ASIA-PACIFIC INSTITUTE OF

MANAGEMENT

PROJECT REPORT ON FISCAL POLICY

OF INDIA

SUBMITTED TO :
SUBMITTED BY:
Mr Jitender Bhandari
Deepika [ib/08]

Devkant [ib/09]
Fatik [ib/10]

Gagan [ib/11]

Gaganjeet [ib/12]
 INDEX
1. INTRODUCTION
2. OBJECTIVES OF FISCAL POLICY
3. TYPES OF FISCAL POLICY
4. COMPONENTS OF FISCAL POLICY
• Revenue budget
• Revenue receipt
• Capital receipts
• Expenditure budget
• Revenue expenditure
• Capital expenditure
5. CHANGE IN CUSTOM AND EXCISE DUTY
6. PLAN AND NON PLAN EXPENDITURES
7. EFFECTS OF FISCAL POLICY ON EMPLOYMENT
AND PRODCUTION
8. REVENUE DEFICIT
9. FISCAL DEFICIT
10. FRBM ACT
11. BIBLIOGRAPHY
FISCAL POLICY
OF
INDIA
 ACKNOWLEDGEMENT

We express our profound gratitude to Mr. Jitender Bhandari; who

assigned us the project on FISCAL POLICY IN INDIA. We want to give
our sincere thanks for his kind advice and guidance. We are grateful to
him for his continuous support and encouragement throughout the
project.We have really appreciated and imbibed many of his sound
advices and it is largely due to his patience that we were able to achieve
our goals successfully. We are greatly obliged to Asia Pacific Institute
of Management, Jasola, New Delhi for giving us an opportunity to
take up this project and providing us a platform to learn and enhance our
professional skills.
 INTRODUCTION

Fiscal policy is the use of government spending and TAXATION to influence the economy. When the
government decides on the goods and services it purchases, the transfer payments it distributes,
or the taxes it collects, it is engaging in fiscal policy. The primary economic impact of any change
in the government budget is felt by particular groups—a tax cut for families with children, for
example, raises their disposable income. Discussions of fiscal policy, however, generally focus on
the effect of changes in the government budget on the overall economy. Although changes in
taxes or spending that are “revenue neutral” may be construed as fiscal policy—and may affect
the aggregate level of output by changing the incentives that firms or individuals face—the term
“fiscal policy” is usually used to describe the effect on the aggregate economy of the overall levels
of spending and taxation, and more particularly, the gap between them.Fiscal policy refers to the
overall effect of the budget outcome on economic activity. Fiscal policy is an additional method to
determine public revenue and public expenditure. Fiscal policy is the means by which a
government adjusts its levels of spending in order to monitor and influence a nation's economy. It
is the sister strategy to monetary policy with which a central bank influences a nation's money
supply. These two policies are used in various combinations in an effort to direct a country's
economic goals.

The idea of using fiscal policy to combat recessions was introduced by John Maynard
Keynes in the 1930s

According to Arther Simithies fiscal policy is a policy under which government uses its
expenditure and revenue programme to produce desirable effects and avoid undesirable effects
on the national income, production and employment.
 OBJECTIVE OF FISCAL POLICIES

1. To achieve desirable price level:

The stability of general prices is necessary for economic stability. The maintenance of a
desirable price level has good effects on production, employment and national income.
Fiscal policy should be used to remove; fluctuations in price level so that ideal level is
maintained.

2. To Achieve desirable consumption level:

A desirable consumption level is important for political, social and economic consideration.
Consumption can be affected by expenditure and tax policies of the government. Fiscal
policy should be used to increase welfare of the economy through consumption level.

3. To Achieve desirable employment level:

The efficient employment level is most important in determining the living standard of the
people. It is necessary for political stability and for maximization of production. Fiscal policy
should achieve this level.

4. To achieve desirable income distribution:

The distribution of income determines the type of economic activities the amount of savings.
In this way, it is related to prices, consumption and employment. Income distribution should
be equal to the most possible degree. Fiscal policy can achieve equality in distribution of
income.

5. Increase in capital formation:

In under-developed countries deficiency of capital is the main reason for under-
development. Large amounts are required for industry and economic development. Fiscal
policy can divert resources and increase capital.

6. Degree of inflation:
In under-developed countries, a degree of inflation is required for economic development.
After a limit, inflationary be used to get rid of this situation.
 TYPES OF FISCAL POLICIES

1. Reflationary Fiscal Policy :

Governments may choose to use reflationary fiscal policy in times of recession or a general
downturn in economic activity. In this situation they will use their fiscal policy to give a boost
to the economy. They may do this by lowering taxes in some form or by increasing the level
of government expenditure. This will encourage people to spend more. If they lower indirect
taxes then this will lower the prices of the taxed goods and encourage more demand.
Alternatively they could lower direct taxes. This will raise people's disposable income (their
take-home pay) and therefore encourage them to spend more. Either way the level of
demand in the economy should rise and help encourage economic growth.

Reflationary fiscal policies could therefore include:

• Cutting the lower, basic or higher rates of tax

• Increasing the level of personal allowances
• Increasing the level of government expenditure

2. Deflationary fiscal policy :

Deflationary fiscal policy is likely to be most appropriate in times of economic boom. If the
economy is growing at above its capacity this is likely to cause inflation and balance of
payments problems. To try to slow the economy down the government could either raise
taxes in some form or perhaps reduce government expenditure. Either of these will reduce
the level of demand in the economy and therefore the level of economic growth. It may
increase indirect taxes which will raise prices and deter people from spending so much, or it
may increase direct taxes, which will leave people with less money in their pockets and so
stop them from spending so much.

Deflationary fiscal policies include:

• Increasing the lower, basic or higher rates of tax

• Reducing the level of personal allowances
• Reducing the level of government expenditure

3. Supply-side policies :

Supply-side policies are policies that aim to increase the capacity of the economy to
produce. Fiscal policy usually acts on the level of demand in the economy and the
deflationary and reflationary policies are often known as demand-side policies.

Supply-side fiscal policies:

• Cutting the lower and basic rates of tax to open up the gap between earnings in and out of
work and ensure people have an incentive to work
• Increasing the level of personal allowances for the same reason
• Reducing the top rate of tax to encourage enterprise, risk-taking and the incentive to work
 hard

Lags which influence the effectiveness of discretionary fiscal policy

Discretionary fiscal policy is subject to the same lags that we discussed for monetary policy. It
takes some time for policy makers to realize that a recessionary or an inflationary gap exists—
the recognition lag. Recognition lags stem largely from the difficulty of collecting economic data
in a timely and accurate fashion. The current recession was not identified until October 2008,
when the Business Cycle Dating Committee of the National Bureau of Economic Research
announced that it had begun in December 2007. Then, more time elapses before a fiscal policy,
such as a change in government purchases or a change in taxes, is agreed to and put into effect
—the implementation lag. Finally, still more time goes by before the policy has its full effect on
aggregate demand—the impact lag.

Changes in fiscal policy are likely to involve a particularly long implementation lag. A tax cut was
proposed to presidential candidate John F. Kennedy in 1960 as a means of ending the recession
that year. He recommended it to Congress in 1962. It was not passed until 1964, three years after
the recession had ended. Some economists have concluded that the long implementation lag for
discretionary fiscal policy makes this stabilization tool ineffective. Fortunately, automatic stabilizers
respond automatically to changes in the economy. They thus avoid not only the implementation
lag but also the recognition lag.

Key Takeways:
• Discretionary fiscal policy involves the same kind of lags as monetary policy. However, the
implementation lag in fiscal policy is likely to be more pronounced, while the impact lag is
likely to be less pronounced.

• Expansionary fiscal policy may result in the crowding out of private investment and net
exports, reducing the impact of the policy. Similarly, contractionary policy may “crowd in”
additional investment and net exports, reducing the contractionary impact of the policy.

• Supply-side economics stresses the use of fiscal policy to stimulate economic growth.
Advocates of supply-side economics generally favor tax cuts to stimulate economic growth.
 Components of Fiscal Policy

1. Revenue budget :

The revenue budget primarily comprises Government revenue receipts like tax and expenditure
met from the revenue. The tax revenues principally constitute yields of taxes and other duties
imposed by the Government of India.

Revenue Budget are classified into:

a. Revenue Receipt :

Revenue receipts are those which neither decrease the asset nor increase the liability of the
government. Net revenue receipts of the Centre grew at an annual average of 18.7 per cent in the
five-year period ending 2007-08

Classification of Revenue Receipt

• Tax Revenue
• Non Tax Revenue

Data on Tax Revenue and Non Tax Revenue for last five year:

Revenue

10
Receipts

9
8 7.5
7.1
7
N
 Classification of Tax Revenue

1. Direct Tax :

When incidence and impact of tax falls on the same person.In other words direct tax is borne
entirely by the entity that pays it, and cannot be passed on to another entity; for example,
corporation tax,Personal Income tax. In 2007-08, direct tax collections exceeded indirect tax
collections; and within direct taxes, the main contribution came from corporate income tax.

2. Indirect Tax :
rsonal/corporation taxes

4.5
When incidence and impact of tax can fall on different person.In other words Charge levied by
the State on consumption, expenditure, privilege, or right but not on income or property.E.g. sale
4
tax, import duty & excise duty.In indirect taxes, excise revenues remained less buoyant, customs
revenue grew somewhat steadily, and service tax emerged as the main driver of revenue growth.

3.5
3 2.8
2.6
2.5
2 1.8
1.6
1.5
1
 Changes in Custom and Excise duties

1. Custom Duties:

• Customs duty on nonagricultural products, reduced from 20% (2003-04)to 10%(2007-08)

• Duty on steel melting scrap and aluminum scrap reduced to Nil (from 5 per cent earlier).

• Customs duty on crude and non-refined sulphur reduced to 2% from 5% to boost domestic
fertilizers

• Customs duty on cigars, cheroots and cigarillos was increased from 30% to 60%.

2. Excise Duties:

• CENVAT rate on all goods from 16% to 14%

• Excise duty was reduced from 16% to 8% on all drugs

• In the automobiles sector, excise duties were reduced on small cars from 16% to 12%;
hybrid cars from 24% to 14%; electric cars from 8% to Nil

• In the food processing sector, excise duty was made fully exempt on packaged tender
coconut water, paws, mudi (puffed rice), milk containing edible nuts and tea/coffee pre-
mixes.
b. Capital Receipt:

Receipt which either decreases the asset or increases the liability of the Government are known
as capital receipts.eg Recovery of loans, borrowing and other liabilities,disinvestment. The sharper
decline budgeted in 2008-09 in non-debt capital receipts was also on account of the base effect in
2007-08 of the accounting transfer of shares of the State Bank of India to the Government from
RBI accounts.In capital receipt borrowing and other Liablities is the major source and in the fig it is
clearly visible that borrowing are continuosly rising and the year ending 2008-09 it was around 6
%.While Other receipts such as PSU Disinvestment and recovery of loan have a very minor share
of around 2.1% in 2004-05 and which was further reduced to 0.2%in 2008-09.

8.0
s
2. Expenditure Budget:

Budget based on the cost of goods and services already received and paid for.

Components of Expenditure Budget:

a. Revenue Expenditure:

Revenue Expenditure are those which neither increases the asset nor decreases the liability of
the government. Revenue expenditure grew by 12.0 per cent and helped lower the deficit on
revenue account

b. Capital Expenditure:

16
Capital Expenditure those which either increases the asset or decreases the liability of the
Government. The transfer of shares of the State Bank of India (SBI) to the Government of India
from RBI in 2007-08.Adjusted for these, there is a decline in capital expenditure expressed as a
proportion of GDP in the period 2003-04 to 2007-08.Capital Expenditure stood at 2.5 per cent of
14
GDP in 2007-08 and was budgeted at 1.7 per cent of GDP in 2008-09

12.2 12.2
12
of GDP

10
)
 Plan and Non Plan Expenditure

Plan Expenditure:

These are the expenses that form a part of the government’s five year plan. For ex- salaries and
pension. As a proportion of GDP, plan revenue expenditure had remained in the range of 2.3 per
cent to 3.4 per cent in the period 1997-98 to 2006-07. It rose to reach 3.7 per cent of GDP in
2007-08 and was budgeted at 3.9 per cent of GDP in 2008-09.
Expenditure (as % of

Non Plan Expenditure:

6
These are the expenses that don’t form a part of the government’s five year plan and include
defense expenses, subsidies, grants to the states.In the last five year. As a proportion of GDP,
non-Plan expenditure was in the range of 9.5 per cent to 10.9 per cent in the period 1997-98 to
5
2006-07 and was placed at 8.9 per cent in 2007-08.The Budget for 2008-09 envisaged it to go
down to 8.4 per cent of GDP
4.2
3.9
4
GDP)

3
nned

2
of
 Effects of Fiscal Policies on Employment and Production

Undoubtedly, the fiscal policies have tremendous effects on individual behavior and everyday
decisions made by households as well as businesses. A change tax schedules has direct effect in
cost of production and the bottom-line for corporations or net income for individuals.

Fiscal Policies and Employment

One of fiscal policy component is taxation. An increase in taxes results in reduced net income.
Organizations look into profitability factors and value of labor force in comparison to return on
investment for use of technology or outsourcing tasks otherwise performed internally or
domestically. Conversely, individuals may perceive an increase in tax as a form of punishment,
which can lead to promotion of more black market labor (cash labor). Of course, a decrease in
taxes may lead to further domestic hiring and lesser black market labor.

Equally, it is important to note that changes in taxation policies, as a part of the fiscal monetary
policy, can have significant effects on the intensity of employment market, and overall efficiency
and productivity. The fiscal monetary policy of the government plays a crucial role on employment
factors.

Fiscal Policies and Production

Interest rate is another component of the fiscal policy. Adjusting the interest rate can have adverse
or favourable impact on production. To clarify, adverse in monetary policy is not negative
connotation, and favourable is not a positive suggestion. In the monetary policy when market is
collapsing too fast the government may want to have an adverse result to bring the market under
control.

Change in interest rates alters velocity of "cash." Meaning, when interest rates hike, cash
becomes scarce and credit tightens, as a result, monetary expansion becomes limited and
production decreases. On the other hand, when interest rates decline, cash becomes more
available and credit loosens, as a result, monetary expansion becomes more vibrant and
production increases.
 Revenue Deficit

The difference between revenue expenditure and revenue receipt of the Government is known as
revenue deficit. Revenue deficit occurs when the actual amount of expenditure and actual
amount of received revenue do not tally with the anticipated expenditure and revenue figures.
Revenue deficit gives evidence of the deficit between revenue incomes and expenditures, which is
normally met by capital account surplus, or borrowings. Thus, the revenue deficit effectively
acquires the resources by preemption, which normally goes into capital investment. The revenue
deficit is causing a major concern to the Government of India. The Government of India expects
to eliminate revenue deficit in 2008-09 financial year and is determined to reduce fiscal deficit to 3
% of the GDP (Gross Domestic Product) by the end of 2008-09 financial year.As in the fig it is
clearly visible that the revenue deficit is following from 2004-05 to 2007-08 from 2.5% to 1.1% but
again in 2008-09 it agains reaches to high of 4.5 % due to economic slowdown.

Data on Revenue Deficit:

 Fiscal Deficit

Fiscal deficit is an economic phenomenon, where the Government's total expenditure surpasses
the revenue generated.It is the difference between the government's total receipts (excluding
borrowing) and total expenditure. Fiscal deficit gives the signal to the government about the total
borrowing requirements from all sources. The government accumulates this amount by currency
emission or borrows the amount in order to compensate for the shortage or deficit in tax
revenues. Normally it is described as a percentage of GDP.As in the Fig it is Clearly visible
that fiscal deficit had reduced from 4% in 2004-05 to 2.6% in 2007-08.But again in 2008-09 it
reaches to 6.1% due to economic slowdown,sixth pay commission,maturity of oil bonds.

Data on Fiscal Deficit:

7.0
 Fiscal Responsibility and Budget Management 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.

FRBM Act has four main requirements:

1. It requires the Government to place before Parliament three statements each year along with
the Budget, covering Medium Term Fiscal Policy, Fiscal Policy Strategy and Macroeconomic
Framework.

2. The Act lays down fiscal management principles, making it incumbent on the Centre to "reduce
the fiscal deficit" (no target is mentioned in the Act, but the Rules prescribe 3 per cent of GDP)
and, more categorically, to "eliminate revenue deficit" by March 31, 2008.

3. In its most stringent provision, the Act prohibits the Centre from borrowing from the Reserve
Bank of India that is, it bans `deficit financing' through Money creation

4. The Finance Minister is required to keep Parliament informed through quarterly reviews on the
implementation, and to take corrective measures if the reviews show deviations. The Act provides
that no deviation shall be permissible "without the approval of Parliament".

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

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.
 Bibliography

http://www.bized.co.uk/virtual/economy/policy/advisors/fiscal4.htm
http://www.informationbible.com/FiscalPolicy.html

http://www.econlib.org/library/Enc/FiscalPolicy.html
http://indiabudget.nic.in/es2008-09/chapt2009/chap32.pdf
www.finmin.nic.in
http://en.wikipedia.org/wiki/Fiscal_policy