6 Fiscal Policy.pdf

Business Environment PGEMP Dr. Pallavi Mody Email: [email protected] @SPJIMR Courage. Heart  Fiscal Policy @SPJIMR Courage. Heart  What is Fis...

Business Environment PGEMP Dr. Pallavi Mody Email: [email protected] @SPJIMR Courage. Heart  Fiscal Policy @SPJIMR Courage. Heart  What is Fiscal Policy? Fiscal Policy (FP) is the policy that is implemented through the government budget. It is the policy that deals with income (receipt) and spending (expenditure) of the government and thereby attempts to influence the macroeconomic variables. What is classical view on Government Budget? Leisseze Faire Balanced Budget Public goods Defence and internal law and order During the Great Depression of 1929-33 it was realized that markets fail to correct the situation. @SPJIMR Courage. Heart  What is Keynesian view on the Government Budget? Keynes analyzed the Problems of Great Depression and recognized the failure of C and I to revive the economy when income and employment had collapsed. The monetary incentive of rate of interest could not revive the economy. Keynes carved out a new role for government that balances the aggregate demand. AD=Y(GDP) = C+I+G+NX The governments everywhere follow the judicious mix of monetary and fiscal policy to stabilize the economy in the post Great Depression period 1930-2024. @SPJIMR Courage. Heart  What are the Objectives of Fiscal Policy? 1. Economic Growth 2. Stability Managing the economy through recession Managing the economy through overheating 3. Equity in income distribution 4. Direct resource allocation @SPJIMR Courage. Heart  What does fiscal policy do? GDP = C + I + G + NX GNI = C + I + G + NX + NR Fiscal Policy attempts to influence G in the aggregate demand function through the Government Budget. Government budget is statement of income and expenditure of the government. @SPJIMR Courage. Heart  How does fiscal policy function? Policy Variables Target Variables Taxation Real GDP Government Expenditure Employment Subsidies Consumption Savings Government Borrowings/Deficits Investment Equitable income distribution Promoting Exports Promoting Housing Specific goals @SPJIMR Courage. Heart  How does the fiscal policy help to combat the business cycles? For a Recession hit economy Increase the government expenditure Reduce the taxes Run a budget deficit There remains the risk of rising prices, creation of asset price bubble and weakening currency. Policy for overheated economy Reduce government expenditure Increase the taxes Run a surplus budget There remains the risk of pulling the economy into recession. Are there any dangers or limits to the use of the fiscal policy? @SPJIMR Courage. Heart  Budget is a statement of income and expenditure of the Government Government Budget Total Total Revenue Expenditure Current Capital Current Capital Revenue Revenue Expenditure Expenditure Tax Revenue Sale of Govt. Development Income Tax Non- Tax Revenue Assets Administrative Exp Corporate tax PSU Divided income (Disinvestment) Defence & Police Infrastructure GST Fees and penalties Recovery of loans Welfare & subsidy Education & Health Custom Interest Borrowings Research @SPJIMR Courage. Heart  Tax as a source of Government Revenue Tax is a major source of government revenue in most countries Tax coverage and compliance is extremely low in India Direct taxes: Income tax and Corporate tax contribute almost 50% of revenue Indirect tax, GST is showing buoyancy Non-tax revenue is abt 25% of tax Tax –GDP ratio in 2024-25 touches 11.7% revenue @SPJIMR Courage. Heart  PSU Disinvestment For the first four decades after Independence, massive investments were made in PSUs in basic & key industries. Privatization was considered important part in Economic Reforms of 1991 Three ways of Privatization Minority sell of shares Majority sell of shares Complete sell of shares How should the proceeds from disinvestment be spent by Government? http://www.bsepsu.com/historical-disinvestment.asp @SPJIMR Courage. Heart  Government Expenditure Revenue Expenditure Central Government Expenditure to GDP ratio over 10 years Administrative Defence Police Subsidy Interest Capital (Developmental) expenditure Infrastructure Health Education Research @SPJIMR Courage. Heart  Trends in Deficits Fiscal Deficit = Government Borrowings Revenue Deficit = Revenue Expenditure – Revenue Receipt Effective Revenue Deficit = Revenue Deficit - grants in aid for creating capital assets Primary Deficit = Fiscal deficit – Interest Payments @SPJIMR Courage. Heart  Why is fiscal deficit considered harmful? Impact on Interest Rates: When government borrows huge sums of money to finance the deficit, the increased demand for funds, raises the interest rates. High fiscal deficit that raises the interest rates , “crowds out” private investment. Impact on Inflation: High fiscal deficit increases demand ahead of supply that builds inflationary pressures. Monetized fiscal deficit increases the money supply which builds inflationary pressures. Impact on public Debt: High ‘Fiscal Deficit’ or ‘Government Borrowings’ over a period of time accumulates the burden of Public Debt. Thus, Fiscal deficit as % of GDP and Public Debt as % of GDP are important macroeconomic indicators. https://www.cia.gov/library/publications/the-world-factbook/rankorder/2186rank.html @SPJIMR Courage. Heart  Public Debt as % of GDP Tax GDP ratio is estimated to be 82% in 2023 @SPJIMR Courage. Heart  Takeaway? @SPJIMR Courage. Heart