Economic Environment of Business_3

Public Finance and Fiscal Policy

Public Finance
How the Government raises resources to meet it’s ever-rising expenditure
The income and expenditure of the public authorities and their adjustments among them
Fiscal policy
The effects of budget on the economy
Classical Economic View
Keep the expenditure to the minimum
Impose minimum taxes
The budget should be balanced
Public borrowings should resorted to only under exceptional conditions, e.g. war, natural calamities etc.
Functional Finance
Balanced budgets are no longer considered sacrosanct
Public Finance should play an active role
It is an instrument of economic regulation, it can be used for maintaining stability through management of aggregate demand

Objectives of Fiscal policy
Sustained Economic Growth
Economic Stability
High level of Employment
Social Justice and Equity
Horizontal and vertical equity
Socially optimum pattern of distribution
Reducing unemployment
Controlling inflationary pressure

Basic Fiscal Concepts
Public Expenditure
Types of Public Expenditure
Trends in Public Expenditure
Effects of Public Expenditure
Public Revenue
-- Types
- Principles
- Effects
Public Borrowings
Internal Debt
External Debt
Deficit
- Revenue Deficit
- Budget Deficit
- Fiscal Deficit
- Primary Deficit

Types of Public Expenditure
Revenue and Capital Expenditure
Transfer Payments and expenditure on goods and services
Developmental and Non-developmental Expenditure

Trends in Public Expenditure
Wagner’s Law of Increasing State Activity
As the economy develops over time, the functions of the government increase
• Wiseman- Peacock Hypothesis
- government expenditure increases in jerks and step-like manner

Factors responsible for growth of Public Expenditure in India
Defence Expenditure
Population growth
Urbanisation
Welfare Activities of the Government
Maintaining Economic Stability
Huge Investments in developmental activities
Mounting Debt Service Charges
Increasing Food and Fertilizer subsidies
Huge expenditure on Employment generating anti-poverty schemes


Effects of Public Expenditure
On Production
- Expenditure on investment projects and capital formation will expand the productive capacity and generate long term growth
- Expenditure on Research and development ensures advancement of technology and would improve the productivity
- Expenditure on Education and Public Health helps in building ‘Human Capital’ and enhances productivity
- At times of recession or depression, increase in Public Expenditure leads to manifolds increase in income and employment through the process of multiplier

On Allocation of Resources
- Government Expenditure can influence the pattern or composition of output
- It leads to reallocation of resources between industries and regions
- It leads to socially desirable allocation resources

On Distribution
- Through Public Expenditure, the Government redistributes income in favour of the poor
- Social Security measures
- Subsidies (food, fertilizer, kerosene, small scale industries, cottage industries)
- Social Infrastructure Government
- Employment Guaranty / assistance schemes
- Free education for girls
Public Revenue
Tax
A tax is a compulsory payment levied by the Government. It does not have any direct quid pro quo
Non-tax Revenue
Fees, penalties etc
Charged for a specific purpose
There is a direct quid pro quo

Types of Taxes
Direct and Indirect Taxes
Specific and Ad-Valorem Taxes
Progressive, Proportional and Regressive Taxes

Direct and Indirect Taxes
- The burden of the direct tax cannot be shifted to others, the person who pays it has to bear it
Income tax, Wealth tax, Capital gains tax
- Those who pay indirect taxes can pass the burden, wholly or partly, to others
Excise Duty, Sales tax

Merits of Direct Taxes
They are progressive in nature
The tax structure can be closely linked to Ability to pay
It is an important instrument of reducing inequalities of income and wealth
They serve as an automatic stabilizers as their revenue elasticity is quite high

Merits of Indirect Taxes
Convenient to pay
Large revenue potential for the Government
It is an important instrument for influencing the pattern of production and investment

Demerits of Indirect Taxes
They are regressive
They are inflationary
Cascading effect
They may lead to inefficient resource allocation

Specific and Ad-Valorem Taxes
- A Specific tax is a tax per unit of a commodity, whatever may be its price
It is based on the volume of operation
Toll tax
- An Ad-Valorem tax is levied on the basis of the value of a commodity
It is expressed as a percentage of price
Sales tax


Progressive, Proportional and Regressive Taxes

Progressive Tax
The rate of tax increases as the tax base (income, wealth etc) increases
Greater the tax base, higher is the tax rate
Income tax in India

Proportional tax
The tax rate is constant irrespective of the magnitude of the tax base
A rate is fixed, and is applicable to all

Regressive tax
The rate of tax decreases as the tax base increases
The burden of the tax is more on the poor than on the rich

Principles/ Canons of Taxation

Adam Smith ‘The wealth of Nations’
Canon of Equality
Canon of Certainty
Canon of Convenience
Canon of Economy

Union Budget
1. Total Expenditure
1.1 Revenue Expenditure
1.1.1 Plan
1.1.2 Non-plan
*1.1.2.1 Interest Payments
1.2 Capital Expenditure
1.2.1 Plan
1.2.2 Non-plan


2. Total Receipts
2.1 Revenue Receipts
2.1.1 Tax
2.1.2 Non-tax


2.2 Capital Receipts
2.2.1 Recovery of Loans
2.2.2 PSU Disinvestment
2.2.3 Borrowings


Revenue Deficit
Revenue Expenditure (–) Revenue Receipts
Revenue Receipts include Tax and Non-tax receipts
Revenue Expenditure includes
Interest payments on public debt
Defence expenditure
Subsidies on food, exports etc.
Civil Administration

Revenue surplus would imply
Prudent resource management by the Government
Government savings are being used for financing developmental activities
revenue deficit would imply
Government is dis-saving
Capital funds are being used for consumption expenditure
The Government has to borrow in order to meet the day to day expenditure.

Budget Deficit
Total Government Expenditure (-) Total Government Receipts
It is financed by borrowing from the RBI against the Government securities and treasury bills
Issuing of new currency against government securities is known as ‘Deficit Financing’ or ‘Monetising of deficit’.

Fiscal Deficit
Total Government Expenditure (-) Total Government Receipts(excluding borrowings)
Budget Deficit (+) borrowings
In India we have had huge Fiscal deficits
Attempts have been made to reduce fiscal deficits by curtailing capital expenditure; which has adversely affected economic growth

Primary Deficit
Fiscal Deficit (-) Interest Payments
It is lower than the fiscal deficit
Indicator of the fiscal management in the current year


Fiscal Policy

1) Discretionary
- To cure Recession
- To control Inflation

2) Non-discretionary ===> Automatic Stabilisers



Measures to cure Recession

Increase in Government Expenditure
by starting public works such as building roads, dams, ports, telecommunication links, irrigation works
The Govt will buy material and employ people
This will directly and indirectly increase incomes, output and effective demand in the economy

Government Expenditure
Multiplier= ΔG / (1 - MPC)
Measures to cure Recession
Reduction of Taxes
Increase in disposable income
Increase in consumption expenditure

Tax Multiplier = ΔT * MPC ÷ (1- MPC)


Measures to control Inflation
Reducing Government Expenditure
Increasing Taxes
Non-discretionary Fiscal Policy
Automatic Stabilisers
Personal Income Taxes
Corporate Income Taxes
Transfer Payments: Unemployment Compensation, Welfare Benefits

REVENUE RECEIPTS (In crore of Rupees) 2004-2005 2004-2005 2005-2006 Budget Revised Budget Estimates Estimates Estimates1. Tax RevenueGross Tax Revenue 317733 306021 370025Union Excise duties 109199 100720 121533Customs 54250 56250 53182Corporation tax 88436 83000 110573Income tax 50929 50929 66239Service tax 14150 14150 17500Taxes of the UnionTerritories 624 707 733Other taxes and duties 145 265 265Less - NCCD transferred tothe National CalamityContingency Fund 1600 1600 1600Less States’ Share 82227 78617 94959Net Tax Revenue 233906 225804 273466
2. Non-Tax RevenueInterest receipts 36950 31538 25500Dividend and profits 18875 20799 23500External grants 3598 3064 3218Other non-tax revenue 15375 19000 24787Receipts of UnionTerritories 618 699 729Total Non-Tax Revenue 75416 75100 77734Total Revenue Receipts 309322 ` 300904 351200
3. CAPITAL RECEIPTS @ 2004-2005 2004-2005 2005-2006Recoveries of loans* 27100 61565 12000Market borrowings Other short, medium & long term loans # 150365 111424 125310Of which under MarketStabilization Scheme ** 60000 65481 15019External assistance 8077 9034 9656Disinvestments of equity holding in public sector enterprises 4000 4091 ...Securities against Small Savings 1350 34015 3010State Provident Funds 4000 4000 5000Special deposits 200 200 ...Others 19818 25014 20047Draw-down onCash balance (excluding MSS) 13597 21025 3140Total Capital Receipts 228507 270368 178163TOTAL RECEIPTS*** 537829 571272 529363* excludes recoveries of short-term loans and advances from Statesand loans to Government servants, etc. 2525 2525 1525

* excludes recoveries of short-term loans and advances from Statesand loans to Government servants, etc. 2525 2525 1525
@ The receipts are net of repayments.

# These include 182/364 day Treasury Bills, etc.

*** Excludes receipts offset by matching expenditure.

** Held as cash balance in a separate identifiable account with RBI.

1. NON-PLAN EXPENDITURE
A. Revenue Expenditure
1. Interest Payments 129500 125905 133945
2. Defence 43517 43517 48625
3. Subsidies 43516 46514 47432
4. Grants to State and
U.T. Governments 19470 14828 33953
5. Pensions 15928 18338 19542
6. Police 9940 10542 12237
7. Assistance to States from National
Calamity Contingency Fund 1600 2600 1500
8. Economic Services
(Agriculture, Industry, Power,
Transport, Communications,
Science & Technology, etc.) 11763 14674 13413


9. Other General Services
(Organs of State, tax
collection, external affairs, etc.) 9318 9502 9028
10. Social Services (Education,
Health, Broadcasting, etc.) 6840 8488 7522
11. Postal Deficit 1355 1457 1417
12. Expenditure of Union
Territories without Legislature 1659 1695 2322
13. Amount met from National
Calamity Contingency Fund -1600 -2600 -1500
14. Grants to
Foreign Governments 844 936 1094
Total Revenue Non-Plan
Expenditure 293650 296396 330530


B. Capital Expenditure
1. Defence 33483 33483 34375
2. Other Non-Plan
Capital Outlay 3317 3354 4460
3. Loans to
Public Enterprises 1509 1809 1258
4. Loans to State and
U.T. Governments 106 715 100
5. Loans to
Foreign Governments 144 291 256
6. Others 30 32356 -132
Total Capital Non-Plan
Expenditure 38589 72008 40317
Total Non-Plan
Expenditure 332239 368404 370847


2. PLAN EXPENDITURE
A. Revenue Expenditure
1. Central Plan 61669 59817 83370
2. Central Assistance
for State & Union
Territory Plans 30174 29856 32612
State Plan 29467 29086 31687
Union Territory Plan 707 770 925
Total Revenue Plan
Expenditure 91843 89673 115982


B. Capital Expenditure
1. Central Plan 26217 22712 27015
2. Central Assistance
for State & Union
Territory Plans 27530 25002 500
State Plan 26773 24303 55
Union Territory Plan 757 699 445
Total Capital
Plan Expenditure 53747 47714 27515
Total - Plan Expenditure 145590 137387 143497
Total Budget Support
for Central Plan 87886 82529 110385
Total Central Assistance
for State & UT Plans 57704 54858 33112
TOTAL EXPENDITURE* 477829 505791 514344


DEBT SERVICING
1. Repayment of debt** 198380 224075 247984
2. Total Interest Payments 129500 125905 133945
3. Total debt servicing (1+2) 327880 349980 381929
4. Revenue Receipts 309322 300904 351200
5. Percentage of 2 to 4 41.9% 41.8% 38.1%