fiscal policy trends in india: since independence

Expenditure Taxes Deficits

Fiscal Policy Trends in India

1

Agenda of the PresentationSection

C

Objectives of Fiscal Policy in India

Three Possible Stances & Methods of Funding

Two Main Instruments of Fiscal Policy

Post Independence: India’s Fiscal Policy

India’s Fiscal Policy: 1970-1990

Post Reform (1991): Fiscal Policy Changes , Trends

Suggestions & Budget Expectations2

Group 06

Fiscal Policy & its Objectives in India

Fiscal policy refers to the overall effect of thebudget outcome on economic activity.

The idea of using fiscal policy to combatrecessions was introduced by John MaynardKeynes in the 1930s

“Fiscal policy deals with the taxation and expenditure decisions of the government. These include, tax policy, expenditure policy, investment or

disinvestment strategies and debt or surplus management.”- Kaushik Basu ( Former Chief Economic Adviser )

Fisc : A French word means ‘Treasure of Government’.

Fiscal Policy= Revenue + Expenditure Policy by Government of India

Related to ‘Development Policy’ of the Nation.

3

Fiscal Policy & its Objectives in India

Increase in capital formation

To stabilize the growth rate & degree of growth of an economy

To achieve desirable price level

To achieve desirable consumption level

To achieve desirable employment level

To achieve desirable income distribution

To maintain equilibrium in the BOP

4


A Neutral position applies when the budget outcome has neutral effect on the level of economic activity where the govt. spending is fully funded by the revenue collected from the tax. Where, G = T

An Expansionary position is when there is a higher budget deficit where the govt. spending is higher than the revenue collected from the tax. Where, G > T

An Contractionary position is when there is a lower budget deficit where the govt. spending is lower than the revenue collected from the tax. Where, G < T

G-Govt. SpendingT-Tax Revenue

5


Methods of FundingGovernments spend money on a wide variety of things, from the military to services like education and healthcare, as well as transfer payments.

This expenditure can be funded in a number of different ways: Taxation Revenue Seigniorage, the benefit from printing money Borrowing money Consumption of fiscal reserves Sale of fixed assets (e.g., land) Types of Fiscal

Policies

Discretionary policy

Automatic stabilisation

6


Post-independence, with the gradual abatement of political and economic uncertainty, stimulating and accelerating growth was one of the primary objectives of fiscal policy.

In the then nascent economy where the income levels and financial savings were low, the fiscal assumed the responsibility of creating the capital base in the form of infrastructure to stimulate growth.

Thus, India embarked on a planning process since 1950 (the year of establishment of Planning Commission of India) which assigned a large role to the public sector and taxation was made the mainstay of public finances.

Conservative fiscal policy to keep deficits under control.

7


1953

Taxation Enquiry Commission

1957-58

Wealth Tax, Expenditure Tax, Gift Tax

1960-70

High Personal & Marginal Income Tax Rates

1960-80

Tax Revenue to GDP Ratio Improved from 6.3 % to 16.1 %

Excise Duty & Customs Duty,

Cascading Effect of such taxes

8


9


During the period 1950-51 to 1961-62, the Central Government revenue expenditure showed a broad pattern of increase, followed by the prevailing accent on social and developmental services.

The focus of government expenditure were education and health. 10


All capital expenditures were treated as developmental and all expenditure oncivil works were treated as non-developmental.

The developmental expenditure increased more rapidly than non-developmentexpenditure. The Government draft on real resources of the economy had notonly increased in absolute terms but also in terms of GDP.

During this phase, expenditure policy was shaped to achieve reduction inincome inequality and counter inflation. On the issue of price stability, theemphasis was on long-term price stability through large expenditure onproduction of goods and services.

Doubling of the plan outlay in the second plan and the subsequent increases insuccessive plans necessitated generation of resources both internally andexternally, to meet the financing needs.

Deficit financing was used as a means to cover the gap between ambitiousinvestment plans and the low levels of savings in an underdeveloped economy.

11


This system turned out to be inefficient and unfair and also led to widespread tax evasion. Growth remained anaemic.

Mai

n R

ole

of

Fisc

al P

olic

y

To transfer private savings

To cater growing consumption & Investment needs

To cover social welfare schemes

1• Highly Redistributive Income Tax Rates

• High Import Tariffs

2• Numerous Excises Besides the Sales Tax

• Administrative Controls on Various Industries

3

• Exemptions & Preferential Treatments Aiming At Channeling Resources Towards Priority Sectors

12

India’s Fiscal Policy : 1970-1990

Taxation & Expenditure Policies more focused on achieving social

justice & equality

Public Expenditure were constantly increasing in compare

with revenue generated from high marginal tax

Public Finances was in a state of disarray, persistent large deficits

1980s- A Decade of Fiscal Deterioration, resulted in

macroeconomic crisis of 1991

Eleven Tax Brackets used as a means to reduce income

inequality

Corporate Income Tax between 45-65 % for widely held

companies

The Direct Taxes Enquiry Committee of 1971 found that the high tax rates encouraged tax evasion. 13

India’s Fiscal Policy : 1970-1990

1974-75: Based on committee’s recommendation- personal tax

was brought down.

1978 -85: Number of Income Tax brackets were reduced from 11 to

8 and finally to 4.

Highest Income Tax rate was brought down from

97.5% to 50%.

14

1991: Crisis & Actions Taken

1991- BoP Crisis

Gulf crisis of 1990--- increase in oil import bill Exports were down significantly due to breakdown of Soviet Union Deterioration in the Exchange Rate of Rupee Growing deficit on capital account due to country's rising obligations to meet

amortization payments.

Action Taken

Acquisition of Foreign Currency

Devaluation of Indian Rupee

Encouragement to Inflow of Funds from Abroad

Compression of Imports

15

Post Reform: India’s Fiscal Policy

Reforms undertaken by the Central Government and State Governmentsin India Since 1991

CENTRAL GOVERNMENT On the Revenue Front

1991-92 to 1995-96• Reduction of maximum marginal rate of personal income tax to 40 per cent.• Unification and reduction of the rates of corporate income tax for both widely held and closely held companies to 46 per cent.• Abolition of wealth tax.• Reduction in import duties to 110 per cent in 1992-93, 85 per cent in 1993-94, 65 per cent in 1994-95, 50 per cent in 1995-96.• Introduction of service tax by imposition of a 5 per cent tax on amount of telephone bills, premium payments for non life insurance and on brokerage charged by the stock brokers.

16

CENTRAL GOVERNMENT On the Expenditure Front

1991-92 to 1995-96• Reduction in fertilizer subsidy.• Abolition of cash compensatory support for exports.• 5 per cent cut on the expenditure of all ministries/departments.

1996-97 to 1999-00• Constitution of Expenditure Reforms Commission in 2000.

2000-01 to 2004-05• Subjecting all existing schemes to zero-based budgeting.• Ban on creation of new posts for one year.• Ban on purchase of new vehicles for one year.• 10 per cent cut in the consumption and allocation of fundsfor expenditure on petroleum oil and lubricants (POL) for staff cars.• Introduction of a new pension scheme in 2004.

Post Reform: India’s Fiscal Policy

17

Post 1991 Tax Reforms

Reducing the corporate tax rate on both domestic and foreign companies, corporate tax rate was reduced to 50 percent and the rates for different closely held companies made uniform at 55 percent.

Rationalization of capital gains tax and dividend tax and excise duties

Progressive reduction in the peak rate of customs duty on non-agricultural products

Value Added Tax (VAT), improving taxation of agriculture and strengthening tax administration.

Minimum Alternate Tax was introduced in 1996-97. It required a company to pay a minimum of 30 percent of book profits as tax

Total tax revenues of the centre were 9.7 percent of GDP in 1990-91. They declined to only 8.8 percent in 2000-01.

As a part of the subsequent direct tax reforms, the personal income tax brackets were reduced to three with rates of 20, 30 and 40 percent in 1992-93.

18

Post 1991 Tax Reforms

New tax savings instruments were introduced

Tax concessions were also given to non-residents to encourage flow of foreign exchange remittances.

A modified system of Value Added Tax (MODVAT) was introduced in 1986 in a phased manner.

Concern due to low elasticity of revenue from direct taxes

lowering the maximum marginal rate on personal income tax

Widening of the tax base by including

introduction of presumptive taxes, Adoption of a set of six (one-by-six) economic criteria for identification of

potential tax payers in urban areas taxation of services

19

Tax Revenue Analysis

20

Five Year Plans: Expenditure Patterns

First Five Year Plan (1951-1956)

Second Five Year Plan (1956-1961)

Third Five Year Plan (1961-1966)

Two Annual Plans (1967-68) & (1968-69)

Fourth Five Year Plan (1969-74)

Fifth Five Year Plan (1975-1980)

Sixth & Seven Five Year Plan (1980-1990)

Eighth Five Year Plan (1992-1997)

Ninth Five Year Plan (1997-200)

Tenth Five Year Plan (2002-2007)

Analysis of Pre-Reform Plans

The FRBMA

21

FIRST FIVE YEAR PLAN (1951-1956)

In determining an outlay on development of Rs. 2069 Cr. by public authorities over this period, the main considerations said to have taken into account are –• The need for initiating a process of development that will form the basis of

much larger effort needed in future.• The total resources likely to be available to the country for the purposes of

development.• The close relationship between the rate of development and the

requirements of resources in public and private sectors.• The necessity of completing the schemes of development initiated by

central and state governments prior to the commencement of the plan.• The need to correct maladjustments in the country caused by War and

Partition.

For the FIRST FYP (Five year Plan), agriculture, including irrigation and power had topmost priority.

22

SECOND FIVE YEAR PLAN (1956-61)

The principle tasks of the Second FYP were declared to be as follows:

• To secure the increase in National Income by about 25% over five years.

• To increase employment opportunities at a rate sufficient to absorb the increase in labor force consequent in increase in population.

• To take a major stride forward in the direction of Industrialization so as to prepare the ground for more rapid advance in the plan period to come.

23

THIRD FIVE YEAR PLAN (1961-1966)

In drawing up the Third FYP, the Planning Commission claimed to have kept in view the following principal aims:

• To secure and increase in the national income of over 5% p.a., pattern of investment being designed to sustain this rate of growth during subsequent plan period.

• To achieve self-sufficiency in food-grains and increase in agricultural production to meet the requirements of industry and export.

• To expand the basic industries like steel, chemical industries, fuel, power, and to establish machine building capacity, so that requirements of further industrialization can be met within a period of 10 years or so, mainly from country’s own resources.

• To utilize to the fullest extent possible the manpower resources of the country and to ensure a substantial expansion in the employment opportunities.

• To establish progressively greater equality of opportunity and to bring about a reduction in disparities in income, wealth and a more even distribution of economic power. 24

TWO ANNUAL PLANS (1966-67 and 1968-69)

25

FOURTH FIVE YEAR PLAN (1969-74)

26

FIFTH FIVE YEAR PLAN (1975-80)

27

SIXTH FIVE YEAR PLAN (1980-85) AND SEVENTH FIVE YEAR PLAN (1985-90)

28

EIGHTH FIVE YEAR PLAN (1992-97)

• The eighth five year plan reflected the process of fiscal reform and also economic reforms which reflected government’s attempt to accelerate economic growth and improve the quality of life of the common man.

• There was a slight improvement in the allocation for social services to 19% in this plan so as to improve “human capital” especially by improving literacy. Also outlay on energy was increased in order to reduce infrastructure constraint.

29

NINTH FIVE YEAR PLAN (1997-2002)

• During this period, infrastructure which became a major constraint due to inadequacy of complementary private investment, was paid due attention. There was a re-orientation of plan priorities and hence the change in public outlay was distinct.

• By allocating 72% of the plan funds to irrigation, energy, transport and communication and social services this plan stressed on the development of infrastructure.

30

TENTH FIVE YEAR PLAN (2002-2007)

• The main objective of the tenth plan has been to set at least an 8% growth rate for the state’s economy as compared to the previous plans with the aim to “catch up” with the rest of the country. The first priority would therefore be generation of more wealth. Basic needs and equity objectives in the state will be better achieved in an environment of high growth.

31

AN ANALYSIS OF PRE REFORM PLANS

• Except during the first plan when agriculture and irrigation were allotted 30% of total outlay, all other plan allotted between 20-24% of outlay.

• The allocation on power development was unfortunately low during the first four plans between10-15% of the total outlay. The low priority given to the power development was on the ground that industries had not come up so fast and the progress in rural electrification, use of electric power in railway transport system was inadequate. It was only in the seventh plan that the allocation on power was raised steeply to28% of the total outlay.

• The high priority given to the agriculture in the public sector programs in the first plan was at the cost of low priority given to the industries. But from the second plan onwards the relative share of industries and minerals was raised sharply from 6% in the first plan to 24% of the total plan outlay in second plan. In the next two plans, outlays to industries declined steeply.

• The allocation in transportation and communication was quite high during the first two plans-between 25 to 28%. But since then their share has declined. However the country was regularly facing serious transport bottlenecks which resulted in retarded output and income. Consequently, the Eighth plan pushed up the outlay to 23%.

32

The FRBMA

• The Fiscal Responsibility and Budget Management Act, 2003 (FRBMA) was enacted by the Parliament of India to institutionalize financial discipline, reduce India’s fiscal deficit, improve macroeconomic management and the overall management of the public funds by moving towards a balanced budget.

• The main purpose was to eliminate revenue deficit of the country (building revenue surplus thereafter) and bring down the fiscal deficit to a manageable 3% of the GDP by March 2008.

33

Fiscal Deficit Analysis : Post Reforms (1991)

34

Fiscal Deficit Analysis : Post Reforms (1991)

35

Budget Deficit & Balance of Trade

India recorded a trade deficit of 8320 USD Million in January of 2015. Balance of Trade in India averaged -1951.70 USD Million from 1957 until 2015, reaching an all time high of 258.90 USD Million in March of 1977 and a record low of -20210.90 USD Million in October of 2012.

36

Early 2000

Fiscal Responsibility and Budget Management (FRBM) Act, 2003 by the Government of India (GOI).

Fiscal Legislations at State levels: Karnataka & Maharashtra (2002), Kerala & Punjab (2003), Tamilnadu & UP (2004)

Task Force on Direct Taxes:

Abolition of surcharge on Income Tax, Exemption limit for senior citizen, Reduction in corporate taxes from 36.75% to 30% for domestic companies.

Abolition on wealth tax

37

Early 2000

Adoption of Value Added Tax (VAT), 2005-06

38

Suggestions on Fiscal Policy

in India, as in many developing countries, fiscal policy does not operate in isolation as ithas close macroeconomic linkages with real, monetary and external sectors. Thus, themacroeconomic impact of fiscal policy is critical for achieving the broader economic goals.

1) fiscal policy can be a powerful tool for accelerating growth, provided resources areraised efficiently without causing distortions and utilised for delivering public goods andservices, including physical and social infrastructure and helping the underprivileged.Total government expenditure as proportion of GDP needs to be maintained, and raisedat the State level.

2) Adherence to fiscal legislation, both at Centre and State level, is critical formacroeconomic, financial, external sector and budgetary sustainability.

3) fiscal empowerment i.e, expanding the scope and size of revenue flows into thebudget, through tax reforms appropriate user charges and restructuring of public sectorundertakings assumes critical importance.

4) The approach to fiscal federalism, both in terms of addressing the vertical andhorizontal imbalances, would have to focus on institutional reforms which align needswith revenue capacities. 39

New Govt. Fiscal Policies – Budget Expectation

Focus on boosting demand & investments , Put GDP back on high growth track

Period for investment allowance should be increase from 2 to 5 years because of higher gestation period.

A rebated income-tax for small start-up businesses called START (STArtup Rebated Tax), on lines of similar schemes in Singapore and China can be introduced.

There is a need to examine setting up of at least one long term lending financial institution for businesses (for example, like IDBI in the past).

Creation of a specialized entity called National Asset Management Company (NAMCO) to effectively tackle the issue of large NPAs.

Continued movement on path of Fiscal Consolidation

Widening of the tax base and formalization of the informal economy to improve Tax to GDP ratio.

Proposed implementation of GST 40

Analysed & Presented By,

Kashyap Shah

K.Sriram

Bilash Das

Divya Saxena

Harsh Jain

Debanjan Banerjee

41

fiscal policy trends in india: since independence

Economy & Finance