Fiscal Policy Of India 112j17
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VIVEKANAND COLLEGE FOR BBA
INTRODUCTION The word fisc means ‘state treasury’ and fiscal policy refers to policy concerning the use of ‘state treasury’ or the govt. finances to achieve the macroeconomic goals. “any decision to change the level, composition or timing of govt. expenditure or to vary the burden ,the structure or frequency of the tax payment is fiscal policy Federal taxation and spending policies designed to level out the business cycle and achieve full employment, price stability, and sustained growth in the economy. Fiscal policy basically follows the economic theory of the 20th-century English economist John Maynard Keynes that insufficient demand causes unemployment and excessive demand leads to inflation. It aims to stimulate demand and output in periods of business decline by increasing government purchases and cutting taxes, thereby releasing more disposable income into the spending stream, and to correct overexpansion by reversing the process. Working to balance these deliberate fiscal measures are the so-called built-in stabilizers, such as the progressive income tax and unemployment benefits, which automatically respond countercyclically. Fiscal policy is istered independently of Monetary Policy by which the Federal Reserve Board attempts to regulate economic activity by controlling the money supply. The goals of fiscal and monetary policy are the same, but Keynesians and Monetarists disagree as to which of the two approaches works best. At the basis of their differences are questions dealing with the velocity (turnover) of money and the effect of changes in the money supply on the equilibrium rate of interest (the rate at which money demand equals money supply. Measures employed by governments to stabilize the economy, specifically by adjusting the levels and allocations of taxes and government expenditures. When the economy is sluggish, the government may cut taxes, leaving taxpayers with extra cash to spend and thereby increasing levels of consumption. An increase in publicworks spending may likewise pump cash into the economy, having an expansionary effect. Conversely, a decrease in government spending or an increase in taxes tends to cause the economy to contract. Fiscal policy is often used in tandem with monetary policy. Until the 1930s, fiscal policy aimed at maintaining a balanced budget; since
FISCAL POLICY
17
VIVEKANAND COLLEGE FOR BBA then it has been used "countercyclically," as recommended by John Maynard Keynes, to offset the cycle of expansion and contraction in the economy. Fiscal policy is more effective at stimulating a flagging economy than at cooling an inflationary one, partly because spending cuts and tax increases are unpopular and partly because of the work of economic stabilizers. Fiscal policy is manifested in a government's policies on taxation and expenditures. To obtain funds for their operation, government units generally collect some form of taxes. The expenditure of these funds not only provides goods and services for constituents, but has a direct impact on the economy. For example, if expenditures are larger than the funds received by the government, the resulting deficit tends to stimulate the economy, as goods and services are produced for government purchase. In contrast, if a government runs a surplus by not spending all the funds it collects, economic growth will generally be curtailed, as the surplus funds are removed from circulation in the economy
DEFINITION OF FISCAL POLICY
FISCAL POLICY
17
VIVEKANAND COLLEGE FOR BBA Fiscal policy is the means by which a government adjusts its levels of spending in order to monitor and influence a nation’s economy. Fiscal policy is that part of government policy which is concerned with razing revenue through taxation and other means and deciding on the level and pattern of expenditure. In other wards the term fiscal policy refers to the expenditure a government undertakes to provide goods and services and to the way in which the government finances these expenditures.
Objectives of Fiscal Policy 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 standardof 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:
FISCAL POLICY
17
VIVEKANAND COLLEGE FOR BBA 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
Fiscal Policy And Macroeconomic Goals •
Economic Growth: By creating conditions for increase in savings & investment.
•
Employment: By encouraging the use of labour-absorbing technology
•
Stabilization: fight with depressionary trends and booming (overheating) indications in the economy
•
Economic Equality: By reducing the income and wealth gaps between the rich and poor.
•
Price stability: employed to contain inflationary and deflationary tendencies in the economy.
The purpose of Fiscal Policy: •
Reduce the rate of inflation.
•
Stimulate economic growth in a period of a recession.
•
Basically, fiscal policy aims to stabilize economic growth, avoiding the boom and bust economic cycle.
FISCAL POLICY
17
VIVEKANAND COLLEGE FOR BBA
Instruments of Fiscal Policy •
Budgetary surplus and deficit
•
Government expenditure
•
Taxation- direct and indirect
•
Public debt
•
Deficit financing Budgetary surplus and deficit
•
“A budget is a detailed plan of operations for some specific future period”
•
Keeping budget balanced (R=E) or deficit (R<E) or surplus (R>E) as a matter of policy is itself a fiscal instrument.
•
An accumulated deficit over several years (or centuries) is referred to as the government debt
•
A deficit is a flow. And a debt is a stock. Debt is essentially an accumulated flow of deficits
Government expenditure It includes : •
Government spending on the purchase of goods & services.
•
Payment of wages and salaries of government servants
•
Public investment
•
Transfer payments
FISCAL POLICY
17
VIVEKANAND COLLEGE FOR BBA
Taxation- direct and indirect •
Meaning : Non quid pro quo transfer of private income to public coffers by means of taxes.
•
Classified into 1. Direct taxes- Corporate tax, Div. Distribution Tax, Personal Income Tax, Fringe Benefit taxes, Banking Cash Transaction Tax 2. Indirect taxes- Central Sales Tax, Customs, Service Tax, excise duty.
Public debt •
Internal borrowings
1. Borrowings from the public by means of treasury bills and govt. bonds 2. Borrowings from the central bank (monetized deficit financing)
•
External borrowings
1. foreign investments 2. international organizations like World Bank & IMF 3. market borrowings
FISCAL POLICY
17
VIVEKANAND COLLEGE FOR BBA
The Golden Rule Fiscal policy framework The Government's fiscal policy framework is based on the five key principles set out in the Code for fiscal stability - transparency, stability, responsibility, fairness and efficiency. The Code requires the Government to state both its objectives and the rules through which fiscal policy will be operated. The Government's fiscal policy objectives are: •
over the medium term, to ensure sound public finances and that spending and taxation impact fairly within and between generations; and
•
over the short term, to monetary policy and, in particular, to allow the automatic stabilisers to help smooth the path of the economy.
•
These objectives 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. Other things being equal, net debt will be maintained below 40 per cent of GDP over the economic cycle.
•
The fiscal rules ensure sound public finances in the medium term while allowing flexibility in two key respects:
•
the rules are set over the economic cycle. This allows the fiscal balances to vary between years in line with the cyclical position of the economy, permitting the automatic stabilisers to operate freely to help smooth the path of the economy in the face of variations in demand; and
•
the rules work together to promote capital investment while ensuring sustainable public finances in the long term. The golden rule requires the current budget to be in balance or surplus over the cycle, allowing the Government to borrow only to fund capital spending. The sustainable investment rule ensures that borrowing is maintained at a prudent level. To meet the sustainable investment rule with confidence, net debt will be maintained below 40 per cent of GDP in each and every year of the current economic cycle.
FISCAL POLICY
17
VIVEKANAND COLLEGE FOR BBA
Fiscal policy in action the effects of the fiscal policy in action as follow The rise in AD leads to an increase in real national income, ceteris paribus, unemployment would fall to 3% but at a cost of higher inflation AD therefore shifts to the right to AD1 AD=C+I+G+(X-M) Apart from G, C and I are also likely to be affected directly or indirectly by the policy change. If government ‘reduces taxes’ ( the subtleties) and or increases spending, it will have various effects: Assume an initial equilibrium position with a level of National Income giving an unemployment rate of 5% (U = 5%) Fiscal Policy influences AD in the short term but can be used to affect AS in the long run – depending on the nature of the policy. Try your hand at Fiscal Policy by going to the Virtual Economy
the graph are shown in the ppt slid
FISCAL POLICY
17
VIVEKANAND COLLEGE FOR BBA
BUDGET •
“A budget is a detailed plan of operations for some specific future period”
•
It is an estimate prepared in advance of the period to which it applies.
COMPONENTS OF BUDGET •
Revenue receipts
•
Capital receipts
•
Revenue expenditure
•
Capital expenditure
FISCAL POLICY
17
VIVEKANAND COLLEGE FOR BBA
other non plan exp. 1 1%
s tate 's s hare of taxe s & duties 18%
subsidies 7%
defe nc e 12 %
interestPOLICY FISCAL 2 0%
non plan a ssistance to s t ates 5% planne d state assis ta nc e 7%
ce ntra l plan 2 0%
17
VIVEKANAND COLLEGE FOR BBA
FISCAL POLICY
17
VIVEKANAND COLLEGE FOR BBA
Government Income •
Tax Revenue
•
Sale of Government Services – e.g. prescriptions, ports, etc.
•
Borrowing (PSNCR)
Public Sector Income
700 600 Government Income (£ billion) 500 FISCAL POLICY
17
VIVEKANAND COLLEGE FOR BBA Inland Revenue
199899
199900
200001
200102
200203
200304
Income Tax (gross of tax credits)
88.4
95.7
106.1
110.3
112.6
118.3
Income Tax Credits
-1.9
-1.8
-1.0
-2.3
-3.4
-4.3
Corporation Tax
30.0
34.3
32.4
32.0
29.5
28.1
Windfall Tax
2.6
0.0
0.0
0.0
0.0
0.0
Petroleum Revenue Tax 0.5
0.9
1.5
1.3
1.0
1.2
Capital Gains Tax
2.0
2.1
3.2
3.0
1.6
2.2
Inheritance Tax
1.8
2.1
2.2
2.4
2.4
2.5
Stamp Duties
4.6
6.9
8.2
7.0
7.5
7.5
NICs
55.1
56.4
60.6
63.2
64.6
72.5
196.5
213.4
216.8
215.8
228.0
Total Inland Revenue 183.2
FISCAL POLICY
17
VIVEKANAND COLLEGE FOR BBA
Customs and Excise
199899
199900
200001
200102
200203
200304
VAT
52.3
56.4
58.5
61.0
63.5
69.1
Fuel Duties
21.6
22.5
22.6
21.9
22.1
22.8
Tobacco Duty
8.2
5.7
7.6
7.8
8.1
8.1
Spirits Duties
1.6
1.8
1.8
1.9
2.3
2.4
Wine Duties
1.5
1.7
1.8
2.0
1.9
2.0
Beer and Cider Duties
2.7
3.0
3.0
3.1
3.1
3.2
Betting and Gaming Duties 1.5
1.5
1.5
1.4
1.3
1.3
Air enger Duty
0.8
0.9
1.0
0.8
0.8
0.8
Insurance Tax
1.2
1.4
1.7
1.9
2.1
2.3
Land Fill Tax
0.3
0.4
0.5
0.5
0.5
0.6
Climate Change Levy
0.0
0.0
0.0
0.6
0.8
0.8
Aggregates Levy
0.0
0.0
0.0
0.0
0.2
0.3
Customs Duties and Levies 2.1
2.0
2.1
2.0
1.9
1.9
Total Customs and Excise
97.3
102.2
104.9
108.7
115.7
94.0
199899
199900
200001
200102
200203
200304
VED
4.6
4.9
4.3
4.3
4.3
4.8
Oil Royalties
0.3
0.4
0.6
0.5
0.4
0.0
Business Rates
14.7
15.4
16.3
17.9
18.5
18.4
Council Tax
12.2
13.1
14.1
15.2
16.9
18.8
Other Taxes and Royalties
7.5
7.9
8.5
9.4
10.2
11.2
Net Taxes and NICs conts
316.6
335.4
359.3
369.1
374.9
196.7
Interest and Dividends
5.0
4.3
6.0
4.7
4.5
4.4
FISCAL POLICY
17
VIVEKANAND COLLEGE FOR BBA Gross Operating Surplus and Rent
18.2
18.1
18.8
19.9
19.0
19.4
Other Receipts and ing Adjustments
-5.3
-0.7
-3.8
-5.7
-5.2
-1.8
Current Receipts
334.5
357.2
380.4
387.9
393.2
418.7
Government Income – Inland Revenue 2003-04
Government Income – Customs and Excise 2003-04
FISCAL POLICY
17
VIVEKANAND COLLEGE FOR BBA
Other Government Income 2003-04
FISCAL POLICY
17
VIVEKANAND COLLEGE FOR BBA
Fiscal policy is the economic term that defines the set of principles and decision of government in setting the level of public expenditure and how the expenditure is funded. In economics, fiscal policy is the use of government spending and revenue collection to influence the economy Fiscal policy can be contrasted with the other main type of economic policy, monetary policy, which attempts to stabilize the economy by controlling interest rates and the supply of money. The two main instruments of fiscal policy are government spending and taxation. Changes in the level and composition of taxation and government spending can impact on the following variables in the economy: •
Aggregate demand and the level of economic activity;
•
The pattern of resource allocation;
•
The distribution of income.
FISCAL POLICY
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VIVEKANAND COLLEGE FOR BBA Fiscal policy refers to the overall effect of the budget outcome on economic activity. The three possible stances of fiscal policy are neutral, expansionary, and contractionary: •
A neutral stance of fiscal policy implies a balanced budget where G = T (Government spending = Tax revenue). Government spending is fully funded by tax revenue and overall the budget outcome has a neutral effect on the level of economic activity.
•
An expansionary stance of fiscal policy involves a net increase in government spending (G > T) through rises in government spending, a fall in taxation revenue, or a combination of the two. This will lead to a larger budget deficit or a smaller budget surplus than the government previously had, or a deficit if the government previously had a balanced budget. Expansionary fiscal policy is usually associated with a budget deficit.
•
A contractionary fiscal policy (G < T) occurs when net government spending is reduced either through higher taxation revenue, reduced government spending, or a combination of the two. This would lead to a lower budget deficit or a larger surplus than the government previously had, or a surplus if the government previously had a balanced budget. Contractionary fiscal policy is usually associated with a surplus.
Methods of funding Governments spend money on a wide variety of things, from the military and police to services like education and healthcare, as well as transfer payments such as benefits. This expenditure can be funded in a number of different ways: •
Taxation
•
Seignorage, the benefit from printing money
•
Borrowing money from the population, resulting in a fiscal deficit
•
Consumption of fiscal reserves.
•
Sale of assets (e.g., land). FISCAL POLICY
17
VIVEKANAND COLLEGE FOR BBA
Funding the deficit A fiscal deficit is often funded by issuing bonds, like treasury bills or consols. These pay interest, either for a fixed period or indefinitely. If the interest and capital repayments are too large, a nation may default on its debts, usually to foreign creditors.
Consuming the surplus A fiscal surplus is often saved for future use, and may be invested in local (same currency) financial instruments, until needed. When income from taxation or other sources falls, as during an economic slump, reserves allow spending to continue at the same rate, without incurring additional debt.
Economic effects of fiscal policy Governments use fiscal policy to influence the level of aggregate demand in the economy, in an effort to achieve economic objectives of price stability, full employment, and economic growth. Keynesian economics suggests that adjusting government spending and tax rates are the best ways to stimulate aggregate demand. This can be used in times of recession or low economic activity as an essential tool for building the framework for strong economic growth and working toward full employment. The government can implement these deficit-spending policies to stimulate trade due to its size and prestige. In theory, these deficits would be paid for by an expanded economy during the boom that would follow; this was the reasoning behind the New Deal. Governments can use budget surplus to do two things: to slow the pace of strong economic growth, and to stabilize prices when inflation is too high. Keynesian theory posits that removing funds from the economy will reduce levels of aggregate demand and contract the economy, thus stabilizing prices. Some classical and neoclassical economists argue that fiscal policy can have no stimulus effect; this is known as the Treasury View, which Keynesian economics rejects. The Treasury View refers to the theoretical positions of classical economists
FISCAL POLICY
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VIVEKANAND COLLEGE FOR BBA in the British Treasury, who opposed Keynes' call in the 1930s for fiscal stimulus. The same general argument has been repeated by neoclassical economists up to the present. From their point of view, when government runs a budget deficit, funds will need to come from public borrowing (the issue of government bonds), overseas borrowing, or the printing of new money. When governments fund a deficit with the release of government bonds, interest rates can increase across the market. This is because government borrowing creates higher demand for credit in the financial markets, causing a lower aggregate demand (AD), contrary to the objective of a budget deficit. This concept is called crowding out; it is a "sister" of monetary policy. In the classical view, fiscal policy also decreases net exports, which has a mitigating effect on national output and income. When government borrowing increases interest rates it attracts foreign capital from foreign investors. This is because, all other things being equal, the bonds issued from a country executing expansionary fiscal policy now offer a higher rate of return. In other words, companies wanting to finance projects must compete with their government for capital so they offer higher rates of return. To purchase bonds originating from a certain country, foreign investors must obtain that country's currency. Therefore, when foreign capital flows into the country undergoing fiscal expansion, demand for that country's currency increases. The increased demand causes that country's currency to appreciate. Once the currency appreciates, goods originating from that country now cost more to foreigners than they did before and
FISCAL POLICY
17
INTRODUCTION The word fisc means ‘state treasury’ and fiscal policy refers to policy concerning the use of ‘state treasury’ or the govt. finances to achieve the macroeconomic goals. “any decision to change the level, composition or timing of govt. expenditure or to vary the burden ,the structure or frequency of the tax payment is fiscal policy Federal taxation and spending policies designed to level out the business cycle and achieve full employment, price stability, and sustained growth in the economy. Fiscal policy basically follows the economic theory of the 20th-century English economist John Maynard Keynes that insufficient demand causes unemployment and excessive demand leads to inflation. It aims to stimulate demand and output in periods of business decline by increasing government purchases and cutting taxes, thereby releasing more disposable income into the spending stream, and to correct overexpansion by reversing the process. Working to balance these deliberate fiscal measures are the so-called built-in stabilizers, such as the progressive income tax and unemployment benefits, which automatically respond countercyclically. Fiscal policy is istered independently of Monetary Policy by which the Federal Reserve Board attempts to regulate economic activity by controlling the money supply. The goals of fiscal and monetary policy are the same, but Keynesians and Monetarists disagree as to which of the two approaches works best. At the basis of their differences are questions dealing with the velocity (turnover) of money and the effect of changes in the money supply on the equilibrium rate of interest (the rate at which money demand equals money supply. Measures employed by governments to stabilize the economy, specifically by adjusting the levels and allocations of taxes and government expenditures. When the economy is sluggish, the government may cut taxes, leaving taxpayers with extra cash to spend and thereby increasing levels of consumption. An increase in publicworks spending may likewise pump cash into the economy, having an expansionary effect. Conversely, a decrease in government spending or an increase in taxes tends to cause the economy to contract. Fiscal policy is often used in tandem with monetary policy. Until the 1930s, fiscal policy aimed at maintaining a balanced budget; since
FISCAL POLICY
17
VIVEKANAND COLLEGE FOR BBA then it has been used "countercyclically," as recommended by John Maynard Keynes, to offset the cycle of expansion and contraction in the economy. Fiscal policy is more effective at stimulating a flagging economy than at cooling an inflationary one, partly because spending cuts and tax increases are unpopular and partly because of the work of economic stabilizers. Fiscal policy is manifested in a government's policies on taxation and expenditures. To obtain funds for their operation, government units generally collect some form of taxes. The expenditure of these funds not only provides goods and services for constituents, but has a direct impact on the economy. For example, if expenditures are larger than the funds received by the government, the resulting deficit tends to stimulate the economy, as goods and services are produced for government purchase. In contrast, if a government runs a surplus by not spending all the funds it collects, economic growth will generally be curtailed, as the surplus funds are removed from circulation in the economy
DEFINITION OF FISCAL POLICY
FISCAL POLICY
17
VIVEKANAND COLLEGE FOR BBA Fiscal policy is the means by which a government adjusts its levels of spending in order to monitor and influence a nation’s economy. Fiscal policy is that part of government policy which is concerned with razing revenue through taxation and other means and deciding on the level and pattern of expenditure. In other wards the term fiscal policy refers to the expenditure a government undertakes to provide goods and services and to the way in which the government finances these expenditures.
Objectives of Fiscal Policy 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 standardof 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:
FISCAL POLICY
17
VIVEKANAND COLLEGE FOR BBA 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
Fiscal Policy And Macroeconomic Goals •
Economic Growth: By creating conditions for increase in savings & investment.
•
Employment: By encouraging the use of labour-absorbing technology
•
Stabilization: fight with depressionary trends and booming (overheating) indications in the economy
•
Economic Equality: By reducing the income and wealth gaps between the rich and poor.
•
Price stability: employed to contain inflationary and deflationary tendencies in the economy.
The purpose of Fiscal Policy: •
Reduce the rate of inflation.
•
Stimulate economic growth in a period of a recession.
•
Basically, fiscal policy aims to stabilize economic growth, avoiding the boom and bust economic cycle.
FISCAL POLICY
17
VIVEKANAND COLLEGE FOR BBA
Instruments of Fiscal Policy •
Budgetary surplus and deficit
•
Government expenditure
•
Taxation- direct and indirect
•
Public debt
•
Deficit financing Budgetary surplus and deficit
•
“A budget is a detailed plan of operations for some specific future period”
•
Keeping budget balanced (R=E) or deficit (R<E) or surplus (R>E) as a matter of policy is itself a fiscal instrument.
•
An accumulated deficit over several years (or centuries) is referred to as the government debt
•
A deficit is a flow. And a debt is a stock. Debt is essentially an accumulated flow of deficits
Government expenditure It includes : •
Government spending on the purchase of goods & services.
•
Payment of wages and salaries of government servants
•
Public investment
•
Transfer payments
FISCAL POLICY
17
VIVEKANAND COLLEGE FOR BBA
Taxation- direct and indirect •
Meaning : Non quid pro quo transfer of private income to public coffers by means of taxes.
•
Classified into 1. Direct taxes- Corporate tax, Div. Distribution Tax, Personal Income Tax, Fringe Benefit taxes, Banking Cash Transaction Tax 2. Indirect taxes- Central Sales Tax, Customs, Service Tax, excise duty.
Public debt •
Internal borrowings
1. Borrowings from the public by means of treasury bills and govt. bonds 2. Borrowings from the central bank (monetized deficit financing)
•
External borrowings
1. foreign investments 2. international organizations like World Bank & IMF 3. market borrowings
FISCAL POLICY
17
VIVEKANAND COLLEGE FOR BBA
The Golden Rule Fiscal policy framework The Government's fiscal policy framework is based on the five key principles set out in the Code for fiscal stability - transparency, stability, responsibility, fairness and efficiency. The Code requires the Government to state both its objectives and the rules through which fiscal policy will be operated. The Government's fiscal policy objectives are: •
over the medium term, to ensure sound public finances and that spending and taxation impact fairly within and between generations; and
•
over the short term, to monetary policy and, in particular, to allow the automatic stabilisers to help smooth the path of the economy.
•
These objectives 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. Other things being equal, net debt will be maintained below 40 per cent of GDP over the economic cycle.
•
The fiscal rules ensure sound public finances in the medium term while allowing flexibility in two key respects:
•
the rules are set over the economic cycle. This allows the fiscal balances to vary between years in line with the cyclical position of the economy, permitting the automatic stabilisers to operate freely to help smooth the path of the economy in the face of variations in demand; and
•
the rules work together to promote capital investment while ensuring sustainable public finances in the long term. The golden rule requires the current budget to be in balance or surplus over the cycle, allowing the Government to borrow only to fund capital spending. The sustainable investment rule ensures that borrowing is maintained at a prudent level. To meet the sustainable investment rule with confidence, net debt will be maintained below 40 per cent of GDP in each and every year of the current economic cycle.
FISCAL POLICY
17
VIVEKANAND COLLEGE FOR BBA
Fiscal policy in action the effects of the fiscal policy in action as follow The rise in AD leads to an increase in real national income, ceteris paribus, unemployment would fall to 3% but at a cost of higher inflation AD therefore shifts to the right to AD1 AD=C+I+G+(X-M) Apart from G, C and I are also likely to be affected directly or indirectly by the policy change. If government ‘reduces taxes’ ( the subtleties) and or increases spending, it will have various effects: Assume an initial equilibrium position with a level of National Income giving an unemployment rate of 5% (U = 5%) Fiscal Policy influences AD in the short term but can be used to affect AS in the long run – depending on the nature of the policy. Try your hand at Fiscal Policy by going to the Virtual Economy
the graph are shown in the ppt slid
FISCAL POLICY
17
VIVEKANAND COLLEGE FOR BBA
BUDGET •
“A budget is a detailed plan of operations for some specific future period”
•
It is an estimate prepared in advance of the period to which it applies.
COMPONENTS OF BUDGET •
Revenue receipts
•
Capital receipts
•
Revenue expenditure
•
Capital expenditure
FISCAL POLICY
17
VIVEKANAND COLLEGE FOR BBA
other non plan exp. 1 1%
s tate 's s hare of taxe s & duties 18%
subsidies 7%
defe nc e 12 %
interestPOLICY FISCAL 2 0%
non plan a ssistance to s t ates 5% planne d state assis ta nc e 7%
ce ntra l plan 2 0%
17
VIVEKANAND COLLEGE FOR BBA
FISCAL POLICY
17
VIVEKANAND COLLEGE FOR BBA
Government Income •
Tax Revenue
•
Sale of Government Services – e.g. prescriptions, ports, etc.
•
Borrowing (PSNCR)
Public Sector Income
700 600 Government Income (£ billion) 500 FISCAL POLICY
17
VIVEKANAND COLLEGE FOR BBA Inland Revenue
199899
199900
200001
200102
200203
200304
Income Tax (gross of tax credits)
88.4
95.7
106.1
110.3
112.6
118.3
Income Tax Credits
-1.9
-1.8
-1.0
-2.3
-3.4
-4.3
Corporation Tax
30.0
34.3
32.4
32.0
29.5
28.1
Windfall Tax
2.6
0.0
0.0
0.0
0.0
0.0
Petroleum Revenue Tax 0.5
0.9
1.5
1.3
1.0
1.2
Capital Gains Tax
2.0
2.1
3.2
3.0
1.6
2.2
Inheritance Tax
1.8
2.1
2.2
2.4
2.4
2.5
Stamp Duties
4.6
6.9
8.2
7.0
7.5
7.5
NICs
55.1
56.4
60.6
63.2
64.6
72.5
196.5
213.4
216.8
215.8
228.0
Total Inland Revenue 183.2
FISCAL POLICY
17
VIVEKANAND COLLEGE FOR BBA
Customs and Excise
199899
199900
200001
200102
200203
200304
VAT
52.3
56.4
58.5
61.0
63.5
69.1
Fuel Duties
21.6
22.5
22.6
21.9
22.1
22.8
Tobacco Duty
8.2
5.7
7.6
7.8
8.1
8.1
Spirits Duties
1.6
1.8
1.8
1.9
2.3
2.4
Wine Duties
1.5
1.7
1.8
2.0
1.9
2.0
Beer and Cider Duties
2.7
3.0
3.0
3.1
3.1
3.2
Betting and Gaming Duties 1.5
1.5
1.5
1.4
1.3
1.3
Air enger Duty
0.8
0.9
1.0
0.8
0.8
0.8
Insurance Tax
1.2
1.4
1.7
1.9
2.1
2.3
Land Fill Tax
0.3
0.4
0.5
0.5
0.5
0.6
Climate Change Levy
0.0
0.0
0.0
0.6
0.8
0.8
Aggregates Levy
0.0
0.0
0.0
0.0
0.2
0.3
Customs Duties and Levies 2.1
2.0
2.1
2.0
1.9
1.9
Total Customs and Excise
97.3
102.2
104.9
108.7
115.7
94.0
199899
199900
200001
200102
200203
200304
VED
4.6
4.9
4.3
4.3
4.3
4.8
Oil Royalties
0.3
0.4
0.6
0.5
0.4
0.0
Business Rates
14.7
15.4
16.3
17.9
18.5
18.4
Council Tax
12.2
13.1
14.1
15.2
16.9
18.8
Other Taxes and Royalties
7.5
7.9
8.5
9.4
10.2
11.2
Net Taxes and NICs conts
316.6
335.4
359.3
369.1
374.9
196.7
Interest and Dividends
5.0
4.3
6.0
4.7
4.5
4.4
FISCAL POLICY
17
VIVEKANAND COLLEGE FOR BBA Gross Operating Surplus and Rent
18.2
18.1
18.8
19.9
19.0
19.4
Other Receipts and ing Adjustments
-5.3
-0.7
-3.8
-5.7
-5.2
-1.8
Current Receipts
334.5
357.2
380.4
387.9
393.2
418.7
Government Income – Inland Revenue 2003-04
Government Income – Customs and Excise 2003-04
FISCAL POLICY
17
VIVEKANAND COLLEGE FOR BBA
Other Government Income 2003-04
FISCAL POLICY
17
VIVEKANAND COLLEGE FOR BBA
Fiscal policy is the economic term that defines the set of principles and decision of government in setting the level of public expenditure and how the expenditure is funded. In economics, fiscal policy is the use of government spending and revenue collection to influence the economy Fiscal policy can be contrasted with the other main type of economic policy, monetary policy, which attempts to stabilize the economy by controlling interest rates and the supply of money. The two main instruments of fiscal policy are government spending and taxation. Changes in the level and composition of taxation and government spending can impact on the following variables in the economy: •
Aggregate demand and the level of economic activity;
•
The pattern of resource allocation;
•
The distribution of income.
FISCAL POLICY
17
VIVEKANAND COLLEGE FOR BBA Fiscal policy refers to the overall effect of the budget outcome on economic activity. The three possible stances of fiscal policy are neutral, expansionary, and contractionary: •
A neutral stance of fiscal policy implies a balanced budget where G = T (Government spending = Tax revenue). Government spending is fully funded by tax revenue and overall the budget outcome has a neutral effect on the level of economic activity.
•
An expansionary stance of fiscal policy involves a net increase in government spending (G > T) through rises in government spending, a fall in taxation revenue, or a combination of the two. This will lead to a larger budget deficit or a smaller budget surplus than the government previously had, or a deficit if the government previously had a balanced budget. Expansionary fiscal policy is usually associated with a budget deficit.
•
A contractionary fiscal policy (G < T) occurs when net government spending is reduced either through higher taxation revenue, reduced government spending, or a combination of the two. This would lead to a lower budget deficit or a larger surplus than the government previously had, or a surplus if the government previously had a balanced budget. Contractionary fiscal policy is usually associated with a surplus.
Methods of funding Governments spend money on a wide variety of things, from the military and police to services like education and healthcare, as well as transfer payments such as benefits. This expenditure can be funded in a number of different ways: •
Taxation
•
Seignorage, the benefit from printing money
•
Borrowing money from the population, resulting in a fiscal deficit
•
Consumption of fiscal reserves.
•
Sale of assets (e.g., land). FISCAL POLICY
17
VIVEKANAND COLLEGE FOR BBA
Funding the deficit A fiscal deficit is often funded by issuing bonds, like treasury bills or consols. These pay interest, either for a fixed period or indefinitely. If the interest and capital repayments are too large, a nation may default on its debts, usually to foreign creditors.
Consuming the surplus A fiscal surplus is often saved for future use, and may be invested in local (same currency) financial instruments, until needed. When income from taxation or other sources falls, as during an economic slump, reserves allow spending to continue at the same rate, without incurring additional debt.
Economic effects of fiscal policy Governments use fiscal policy to influence the level of aggregate demand in the economy, in an effort to achieve economic objectives of price stability, full employment, and economic growth. Keynesian economics suggests that adjusting government spending and tax rates are the best ways to stimulate aggregate demand. This can be used in times of recession or low economic activity as an essential tool for building the framework for strong economic growth and working toward full employment. The government can implement these deficit-spending policies to stimulate trade due to its size and prestige. In theory, these deficits would be paid for by an expanded economy during the boom that would follow; this was the reasoning behind the New Deal. Governments can use budget surplus to do two things: to slow the pace of strong economic growth, and to stabilize prices when inflation is too high. Keynesian theory posits that removing funds from the economy will reduce levels of aggregate demand and contract the economy, thus stabilizing prices. Some classical and neoclassical economists argue that fiscal policy can have no stimulus effect; this is known as the Treasury View, which Keynesian economics rejects. The Treasury View refers to the theoretical positions of classical economists
FISCAL POLICY
17
VIVEKANAND COLLEGE FOR BBA in the British Treasury, who opposed Keynes' call in the 1930s for fiscal stimulus. The same general argument has been repeated by neoclassical economists up to the present. From their point of view, when government runs a budget deficit, funds will need to come from public borrowing (the issue of government bonds), overseas borrowing, or the printing of new money. When governments fund a deficit with the release of government bonds, interest rates can increase across the market. This is because government borrowing creates higher demand for credit in the financial markets, causing a lower aggregate demand (AD), contrary to the objective of a budget deficit. This concept is called crowding out; it is a "sister" of monetary policy. In the classical view, fiscal policy also decreases net exports, which has a mitigating effect on national output and income. When government borrowing increases interest rates it attracts foreign capital from foreign investors. This is because, all other things being equal, the bonds issued from a country executing expansionary fiscal policy now offer a higher rate of return. In other words, companies wanting to finance projects must compete with their government for capital so they offer higher rates of return. To purchase bonds originating from a certain country, foreign investors must obtain that country's currency. Therefore, when foreign capital flows into the country undergoing fiscal expansion, demand for that country's currency increases. The increased demand causes that country's currency to appreciate. Once the currency appreciates, goods originating from that country now cost more to foreigners than they did before and
FISCAL POLICY
17
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