Public Administration CL 2

 

Fiscal Policy

Fiscal Policy deals with the revenue and expenditure policy of the Govt.

Fiscal derives from the Latin noun fiscus, meaning "basket" or "treasury." In ancient Rome, "fiscus" was the term for the treasury controlled by the emperor, where the money was literally stored in baskets and was collected primarily in the form of revenue from the provinces.

It is the policy taken out by the government regarding the use of revenue (taxation) and expenditure among various sectors to influence the country's economy and achieve welfare objectives like economic growth and development full employment,price stability and balanced demand and supply system within and outside. The fiscal policy is a statement of the same. And the most visible tool of the fiscal policy in action is the 'Budget'. Monetary policy and Fiscal Policy are complementary and equally necessary in managing a nation's economy as is already explained above under Monetary Policy.

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Definition of Fiscal Policy

When the government of a country employs its tax revenue and expenditure policies to influence the overall demand and supply for commodities and services in the nation’s economy is known as Fiscal Policy. It is a strategy used by the government to maintain the equilibrium between government receipts through various sources and spending over different projects. The fiscal policy of a country is announced by the finance minister through budget every year.

If the revenue exceeds expenditure, then this situation is known as fiscal surplus, whereas if the expenditure is greater than the revenue, it is known as the fiscal deficit. The main objective of the fiscal policy is to bring stability, reduce unemployment and growth of the economy. The instruments used in the Fiscal Policy are the level of taxation & its composition and expenditure on various projects.

There are three possible ways of Fiscal policy in the Public domain-
1) Neutral Fiscal policy - It implies a policy for a balanced budget where government spending is equal to the revenue/tax collected and so there is status quo in the economy.

2) Expansionary Fiscal Policy - Where govt. spending exceeds taxation revenue leading to a larger budget deficit.

3) Contractionary fiscal policy - Where govt. spending is less then what is collected as revenue. It is usually associated with a budget surplus remaining with the govt.

Various combinations of fiscal policies

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Tools of fiscal policy:- Taxation Public expenditure Public debt Plan and Non-Plan Expenditure Public Debt means debt on the Govt -It is accumulated borrowing of the Govt Components of Public Debt Internal Debt or liabilities Other Liabilities External debt

1.    Reduction in Government Spending and no Change in Tax Rates (Contractionary fiscal policy): This policy is useful in moderate inflation, which though is part of government’s priority, is not the foremost objective. This would affect the growth little and sometimes even boost growth due to cut in inflation.

2.    Reduction in Government Spending and Increase in Tax Rates (Contractionary fiscal policy): This policy is useful in high inflation, when curbing inflation is the foremost objective, even above the economic growth in the short run.

3.    Rigid Government Spending and Increasing Tax Rates (Contractionary fiscal policy): This is used when economy is overheated (When a prolonged period of good economic growth and activity causes high levels of inflation as producers overproduce and create excess production capacity in an attempt to capitalize on the high levels of wealth) due to too much excitement on the part of investors. Increase in taxes and interest rates (through monetary policy) would curb the investments in short-run and prevent economy from going into recession after over-heating.

4.    Reduction in Government Spending and an Equivalent Reduction in Taxes (Balanced Fiscal Policy): This, is a balanced budget approach, when a government decides to reduce its size and level of its intervention in economy, then this policy can be adopted. It simply means government is managing less money and hence less impact on markets and business.

5.    Increase in government spending and tax rates (Balanced fiscal policy): This would be opposite to the previous policy as it would increase the size of government. A government on the path of socialization would adopt such policy.

6.    Increase in government spending and decrease in tax rates (Expansionary fiscal policy): This would be adopted to give economy a stimulus though injection of funds, first the government decreases taxes and leaves more income with people to spend and invest, then it also spends more to give further boost to demand through additional income generated through government work. This is only possible in short-run as this policy leads to massive deficits and thus, should be used when situation is alarming.

1.    Consolidated Fund of India This is the most important of all accounts of the government. o     This fund is filled by: § Direct and indirect taxes § Loans taken by the Indian government § Returning of loans/interests of loans to the government by anyone/agency that has taken it o The government meets all its expenditure from this fund. 2.    The government needs parliamentary approval to withdraw money from this fund. The provision for this fund is given in Article 266(1) of the Constitution of India. Each state can have its own Consolidated Fund of the state with similar provisions. The Comptroller and Auditor General of India audits these funds and reports to the relevant legislatures on their management.

6.    Increase in government spending and no change in tax rates (Expansionary fiscal policy): This is also a stimulus policy (through public sector), but a more moderate one, which can be used for a bit longer compared to previous.

7.    Rigid Government spending and decrease in tax rates (Expansionary fiscal policy): This policy is usually adopted to give incentive to private sector to invest and boost growth. Again, a short-run stimulus policy like previous two.

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Tools of fiscal policy

Components of Spending Maintenance (including staff salaries): This component can’t be altered in short-run and hence is hardly a part of policy making, however, in long-run, through VRS and reducing new jobs in public sector or vice versa, this expenditure can be altered.

Loan payments: This again is a component, which can’t be touched in short-run, however, governments in long-run can reduce these payments or eliminate them by running the budget surplus.

Welfare schemes: These are one of the policy options that once introduced can’t be removed due to their populist nature. Similarly, in most of the cases these are necessary too and important instrument of social welfare and economic growth. However, it is the implementation part, which is key, as these schemes generally suffer from poor implementation and massive corruptions and loopholes. Thus, despite being meritorious expenditure in nature, these at time appears as waste.

Wasteful expenses: Needless to say these are the expenditures that must be curbed with immediate effect; however, no government in world has neither shown the intention to curb them, though there are efforts to reduce them from time to time under public pressure. For example, full page government advertisements in newspapers.

 

Contingency Fund of India ·         Provision for this fund is made in Article 267(1) of the Constitution of India. ·         Its corpus is Rs. 500 crores. ·         The Secretary, Finance Ministry holds this fund on behalf of the President of India. ·         This fund is used to meet unexpected or unforeseen expenditure. ·         Each state can have its own contingency fund.

Components of Earning

Tax: single: Single most important source on government revenue is also a very important policy measure as elaborated in the policy combinations above.

Borrowing:  Borrowing is a necessary source of funds, though not a desirable one. Particularly, in developing countries, as tax/GDP ratio is low due to less per capita income. However, it becomes an important part of monetary policy as well due to its impact on interest rates and credit creation and thus, overall money supply.

Proceeds from sale/lease of assets: This is a both a one-time and regular source of income. For example, lending government buildings for private use, or other assets such as telecom spectrum or lease of a mine block for certain years, is a regular source of income, whereas sale of PSUs is a onetime income. These however, are good sources of revenue, as they provide government more room to spend without increasing taxes.

 Profits from PSU: Profits from PSUs can also be a potential source of revenue, however, since most of PSUs are generating losses, Indian government usually ends up subsidizing them. At times PSUs are deliberately kept in losses to keep prices low and ensure wider outreach for social welfare, example, PSU banks in pre-reform era and post-offices. Similarly, at other times, they are in losses due

Public Accounts of India This is constituted under Article 266(2) of the Constitution. ·         All other public money (other than those covered under the Consolidated Fund of India) received by or on behalf of the Indian Government are credited to this account/fund. This is made up of: ·         Bank savings account of the various ministries/departments  ·         National small savings fund, defense fund ·         National Investment Fund (money earned from disinvestment) ·         National Calamity & Contingency Fund (NCCF) (for Disaster Management) ·         Provident fund, Postal insurance, etc. ·         Similar funds                 The government does not need permission to take advances from this account.                 Each state can have its own similar accounts

to inefficiency and wasteful expenditure. Most striking case in India, is of ministerial corruption to keep PSUs in loss deliberately to benefit private sector, for example, CAG report says that, Indian Airlines was deliberately kept in losses by avoiding flights on profitable routes to benefit private airlines during UPA government’s rule. Similarly, in previous NDA government, BSNL was deliberately pushed into loss, by increasing tariffs to provide competitive edge to a newly launched company by one of the biggest business conglomerate in India.

 

Types of Govt. funds

• Consolidated Fund of India
• Contingency Fund
• Third Fund also called Public accounts

To know more about the different government funds in detail, refer to the linked article.

Debt Trap – Situation where the borrower has to borrow again for the payment of an instalment on the previous debt. A borrower unable to meet debt service obligations without borrowing is known to be in debt trap.

Tools of fiscal policy:

• Taxation
• Public expenditure
• Public debt
• Plan and Non-Plan Expenditure

Public Debt means debt on the Govt. -It is accumulated borrowing of the Govt.

Components of Public Debt

• Internal Debt or liabilities
• Other Liabilities
• External debt

Types of Govt. funds

• Consolidated Fund of India
• Contingency Fund
• Third Fund also called Public accounts

Fiscal Federalism

It refers to the distribution of resource between centre and states.

Distribution of taxes between centre and states is mentioned in the 7^th schedule of our constitution.

There are 3 lists where the taxes are distributed

• Union List
• State List
• Concurrent List

Taxes are classified under 5 categories

• Central taxes or Central Govt. Taxes
• Shareable taxes – Income tax and Union Excise duty
• State taxes
• Taxes imposed and collected by Centre and appropriated by the state
• Taxes imposed by centre but collected and used by state – Stamp duties and agriculture properties.

This 5 classification arrangement has been amended and the last two categories have now been merged. Now they are called central shareable taxes. 10^th Finance commission headed by K.C. Pant recommended these amendments.

By the 80^th constitution amendment in 2003, the first two taxes were merged leaving all taxes shareable.

Fiscal Responsibility and Budget Management (FRBM) Act, 2003

In the 1980s, in India there was a severe deterioration in the fiscal situation culminating in the balance of payments crisis of 1991. Subsequently, economic reforms were introduced in 1991 in which fiscal consolidation emerged as one of the key areas of reforms. It had a good start in the early nineties, the fiscal consolidation started faltering after 1997-98. The fiscal deficit zoomed up after 1997-98.

In this context, the Government introduced Fiscal Responsibility and Budget Management (FRBM) Act, 2003 to put a check on the deteriorating fiscal situation. The FRBM act was born out of the need to institutionalize a new fiscal discipline framework. The FRBM Bill 2000 was introduced by previous NDA government in the parliament to institutionalize the fiscal discipline at both the centre and state level. However, the bill took three years to become an act.

What is Fiscal Responsibility and Budget Management (FRBM) Act?

The FRBM Act is a fiscal sector legislation enacted by the government of India in 2003. It wanted to ensure fiscal discipline for the centre by setting targets including reduction of fiscal deficits and elimination of revenue deficit. It is a legal step to ensure fiscal discipline and fiscal consolidation in India.

The FRBM Act attempted to fix up responsibility on the government to strengthen the framework for adopting a prudent fiscal policy. It paves the way for accomplishing macroeconomic stability.

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Major Provisions of the FRBM Act, 2003

• The FRBM rule set a target reduction of fiscal deficit to 3% of the GDP by 2008-09. This will be realized with an annual reduction target of 0.3% of GDP per year by the Central government.
• Revenue deficit has to be reduced by 0.5% of the GDP per year with complete elimination by 2008-09.
• Reduction of Public Debt
• The government has to take appropriate measures to reduce the fiscal deficit and revenue deficit so as to eliminate revenue deficit by 2008-09 and thereafter, sizable revenue surplus has to be created.
• It mandated setting annual targets for reduction of fiscal deficit and revenue deficit, contingent liabilities and total liabilities.
• The government shall end its borrowing from the RBI except for temporary advances.
• The RBI was supposed to not subscribe to the primary issues of the central government securities after 2006.
• The revenue deficit and fiscal deficit may exceed the targets specified in the rules only on grounds of national security, calamity and other exceptional grounds to be specified by the Central government.

Major objectives of the FRBM Act

• Reduction of fiscal deficit and revenue deficit;
• To achieve inter-generational equity in fiscal management by reducing the debt burden of the future generation;
• Achieving long-term macroeconomic stability;
• Better coordination between fiscal and monetary policy;
• Transparency in fiscal operation of the Government.

Implementation of the FRBM Act

There was an improvement in the fiscal performance of both centre and states because of the implementation of the FRBM Act. The States achieved the targets much ahead of the prescribed timeline. The central government was also on the right path of achieving this objective in the right time. However, due to the global financial crisis, this was suspended. Consequently, the fiscal consolidation as mandated in the FRBM Act was put on hold in 2007-08.The crisis period called for increased level of expenditure by the government to boost demand in the economy. As a result of fiscal stimulus, the government has moved away from the path of fiscal consolidation.

Amendments to FRBM Act

The amendments were made to the Fiscal Responsibility and Budget Management Act, 2003 by the Finance Act, 2012. Consequently, it was decided that the Central government shall lay another document - the Medium Term Expenditure Framework Statement (MTEF) - before both Houses of Parliament in the Session immediately following the Session of Parliament in which Medium-Term Fiscal Policy Statement, Fiscal Policy Strategy Statement and Macroeconomic Framework Statement are laid.

The amendments to the FRBM Act were introduced subsequent to the recommendations of 13th Finance Commission. Concept of “Effective Revenue Deficit” and “Medium Term Expenditure Framework” statement were the two important features of amendment to FRBM Act in the direction of expenditure reforms. Effective Revenue Deficit is the difference between revenue deficit and grants for creation of capital assets. This was expected to help in the reduction of consumptive component of revenue deficit and create space for increased capital spending.

As per the amendments in 2012, the Central Government was supposed to take appropriate measures to reduce the fiscal deficit, revenue deficit and effective revenue deficit to eliminate the effective revenue deficit by the 31st March, 2015. Subsequently, it was supposed to build up adequate effective revenue surplus and also to reach a revenue deficit level of not more than two percent of Gross Domestic Product (GDP) by the 31st March, 2015.

Further, it was also stipulated that the Central Government may entrust the Comptroller and Auditor-General of India to periodically review the compliance of the provisions of FRBM Act. Such reviews shall be laid on the table of both the Houses of Parliament.

Again by the Finance Act 2015, the target dates for achieving the prescribed rates of effective revenue deficit and fiscal deficit were further extended. Earlier the effective revenue deficit had to be eliminated by March 2015. This target date was extended by three years till March 2018. The 3% target of fiscal deficit to be achieved by 2016-17 was extended by one year to the end of 2017-18.

Criticism of the FRBM Act

1. The FRBM Act was totally undemocratic in its approach as it denied freedom to future governments in respect of fiscal management. Its aim was to bind future governments to a pre-specified fiscal policy framework which was in a way an anti-democratic measure.
2. It has been held that in order to meet its revenue deficit targets the government has to cut down on social sector expenditures on important segments like health and education.
3. It led to low levels of capital expenditure.
4. It leads to neglect of equity as well as economic growth. Under the FRBM Act, 2003 the dice is heavily loaded against investments in not only human resources development, but also infrastructure. This is because of the view that the infrastructure investments on account of their large externalities do not directly contribute to the government revenue.
5. The FRBM Act did not address the problem of financing public expenditure in a serious manner. In the 1990s the tax-GDP ratio declined significantly. Hence, the need to raise this ratio should have received top priority under the legislation. But this did not happen. There was no target under the legislation for the tax-GDP ratio. Actually the FRBM Act could have provided for raising tax-GDP ratio by making improvements in tax administration and collections and effective measures to rein in tax evasion.
6. THE FRBM Act fails to recognise the fact that borrowing from the RBI on a moderate scale for financing government investment serves useful purpose especially in developing countries like India.
7. It makes a flawed assumption that lower fiscal deficits lead to higher and more sustained growth. This is not always true.
8. It also makes a flawed assumption that large fiscal deficits necessarily lead to higher inflation. However, economists point out that inflation is caused by the excess of aggregate demand over aggregate supply, which may come from public or private sectors. Hence, fiscal deficit must not be blamed all the time for higher inflation.

Again it makes a flawed assumption that large fiscal deficit increases external vulnerability of the economy. However, economists point out that the external vulnerability depends more on capital and trade account convertibility and the perception of international finance rather than fiscal discipline. Therefore, capital flight may begin at a time when fiscal deficit is low. The higher fiscal deficit may not necessarily cause external crisis. In India we have managed to build large foreign exchange reserves despite the fact that the fiscal deficit has not come down.

K. Singh Committee Review of FRBM

The Union Budget 2016-17 proposed to constitute a Committee to review the implementation of the FRBM Act and give its recommendations on the way forward. Some experts opined that instead of fixed numbers as fiscal deficit targets, it may be better to have a fiscal deficit range as the target. This would give necessary policy space to the Government to deal with dynamic situations. The Budget explicitly stated that the government is committed to fiscal prudence and consolidation. However, the uncertainty and volatility have become the new norms of global economy and in this context it has become appropriate to review the FRBM Act.

In May 2016, the government constituted the Committee under the chairmanship of Shri N.K. Singh, former Revenue and Expenditure Secretary and former Member of Parliament. The other members of the Committee were Dr. Urjit R. Patel, Governor, Reserve Bank of India (RBI), Shri Sumit Bose, former Finance Secretary, Dr. Arvind Subramanian, Chief Economic Adviser and Dr. Rathin Roy, Director, National Institute of Public Finance & Policy (NIPFP).

The Committee was supposed to comprehensively review the existing FRBM Act in the light of contemporary changes, past outcomes, global economic developments, the best international practices. It was also tasked with giving a future fiscal framework and roadmap for the country. Later the Terms of Reference of the Committee were enlarged to seek the Committee’s views on certain recommendations of the Fourteenth Finance Commission and the Expenditure Management Commission. These primarily related to strengthening the institutional framework on fiscal matters as well as certain issues connected with new capital expenditures in the budget. The N.K. Singh Committee submitted its report in January 2017.

Major Recommendations of the N.K. Singh Committee

1. Public debt to GDP ratio should be considered as a medium-term anchor for fiscal policy in India. The combined debt-to-GDP ratio of the centre and states should be brought down to 60 per cent by 2023 (comprising of 40 per cent for the Centre and 20% for states) as against the existing 49.4 per cent, and 21per cent respectively.
2. Fiscal deficit as the operating target: The Committee advocated fiscal deficit as the operating target to bring down public debt. For fiscal consolidation, the centre should reduce its fiscal deficit from the current 3.5% (2017) to 2.5% by 2023.
3. Revenue deficit target: 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 advised government not to finance government’s day to day expenditure through borrowings. Revenue deficit implies financing of government’s day today activities from borrowings.
4. Formation of Fiscal Council to advice the government: The Committee advocated formation of institutions to ensure fiscal prudence in accordance with the FRBM spirit. It recommended setting up an independent Fiscal Council. The Council will provide several advisory functions.
5. Escape Clause to accommodate counter cyclical issues: The Committee points out that there are disadvantages with set fiscal deficit target if some economic instability like an external crisis affects the Indian economy. For example, the government has to spend more during the time of a recession and hence it need not restrict its borrowing to keep the fiscal deficit target. Hence, the committee advocates countercyclical covers in fiscal policy while following the FRBM. Here, the committee recommends fiscal flexibilities to go above or below the fiscal deficit targets in the form of ‘escape clauses’. The Committee set 0.5% as escape clause for fiscal deficit target.
6. Fiscal consolidation responsibility for states: The Committee observes that state government’s fiscal position is important after greater resource transfer to them especially in the light of 14^th Finance Commission award. Now, total state expenditures (as a percent of GSDP) is even greater than the Centre. Hence, fiscal consolidation should also be made by the states. They should bring down their debt target to 20% of GDP from the current 21%.
7. Congruence of Fiscal and Monetary Policy: The FRBM Review Committee observed that both monetary and fiscal policies must ensure growth and macroeconomic stability in a complementary manner. For this, the inflation targeting regime and fiscal rules have to interact with each other.

Conclusion

Despite all its shortcomings the FRBM act rightly emphasised upon the value of prudent fiscal management. There were amendments in the act earlier and now the FRBM Review committee has made some welcome changes. This should be followed by both the central government and state governments in the right spirit as the act provides for a welcome fiscal discipline and greater transparency in fiscal operations.

Difference Between Fiscal Policy and Monetary Policy

The economic position of a country can be monitored, controlled and regulated by the sound economic policies. The fiscal and monetary policies of the nation are the two measures, which can help in bringing stability and developing smoothly. Fiscal policy is the policy relating to government revenues from taxes and expenditure on various projects. Monetary Policy, on the other hand, is mainly concerned with the flow of money in the economy.

Fiscal policy alludes to the government’s scheme of taxation, expenditure and various financial operations, to attain the objectives of the economy. On the other hand, monetary policy, scheme carried out by the financial institutions like the Central Bank, to manage the flow of credit in the country’s economy. Here, in this article, we provide you all the differences between the fiscal policy and monetary policy, in tabular form.

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The following are the major differences between fiscal policy and monetary policy.

1. The policy of the government in which it utilises its tax revenue and expenditure policy to influence the aggregate demand and supply for products and services the economy is known as Fiscal Policy. The policy through which the central bank controls and regulates the supply of money in the economy is known as Monetary Policy.
2. Fiscal Policy is carried out by the Ministry of Finance whereas the Monetary Policy is administered by the Central Bank of the country.
3. Fiscal Policy is made for a short duration, normally one year, while the Monetary Policy lasts longer.
4. Fiscal Policy gives direction to the economy. On the other hand, Monetary Policy brings price stability.
5. Fiscal Policy is concerned with government revenue and expenditure, but Monetary Policy is concerned with borrowing and financial arrangement.
6. The major instrument of fiscal policy is tax rates and government spending. Conversely, interest rates and credit ratios are the tools of Monetary Policy.
7. Political influence is there in fiscal policy. However, this is not in the case of monetary policy.

Comparison Chart

Characterstic	MONETARY POLICY	FISCAL POLICY
Meaning	The tool used by the central bank to regulate the money supply in the economy is known as Monetary Policy.	The tool used by the government in which it uses its tax revenue and expenditure policies to affect the economy is known as Fiscal Policy.
Administered by	Central Bank	Ministry of Finance
Nature	The change in monetary policy depends on the economic status of the nation.	The fiscal policy changes every year.
Related to	Banks & Credit Control	Government Revenue & Expenditure
Focuses on	Economic Stability	Economic Growth
Policy instruments	Interest rates and credit ratios	Tax rates and government spending
Political influence	No	Yes

Conclusion

The main reason of confusion and bewilderment between fiscal policy and monetary policy is that the aim of both the policies is same. The policies are formulated and implemented to bring stability and growth in the economy. The most significant difference between the two is that fiscal policy is made by the government of the respective country whereas the central bank creates the monetary policy.

 

 

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