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  • 2. Fiscal Policy Influencing the level of economic activity though manipulation of government income and expenditure  Associated with Keynesian Demand Management Policies  Influence Aggregate Demand –  ◦ ◦ Tax regime influences consumption (C) and investment (I) Government Spending (G) Influences key economic objectives  Acts as an ‘automatic stabiliser’  Also used to influence non-economic objectives and provide framework for supply side policy e.g. education and health, poverty reduction, welfare reform, investment, regional policies, promotion of enterprise, etc. 
  • 3. Government Income    Tax Revenue Sale of Government Services – e.g. prescriptions, passports, etc. Borrowing
  • 4. Why do we need to pay taxes?      To raise revenue to finance spending on goods and service by central & local government The government when managing the level of AD output and prices uses taxation. When demand is perceived as being too strong the government can increase direct taxation, to reduce the level of real disposable income and household spending. A progressive system of taxation can be utilized to achieve great equality in income & wealth between individuals and households Taxes can correct for externalities and other forms of market failure (such as monopoly) Import taxes may control imports and therefore help the country's international balance of payments and protect industries from overseas competition.
  • 5. Objectives for the tax system         Revenue yield should be adequate To reduce inequalities in income To keep the overall tax burden as low as possible To reduce tax rates on income to sharpen incentives to work and create wealth in the economy To maintain a broad tax base - having a range of taxes helps to keep each separate tax rate low To shift the balance of taxation away from taxes on income towards taxes on spending To ensure taxes are applied equally and fairly to everyone To use taxes to make markets work better (including the use of environmental taxes to make both consumers and producers aware of external costs)
  • 6. Progressive Regressive and Proportional taxes     Generally, indirect taxes are seen as regressive; the proportion of income paid in tax decreases as income rises. Direct taxes are progressive because the proportion of income paid in tax increases as income rises. With a progressive tax, the marginal rate of tax exceeds the average rate of tax. As a result, progressive taxes act to reduce inequalities in the distribution of income. With a proportional tax, the proportion of income paid in tax remains constant as income changes. In this situation, the marginal rate of tax will be equal to the average rate of tax. Any tax that does not vary with income is called a lump sum tax
  • 7. Progressive Regressive and Proportional taxes
  • 8. The principles of taxation      The two central principles of taxation relate to the impact of tax on efficiency (concerned with the allocation of resources) and equity (concerned with the distribution of income. Other principles relate to the cost of operation of the tax system, to its flexibility and certainty. The costs of operation are divided into two types administrative costs and compliance costs. Direct and Indirect Taxes India
  • 9. Laffer’s Curve
  • 10. Government Expenditure        Social Security Law and Order Emergency Services Health Education Defence Foreign Aid       Environment Agriculture Industry Transport Regions Culture, Media and Sport
  • 11. Fiscal policy framework    Objectives of fiscal policy are implemented through two fiscal rules, against which the performance of fiscal policy can be judged. The fiscal rules are: the golden rule: over the economic cycle, the Government will borrow only to invest and not to fund current spending; and the sustainable investment rule: public sector net debt as a proportion of GDP will be held over the economic cycle at a stable and prudent level.
  • 12. AS Inflation TheAD=C+I+G+(X-M) If Assume an rise in AD leads to government AD initial in real therefore an increase taxes’ ‘reduces Apart from G, C national income,the (remember equilibrium shifts are also and I to the ceteris paribus,and a subtleties)with position likelyto be to AD1 rightincreases unemployment would orlevel of affected directly or fall to National at will spending, it a cost 3% but indirectly by the of higher inflation have various Income giving policy change. effects: an unemploymen t rate of 5% (U = 5%) 2.5% 2.0% AD 1 AD U=5% U=3% Fiscal Policy In Action Real National Income
  • 13. Supply Side Policy    Intention is to shift the aggregate supply curve to the right, increasing the long term productive capacity of the economy Tend to be long-term policies Arguments about how effective they are – e.g. lowering taxes increases incentives, reducing welfare dependency increases the urge to find work
  • 14. Supply Side Policy Inflation AS AS1 Supply side Increases in policies can long-term help to push can help capacitythe AS curve to the right the economy to increasing the grow without capacity of the undue pressure economy from Yf on Yf2 to inflation. 2.3% 2.0% AD Yf Yf2 Real National Income
  • 15. Supply Side Policies    Policies aim to influence productivity and efficiency of the economy Key feature – open up markets and deregulate to improve efficiency in the working of markets and the allocation of resources Main areas of policy:     Labour Market Tax and Welfare Reform Education and Training Incentives and technology
  • 16. What is the FRBM Act?  The FRBM Act was enacted by Parliament in 2003 to bring in fiscal discipline. It received the President’s assent in August the same year. The United Progressive Alliance (UPA) government had notified the FRBM Rules in July 2004.
  • 17. How will it help in redeeming the fiscal situation? The FRBM Rules impose limits on fiscal and revenue deficit. Hence, it will be the duty of the Union government to stick to the deficit targets.  As per the target, revenue deficit, which is revenue expenditure minus revenue receipts, have to be reduced to nil in five years beginning 2004-05. Each year, the government is required to reduce the revenue deficit by 0.5% of the GDP.  The fiscal deficit is required to be reduced to 3% of the GDP by 2008-09.It would mean reduction of fiscal deficit by 0.3 % of GDP every year. 
  • 18. How are these targets monitored?   The Rules have mid-year targets for fiscal and revenue deficits. The Rules required the government to restrict fiscal and revenue deficit to 45% of budget estimates at the end of September (first half of the financial year). In case of a breach of either of the two limits, the FM will be required to explain to Parliament the reasons for the breach, the corrective steps, as well as the proposals for funding the additional deficit.
  • 19. What is fiscal deficit? Every government raises resources for funding its expenditure. The major sources for funds are taxes and borrowings.  Borrowings could be from the Reserve Bank of India (RBI), from the public by floating bonds, financial institutions, banks and even foreign institutions. These borrowings constitute public debt and fiscal deficit is a measure of borrowings by the government in a financial year.  In budgetary arithmetic, it is total expenditure minus the sum of revenue receipts, recoveries of loans and other receipts such as proceeds from disinvestment.   Indian Budget at a glance
  • 20. Fiscal Deficit      Structural deficit is a government deficit that is independent of the business cycle—it remains even when an economy is at its full potential. Structural deficit is created when a government is spending more than a long-term average of tax revenue can bring in. The component of the budget that depends on the ebbs and flows of the business cycle is called cyclical deficit. Economists generally maintain that structural deficit is much more serious than cyclical deficit, as it implies unsustainable spending. Investment is one justification for taking on structural deficit. A common example of this is investment in infrastructure, such as roads and railways. While these projects are expensive, they create jobs and can be used for many years.
  • 21. Cyclical Deficit    The government budget deficit always goes deep in the red during recessions.. Expenditures rise and receipts fall during a recession.. Automatic stabilizers exacerbate the swing of the deficit during a recession..
  • 22. Do economies need a fiscal deficit?     Many economists, including Lord Keynes, had advocated the need for small fiscal deficits to boost an economy, especially in times of crises. What it means is that government should raise public investment by investing borrowed funds. This exercise is also called pump-priming. The basic purpose of the whole exercise is to accelerate the growth of an economy by public intervention. Hence, there is nothing fundamentally wrong with a fiscal deficit, provided the cost of intervention does not exceed the emanating benefits. For example, if the government borrows Rs 100 at 10%, it must earn more than 10% on investment of Rs 100. In that situation, fiscal deficit will not pose any problem. However, the government spends money on all kinds of projects, including social sector schemes, where it is impossible to calculate the rate of return at least in monetary terms. So, one will never know whether the borrowed funds are being invested wisely.
  • 23. WAYS & MEANS ADVANCES  These are temporary advances (overdrafts) extended by RBI to the govt. Section 17(5) of RBI Act allows RBI to make WMA both to the Central and State Govt. Objective - to bridge the interval between expenditure and receipts. They are not a sources of finance but are meant to provide support, for purely temporary difficulties that arise on account of mismatch/shortfall in revenue or other receipts for meeting the govt. liabilities. They have to be periodically adjusted to enable use of such financing for future mis- matches. W hen did it start ? On March 26, 1997, Govt. of India and RBI signed an agreement putting the ad hoc T-bills system to end w.e.f April 1, 1997.
  • 24. WAYS & MEANS ADVANCES  Interest rate The interest rate on WMA is at or around bank rate (with small adjustment for different kinds of WMA for State Govt.) and overdrawing if any carries 2% higher interest. Duration 10 consecutive working days for Central Govt. and 14 days for State Govt. Amount ceiling Limits on WMA are fixed at the beginning of a fiscal year by RBI. For 2005-06, Central Govt. limit is Rs.10000 cr for AprSept and Rs.6000 cr for Oct-Mar. Minimum balances The minimum balance required to be maintained by Govt. on Fridays and at the close of the Govt.’s or RBI’s financial year shouldn’t be less than Rs.100 cr and on any other working day not less than Rs.10 cr. Further when 75% of WMA is utilized, the RBI may consider fresh flotation of market loans depending on the market conditions.
  • 25. Fiscal Deficit & Public Debt  The concepts of fiscal deficit and public debt are closely linked. It has been observed that in situations where fiscal deficit is high, amount of public debt owed by governments is proportionately high as well. This can have an adverse impact on economic growth.
  • 26. The Deficit and the Explosion of Government Debt Debt at the start of next year = Debt at the start of this year + Purchases this year + Transfers this year + Interest on the debt this year - Receipts this year 
  • 27. Fiscal Deficit & Public Debt   Government debt also known as public debt, national debt is money owed by any level of government. By contrast, annual government deficit refers to the difference between government receipts and spending in a single year.
  • 28. Public Debt      Government debt can be categorized as internal debt, owed to lenders within the country, external debt, owed to foreign lenders and other liabilities. Both internal and external debt is secured under ‘Consolidated Fund of India’ and other liabilities under Public account. Governments usually borrow by issuing securities and government bonds and bills. Less creditworthy countries sometimes borrow directly from international institutions. Rank Country % of GDP Date 1 Zimbabwe 282.60 2009 est. 2  Japan 189.30 2009 est.
  • 29. Public Debt Short-term public debt is foreseen to last only one or two years, so the turnover rate is fairly high.  Long-term public debt is designed to last more than ten years, with some long term debt lasting considerably longer than that.  Mid-term public debt lasts anywhere between three and ten years.   Public Debt: India
  • 30. Ricardian Equivalence    The Ricardian equivalence proposition suggests consumers internalise the government's budget constraint and thus the timing of any tax change does not affect their change in spending. Ricardian equivalence suggests that it does not matter whether a government finances its spending with debt or a tax increase, the effect on total level of demand in an economy being the same. Governments can raise money either through taxes or by issuing bonds. Since bonds are loans, they must eventually be repaid— presumably by raising taxes in the future. The choice is therefore "tax now or tax later."