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Economic Environment

of Business

Indias Fiscal Policy

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Fiscal Policy

Also referred to as Budgetary Policy

It is a policy under which the govt. uses

its revenue & expenditure programs toproduce desirable effects & avoidundesirable effects on national income,production & employment

Became popular after the GreatDepression

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Objectives of Fiscal Policy

Mobilization & Allocation of resources Provision of social goods

Distribution Equitable distribution of

resources Stabilization Through its effect on

aggregate demand & level of economicactivity

Economic Growth Employment Price Stability

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Instruments Public Expenditure

Public Expenditure consists of Govt.purchases of goods & services(eg.defence); Govt. transfer payments(eg.pensions); Public enterprises & Capitalformation

Increasing expenditure increases

aggregate demand which increases moneywith pvt. sector & this leads to an increasein wages & salaries which also increasesdemand (& vice versa)

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Public Expenditure (cont.)

But while decreasing expenditure only nonproductive expenditure should bedecreased & not developmental otherwisesupply side will also get affected

To increase equity govt. expenditureshould be directed towards eradicatingpoverty & providing subsidies to socially

desirable sectors & rations, etc.

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Instruments - Taxation

Taxation source of public revenue -taxes are either Direct (eg. income &wealth tax) or Indirect (eg. excise &custom)

Direct taxes are progressive & Indirecttaxes are regressive but this can berectified by taxing goods used by highincome groups

Indirect Taxes have a wider coverage butthey increase inflation

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Taxation (cont.)

Increasing Taxes decreases purchasingpower by affecting incomes & prices

Increasing Taxes also decreases rate of

return for business & therefore decreasesinvestment

Other govt. receipts include non-taxrevenue receipts like commercial &administration receipts & capital receiptslike grants, recoveries of loans &disinvestment

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Instruments Public Debt

Public Debt Borrowings from RBI,domestic & external

By borrowing govt. takes away purchasing

power & funds get transferred from pvt. topublic sector but govt. should spend thesefunds for production & not consumptionotherwise it adds to inflation

Govt. should avoid paying back loansduring inflation

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Trends in Indias Fiscal Policy

Public Expenditure has been increasingover the years but it is not reaching thepoor

Tax/GDP ratio has increased from 6.3% in1950-51 to 15.8% in 1991-92

Direct taxes have fallen from 40% to 16%of total taxes during the same period

Indirect taxes are being used for revenuegeneration & not allocational efficiency

Fiscal deficit is increasing

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Trends (cont.)

Main components of expenditure areSubsidies, Wages & Salaries, InterestPayments & Defence Expenditure

Till recently the tax rates were very high,there was a multiplicity of slabs, services& agriculture were not covered, therewere a no. of concessions & exemptions &widespread evasion

As compared to discretionary measures,automatic measures only minimize cyclicaleffects, they do not eliminate them

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Trends (cont.)

When a new measure is introduced thereare lags - Inside (Recognition, Decision &Action Lags) & Outside which mitigate its

effect

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Reforms in Indias Fiscal Policy

Fiscal Responsibility & BudgetManagement Act was introduced in 2004

Decrease interest payments & non interest

expenditure on subsidies, assistance tonon-viable & inefficient enterprises, staff &defence

Simplification of the tax structure by

reduction in the rates & the no. of slabs;introduction of VAT & service tax; betteradministration & enforcement

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Reforms (cont.)

Decrease deficit to 3% of GDP by March2009

Link fiscal & monetary policy & make fiscal

policy more equitable Optimal rate of taxation