down and recession.
• These policy will increase the fiscal deficit.
 DEFLATIONARY FISCAL POLICY
• Policy adopted during boom period to stop the
growth.
• Economy growing above its capacity will cause
inflation and balance of payment problem.
• Aims to increase indirect tax and reduce the
government expenditure.
• Aims to increase the direct tax which will leave
people to spend less.
• These policy will reduce the fiscal deficit.
 SUPPLY SIDE POLICY
• Aims to increase the capacity of the country to
produce more.
• Reduction in the tax rate to motivate the
enterprises to start new business ventures.
• These policy will increase the fiscal deficit.
 THE KEYNESIAN VIEW OF FISCAL POLICY
• Keynesians argued that the country budget should be
used to promote a level of aggregate demand
consistent with the full-employment rate of output.
• EXPANSIONARY FISCAL POLICY
An increase in government expenditures and/or a
reduction in tax rates such that the expected size of
the budget deficit expands.
• RESTRICTIVE FISCAL POLICY:
A reduction In government expenditures and/or an
increase in tax rates such that the expected size of
the budget deficit declines (or the budget surplus
increases).
Expansionary & Restrictive Fiscal Policy
 SELF-CORRECTIVE PROCESS
• Initially, the economy is operating at c. Output is
below potential capacity and unemployment exceeds
its natural rate.
• If there is no change in policy, abnormally high
unemployment and excess supply in the resource
market will reduce real wages and other resource
prices, which will direct the economy toward b.
• In addition, interest rates would decline as the result
of the weak demand for investment, and increase
aggregate demand.
• However, Keynesians believe this self-
corrective process will work slowly, if at all.
(1) Wages and prices are inflexible, particularly
in a downward direction.
(2) Lower interest rates may not stimulate
much additional spending in a recessionary
economy dominated by consumer pessimism
and excess production capacity.
• Keynesians recommend government action.
• When an economy is operating below its
potential capacity, the Keynesian prescription
calls for expansionary fiscal policy---a
deliberate change(Increase) in expenditures
and/or (Decrease) In taxes that will increase
the size of the government’s budget deficit.
• The Keynesian revolution challenged the view
that a responsible government should
constrain spending within the bounds of its
revenues. Rather than balancing the budget
annually, Keynesians stressed the importance
of countercyclical policy.
FISCAL POLICY & CROWDING-OUT EFFECT

• CROWDING-OUT EFFECT
A reduction in private spending as a result of
higher interest rates generated by budget
deficits that are financed by borrowing in the
private loanable funds market.
• The crowding-out effect suggests that budget deficits
will have less effect on aggregate demand than the
basic Keynesian model implies. Because financing the
deficit pushes up interest rates, budget deficits will
tend to retard private spending, particularly spending
on investment and consumer durables.

• Thus, the expansionary fiscal policy will have little, if

any, effect on demand, output, and employment.
• Keynesians argue that an increase in government
purchases financed by a deficit will exert a strong
multiplier effect on output, employment, and real
income.

• Moreover, when applied during a recession, the

demand stimulus may improve business profit
expectations and thereby stimulate additional private
investment.
• Restrictive fiscal policy will “crowd in” private
spending. If the government increases taxes and/or
reduces its spending , the budget will shift toward a
surplus. As a result, the government’s demand for
loan funds will decrease, placing downward pressure
on the real interest rate. The lower real interest rate
will stimulate additional private investment and
consumption.

• So the fiscal policy restraint will be at least partially

offset by an expansion in private spending.
 THE NEW CLASSICAL VIEW OF FISCAL POLICY

• New classical economists

Economists who believe that there are strong
forces pushing a market economy toward full-
employment equilibrium and that
macroeconomic policy is an ineffective tool
with which to reduce economic instability.
• Robert Lucas (University of Chicago)
Thomas Sargent (New York University)
Robert Barro (Harvard University):

“Budget deficits imply higher future taxes and that

taxpayers will reduce their current consumption just
as they would have if the taxes had been collected
during the current period.”
Thus, new classical economists do not believe that
budget deficits will stimulate additional consumption
and aggregate demand.
• The new classical economists stress that debt
financing simply substitutes higher future taxes for
lower current taxes. Thus, budget deficits affect the
timing of the taxes, but not their magnitude.
• RICARDIAN EQUIVALENCE
The view that a tax reduction financed with
government debt will exert no effect on current
consumption and aggregate demand because people
will fully recognize the higher future taxes implied by
the additional debt.
 example
• Suppose you knew that your taxes were going
to be cut by $1,000 this year, but that next
year they were going to be increased by
$1,000 plus the interest on that figure.
Would you increase your consumption
spending this year?
 HIGHER EXPECTED FUTURE TAXES CROWD OUT PRIVATE
SPENDING
Price Real
level interest S1
SRAS rate S2

e1
r1 e2
P1 E1 AD2

D2
AD1
D1

Y1 Q1 Q2

Goods & services (real GDP) Loanable funds

• New classical economists emphasize that budget deficits
merely substitute future taxes for current taxes.

• If households did not anticipate the higher future taxes,

aggregate demand would increase to AD2. However, demand
remains unchanged at AD1 when households fully anticipated
the future increase in taxes.

• Simultaneously, the additional saving to meet the higher future

taxes will increase the supply of loanable funds to S2 and allow
the government to borrow the funds to finance its deficit
without pushing up the real interest rate.

• In this model, fiscal policy exerts no effect. The real interest

rate, real GDP, and level of employment all remain unchanged.
 KEY CHANGES IN BUDGET TO CONTROL
FISCAL BALANCES
• 1954-1955 (The taxation enquiry commission)
• Raising tax revenue through higher taxes and
greater progressivity of direct taxes.
• 1985-1986 (Budget presented by Mr.V.P.Singh)
• Reduce the number of income tax slabs from
four to eight.
• 1985-1986(Mr.V.P.Singh)
• Submitted full fledged long term fiscal policy
in the parliament.
• Sweeping reforms has been made in custom
duties and central excise duty.
• Phased introduction VAT called as
MODVAT(modified VAT).
• 1986-1987(Mr.V.P.Singh)
• Implementation of MODVAT
• It enabled manufacturers to deduct the excise
paid on domestically produced inputs and duties
paid on imported inputs from their excise duty
on output.
• By 1990 MODVAT covered all sub-sectors of
manufacturing except petroleum products,
textiles, and tobacco.
• 1991-1992(Chelliah committee)
• Simplification and rationalization of direct tax structure.

• Introduction of three-tier personal income tax structure

with an entry rate of 20% and a top rate of 40% .
• The rates of corporate income tax for both publicly
listed companies and closely held companies have been
unified and reduced to 46% from 51.75% 57.5%
respectively.
• Extension of MODVAT to all inputs including machinery.
• 1992-1993(Dr. Manmohan Singh)
• Import duties has been reduced.
• 110% in 1992-1993
• 85% in 1993-1994
• 65% in 1994-1995
• 50% in 1995-1996
• 1994 (Chelliah committee)
• Widening the tax base by including the service tax and
extending its coverage gradually.
• Services brought under the tax net in 1994–1995 are
Telephone, Stockbroker and General Insurance at the tax
rate of 5%
• 1996-1997(finance act)
• Advertising agencies, courier agencies and radio pager
services were added to Service Tax Net.
• 1997-1998(Mr.Chidambaram)
• Reduction in custom duties to 40%.
• Reduction in triple rate structure of personal
income tax to 10–20–30%.
• Decrease in company tax rate to 35%.
• Reduction in excise duty rates.
• Abolition of dividend taxation in the
recipients’ hands
• 2004-2005(Mr.P.Chidambaram)
• Introduction of New Securities Transaction Tax
(New STT), Fringe Benefit Tax (FBT),
commodities transaction tax (CTT).
• FBT includes Tax on employee stock option.
• Taxes on employee travel welfare and
accommodation.
• Securities transaction tax means Taxable
securities transaction, payable by both the
buyer and the seller, refers to any transaction
of securities entered into in a recognized Stock
Exchange in India which is increase from 0.1%
to 0.125%.
• 2011-2012(proposals)
• Introduction of Direct Tax code
• To cut corporate profit tax from 34% (including surcharge
and tax) to 25% (all inclusive).
• Changes in Mininimum alternate tax.
• Companies having large profits and declaring substantial
dividends to shareholders but who were not contributing to
the Govt by way of corporate tax, by taking advantage of the
various incentives and exemptions provided in the Income-
tax Act, pay a fixed percentage of book profit as minimum
alternate tax.
• Introduction of GST
• Central GST and State GST are the two
components of GST.
• Finance Minister Pranab Mukherjee has said
that the successful implementation of the
Goods and Services Tax (GST) can give a
trillion-dollar boost to the economy, taking the
total output to $2 trillion.
• All the existing taxes like VAT, Service tax,
Excise duty will be removed.
• It is a consumer based tax and not origin
based tax.
• That tax for product will be collected by states
which consumes.
• The rate is expected to be between 14-16%.
 FISCAL STIMULUS
• Increase of Rs.20000 crore towards plan
expenditure.
• 4% cut in central value added tax.
• Interest reduction for about 2% for exporters.
• Additional allocation for export incentive schemes.
• Full refund of service tax paid by foreign agents.
• No export duty for iron ore.
• Export duty for steel reduced.
DEBT MONETIZATION AND FISCAL DEFICIT

• In simple terms paying off government debt

by printing more money.
• This can reduce the value of the money.
• Leads to increase in the inflation because of
more money supply in the market.
• Downgrade the countries reputation by
international financial observers.
 WHAT IS HAPPENING IN DEBT
MONETIZATION?
• Suppose government expense is RS.10,000 and income
is Rs 9,000.
• Now government has options such as either go to RBI
and take loan of Rs 1000, go to public and issue bonds
worth Rs 1000 or print brand new Rs 1000 note.
• Suppose it goes for third option after printing Rs.1000 it
goes to the public through treasury and buy the already
issued bond worth of Rs 1000 which will increase the
money supply in large scale which will cause inflation.
 FISCAL RESPONSIBILITY AND BUDGET
MANAGEMENT( FRBM) BILL
• An act initiated to keep fiscal deficit in control.
• It was introduce in Lok Sabha in the year 2000.
• The bill attempted to fix up responsibility to
adopt prudent fiscal policy.
• To ensure proper fiscal management and long
term macro economic stability by achieving
revenue surplus.
 KEY OBJECTIVES IN THE ACT
• Reducing the revenue deficit by an amount equivalent
to 0.5% or more of the GDP at the end of each
financial year.
• To bring down the gross fiscal deficit to less that 2%
within FY 2006.
• Within 10 financial years (ie) from April 2001 to March
2011 to bring down the external debt which do not
exceed 50% of GDP.
• But now targets under FRBM act have been kept in
abeyance.
 AFTERMATH OF FRBM
• Central govt. exp fell from 16 to 14% over next
2 years(cutting down capital exp)
• Public debt reduced from 81.4% in 03-04 to
74% in 08-09.
• Fiscal deficit decreased as the output
decreased, due to implementation and
realization of FRBM targets.
 MISCONCEPTIONS IN FRBM ACT
• These measures might trigger deflation
because of the decrease in the expenditure.
• Decrease in the public expenditure will block
the growth in long term aspect.
• Money supply will get reduced in the market
because of the decrease in the expenditure.
 REASONS FOR FISCAL DEFICIT
• Increase in the defense expenditure which is
2.5% of GDP.
• India expects to spend $50 billion in next 10
years.
• Stimulus package like loan waiver to farmers.
• Increase in the expenditure for sick public sector
companies.
• Increase in the salary of government employees
salary in terms of 6th pay commission.
 IMPACTS OF FISCAL DEFICIT
• Forcing the government to cut spending in the
improvement of social and physical
infrastructure.
• Increase in the taxes which will reduce the
purchasing power.
• Increase in the fuel price which triggers
inflation.
 HOW FISCAL DEFICIT IS MANAGED?

• When revenue is not met to the expected

level government borrows money from RBI or
print additional money.
• Normally prefers borrowing because printing
money can lead to increase money supply in
the market.
• Increase in the money supply will cause
inflation.
• Governments will consume the entire money
in capital market.
• This will increase the loan amount to be
costlier and affects the growth of private
companies.
HOW TO REDUCE FISCAL DEFICIT?
• Disinvestment of public sector companies.
• Increase the revenue generation by selling
spectrum and wi-max licenses.
• Rapid growth in the country will increase the
tax collection.
• Roll back the stimulus package.
• Reduce the subsidy and tax relaxation.
• Increase the efficiency of sick PSU’s.
Thank you