Public Finance and Fiscal Policy
Public Finance
How the Government raises resources to meet its ever-rising expenditure
The income and expenditure of the public authorities and their adjustments among them
Fiscal policy
The effects of budget on the economy
Classical Economic View
Keep the expenditure to the minimum Impose minimum taxes The budget should be balanced
Public borrowings should resorted to only under exceptional conditions, e.g. war, natural calamities etc.
Functional Finance
Balanced budgets are no longer considered sacrosanct
Public Finance should play an active role
It is an instrument of economic regulation, it can be used for maintaining stability through management of aggregate demand
Objectives of Fiscal policy
Sustained Economic Growth Economic Stability High level of Employment Social Justice and Equity
Horizontal and vertical equity Socially optimum pattern of distribution Reducing unemployment Controlling inflationary pressure
Basic Fiscal Concepts
Public Expenditure
Types of Public Expenditure
Trends in Public Expenditure Effects of Public Expenditure
Public Revenue -- Types
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Principles
Effects
Basic Fiscal Concepts
Public Borrowings
Internal Debt External Debt - Revenue Deficit - Budget Deficit - Fiscal Deficit - Primary Deficit
Deficit
Types of Public Expenditure
Revenue and Capital Expenditure Transfer Payments and expenditure on goods and services Developmental and Non-developmental Expenditure
Trends in Public Expenditure
Wagners Law of Increasing State Activity
As the economy develops over time, the functions of the government increase
Wiseman- Peacock Hypothesis
- government expenditure increases in jerks and step-like manner
Factors responsible for growth of Public Expenditure in India
Defence Expenditure Population growth Urbanisation Welfare Activities of the Government Maintaining Economic Stability Huge Investments in developmental activities Mounting Debt Service Charges Increasing Food and Fertilizer subsidies Huge expenditure on Employment generating antipoverty schemes
Effects of Public Expenditure
On Production
Expenditure on investment projects and capital formation will expand the productive capacity and generate long term growth Expenditure on Research and development ensures advancement of technology and would improve the productivity
Effects of Public Expenditure
On Production
Expenditure on Education and Public Health helps in building Human Capital and enhances productivity At times of recession or depression, increase in Public Expenditure leads to manifolds increase in income and employment through the process of multiplier
Effects of Public Expenditure
On Allocation of Resources
Government Expenditure can influence the pattern or composition of output It leads to reallocation of resources between industries and regions It leads to socially desirable allocation resources
Effects of Public Expenditure
On Distribution Through Public Expenditure, the Government redistributes income in favour of the poor
Social Security measures Subsidies (food, fertilizer, kerosene, small scale industries, cottage industries) Social Infrastructure Government Employment Guaranty / assistance schemes Free education for girls
Public Revenue
Tax
A tax is a compulsory payment levied by the Government. It does not have any direct quid pro quo
Non-tax Revenue
Fees, penalties etc
Charged for a specific purpose
There is a direct quid pro quo
Types of Taxes
Direct and Indirect Taxes
Specific and Ad-Valorem Taxes Progressive, Proportional and Regressive Taxes
Direct and Indirect Taxes
The burden of the direct tax cannot be shifted to others, the person who pays it has to bear it
Income tax, Wealth tax, Capital gains tax
Those who pay indirect taxes can pass the burden, wholly or partly, to others
Excise Duty, Sales tax
Merits of Direct Taxes
They are progressive in nature The tax structure can be closely linked to Ability to pay
It is an important instrument of reducing inequalities of income and wealth
They serve as an automatic stabilizers as their revenue elasticity is quite high
Merits of Indirect Taxes
Convenient to pay Large revenue potential for the Government It is an important instrument for influencing the pattern of production and investment
Demerits of Indirect Taxes
They are regressive
They are inflationary
Cascading effect
They may lead to inefficient resource allocation
Specific and Ad-Valorem Taxes
A Specific tax is a tax per unit of a commodity, whatever may be its price
It is based on the volume of operation
An Ad-Valorem tax is levied on the basis of the value of a commodity
It is expressed as a percentage of price
Sales tax
Toll tax
Progressive, Proportional and Regressive Taxes
Progressive Tax
The rate of tax increases as the tax base (income, wealth etc) increases
Greater the tax base, higher is the tax rate
Income tax in India
Proportional tax
The tax rate is constant irrespective of the magnitude of the tax base A rate is fixed, and is applicable to all
Regressive tax
The rate of tax decreases as the tax base increases
The burden of the tax is more on the poor than on the rich
Principles/ Canons of Taxation
Adam Smith The wealth of Nations
Canon of Equality
Canon of Certainty
Canon of Convenience
Canon of Economy
Union Budget
1. Total Expenditure
1.1 Revenue Expenditure
1.1.1 Plan 1.1.2 Non-plan *[Link] Interest Payments
2. Total Receipts
2.1 Revenue Receipts
2.1.1 Tax 2.1.2 Non-tax
1.2 Capital Expenditure
1.2.1 Plan 1.2.2 Non-plan
2.2 Capital Receipts
2.2.1 Recovery of Loans 2.2.2 PSU Disinvestment 2.2.3 Borrowings
Revenue Deficit
Revenue Expenditure () Revenue Receipts Revenue Receipts include Tax and Non-tax receipts Revenue Expenditure includes
Interest payments on public debt Defence expenditure Subsidies on food, exports etc. Civil Administration
Revenue surplus would imply
Prudent resource management by the Government Government savings are being used for financing developmental activities
Revenue deficit would imply
Government is dis-saving Capital funds are being used for consumption expenditure The Government has to borrow in order to meet the day to day expenditure.
Budget Deficit
Total Government Expenditure (-) Total Government Receipts It is financed by borrowing from the RBI against the Government securities and treasury bills Issuing of new currency against government securities is known as Deficit Financing or Monetising of deficit.
Fiscal Deficit
Total Government Expenditure (-) Total Government Receipts(excluding borrowings) Budget Deficit (+) borrowings In India we have had huge Fiscal deficits Attempts have been made to reduce fiscal deficits by curtailing capital expenditure; which has adversely affected economic growth
Primary Deficit
Fiscal Deficit (-) Interest Payments It is lower than the fiscal deficit Indicator of the fiscal management in the current year
Fiscal Policy
Discretionary
Non-discretionary
Automatic Stabilisers
To cure Recession
To control Inflation
Measures to cure Recession
Increase in Government Expenditure
by starting public works such as building roads, dams, ports, telecommunication links, irrigation works The Govt will buy material and employ people This will directly and indirectly increase incomes, output and effective demand in the economy
Government Expenditure Multiplier= G / (1 - MPC)
Measures to cure Recession
Reduction of Taxes
Increase in disposable income Increase in consumption expenditure
Tax Multiplier = T * MPC (1- MPC)
Measures to control Inflation
Reducing Government Expenditure Increasing Taxes
Non-discretionary Fiscal Policy
Automatic Stabilisers
Personal Income Taxes Corporate Income Taxes Transfer Payments: Unemployment Compensation, Welfare Benefits
What do these number tell us?
(In crore of Rupees) 2004-2005 Budget Estimates DEBT SERVICING 1. Repayment of debt** 2. Total Interest Payments 3. Total debt servicing (1+2) 4. Revenue Receipts 5. Percentage of 2 to 4 198380 129500 327880 309322 41.9% 2004-2005 Revised Estimates 224075 125905 349980 300904 41.8% 2005-2006 Budget Estimates 247984 133945 381929 351200 38.1%
