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Fiscal policy


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Fiscal policy

  2. 2. Fiscal Policy - fundamentals <ul><li>Fiscal policy concerns the plans for taxation, borrowing and spending by the Government of a country. </li></ul><ul><li>A fiscal stance may be </li></ul><ul><ul><li>Neutral </li></ul></ul><ul><ul><li>Expansionary </li></ul></ul><ul><ul><li>Contractionary </li></ul></ul><ul><li>Collecting more taxes to finance more spending indicates a neutral stance </li></ul><ul><li>Spending more and financing it by borrowing and taxes would indicate a fiscal expansion </li></ul><ul><li>Collecting more taxes without increase in spending indicates fiscal contraction. </li></ul>
  3. 3. 45 degree model C+I+G C+I+G+G1 Y 1 Y2 Government spending is an injection into the circular flow whereas taxes are withdrawals
  5. 5. <ul><li>To raise revenues for the Government </li></ul><ul><li>To control externalities </li></ul><ul><li>To redistribute income and wealth </li></ul><ul><li>To protect industries from foreign competition </li></ul><ul><li>To provide a stabilizing effect on National Income e.g. taxes can dampen upswings of a trade cycle by reducing inflationary pressures. </li></ul>Functions of Taxation
  6. 6. QUALITIES OF A GOOD TAX <ul><li>According to ability to pay </li></ul><ul><li>Taxes should be comprehensive </li></ul><ul><li>Cost of collection should be small </li></ul><ul><li>Payment of tax should be according to how and when people receive and spend income </li></ul><ul><li>Tax evasion should be difficult. </li></ul><ul><li>Taxes should be equitable </li></ul>
  7. 7. Direct vs Indirect taxes <ul><li>Advantages of Direct Taxes: </li></ul><ul><li>Direct taxes are”fair and equitable” </li></ul><ul><li>They act as built in or automatic stabilizers </li></ul><ul><li>Less inflationary than indirect taxes </li></ul>
  8. 8. <ul><li>Can be proportional, progressive or regressive </li></ul><ul><li>Disdavantages of Direct Taxes </li></ul><ul><ul><li>Encourages migration </li></ul></ul><ul><ul><li>Reduce the initiative to train skilled workers </li></ul></ul><ul><ul><li>Encourages tax avoidance </li></ul></ul><ul><ul><li>Disincentives </li></ul></ul>Direct taxes
  9. 9. Progressive Taxes <ul><li>Advantages </li></ul><ul><ul><li>According to ability to pay </li></ul></ul><ul><ul><li>Enables redistribution of wealth </li></ul></ul><ul><ul><li>Progressive taxes counter-balance indirect taxes which are by nature regressive </li></ul></ul><ul><li>Disadvantages </li></ul><ul><ul><li>Not required in affluent societies </li></ul></ul><ul><ul><li>Reduces initiative to earn extra income and profits </li></ul></ul><ul><ul><li>Encourages tax evasion </li></ul></ul><ul><ul><li>Could encourage migration </li></ul></ul>
  10. 10. Advantages of Indirect Taxes: <ul><li>Can be painlessly extracted </li></ul><ul><li>Can discourage externalities </li></ul><ul><li>More flexible </li></ul><ul><li>Less administrative burden </li></ul>
  11. 11. Disadvantages of indirect taxes <ul><li>Inflationary effect </li></ul><ul><li>Indirect taxes are regressive </li></ul><ul><li>Evasion is possible through black marketing </li></ul>
  12. 12. Government Finances <ul><li>Revenue </li></ul><ul><ul><li>Gross tax revenue </li></ul></ul><ul><ul><ul><li>Corporate Profit tax, Income tax, Excise duty, Import Duty </li></ul></ul></ul><ul><ul><ul><li>Other taxes and duties </li></ul></ul></ul><ul><ul><li>Devolvement to State and Union Territories </li></ul></ul><ul><ul><li>Net Tax revenue = (1) minus (2) </li></ul></ul><ul><ul><li>Non Tax revenue </li></ul></ul><ul><ul><li>Net revenue receipts = (3) plus (4) </li></ul></ul><ul><ul><li>Non Debt capital receipts </li></ul></ul><ul><ul><ul><li>Recovery of loans </li></ul></ul></ul><ul><ul><ul><li>Privatisation </li></ul></ul></ul><ul><ul><li>Borrowing and other liabilities </li></ul></ul><ul><ul><li>Total Receipts = 1+6+7 </li></ul></ul>
  13. 13. Government Finances - II <ul><li>Expenditure </li></ul><ul><ul><li>Revenue Expenditure </li></ul></ul><ul><ul><ul><li>Interest, Subsidy, Defence, Admin </li></ul></ul></ul><ul><ul><ul><li>Plan Expenditure </li></ul></ul></ul><ul><ul><li>Capital Expenditure </li></ul></ul><ul><ul><ul><li>Planned Expenditure </li></ul></ul></ul><ul><ul><ul><li>Loans </li></ul></ul></ul><ul><ul><ul><li>Defence </li></ul></ul></ul><ul><ul><ul><li>Others </li></ul></ul></ul><ul><ul><li>Planned expenditure on Rev and Capital Account </li></ul></ul><ul><ul><li>Non Plan expenditure on Rev and Capital Account </li></ul></ul><ul><ul><li>Total Expenditure = 3 + 4 </li></ul></ul>
  14. 14. Budget Deficit <ul><li>Revenue Deficit = Rev Exp – Rev Receipts </li></ul><ul><li>Capital Deficit = Capital Exp – Capital Receipts </li></ul><ul><li>Budgetary Deficit = Total Revenue – Total Expenditure </li></ul><ul><li>Gross Fiscal Deficit = Total Expenditure – Total Receipts excluding Borrowings (this implies the overall borrowing requirement of the Govt. </li></ul><ul><li>Primary Deficit = Gross Fiscal Deficit - Interest </li></ul>
  15. 15. Government Balance Sheet <ul><li>Liabilities of Central Government </li></ul><ul><ul><li>Public Debt = Internal Debt + External Debt </li></ul></ul><ul><ul><ul><li>Internal Debt </li></ul></ul></ul><ul><ul><ul><ul><li>Market Loans, Treasury Bills, Bonds, Govt Securities </li></ul></ul></ul></ul><ul><ul><li>Small Savings </li></ul></ul><ul><ul><li>Provident Funds </li></ul></ul><ul><ul><li>Reserve Funds </li></ul></ul><ul><li>Assets of Central Govt </li></ul><ul><ul><li>Capital Outlay </li></ul></ul><ul><ul><li>Loans and Advances to States, Union Territories, Foreign Govts, PSUs, Govt Depts (Rail, P&T, Education, Other Govt employees) </li></ul></ul>
  16. 16. Public Debt <ul><li>Debt Instruments </li></ul><ul><ul><li>Marketable Debt </li></ul></ul><ul><ul><ul><li>Treasury Bills – Short term </li></ul></ul></ul><ul><ul><ul><li>Govt Securities – Long term </li></ul></ul></ul><ul><ul><li>Non-marketable Debt </li></ul></ul><ul><ul><ul><li>National Saving Schemes </li></ul></ul></ul><ul><ul><ul><li>Non-marketable loans </li></ul></ul></ul>
  17. 17. Measurement of Public Debt <ul><li>Public Sector Borrowing Requirement (PSBR) is the annual excess of spending over income </li></ul><ul><li>Servicing the Debt involves redistribution of funds through taxes and borrowing with interest </li></ul>
  18. 18. Real Vs Nominal Deficit <ul><li>Real Deficit is arrived at by reducing inflation adjusted Public Debt from Nominal Deficit </li></ul><ul><li>Real Budget Deficit = Nominal Budget Deficit – Public Debt x Inflation </li></ul><ul><li>Example : Where Public Debt is 4000Bln and Budget Deficit is 250Bln, Inflation rate is 5% then Real Budget Deficit = 250 – 4000x0.05 = 50 </li></ul>
  19. 19. Cyclical deficit and Structural deficit <ul><li>Cyclical Deficit is part of the deficit that results from the economy being a low level economic activity </li></ul><ul><li>Structural Deficit is that portion of the deficit that would exist even if the economy was operating at it’s full potential and hence it is not directly attributable to the business cycle and policy makers are directly responsible for it </li></ul><ul><li>To break the deficit into two parts we need a measure of potential output e.g. actual deficit = 100 but economy below potential if level of economic activity increases to the potential tax revenues will rise by 30 and transfers would fall by 10 hence structural deficit = 100 -10-30 = 60 </li></ul>
  20. 20. Monetized Deficit <ul><li>Amount of the deficit that is financed by borrowings from the RBI, this increases the money supply in the economy by an equivalent amount. </li></ul>
  21. 21. Effectiveness of Fiscal Policy <ul><li>Taxes act as automatic stabilizers – help to reduce upward and downward movement of national income but they also act as a drag on expansion (fiscal drag) by reducing the size of the multiplier </li></ul><ul><li>Dis-incentive to work and invest </li></ul><ul><li>Crowding Out controversy – private investment falls due to high interest rates when Govt deficit is financed by accessing the public markets i.e. savings in the economy </li></ul><ul><li>Time lag between recognition and recovery </li></ul><ul><ul><li>Lag between recognition and action </li></ul></ul><ul><ul><li>Lag between action and implementation </li></ul></ul><ul><ul><li>Lag between implementation and effect </li></ul></ul>