Chapter 2 Budget Deficit and Taxation.pdf

Chapter 2: Budget Deficit and Taxation 10/26/23 10:17 PM Notes Government needs finance to support all economic activities. The expenditure and revenue statement by the govt forms t...

Chapter 2: Budget Deficit and Taxation 10/26/23 10:17 PM Notes Government needs finance to support all economic activities. The expenditure and revenue statement by the govt forms the budget Goals: Process to prepare the budget Size of the budget How budget expenditure is financed Are budget deficits bad for the country What should everyone be aware of in a budget Budget presented in Feb to allow for enough time for approval in both houses and implement by April What is the 1st. timing of the budget in India? Railway budget is separately presented Finance Minister speech has 2 parts: What is part of the Part A budget? Economic survey of the year gone by Part B Budget presentation Annual Financial statement Consists of estimated receipts and spending operated through 3 separate accounts: a. Consolidated fund - all revenues and loans raised/recovered. Needs parliament approval for spending b. Contingency fund: President of India to meet unforseen expenditures (ex. disasters/accidents) Post facto expense from Consolidated fund c. Public account: PPF, SSC. Dont belong to govt and has to be returned to the people. What is the size of the 2010-11: Over 1100 thousand crores ($246 million) budget? receipts are only 682 thousand crores GDP was 7800 thousand crores Government participation in the economy is small (only 14%). For developed countries about 30% Note: 2023-24 budget: 4503 thousand crores 2023-24 GDP 40 lakh crore ($3.8 trillion) Expenditure, Revenue and Deficit Revenue Expenditure What is revenue All expenditures for functioning of judiciary, maintaining law, admin, salaries, subsidies and expenditure? pension etc. Essentially all expenditures that do not lead to creation of assets and are used for the normal functioning of the government. Capital Expenditure what is Capital Expenditure? Includes asset creation expenditures for providing public goods ex. Dams, bridges and roads, plants and machineries for government sector. Other side of the budget : Government Receipts Revenue Receipts Tax receipts Non-tax receipts Examples: Stamp duty Dividends from PSUs Capital Receipts Grants received Loans recovered Non debt Capital Receipts: Occasional disinvestment proceeds by selling stake in PSU (Think LIC, ONGC etc. ) What does low % of Low tax and non tax revenue vs expenditure revenue wrt expenditure Doesnt mean govt interference in economy is low. mean? Could mean govt is not efficient in collecting sufficient revenue to balance expenses Borrowing What are the options to Needed to cover deficit borrow? 3 Options 1. Domestically from the public 2. External financial institutions (not good - external exposure) 3. Borrow from central bank (extreme conditions) - why is this bad? Difference: Difference between ○ Equivalent to leakage real and nominal GDP Types of Deficit 1. Revenue deficit Difference between revenue expenditure and revenue receipts Reflects poorly on management of govt finances Implies govt has to borrow money to finance administrative activities which do not create any assets 2. Fiscal deficit Difference between Govt's total expenditure and total non-debt receipts. § Indicates govt has exhausted all options for financing its expenditure § This deficit may be justified as long as the expenditure are being incurred to finance creation of national assets. § Concerning if incured year after year and cumulative effect can get it out of control 3. Primary deficit This is the difference between the fiscal deficit and interest payments incurred in earlier years. § Can be used by current governments to indicate that interest payments are not of its making. Size and composition of debt See Appendix for latest numbers. See transition above. Global recession and meltdown. Housing crisis Govt had to cut duties and increased expenditure for stimulus. High pcentage of Revenue / Fiscal deficit percent indicates govt not working efficiently. Money spent on admin stuff and not for asset creation. Try to get a similar stats for last 5 years! 1. Negative impact of heavy fiscal deficit 1. Crowding out of private investments What is crowding out of private investments by public borrowing? 2. Ceteris Paribus, as govt borrows more from credit market it may have to borrow from external sources TAXATION AND FISCAL CONSOLIDATION Principles of Taxation Taxes are necessary to finance the business of the Government but not popular for people and firms. What are the tradeoffs or principles to achieve a balance. 1. Benefit Principle Tax in proportion to the benefit received from the government 2. Ability to Pay Principle Pay in proportion to income and wealth (India :( ) 3. Horizontal and Vertical Equity Principles Those who are equal must be taxes equally. Those who are unequal must be taxed unequally. Overarching principle Taxes should have minimal impact on free market consumption and production decisions Usually Goverment use a combination of above principles ○ Toll roads - benefits principle and horizonal equity (same benefit - same tax) ○ Income tax - ability to pay ○ Tax on Essential Food - Has to be minimal to ensure vertical equity Types of Taxes 1. Direct Taxes Income tax, wealth tax (in line with ability to pay) Progressive § Rich pay higher proportion and higher amount 2. Indirect taxes Sales tax, excise duty, property tax etc Easier to charge since it is at point of sale Regressive: Depends on price of good or service Rich pay lower percentage compared to poor. But also in line with equity Composition of Taxes Start with higher indirect taxes since income base was low and informal sector was large. Gradually increase IT base - PAN card etc. Look for 2020-21 numbers for comparison Fiscal Deficit Target 3% Revenue Deficit Target 0% Summary: Budget 2 Parts ○ Part A - Economic survey of year gone by ○ Part B - Annual financial statement § Operated through □ Consolidated Fund □ Contingency fund □ Public fund ○ Revenue Expenditure and Capital Expenditure to offset revenue receipts and capital receipts Deficits Fiscal (Asset creation. Target 3% of GDP) Revenue (Admin Related. Goal 0) Taxation Direct and Indirect Regressive and Progressive Laffer Curve (optimum taxation, inverse bell curve) Definitions Ability to Pay Principle: The taxes which people pay should relate to their earning capacity, income and wealth. Benefit Principle: Individuals and firms must be taxed in proportion to the benefits they receive from the government. Capital Expenditure: Asset-creating expenditure on providing public goods, such as, dams, bridges and roads, and plants and machineries built for use in the government sector. Capital Receipt: The debt receipt, which includes domestic borrowings from the public, external borrowings, and occasional borrowing from the central bank of the country. And the non-debt receipt which comprises net grants received by the government, loan recoveries, and disinvestment proceeds earned by selling PSUs. Direct Tax: Taxes charged directly on individuals and firms. Fiscal Deficit: The difference between the government’s total expenditure and the total non-debt receipts. GDP: The Gross Domestic Product (GDP) at market prices, defined as the value of final goods and services at current market prices produced in a given period (generally one year) within the territorial boundaries of a country. Also referred to as the Nominal GDP. Horizontal Equity: Those who are equal should be taxed equally. Indirect Tax: Taxes that are charged on goods and services and, therefore, are charged indirectly on individuals and firms. Laffer Curve: An inverted U-shaped graphic relation between tax revenue (on the y-axis) and tax rate (on the x-axis) attributed to Professor Arthur Laffer. Primary Deficit: The difference between Fiscal Deficit and the interest on the previous government’s debt. Progressive Income Tax: Income tax where a higher income attracts a higher proportion of income tax. Proportional Income Tax: Income tax where all taxpayers pay exactly the same proportion of their income as tax. Regressive Income Tax: Income tax where a higher income attracts a lower proportion of income tax. Revenue Deficit: The difference between revenue expenditure and revenue receipts. Revenue Expenditure: Expenditure incurred on the functioning of the judiciary, maintaining law and order, routine administration, salaries, subsidies, pensions for administrative staff, and payments on past debts. Revenue Receipt: Receipt from taxes and non-tax receipts, such as, stamp duty, fees, and dividends, if any, from PSUs. Value Added Tax: Tax levied on the difference between sales proceeds and material cost. Essentially, it is a tax on the factor income generated in an economic activity. Vertical Equity: Those who are unequal must be taxed unequally. Appendix FY 2010 FY 2011 FY 2012 FY 2013 FY 2014 FY 2015 FY 2016 FY 2017 FY 2018 FY 2019 FY 2020 FY 2021 FY 2022 FY 2023 FY 2024 * Fiscal 6.60 4.90 5.90 4.90 4.50 4.10 3.90 3.50 3.50 3.40 4.60 9.20 6.70 6.40 5.80 deficit Revenue 5.30 3.30 4.50 3.70 3.20 2.90 2.50 2.10 2.60 2.40 3.30 7.30 4.40 4.10 2.90 deficit Effective - - 3 2.50 1.90 1.90 1.50 1 1.50 1.40 2.40 6.30 4.10 2.80 1.80 revenue deficit Primary 3.20 1.80 2.80 1.80 1.10 0.90 0.70 0.40 0.40 0.40 1.60 5.70 3.30 3.00 2.30 deficit