Fiscal Policy, Budget Deficits and the Government DebtDr. Shylajan, C.S

Topics of DiscussionFiscal Policy and Economics GrowthFiscal Policy and Stabilization The Fiscal Policy and Fiscal InstrumentsFiscal policy impacts on ADCrowding OutCentral Government BudgetGovernment Budget PolicyMeasures of DeficitMethods of deficit financing Government BorrowingsSome Numerical Problems

The Fiscal Policy and Fiscal Instruments

Fiscal Policy:The use of government spending and taxation, as opposed to monetary policy (interest rates and money supply), to try to influence the level of economic activity.

The Fiscal Policy and Fiscal InstrumentsFiscal Instruments and impacts on target variablesHow does fiscal policy instruments influence all major real macro variables? Target variables:Disposable income, Aggregate consumption expenditure, Saving and investment, Imports and exports

The Fiscal Policy and Fiscal InstrumentsHow fiscal policy influence aggregate demand?

Budget policies:Balance budget policy, Deficit budget policy and Surplus budget policy

Types of Fiscal policyAutomatic stabilization Vs Discretionary fiscal policyAutomatic stabilization: Suppose slow down phase of the economy.. government spending automatically increases in the form of benefits to the vulnerable sections of the society (transfer payments for instance)AD may increase automatically

Types of Fiscal policyPeriod of boom: number of eligible beneficiaries shrinksgovernment spending automatically slow down the growth of AD.So stabilization takes place automatically

Types of Fiscal policyDiscretionary fiscal policy: govt takes deliberate changes in tax, expenditure etc.Recall what is expansionary fiscal policyAn expansionary fiscal policy : lowering taxes and higher government spendingRecall what is contractionary fiscal policy A contractionary fiscal policy : raising taxes and cutting government spending.In which period we follow these policies?

The Fiscal Policy and Fiscal Instruments

Government spending Tax policy

Implementation thru budget

Governments Expenditure and Receipts

Revenue Expenditure (RE)

Consumption expenditureInterest Payments Transfer Payments (food and fertilizer subsidy, unemployment benefit, pension etc)Capital Expenditure (CE)Amount used during a particular period to acquire or improve long term assets.Example: Govt spending on new Roads, Dams, new machines and equipments etcTotal Expenditure = RE + CE

Governments Expenditure and ReceiptsIn India, Revenue expenditure accounts for more than 80 % of total government expenditureWithin revenue expenditure, more than 35 % of central govts expenditure goes towards payment of interest on government debt20% on Transfer Payments

Government Receipts: Tax and Non Tax Revenue Revenue Receipts (RR)

1. Tax Revenue (net to centre)2. Non-Tax revenue (lotteries etc)Capital Receipts (CR)

1. Recovery of Loans2. Other Receipts (receipts from disinvestments)3. Borrowings and other liabilitiesTotal Receipts = RR + CR

Capital ReceiptsLoans raised by the Government from the public (called market loans);

Borrowings by the Government from the Reserve Bank of India (RBI)

Loans received from foreign governments and bodies; and

Capital ReceiptsRecoveries of loans granted by the Union Government to State governments, Union Territories and other parties.

Proceeds from divestment of government equity in public enterprises.

Tax and Non Tax RevenueNon-Tax revenue: Interest and dividends received from its various investments in public sector undertaking, fees etc

Lotteries and user charges for State govts

Government's own receipts include tax revenue, non tax revenue, recovery of loans and receipts from public sector disinvestments

Tax RevenueDirect Tax

Tax on Income and related AssetsDirect taxes affect both aggregate demand and aggregate supply. How?

Indirect Tax

Tax on Commodities and Services. Customs and excise duties

Direct and indirect taxA direct tax is collected directly by government from the persons on which it is levied.

An indirect tax on goods and services tax is collected from the person who bears the tax by intermediaries and the proceeds passed on to government.

Tax Structure

Progressive : people with higher levels of income are imposed with higher rate of taxes. Direct taxes in India is progressive in natureProportional: same percentage of tax is paid Regressive: a tax in which the poor pay a larger percentage of his/her income than the rich (incidence of tax is higher on poor)

Measures of Deficit of the Central Government:Fiscal Deficit: Difference between government expenditure and governments own receipts.

Fiscal Deficit = Total Expenditure - (Revenue Receipts + Recoveries of Loans + Other Receipts)

Measures of Deficit of the Central Government:Revenue Deficit: Revenue Expenditure minus Revenue Receipts

Monetized Deficit: When the deficit is being financed from borrowing from RBI it is called MD. This will result in increase in money supply

Primary Deficit = Fiscal Deficit - Interest Payments

Numerical ProblemsQ1. Compute Revenue Deficit Fiscal Deficit and Primary Deficit from Indian Budget Estimatessee the data in the next slide

Indian Budget- (Rs in Crores)Revenue Receipts253935Revenue Expenditure366227Non-Plan Expenditure302708Plan Expenditure111455Recoveries of Loans34191Other Receipts3151Interest Payments117804

Revenue deficit: Rs. 112292 CrFiscal deficit: Rs.153637 CrPrimary deficit:Rs.30414 Cr

Numerical ProblemsQ 2. Compute

Revenue deficitFiscal deficit and Primary deficit from the data. see data in the next slide

Numerical ProblemsRevenue Receipts309322Recovery of Loans27100Other receipts4000Non-plan revenue expenditure293650Interest Payments129500Non-plan capital expenditure38589Plan revenue expenditure 91843Plan capital expenditure 53747

Revenue deficit: Rs. 76171 CrFiscal deficit: Rs. 137407 CrPrimary deficit:Rs. 7907 Cr

How does Government finance Fiscal Deficit? Borrowing from the Central Bank (Money financing results in Inflation)Borrowings from the Domestic MarketBorrowing from AbroadBy Increasing Taxes (result: Disincentives)

Trends in gross fiscal deficit of central govt: India (% of GDP)1986-877.571990-916.611991-924.721993-946.431997-984.812001-026.202005-064.302006-073.52008-20093?

Trends in gross fiscal deficit of central govt: India2002 onwards, gross fiscal deficit is in declining trend.

There is a sharp fall in borrowings for capital expenditure.

Topics of DiscussionHow does fiscal policy work?How does fiscal policy affect aggregate demand?Discretionary and Automatic stabilizationFiscal Policy and EfficiencyICORWhen is Government Expenditure Productive?

Topics of DiscussionEconomic impact of fiscal deficits and debt

Fiscal Policies in India

The Interaction of Monetary and Fiscal Policies

Crowding out controversy

Deficit financing----net injection into the economyAn increase in ADA rise in general price levelIf govt spends on remote-return projects, results in increase in money income without increase in output.Sets an inflationary trend

Crowding out controversyTo control inflation, central bank intervenes It adopts tight monetary policy (Then what happens?)Tightens the credit availability and raises the rRise in r finally crowds out private investment

Question for discussion

Do you think fiscal deficit is important in economies like India? If yes, Why?

What are the views against and for fiscal deficit financing?

Suppose the government has the option of stimulating the economy through (a) an increase in government expenditure and (b ) a reduction in taxes.

Other things being equal, which will have a larger impact on GDP and why?

Thank you