Fiscal policy

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FISCAL POLICY & Economic Consequence Of Debt:

FISCAL POLICY & Economic Consequence Of Debt T.J. Joseph

Macroeconomic Policy Objectives:

Macroeconomic Policy Objectives Macroeconomic policies or Stabilization policies are policies by the government to achieve the following main objectives: Sustain GDP growth (maintain full employment), and Control inflation (maintain reasonably stable price level) Macroeconomic Policy instruments: Fiscal Policy, and Monetary Policy

Fiscal Policy:

Fiscal Policy ‘ fisc ’ means state treasury ‘fiscal policy’ refers to the use of state treasury or government finances to achieve the macroeconomic goals Fiscal policy is also called budgetary policy The tax and expenditure policies together constitutes fiscal policy of the government Budget / spending plan Fiscal Policy Instruments: Tax policies Government expenditure policies

Fiscal Policy - – Theories behind Keynesian Argument:

Fiscal Policy - – Theories behind Keynesian Argument Under Economic Depression Keynesian Theory: Y = AD = C + I + G + X – M Great Depression of 1930s: low AD

Fiscal Policy Keynesian Argument:

Fiscal Policy Keynesian Argument Govt. interference by:- Increasing spending or Cutting taxes or Increasing transfer payments Criticism: A deficit for government and the ill-effects of deficit Answer: “deepening of economic decline is worse than a deficit ” Income rises

PowerPoint Presentation:

AD=C+I+G+(X-M) Output, Income AD’  E’ 45 o AD  E  G Recessionary GDP gap 4000 5000 Potential GDP Potential GDP

PowerPoint Presentation:

AD-AS framework AD 0 AD 1 • • AS Y 0 Price level Real GDP Y 1 P 0 P 1

Fiscal Policy (Keynesian Argument):

Fiscal Policy (Keynesian Argument) Large govt. spending & tax cut, along with strong consumer spending causes inflation Therefore, Govt. should either reduce spending or raise taxes Criticism: Is it politically viable ? Under Excess Demand

Fiscal Policy (Keynesian Argument):

Fiscal Policy (Keynesian Argument) Creates a dilemma A situation of both high unemployment and high inflation – called ‘stagflation’ – Keynesian argument does not work Deficit seems to be a permanent part of fiscal scene Reducing deficit – the goal of fiscal policy Under External Shocks (like Oil price rise)

Kinds of Fiscal Policy:

Kinds of Fiscal Policy How does Fiscal Policy work? There are two elements to the working of fiscal policy: i ) Non-discretionary Fiscal Policy (Also called Automatic Stabilization Fiscal Policy) ii ) Discretionary Fiscal Policy (Also called Compensatory Fiscal Policy)

Automatic Stabilization Policy:

Automatic Stabilization Policy Means automatic adjustment in the net taxes in response to rise and fall in GNP (economic growth) When the economy begins to contract (GNP declines), tax revenue falls and government’s transfer payments increase automatically When the economy expands (GNP rises), tax revenue increases and government transfers fall automatically In this kind of fiscal policy, the government adopts a tax system and an expenditure program linked to GNP and unemployment Also called non-discretionary fiscal policies

Discretionary Fiscal Policy:

Discretionary Fiscal Policy Economies do not work as expected under automatic fiscal policy regime Such regime are more suitable for mature and developed economies Discretionary fiscal policy is the most common form Ad hoc changes are made in the government expenditure and taxation at the discretion of the government Discretionary changes are taken (in taxation, govt. expenditure and public debt) to achieve certain specific objectives For example, changes in tax rates or tax base or tax system to reduce inflationary pressure

Compensatory Fiscal Policy:

Compensatory Fiscal Policy Compensatory Fiscal Policy is a form of Discretionary Fiscal Policy A deliberate budgetary action by the govt. to compensate for the deficiency in or excess of AD Usually in the form of surplus budgeting or deficit budgeting During depression, taxes are reduced and govt. spending goes up (deficit budgeting) Surplus budgeting is adopted during the period of high inflation rate that caused by excessive demand Govt. keeps its expenditure lower than its revenue, introducing higher rate of taxation

Govt. Expenditure Vs. Tax Policy:

Govt. Expenditure Vs. Tax Policy An increase in govt. expenditure or a lowering of taxes – which has the greater impact o aggregate income? (see Shyamal Roy)

Budget:

Budget Government budget is the Annual Financial Statement of the government about its all planned expenses and revenues Two sides of the budget: Receipts and Expenditure Receipts include all tax and non-tax receipts, capital receipts, and borrowings Expenditures include revenue and capital expenditures (also classified as Plan and Non-plan expenditures)

Government Receipts:

Government Receipts

Government Receipts:

Government Receipts Taxes are the major source of revenue for the govt. Major categories of taxes: personal income tax; corporate tax; customs duties; union excise duties, VAT, services tax Non-tax revenues includes interest and dividend received from its various investments, especially from the public sector undertakings, fees, etc. Also includes revenue from lotteries and user charges Revenue Receipts = Taxes + Non-tax Revenues Capital receipts = recovery of loans + public sector disinvestments Total Receipts = Revenue Receipts + Capital Receipts

Taxation:

Taxation Which is the best base for taxation, income or consumption? Direct taxes use income base, indirect taxes use consumption base

Government Expenditure:

Government Expenditure

Government Expenditure:

Government Expenditure Government expenditures are classified into three different ways A) Revenue and Capital Expenditure B) Plan and Non-Plan Expenditure , representing new and existing works under India’s Five Year Plans Both plan and non-plan expenditure will have elements of revenue and capital expenditures C) By departments, i.e., development and non-development expenditure under various departments of the government Components of both revenue and capital expenditure will find place in these development and non-development expenditures

Budget at a Glance 2011-12:

2007-08 Actuals 2008-09 Actuals @ 2009-10 Actuals @ 2010-11 (RE) 2011-12 (BE) 1.    Revenue Receipts 541864 540259 572811 783833 789892 2.    Tax Revenue (net to Centre) 439547 443319 456536 563685 664457 3.    Non-tax Revenue 102317 96940 116275 220148 125435 4.    Capital Receipts (5+6+7) 170807 343697 451676 432743 467837 5.    Recoveries of Loans 5100 6139 8613 9001 15020 6.    Other Receipts 38795 566 24581 22744 40000 7.    Borrowings & other Liabilities 126912 336992 418482 400998 412817 8.    Total Receipts  (1+4) 712671 883956 1024487 1216576 1257729 9.    Non-plan Expenditure 507589 608721 721096 821552 816182 10. On Revenue Account of which, 420861 559024 657925 726749 733558 11.   Interest  Payments 171030 192204 213093 240757 267986 12.   On Capital Account 86728 49697 63171 94803 82624 13.   Plan Expenditure 205082 275235 303391 395024 441547 14.   On Revenue Account 173572 234774 253884 326928 363604 15.   On Capital Account 31510 40461 49507 68096 77943 16.   Total Expenditure (9+13) 712671 883956 1024487 1216576 1257729 17.   Revenue Expenditure (10+14) 594433 793798 911809 1053677 1097162 18.   Capital Expenditure (12+15) 118238 90158 112678 162899 160567 19.   Revenue Deficit (17-1) 52569 253539 338998 269844 307270 -1.1 -4.5 -5.2 -3.4 -3.4 20.   Fiscal Deficit {16-(1+5+6)} 126912 336992 418482 400998 412817 -2.7 -6 -6.4 -5.1 -4.6 21.   Primary Deficit (20-11) -44118 144788 205389 160241 144831 -0.9 -2.6 -3.1 -2 -1.6 Budget at a Glance 2011-12 (In Rs. crores )

Receipts (Revenue):

Receipts (Revenue) 2008-2009 Budget Estimate 2008-2009 Revised Estimates 2009-2010 Budget Estimates REVENUE  RECEIPTS 1.  Tax Revenue Gross Tax Revenue 687715 627949 641079 Corporation tax 226361 222000 256725 Income tax 138314 122600 112850 Other taxes and Duties 325 400 425 Customs 118930 108000 98000 Union Excise Duties 137874 108359 106477 Service Tax 64460 65000 65000 Taxes of the Union Territories 1451 1590 1602 Less- NCCD transferred to the National Calamity Contingency Fund 1800 1800 2500 Less States' Share 178765 160179 164361 Net Tax Revenue 507150 465970 474218 2. Non -Tax Revenue Interest Receipts 19135 19036 19174 Dividend and Profits 43204 39736 49750 External Grants 1795 2748 2136 Other Non-Tax Revenue 30836 33934 68465 Receipts of Union Territories 815 749 754 Total Non-Tax Revenue 95785 96203 140279 Total Revenue Receipts 602935 562173 614497

Receipts (Capital):

Receipts (Capital) 2008-2009 Budget Estimate 2008-2009 Revised Estimates 2009-2010 Budget Estimates 3. CAPITAL RECEIPTS A. Non-debt Receipts 1. Recoveries of Loans & Advances 4497 9698 4225 2. Miscellaneous Capital receipts 10165 2567 1120 Total 14662 12265 5345 B. Debt Receipts 3. Market Loans 100571 261972 397957 4. Short term borrowings 12429 57500 ... 5. External assistance (Net) 10989 9603 16047 6. Securities issued against Small Savings 9873 1324 13256 7. State Provident Funds (Net) 4800 4800 5000 8. Other Receipts (Net) -12600 -38668 -31264 Total 126062 296531 400996 Total Capital Receipts (A+B) 140724 308796 406341 Total Receipts ( 1+2+3) 750884 900953 1020838

Expenditure (Non-Plan):

Expenditure (Non-Plan) 2008-2009 Budget Estimates 2008-2009 Revised Estimates 2009-2010 Budget Estimates 1. NON-PLAN EXPENDITURE A. Revenue Expenditure 1. Interest Payments and Prepayment Premium 190807 192694 225511 2. Defence 57593 73600 86879 3. Subsidies 71431 129243 111276 4. Grants to State and U.T. Governments 43294 38421 48570 5. Pensions 25086 32690 34980 6. Police 15562 20711 25390 7. Assistance to States from NCCF 1800 3265 2500 8. Economic Services (Agri., Indu ., Infra. etc.) 17987 22055 23840 9. Other General Services (State Depts.) 11498 15898 18729 10. Social Services (Education, Health, etc) 10385 28126 33491 11. Postal Deficit 958 3825 5395 12. Expenditure of U.T. without Legislature 2269 3092 3162 13. Amount met from NCCF -1800 -3265 -2500 14. Grants to Foreign Governments 1482 1435 1611 Total Revenue Non-Plan Expenditure 448352 561790 618834 B. Capital Expenditure 1. Defence 48007 41000 54824 2. Other Non-plan Capital Outlay 10567 13694 21056 3. Loans to Public Enterprises 673 788 637 4. Loans to State and U.T. Governments 89 89 89 5. Loans to Foreign Governments 4 815 125 6. Others -194 -180 124 Total Capital Non-Plan Expenditure 59146 56206 76855 Total Non-Plan Expenditure 507498 617996 695689

Expenditure (Planned):

Expenditure (Planned) 2008-2009 Budget Estimates 2008-2009 Revised Estimates 2009-2010 Budget Estimates 2. PLAN EXPENDITURE A. Revenue Expenditure 1. Central Plan 151417 171633 200290 2. Central Assistance for State & Union Territory Plans 58350 70023 78108 Total-Revenue Plan Expenditure 209767 241656 278398 B. Capital Expenditure 1. Central Plan 28537 32495 39550 2. Central Assistance for State & Union Territory Plans 5082 8806 7201 Total Capital Plan Expenditure 33619 41301 46751 Total - Plan Expenditure 243386 282957 325149 Total Budget Support for Central Plan 179954 204128 239840 Total Central Assistance for State & UT Plans 63432 78829 85309 TOTAL EXPENDITURE* 750884 900953 1020838

Government Deficit:

Government Deficit Government deficit (usually called fiscal deficit ) arises because total govt. expenditure exceeds govt.’s own receipts Fiscal deficit can be incurred either due to revenue deficit or deficit on capital account This deficit is financed through borrowing , either from domestic sources or from external sources Domestic sources include market borrowings (by floating bonds, etc.) and other liabilities like PFs, etc. External sources can be bilateral or multilateral

PowerPoint Presentation:

Monetized Deficit: When the deficit is being financed from borrowing from the Central Bank (RBI), it is called monetized deficit So called because it results in an increase in money supply MD is a part of Fiscal Deficit Government debt: When the fiscal deficit accumulated over the years, it is the stock of the debt Called government debt or public debt or national debt Primary Deficit = Fiscal Deficit – interest payments It is the difference between govt.’s current expenditure (total expenditure – interest payments), minus govt.’s total receipts

Fiscal Deficit:

Fiscal Deficit Definition “The difference between the total expenditure of Government and revenue receipts of government and capital receipts which are not in the form of borrowing constitutes Gross Fiscal Deficit” – http://indiabudget.nic.in Essentially, it is the difference between what the government spends and what it earns. Fiscal Deficit = {Revenue Receipts + Capital Receipts (Non-debt)} – Total Expenditure (Revenue + Capital Expenditure)

Fiscal Deficit:

Fiscal Deficit Why fiscal deficit a concern? It’s a borrowing Borrowing for what? Where is it spend? For capital or revenue expenditure? A lower deficit reduces government borrowing, bring down interest rates, more capital to finance expansion How to make capital expenditure without causing inflation or increasing fiscal deficit? How to increase resources without increasing fiscal deficit?

PowerPoint Presentation:

Implications of High Fiscal Deficit 1. Money supply growth: When debt is monetized, it leads to increased high-powered money With the introduction of Ways and Means Advances (WMA), the component of debt monetized is limited, therefore, no strong impact on money supply 2. Inflation: Unproductive govt. expenditures increases AD but not the production or supply

PowerPoint Presentation:

Implications of High Fiscal Deficit 3 . Crowding-out of Private Investment: Continued market borrowing to meet fiscal deficit leads to high interest rates This may crowd-out private sector investment, which is more efficient than government investment. So, growth suffers. 4. Crowding-out of Exports: High interest rate attract more capital from abroad, appreciating domestic currency against foreign currencies, crowding-out exports 5. Crowding-out Essential Public Expenditure on health, education, and other social welfare Large amount of money is spent for debt servicing

PowerPoint Presentation:

Implications of High Fiscal Deficit Government spending may not always crowd-out private Investment : If private sector has large unutilised capacity , they may not be investing and therefore, interest rate may not rise (Soft interest rate prevailed in India during recession 2008-09) 2. The sensitivity of private investment to increase in interest rate may be very low if their expectations about future growth are very positive (Happened during the initial years of eco. Liberalization) 3. Export competitiveness is more important and it depends upon foreigner’s economic conditions

PowerPoint Presentation:

Complementarity Between Public and Private Investment – The ‘Crowding-in’ Effect Mainly a Keynesian view Complementarity or ‘Crowding-in’ occurs because public expenditure enhances the productivity of private investment E.g.: investment in infrastructure and public goods, increased demand for private goods through demand for inputs and ancillary services, etc. The overall relationship is not definitive

Exercise:

Exercise Five economists are debating the impact of fiscal deficit on the economy. This is what each has to say: Economist 1: Fiscal deficit is an excellent way of stimulating the economy Economist 2: No, fiscal deficit crowds out private investment Economist 3: No, fiscal deficit crowds in private investment Economist 4: It is not a concern for India when we compare the fiscal deficits of many other countries at present Economist 5: Whatever you say, fiscal deficit is matter of concern in India Assume each economist is correct in what he/she is saying . Spell out the conditions that must hold true in the economy for each argument to be correct.

References:

References Chapters 11, ‘ Principles of Macroeconomics’ , 8 th edn . by Michael Melvin and William Boyes . Chapters 4, ‘Macroeconomic Policy Environment’ by Shymal Roy Videos http://www.moneycontrol.com/video/economy/is-supply-crunchonly-reason-for-food-inflation_513573.html http://www.moneycontrol.com/video/economy/fiscal-deficit-goal46-not-easy-to-meet-economists_527733.html http://www.moneycontrol.com/video/economy/rbi-likely-to-hike-repo-rate-to-675-cnbc-tv18-poll_529104.html

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