PUBLIC FINANCE-II PU Economics notes

Public Finance

Fiscal Policy

Meaning:

Public Finance is a study of the financial operations of the govt. According to Dalton, “IT is concerned with the income and expenditure of public authorities and with the adjustment of the one to the other”.

Fiscal Policy is a powerful instrument of stabilization. It is playing an important role in the economy and social front of the country. Fiscal policy is an instrument of economic policy.

Arther Smithies defines fiscal policy as “A policy under which the govt. uses its expenditure and revenue programmes to produce desirable effects and avoid undesirable effects of the national income, production and employment”.

Harvey and Johnson define Fiscal policy as “Changes in govt. expenditure and taxation designed to influence the pattern and level of activity”.

Objectives of Fiscal Policy:

·         To mobilize adequate resources fro financing various programmes and projects adopted for economic developments.

·         To promote necessary developments in the Pvt. Sector through fiscal incentive.

·         To arrange an optimum utilization of resources.

·         To raise the rate of savings and investment for increasing the rate of capital formation.

·         To control inflationary pressures in the economy in order to attain economic stability.

·         To remove poverty and unemployment.

·         To attain the growth of public sector for attaining the objective of socialistic pattern of society.

·         To reduce regional disparities and

·         To reduce the degree of inequality in the distribution of income and wealth.

Budget:

Meaning:

An estimate of all anticipated revenue and expenditure of the govt. for the ensuring financial year is called as budget. This is known as “The Annual Financial Statement”.

Types of Budget:

a)    Balanced Budget: A budget is said to be balanced when its tax revenue and expenditure are equal.

b)    Surplus Budget: When the anticipated revenue exceeds expenditure an imbalance is created in the budget. This kind of a budget is called Surplus Budget.

c)    Deficit Budget: Deficit Budget is one which the anticipated expenditure is more than the anticipated revenue. At present, most of the govt. in the world presents deficit budgets.

Public Revenue

Sources of Public Revenue:

1.    Tax Revenue: Taxes are the main sources of revenue to the main sources of revenue to the govt. Tax revenue refer to the revenues collected from taxes.

“Tax is a compulsory payment made buy the people to the government without expecting any quid pro quo relations”. The central govt. mobilize its tax revenues from two main sources. They are:

a)    Direct Tax and

b)    In-direct tax

Tax revenues account for the largest part that is 70% of the total revenues of the Central Govt. Different sources of tax revenues of the central govt. are explained below:

a)    Direct Taxes: Taxes lived on the income and wealth and wealth of the people are called as Direct taxes. The include personal tax, corporate tax, wealth tax, gift tax, estate duty, interest tax, expenditure tax, etc, Direct taxes bring about 43.9% of revenue to Govt.

              i.    Income Tax: Income tax which is known as personal tax is a tax levied by the central Govt. on the incomes of individuals, Hindu undivided families and unregistered firms and associations. The Govt. raised income tax limit from Rs.50,000 to Rs.1,00,000 during 2005-06.

            ii.    Corporate Tax: Corporate tax is levied on the incomes of registered companies and corporation. It is levied at a flat rate and at present the rate is 30% of the net profit.

           iii.    Wealth Tax: Wealth tax is levied on the excess of the net wealth over exemption of individuals, Hindu undivided families and companies.

           iv.    Gift Tax: Gift tax is levied on the donations and gifts except the ones given by the charitable institutions, Govt. companies and Pvt. Companies. Gift tax is progressive in nature. It was abolished in 1998.

            v.    Death Duty or Estate Duty: Death duty or Estate duty was levied by the central govt. on the property of a person passed on to his heirs after his death. It was first introduced in India in 1953. Now it is not in force.

           vi.    Interest Tax: It is the tax levied on the gross interest earned by commercial banks and individuals. It was first introduced in 1974. The income from this  source is negligible and just Rs.189 crore in 2001-02.

          vii.    Expenditure Tax: This is another tax levied by the govt. The yield from this tax was Rs.49 crore in 2003-04.

b)    Indirect Taxes: The taxes levied on the goods and services called indirect taxes. Revenue from the indirect taxation is the most important source of income to the central government. The principal indirect taxes levied by the union Govt. are customs duties and exercise duties. Indirect taxes bring about largest amount of revenue to the central government.

              i.    Central Excise Duties: Central excise duties are the taxes levied on commodities which are produced within the country. Central excise duties are the largest source of revenues to the central Govt. and its share in total tax revenue.

            ii.    Customs Duties: Customs duties are the taxes levied on commodities imported into India (Import duties). Or those exported from India (Export Duties). Import duties are more important that export duties, as export duties have almost been removed Customs duties constitute the third most important source of revenue to the central Govt.

           iii.    Service Tax: Various services are brought under tax net by the Central Govt. and it was introduced in 1994-95. They include banking, insurance, telecom, transport, real estate, etc.

           iv.    Other taxes and Duties: The central govt. is getting about 1% revenue from other taxes and duties.

            v.    Taxes of the union territories: The taxes levied and collected from union territories is another source of revenue to the central govt. But this revenue has to be spent in the respective union territorities.

2.    Non – Tax Revenue:

              i.    The central government owns a large no. of commercial and industrial establishments. When they earn profits, it will become the revenue of the central govt. Public Enterprises.

            ii.    Interest Receipts: The major source of non-tax revenue (that is 70%) is interest receipts. These are receipt from Central loans to state govts. Union territories railways, tele-communication department, etc.

           iii.    Administrative Revenue: The central govt. from its day-to-day administration and various economic, social, general and fiscal services gets sizable revenue by way of fees, license fees, fines and penalties, special assessments, etc.

           iv.    Railways, Post and Telegraphs: Railways, Post and Telegraphs owned by the govt. The profits earned by these undertakings constitute the sources of revenue to the central govt.

            v.    Reserve Bank of India: The profits earned by the RBI from its operations becomes one of the important sources of revenue to the central govt.

           vi.    Incomes from Currency and Mint: The union govt. of India earns revenues from currency and mint.

3.    Capital Receipts: When the revenue mobilized through tax and non-tax sources is insufficient to meet its expenditures, the central govt. will try to mobilize income through capital receipts. The examples

              i.    Internal and external borrowing  small savings

            ii.    Loan recovery and

           iii.    Public deposits

Concept of Value Added Tax (VAT)

The concept of value added tax (VAT has been gaining increasing recognition these days. At present, it has been regarded as world’s fastest growing tax and it has already been implemented in more than 125 countries.

Meaning

The value added tax is a tax levied on the value added to the product at all states. In other words, VAT is normally levied on the added value of goods in various processes of its production and distribution.

Public Expenditure

Classification of Public Expenditure:

The expenditure made by the Central govt. can be broadly classified into two categories, that is

1)    Plan expenditure  and non plan expenditure

2)    Revenue expenditure and capital expenditure

1)    PLAN EXPENDITURE: The expenditure made on various social and economic services, nation building activities is called as Plan Expenditure. The plan outlay consists of agriculture and allied activities, rural development, irrigation and flood control, energy industry and minerals, transport, education and science and technology etc.

a)    Central Plan Schemes: In the central plan scheme there are economic, social and general services.

              i.    Economic Service: Expenditure on economic services include such projects as agriculture and allied activities, rural development, industry and minerals, energy, transport, science, technology, environment, etc.

            ii.    Social Service: Expenditure on social service include such activities like education, art and culture, health and family, social welfare, nutrition sanitation and housing.

           iii.    General Services: The expenditure on general services include maintainence of laws and older, internal & external security etc.

b)    Central Assistance to State Plans: India has a quasi-federal form of constitution in which there is a strong central Govt. and several state govts. The central govt. is giving plan assistance to state govt. and this assistance is included in central plan expenditure. Central Plan assistance to state in 2000-01 was Rs.29,283 crores,

c)    Central Assistance for Union Territory Plans: Some territories in the country are under the direct control of the Central Government. It gives plan assistance to these territories which is also included in the central plan expenditure.

2)    Non – Plan Expenditure: Non – Plan Expenditure is a term used to cover all expenditures of the government not included in the plan. It includes both development and non – developmental expenditures.

              i.    Civil Expenditure: Civil Expenditure refers to administrative expenditure of the government. It includes maintenance of law & order, civil administration, tax collection, public and internal security, judiciary, pensions, etc.

            ii.    Defence Expenditure: Defence expenditure is the most important item of expenditure of the Central govt. Production of arms and ammunitions, purchase of costly defence equipments, salary, pension and training defence personnel etc. are included in Defence expenditure.

           iii.    Interest Payments: The biggest item in the Central govt. expenditure is the interest payments made on the internal and external borrowings.

           iv.    Subsides: Another important item of the Central govt. non – plan expenditure is subsidies for food, fertilizers and export promotion.

            v.    Grant –In – Aid: The central govt. gives grant – in – aid to the state governments and union territories.

           vi.    Loans and Advances: The Central government also gives loans and advances to state and union territories. The loans and advances gives in 1999-00 was Rs.3110/-.

          vii.    Miscellaneous Expenditure: Relief’s given at the time of floods, droughts, earthquakes and such other national calamities, rehabilitation expenditure, aid to backward regions etc. are other items of non-plan expenditure.

Causes for Enormous Growth of Public Expenditure:

There has been a spectacular rise in the public expenditure during the last four and a half decades. The total expenditure of the central govt. which stood at Rs.900 crore in 1950-51 shot up to Rs.5,05,791 crores in 2004-05.

• Rapid growth of population
• Effect of Urbanisation
• Increase in national income
• Increase in defence expenditure
• Burden of debt and interest payments.
• Increasing subsidies.
• Expansion of administrative machinery.
• Development projects
• Inflation
• Burden of democracy and democratic institutions
• National calamities
• Poverty, unemployment, etc.

Public Debt

Public debt refers to all types of borrowings by the govt. from among the institutions, organisations and the public.

Classification of Public Debt:

The public debt of the govt. of India has now been reclassified into three major groups:

  i.    Internal debt

ii.    External debt, and

iii.    Other outstanding liabilities

a)    Internal Debt: Internal debt comprises of all borrowings and market loans which were formerly called permanent or funded debt. In consists of all internal borrowings and market loans. It include treasury bills issued by the govt. of India to the RBI, state govt., Commercial Banks and other parties.

b)    External Debt: External debt includes loans taken by the govt. of India against the non – negotiable, non – interest hearing securities issued to international financial institutions like the IMF, IBRD, IDA, ADB, etc. Besides these the loans taken by the govt. of India from friendly countries are also included. External debt also includes loans taken from the IMF trust fund.

c)    Other Outstanding Liabilities: This include all outstanding liabilities against the various small savings schemes, public provident fund and state provident fund contributions, income tax annuity deposit schemes, interest bearing reserve funds of the department of the Railways, Post and telegraphs, etc.

Causes for the Growth of Public Debt

1)    Development Plans: After Independence, India implemented economic plans to accelerate the growth rate of economy. The govt. is required to invest huge amount of capital to implement development plans. But, the financial resource mobilized through tax sources is insufficient. Therefore, the govt. is forced to borrow heavily.

2)    Removal of Temporary Deficit: When the expenditure of the govt. exceeds its revenue, temporary deficit may arise. To remove this temporary deficit the government is forced to borrow. As a result, public debt months up.

3)    Disliking of Taxes: Taxes are important sources of revenues to the govt. But taxes are not to be levied on such a way as to avoid any burden on the people. The taxable capacity of the people in India is very low. The funds required for meeting the growing public expenditure cannot be raised only through taxation. So, the govt. is forced to resort to public borrowings.

4)    Control of Inflation: In India, Public debt is used as tool to control inflationary trends in the economy. Due to larger investment and money supply the prices are increasing. Transfer of funds from private to govt. hands through public debt, and aggregate money supply can bring inflation under control.

5)    Low Taxable Capacity: As stated above, the taxable capacity of the people in India is very low. The govt. cannot mobilize required funds through taxation. Consequently the govt. is forced to borrow from the public.

6)    Higher Government Interference: In a socialistic pattern of society the government is expected to promote social welfare and work for the well being of the people. Due to the increased govt. interference in economic matters, the expenditure has increased. But, the fund mobilized through taxation is in sufficient. So, the dependence of the govt. on the----.

7)    Mounting Defence Expenditure: The defence expenditure of the country is increasing day – by – day. At present, it is more than Rs.83000 more. The growing defence expenditure could not be met out of normal revenues. The central government, as a result, is forced to resort to heavy public borrowing.

8)    Rise in Non – Development Expenditure: The non-development expenditure of both the central and state govt. has been increasing. The sources to meet this expenditure is insufficient and therefore the govt. is borrowing heavily from the public.

9)    Burden of Interest Payment: The burden of interest payments on debt is ever increasing, it has gone up to Rs.600 crore in 1970-71 to Rs.1, 25,905 crore in 2004-05 and it is expected to be around Rs.1, 33,945 crore in 2005-06.

10) Meeting Emergencies: To meet some emergencies like floods, droughts, cyclones, earth quakes, war, etc. large sums of money is required. When the funds available with the govt. falls short, it is forced to borrow from the public.

11) Populist Schemes: The govt. with an eye on elections implement various populist schemes. These schemes are highly unproductions and lead to wastage of public funds. The government due to its faulty policies in sometimes forced to borrow heavily from the public.

Budget Deficits

Meaning:

According to the Planning Commission “The term deficit financing is used to denote the direct addition to gross national expenditure through budget deficits whether the deficits are on the resources of capital accounts”.

1)    Revenue Deficit: The concept of revenue deficit is a simple and straight forward one. Revenue deficit equals the difference between the Revenue receipts and the revenue expenditure.

2)    Budget Deficit: Budget deficit occurs when total expenditure exceeds total receipts. Here, total expenditure includes aggregate of both revenue expenditure and capital expenditure. Like wise, total receipts includes both revenue receipts and capital receipts.

3)    Fiscal Deficit: The term fiscal deficit may be defined as budgetary deficit plus market borrowings and other liabilities of the govt. of India. In other words, fiscal deficit equals revenue receipts plus non-debt capital receipts mines total expenditure.

4)    Primary Deficit: In recent years the Finance Ministry has introduced one more concept of deficit known as ‘Primary deficit’. Primary deficit is determined by arriving at the gap between the govts. Total income and expenditure after excluding interest savings as well as interest payments.

Fiscal Sector Reforms

Fiscal reform included correcting the existing fallacies in the tax system, resources, mobilization, public expenditure policy and progressive reduction in fiscal deficit which had gone up to 8.4% of GDP in 1990-91.

Major fiscal measures taken so far include:

1)    Exemption limit for income tax was raised to Rs.40, 000 in 1995, Rs.50, 000 in 1998 and further to Rs.1, 00,000 in 2005 with reduction of tax slabs to three.

2)    Reduction is maximum marginal rate of income tax to 40% and subsequently to 30%.

3)    Reduction in corporate income tax on domestic companies to a uniform rate of 30%, with a surcharge of 10% in 2005.

4)    To widen the tax base, presumptive taxation was introduces for small traders, retailers and road transport operators.

5)    Five year tax holiday was introduced for infrastructural investment projects.

6)    The incentive structure for savings and tax rebate have been strengthened and modified.

7)    Reforms in indirect tax structure by reducing the number of rates, removing exemptions and by switching over to advelorem rates. Customs duties have been lowered and made closer to that of East Asian neighbors to reduce the cost of imported goods.

8)    The service tax net is widened

9)    Various economy measures introduced include downsizing come.