Fiscal policy its objectives

Definition of Fiscal Policy. Fiscal policy involves the Government revenue and Government Spending in order to influence Aggregate Demand (AD) and therefore the level of economic activity.

Objectives
Growth and employment by increasing aggregate demand Redistribution of income and wealth Allocation of resources in desired directions Stabilization of the economy External Balance

 Fiscal Stance: This refers to whether the govt is increasing AD or decreasing AD Expansionary (or loose) Fiscal Policy. This involves increasing AD, Therefore the govt will increase spending (G) and cut taxes. Lower taxes will increase consumers spending because they have more disposable income(C) This will worsen the govt budget deficit Contractionary (or tight) Fiscal Policy This involves decreasing AD Therefore the govt will cut govt spending (G) And or increase taxes. Higher taxes will reduce consumer spending (C) This will lead to an improvement in the government budget deficit Fine Tuning : This involves maintaining a steady rate of economic growth through using fiscal policy. However this has proved quite difficult to achieve precisely.

Instruments of fiscal policy

Taxes Public Expenditure Public debt or borrowings Deficit financing

TYPES OF TAXES
When it is said Indian Government, it can be classified into Central Government and then into state government. Taxes imposed on citizens of India can be broadly classified into two categories: 1. Direct Taxes and 2. Indirect Taxes Progressive Regressive Proportional

 Taxes can be distinguished by the effect they have on the distribution of income and wealth. A proportional tax is one that imposes the same relative burden on all taxpayersi.e., where tax liability and income grow in equal proportion. A progressive tax is characterized by a more than proportional rise in the tax liability relative to the increase in income, and A regressive tax is characterized by a less than proportional rise in the relative burden. Thus, progressive taxes are seen as reducing inequalities in income distribution, whereas regressive taxes can have the effect of increasing these inequalities.

Public Expenditure
Government Expenditure = (revenue +capital exp.) and Transfer payments Revenue Expenditure: is recurring spending or, in other words, spending on items that are consumed and only last a limited period of time. They are items that are used up in the process of providing a good or service. In the case of the government, revenue expenditure would include wages and salaries and expenditure on consumables - stationery, drugs for health service and so on.

 Capital Expenditure: by contrast, capital expenditure is spending on assets. It is the purchase of items that will last and will be used time and time again in the provision of a good or service. In the case of the government, examples would be the building of a new hospital, the purchase of new computer equipment or networks, building new roads and so on.

 The breakdown between these two types of spending is very important. Capital expenditure has a lasting impact on the economy and helps provide a more efficient, productive economy. A new hospital, for example, will be much more efficient and allow more patients to be treated for many years into the future. revenue expenditure, however, doesn't have such a lasting impact. Once the money is spent, it is gone and the effect on the economy is simply a short-term one.

Public Debt
Over the years, the public debt of the India's Central and that of State government has increased considerably during the planning period. The Government borrows funds by way of public debt to meet the various development and non-development expenses. Internal Debt:
The various internal sources from which the government borrows include individuals, banks, business firms, and others. The various instruments of internal debt include market loans, bonds, treasury bills, ways and means advances, etc. Internal debt is repayable only in domestic currency. It imply a redistribution of income and wealth within the country & therefore it has no direct money burden.

 External Debt
External loans are raised from foreign countries or international institutions. These loans are repayable in foreign currencies. External loans help to take up various developmental programmes in developing and underdeveloped countries. These loans are usually voluntary. An external loan involves, initially a transfer of resources from foreign countries to the domestic country but when interest and principal amount are being repaid a transfer of resources takes place in the reverse direction

Flexibility of Fiscal policy

Discretionary Fiscal Policy Non Discretionary Fiscal Policy: Automatic stabilizers or built in stabilizers

Automatic Fiscal Stabilizers

If the economy is growing, people will automatically pay more taxes ( VAT and Income tax) and the Government will spend less on unemployment benefits. The increased T and lower G will act as a check on AD. In a recession the opposite will occur with tax revenue falling but increased government spending on benefits, this will help increase AD

Discretionary Fiscal Stabilizers

This is a deliberate attempt by the govt to affect AD and stabilize the economy, e.g. in a boom the govt will increase taxes to reduce inflation Injections (J): This is an increase of expenditure into the circular flow, it includes govt spending(G), Exports (X) and Investment (I) Withdrawals (W): This is leakages from the circular flow This is household income that is not spent on the circular flow. It includes: Net savings (S) + Net Taxes (T) + Net Imports (M). Fiscal Policy was particularly used in the 50s and 60s to stabilize economic cycles. These policies were broadly referred to as 'Keynesian' In the 1970s and 80s governments tended to prefer monetary policy for influencing the economy. There are many factors which make successful implementation of fiscal Policy difficult .

Budget and various concepts of budget deficits

The budget of the government of India, for any year , gives a complete picture of the estimated receipts and expenditure of the govt on the on the basis of the figures of the two previous year . Every budget , for instance gives three sets of figures . For example, the budget estimates for the year 2008-09 contains : Actual or account for the year 2006-07. Budget and revised figures for the year 207-08. Budget estimates for 2008-09

Receipts and Expenditure of central government 1.REVENU RECEIPTS (a+b) (net) a. Tax Revenue b.Non Tax Revenue 2.Revenue Expenditure of which a. Interest payments b. Major subsidies c. Defense expenditure 3. Revenue Deficits (2-1) 4. Capital Receipts of which a. Recovery of loans b. Other Receipts ( mainly PUS disinvestment ) c. Borrowing and other liabilities 5. Capital Expenditure 6. Total Expenditure ( 2+5= 6(a)+6(b) of which a.Plan Expenditure b. Non plan Expenditure 7.Fiscal Deficit( (6-1-4 (a)-4(b) 8.Primary deficit( 7-2(a)

Budget Deficits Basic Definitions Revenue Deficit= Revenue Receipts Revenue Expenditure Budget Deficits = Total Receipts( Revenue Receipts + Capital Receipts ) Total expenditure Fiscal Deficit = Revenue Receipts + (Capital Receipts Borrowing and other liabilities ) Total Expenditure Primary Deficit= Fiscal Deficit Interest Payments

Burden of deficits and Debt and monetized public debt

Implications of high fiscal deficits

Money Supply growth rate Inflation Crowding out of private investment

Crowding out of essential public expenditure

The following data are extracted from the quarterly report, Jan The following estimates are extracted from the Union Budget for the

year 1998-99 Calculate

Rs. in crore Tax revenue 1,16857

Non-tax revenue
Recoveries of loans Other capital receipts Borrowings/other liabilities

45,137
9,908 5,000 91,025

Non plan expenditure On revenue account 1,66301 (of which interest payment is Rs.75,000 crore)

On capital account
Plan expenditure On revenue account On capital account

29,624

43,761 28,241

You are required to compute Revenue Receipts Capital Receipts Revenue Expenditure Capital Expenditure Revenue Deficit Fiscal Deficit Primary Deficit

Answers
Revenue Receipts=161994 Capital Receipts=105933 Revenue Expenditure=210062 Capital Expenditure=57865 Budget Deficit=0 Revenue Deficit=48068 Fiscal Deficit=92025 Primary Deficit=16025