Fiscal Policy Notes | EduRev

Economy Traditional for UPSC (Civil Services) Prelims

UPSC : Fiscal Policy Notes | EduRev

The document Fiscal Policy Notes | EduRev is a part of the UPSC Course Economy Traditional for UPSC (Civil Services) Prelims.
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INTRODUCTION

Fiscal policy is the guiding force that helps the government decide how much money it should spend to support the economic activity, and how much revenue it must earn from the system, to keep the wheels of the economy running smoothly.
For example: During an economic downturn, the government may decide to open up its coffers to spend more on building projects, welfare schemes, providing business incentives, etc. The aim is to help make more of productive money available to the people, free up some cash with the people so that they can spend it elsewhere, and encourage businesses to make investments. At the same time, the government may also decide to tax businesses and people a little less, thereby earning lesser revenue itself.
Fiscal Policy Notes | EduRevOBJECTIVES OF FISCAL POLICY

  • Economic growth: Fiscal policy helps maintain the economy’s growth rate so that certain economic goals can be achieved.
  • Price stability: It controls the price level of the country so that when the inflation is too high, prices can be regulated.
  • Full employment: It aims to achieve full employment, or near full employment, as a tool to recover from low economic activity.


IMPORTANCE OF FISCAL POLICY

  • In a country like India, fiscal policy plays a key role in elevating the rate of capital formation both in the public and private sectors.
  • Through taxation, the fiscal policy helps mobilise considerable amount of resources for financing its numerous projects.
  • Fiscal policy also helps in providing stimulus to elevate the savings rate.
  • The fiscal policy gives adequate incentives to the private sector to expand its activities.
  • Fiscal policy aims to minimise the imbalance in the dispersal of income and wealth.


Fiscal Policy Notes | EduRev


COMPONENTS OF FISCAL POLICY

1. Capital Account: A capital account is an account that includes the capital receipts and the payments. It basically includes assets as well as liabilities of the government.

Fiscal Policy Notes | EduRev

(a) Capital Expenditure: Capital expenditure is the expenditures made by the government to create physical or financial assets.

Capital expenditure either create an asset or causes a reduction on liabilities of the government.
Fiscal Policy Notes | EduRev
(b) Capital Receipts: Capital receipts are those which create a liability on the government or reduces the assets.
Fiscal Policy Notes | EduRev
2. Revenue Account: A revenue account is an account with a credit balance. It includes all the revenue receipts and the revenue expenditure of the government.
Fiscal Policy Notes | EduRev
(a) Revenue Expenditure: Revenue expenditure is the expenditure made by the government which creates neither an asset or liability. These expenditures are simply interest payments on debts by the government, grants to state governments and general expenses.

Revenue Expenditure is divided into:

  • Plan Expenditure which is made for central government plans (Five year plans), and other State and Union Territory plans.
  • Non Plan Expenditure which are general expenditures such as salaries, pensions, Interest payments.

Fiscal Policy Notes | EduRev
(b) Revenue Receipts: Revenue receipts are the current income to the government and they cannot be taken back from the government.

The Revenue receipts are divided into Tax and Non Tax Revenue: 

  • Tax Revenue is the main component of revenue receipts. It includes taxes and duties made by the government.

Tax Revenue mainly includes:
- Direct taxes (personal income tax, corporation tax) 
which fall directly on a person.
- Indirect taxes includes (excise duties and customs duties) which are on goods produced in the country or goods that are exported and imported.
 

  • Non Tax Revenue includes interest on loans of the government, dividends and profits on investment and foreign aid.

Fiscal Policy Notes | EduRev

DEFICITS AND ITS TYPES

What Is a Deficit?
A deficit is an amount by which a resource, especially money, falls short of what is required. A deficit occurs when expenses exceeds revenues, imports exceed exports, or liabilities exceed assets.
In a deficit, the total of negative amounts is greater than the total of positive amounts. In other words, the outflow of money exceeds the inflow of funds. A deficit can occur when a government, company, or individual spends more than is received in a given period, usually a year.
Fiscal Policy Notes | EduRev

(i) Current account deficit is when a country imports more goods and services than it exports.

Current Account = Trade gap + Net current transfers + Net income abroad Trade gap = Exports – Imports

(ii) A fiscal deficit occurs when a government's total expenditures exceed the revenue that it generates, excluding money from borrowings.

Fiscal Deficit = Total expenditure of the government (capital and revenue expenditure) – Total income of the government (Revenue receipts + recovery of loans + other receipts)

(iii) Primary deficit is the fiscal deficit of current year minus interest payments on previous borrowings.
Primary Deficit = Fiscal Deficit (Total expenditure – Total income of the government) – Interest payments (of previous borrowings)

(iv) Revenue deficit relates only to the government: It describes the shortfall of total revenue receipts compared to total revenue expenditures.

Revenue Deficit: Total revenue receipts – Total revenue expenditure.

(v) Effective Revenue Deficit the difference between revenue deficit and grants for creation of capital assets.

Effective Revenue Deficit: Revenue deficit - Grant for creation of capital assets.

Fiscal Responsibility and Budget Management Act (FRBMA), 2003

The objective of this FRBM Act is to impose fiscal discipline on the government.

It means fiscal policy should be conducted in a disciplined manner or in a responsible manner i.e. government deficits or borrowings should be kept within reasonable limits and the government should plan its expenditure in accordance with its revenues so that the borrowing should be within limits.

Targets under this FRBM Act

  • The FRBM rule specifies reduction of fiscal deficit to 3% of the GDP by 2008-09 with annual reduction target of 0.3% of GDP per year by the Central government.
  • Similarly, revenue deficit has to be reduced by 0.5% of the GDP per year with complete elimination to be achieved by 2008-09.

Fiscal Policy Notes | EduRev
METHODS TO CONTROL FISCAL DEFICIT

  • Printing Fresh Currency by RBI (May Cause Inflation)
  • Market Borrowing (May Cause Crowding Out of Private Investment)

Better Approach Is That Resources Should Be Raised from Taxes, User Charges, Disinvestment Etc.
Expenditure Control Should Not Involve Cost Cuts on Important Social Schemes Like Mgnrega Etc.

  • GST
  • Selective Disinvestment (Air India)
  • Broadening of Tax Base
  • Tax Buoyancy Etc

NK Singh Committee Recommendations (From Review Committee).
The FRBM Review Committee headed by former Revenue Secretary, NK Singh was appointed by the government to review the implementation of FRBM.


Major Recommendations of the N.K. Singh Committee

  • Public debt to GDP ratio should be considered as a medium-term anchor for fiscal policy in India.
  • The Committee advocated fiscal deficit as the operating target to bring down public debt.

Focus on Public Debt to GDP Ratio Target Of 60% By 2023 From Present Level Of 68-70% Fo Central Government And 20% For State Government.

  • The Committee also recommends that the central government should reduce its revenue deficit steadily by 0.25 percentage (of GDP) points each year, to reach 0.8% by 2023, from a projected value of 2.3% in 2017.
  • The Committee advocated formation of institutions to ensure fiscal prudence in accordance with the FRBM spirit.
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