Economic Environment of Business

Indias Fiscal Policy

Fiscal Policy

Also referred to as Budgetary Policy It is a policy under which the govt. uses its revenue & expenditure programs to produce desirable effects & avoid undesirable effects on national income, production & employment

Became popular after the Great Depression

: PGM, 2011

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 economic activity Economic Growth Employment Price Stability
: PGM, 2011

Instruments Public Expenditure

Public Expenditure consists of Govt. purchases of goods & services (eg.defence); Govt. transfer payments (eg.pensions); Public enterprises & Capital formation Increasing expenditure increases aggregate demand which increases money with pvt. sector & this leads to an increase in wages & salaries which also increases demand (& vice versa)
: PGM, 2011

Public Expenditure (cont.)

But while decreasing expenditure only non productive expenditure should be decreased & not developmental otherwise supply side will also get affected

To increase equity govt. expenditure should be directed towards eradicating poverty & providing subsidies to socially desirable sectors & rations, etc.

: PGM, 2011

Instruments - Taxation

Taxation source of public revenue taxes are either Direct (eg. income & wealth tax) or Indirect (eg. excise & custom) Direct taxes are progressive & Indirect taxes are regressive but this can be rectified by taxing goods used by high income groups Indirect Taxes have a wider coverage but they increase inflation

: PGM, 2011

Taxation (cont.)

Increasing Taxes decreases purchasing power by affecting incomes & prices Increasing Taxes also decreases rate of return for business & therefore decreases investment Other govt. receipts include non-tax revenue receipts like commercial & administration receipts & capital receipts like grants, recoveries of loans & disinvestment
: PGM, 2011

Instruments Public Debt

Public Debt Borrowings from RBI, domestic & external By borrowing govt. takes away purchasing power & funds get transferred from pvt. to public sector but govt. should spend these funds for production & not consumption otherwise it adds to inflation Govt. should avoid paying back loans during inflation

: PGM, 2011

Trends in Indias Fiscal Policy

Public Expenditure has been increasing over the years but it is not reaching the poor Tax/GDP ratio has increased from 6.3% in 1950-51 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 revenue generation & not allocational efficiency Fiscal deficit is increasing
: PGM, 2011

Trends (cont.)

Main components of expenditure are Subsidies, Wages & Salaries, Interest Payments & Defence Expenditure Till recently the tax rates were very high, there was a multiplicity of slabs, services & agriculture were not covered, there were a no. of concessions & exemptions & widespread evasion As compared to discretionary measures, automatic measures only minimize cyclical effects, they do not eliminate them
: PGM, 2011

Trends (cont.)

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

: PGM, 2011

Reforms in Indias Fiscal Policy

Fiscal Responsibility & Budget Management Act was introduced in 2004 Decrease interest payments & non interest expenditure on subsidies, assistance to non-viable & inefficient enterprises, staff & defence Simplification of the tax structure by reduction in the rates & the no. of slabs; introduction of VAT & service tax; better administration & enforcement

: PGM, 2011

Reforms (cont.)

Decrease deficit to 3% of GDP by March 2009 Link fiscal & monetary policy & make fiscal policy more equitable Optimal rate of taxation

: PGM, 2011