Fiscal policy

Fiscal policy

Fiscal policy deals with the taxation and expenditure decisions of the government.

Monetary policy, deals with the supply of money in the economy and the rate of interest.

These are the main policy approaches used by economic managers to steer the broad

aspects of the economy.

government deals with fiscal  policy while the central bank is responsible for monetary policy. Fiscal policy is composed of several parts. These include, tax policy, expenditure policy, investment or

disinvestment strategies and debt or surplus management.  Fiscal policy is an important

constituent of the overall economic framework of a country and is therefore intimately

linked with its general economic policy strategy.

Fiscal policy also feeds into economic trends and influences monetary policy. When the

government receives more than it spends, it has a surplus. If the government spends more

than it receives it runs a deficit. To meet the additional expenditures, it needs to borrow

from domestic or foreign sources, draw upon its foreign exchange reserves or print an

equivalent amount of money.

This tends to influence other economic variables. On a broad generalisation, excessive printing of money leads to inflation. If the government borrows too much from abroad it leads to a debt crisis. If it draws down on its foreign exchange reserves, a balance of payments crisis may arise. Excessive domestic borrowing

by the government may lead to higher real interest rates and the domestic private sector

being unable to access funds resulting in the „crowding out‟ of private investment.

Revenue & Expendature:

A spending item is a capital expenditure if it relates to the creation of an

asset that is likely to last for a considerable period of time and includes loan

disbursements. Such expenditures are generally not routine in nature. By the same logic a

capital receipt arises from the liquidation of an asset including the sale of government

shares in public sector companies (disinvestments), the return of funds given on loan or

the receipt of a loan. This again usually arises from a comparatively irregular event and is

not routine. In contrast, revenue expenditures are fairly regular and generally intended to

meet certain routine requirements like salaries, pensions, subsidies, interest payments,

and the like. Revenue receipts represent regular „earnings‟, for instance tax receipts and

non-tax revenues including from sale of telecom spectrums.

There are various ways to represent and interpret a government‟s deficit. The simplest is

the revenue deficit which is just the difference between revenue receipts and revenue

expenditures.

Revenue Deficit = Revenue Expenditure  – Revenue Receipts  (that is Tax + Non-tax

Revenue)

A more comprehensive indicator of the government‟s deficit is the fiscal deficit. This is

the sum of revenue and capital expenditure less all revenue and capital receipts other than 6

loans taken. This gives a more holistic view of the government‟s funding situation since

it gives the difference between all receipts and expenditures other than loans taken to

meet such expenditures.

Fiscal Deficit = Total Expenditure (that is Revenue Expenditure + Capital Expenditure) –

(Revenue Receipts + Recoveries of Loans + Other Capital Receipts (that is all Revenue

and Capital Receipts other than loans taken))

Gov revenue:

Direct Tax

Indirect  Tax

Non-tax Revenue

Gov Expenditure:

Defence

Interest

Subsidies

Other Revenue Expenditure

Looking ahead, the government would probably focus on reforms on both the tax and

expenditure fronts. With regard to tax policy, changes can be expected in terms of

legislation as well as administrative reforms to improve efficiency. The main legislative

proposals are the DTC and the GST both of which are in various stages of legislative

consultation. The DTC seeks to simplify the tax code, revamp the system of tax

deductions and remove ambiguities of law. The GST aims at bringing a fairly unified

system of input tax credits across the value chain and at an interstate level. Currently the

central excise and service taxes have limited credit facilities up to the manufacturing

stage. The state VAT is not geared to provide interstate input tax credits. It is proposed to

institute a dual GST structure with separate central and state GSTs. This would require a

constitutional amendment to allow both the central and state governments to have

concurrent jurisdiction over the entire value chain. Interstate GST credit and full credit

for the central GST is envisaged. This would also require an advanced information

technology (IT) infrastructure (Empowered Committee, 2009). IT is also likely to be

further leveraged for improving the direct tax administration. Moves in this direction

include increasing the number of Centralised Processing Centres (CPCs) that carry out

bulk processing functions from one to four. The number of taxpayer help centres and

web-based taxpayer interface facilities are also to be increased substantially (Ministry of

Finance, 2011). 

It also appears that there are moves to improve social expenditure outcomes and target

subsidies in a better manner. With respect to energy related subsidies in particular, given

the Integrated Energy Policy of 2009, the basic principle would be to equalise the prices

of domestic energy with that of imported energy while targeting subsidies to the poor and

needy (Planning Commission, 2011). Much of this would hinge on the adoption of new

techniques and technologies including IT based identification systems as proposed by the

Aadhar Unique Identification system.

Meaning of Fiscal Policy ↓

The fiscal policy is concerned with the raising of government revenue and incurring of government expenditure. To generate revenue and to incur expenditure, the government frames a policy called budgetary policy or fiscal policy. So, the fiscal policy is concerned with government expenditure and government revenue.

Fiscal policy has to decide on the size and pattern of flow of expenditure from the government to the economy and from the economy back to the government. So, in broad term fiscal policy refers to "that segment of national economic policy which is primarily concerned with the receipts and expenditure of central government." In other words, fiscal policy refers to the policy of the government with regard to taxation, public expenditure and public borrowings.

The importance of fiscal policy is high in underdeveloped countries. The state has to play active and important role. In a democratic society direct methods are not approved. So, the government has to depend on indirect methods of regulations. In this way, fiscal policy is a powerful weapon in the hands of government by means of which it can achieve the objectives of development.

Main Objectives of Fiscal Policy In India ↓

The fiscal policy is designed to achive certain objectives as follows :-

1. Development by effective Mobilisation of Resources

The principal objective of fiscal policy is to ensure rapid economic growth and development. This objective of economic growth and development can be achieved by Mobilisation of Financial Resources.

The central and the state governments in India have used fiscal policy to mobilise resources.

The financial resources can be mobilised by :-

1.     Taxation : Through effective fiscal policies, the government aims to mobilise resources by way of direct taxes as well as indirect taxes because most important source of resource mobilisation in India is taxation.

2.     Public Savings : The resources can be mobilised through public savings by reducing government expenditure and increasing surpluses of public sector enterprises.

3.     Private Savings : Through effective fiscal measures such as tax benefits, the government can raise resources from private sector and households. Resources can be mobilised through government borrowings by ways of treasury bills, issue of government bonds, etc., loans from domestic and foreign parties and by deficit financing.

2. Efficient allocation of Financial Resources

The central and state governments have tried to make efficient allocation of financial resources. These resources are allocated for Development Activities which includes expenditure on railways, infrastructure, etc. While Non-development Activities includes expenditure on defence, interest payments, subsidies, etc.

But generally the fiscal policy should ensure that the resources are allocated for generation of goods and services which are socially desirable. Therefore, India's fiscal policy is designed in such a manner so as to encourage production of desirable goods and discourage those goods which are socially undesirable.

3. Reduction in inequalities of Income and Wealth

Fiscal policy aims at achieving equity or social justice by reducing income inequalities among different sections of the society. The direct taxes such as income tax are charged more on the rich people as compared to lower income groups. Indirect taxes are also more in the case of semi-luxury and luxury items, which are mostly consumed by the upper middle class and the upper class. The government invests a significant proportion of its tax revenue in the implementation of Poverty Alleviation Programmes to improve the conditions of poor people in society.

4. Price Stability and Control of Inflation

One of the main objective of fiscal policy is to control inflation and stabilize price. Therefore, the government always aims to control the inflation by Reducing fiscal deficits, introducing tax savings schemes, Productive use of financial resources, etc.

5. Employment Generation

The government is making every possible effort to increase employment in the country through effective fiscal measure. Investment in infrastructure has resulted in direct and indirect employment. Lower taxes and duties on small-scale industrial (SSI) units encourage more investment and consequently generates more employment. Various rural employment programmes have been undertaken by the Government of India to solve problems in rural areas. Similarly, self employment scheme is taken to provide employment to technically qualified persons in the urban areas.

6. Balanced Regional Development

Another main objective of the fiscal policy is to bring about a balanced regional development. There are various incentives from the government for setting up projects in backward areas such as Cash subsidy, Concession in taxes and duties in the form of tax holidays, Finance at concessional interest rates, etc.

7. Reducing the Deficit in the Balance of Payment

Fiscal policy attempts to encourage more exports by way of fiscal measures like Exemption of income tax on export earnings, Exemption of central excise duties and customs, Exemption of sales tax and octroi, etc.

The foreign exchange is also conserved by Providing fiscal benefits to import substitute industries, Imposing customs duties on imports, etc.

The foreign exchange earned by way of exports and saved by way of import substitutes helps to solve balance of payments problem. In this way adverse balance of payment can be corrected either by imposing duties on imports or by giving subsidies to export.

8. Capital Formation

The objective of fiscal policy in India is also to increase the rate of capital formation so as to accelerate the rate of economic growth. An underdeveloped country is trapped in vicious (danger) circle of poverty mainly on account of capital deficiency. In order to increase the rate of capital formation, the fiscal policy must be efficiently designed to encourage savings and discourage and reduce spending.

9. Increasing National Income

The fiscal policy aims to increase the national income of a country. This is because fiscal policy facilitates the capital formation. This results in economic growth, which in turn increases the GDP, per capita income and national income of the country.

10. Development of Infrastructure

Government has placed emphasis on the infrastructure development for the purpose of achieving economic growth. The fiscal policy measure such as taxation generates revenue to the government. A part of the government's revenue is invested in the infrastructure development. Due to this, all sectors of the economy get a boost.

11. Foreign Exchange Earnings

Fiscal policy attempts to encourage more exports by way of Fiscal Measures like, exemption of income tax on export earnings, exemption of sales tax and octroi, etc. Foreign exchange provides fiscal benefits to import substitute industries. The foreign exchange earned by way of exports and saved by way of import substitutes helps to solve balance of payments problem.

Conclusion On Fiscal Policy ↓

The objectives of fiscal policy such as economic development, price stability, social justice, etc. can be achieved only if the tools of policy like Public Expenditure, Taxation, Borrowing and deficit financing are effectively used.

Though there are gaps in India's fiscal policy, there is also an urgent need for making India's fiscal policy a rationalised and growth oriented one.

The success of fiscal policy depends upon taking timely measures and their effective administration during implementation.