Essay on Fiscal Policy of India

In this essay we will discuss about Fiscal Policy in India. After reading this essay you will learn about: 1. Definition of Fiscal Policy 2. Objectives of Fiscal Policy 3. Role 4. Techniques 5. Merits 6. Shortcomings 7. Suggestions 8. Measures.

Contents:

1. Essay on the Definition of Fiscal Policy
2. Essay on the Objectives of Fiscal Policy
3. Essay on the Role of Fiscal Policy in Economic Development
4. Essay on the Techniques of Fiscal Policy
5. Essay on the Merits or Advantages of Fiscal Policy
6. Essay on the Shortcomings of Fiscal Policy in India
7. Essay on the Suggestions for Necessary Reforms in Fiscal Policy
8. Essay on the Measures of Fiscal Policy Reforms

---

Essay # 1. Definition of Fiscal Policy:

Fiscal policy is playing an important role on the economic and social front of a country. Traditionally, fiscal policy in concerned with the determination of state income and expenditure policy. But with the passage of time, the importance of fiscal policy has been increasing continuously for attaining rapid economic growth.

Accordingly, it has included public borrowing’ and deficit financing as a part of fiscal policy of the country. An effective fiscal policy is composed of policy decisions relating to entire financial structure of the government including tax revenue, public expenditures, loans, transfers, debt management, budgetary deficit, etc.

The policy also tries to attain proper balance between these aforesaid units so as to achieve the best possible results in terms of economic goals. Harvey and Joanson, M., defined fiscal policy as “changes in government expenditure and taxation designed to influence the pattern and level of activity.”

According to G.K. Shaw, “We define fiscal policy to include any design to change the price level, composition or timing of government expenditure or to vary the burden, structure or frequency of the tax payment.” Otto Eckstein defined fiscal policy as “changes in taxes and expenditure which aim at short run goals of full employment price level and stability.”

---

Essay # 2. Objectives of Fiscal Policy:

In India, the fiscal policy is gaining its importance in recent years with the growing involvement of the government in developmental activities of the country.

Following are some of the important objectives of fiscal policy adopted by the Government of India:

1. To mobilise adequate resources for financing various programmes and projects adopted for economic development.

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

3. To promote necessary development in the private sector through fiscal incentive;

4. To arrange an optimum utilisation of resources;

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

6. To remove poverty and unemployment;

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

8. To reduce regional disparities; and

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

In order to attain all these aforesaid objectives, the Government of India has been formulating its fiscal policy incorporating the revenue, expenditure and public debt components in a comprehensive manner.

---

Essay # 3. Role of Fiscal Policy in Economic Development:

One of the important goals of fiscal policy formulated by the Government of India is to attain rapid economic development of the country.

To attain such economic development in the country, the fiscal policy of the country has adopted following two objectives:

1. To raise the rate of productive investment of both public and private sector of the country.

2. To enhance the marginal and average rates of savings for mobilising adequate financial resources for making .investment in public and private sectors of the economy.

The fiscal policy of the country is trying to attain both these two objectives during the plan periods.

---

Essay # 4. Techniques of Fiscal Policy:

Following are the four important techniques of fiscal policy of India:

(i) Policy of Taxation of Government of India:

One of the important sources of revenue of the Government of India is the tax revenue. Both the direct and indirect taxes are being levied by the Government of India. Direct taxes are progressive by nature and most of indirect taxes are regressive in nature. Taxation plays an important role in mobilising resources for plan.

During the First, Second and Third Plan, additional taxation alone contributed nearly 12.7 per cent, 22.8 per cent and 34 per cent of public sector plan expenditure respectively. The shares during the Fourth, Fifth, Sixth and Seventh Plan were 27 per cent, 37 per cent 22 per cent and 15 per cent respectively.

Total tax revenue collected by the Government of India stands at 72.13 per cent of the total revenue of the Government. Mobilisation of taxes by the Government stands around 15 to 16 per cent of the national income of the country during recent years.

Main objectives of taxation policy in India includes:

(a) Mobilisation of resources for financing economic development;

(b) Formation of capital by promoting saving and investment through time deposits, investment in government bonds, in units, insurance etc.;

(c) Attainment of equality in the distribution of income and wealth through the imposition of progressive direct taxes; and

(d) Attainment of price stability by adopting anti-inflationary taxation policy.

(ii) Public Expenditure Policy of Government of India:

Public expenditure is playing an important role in the economic development of a country like India. With increase in responsibilities of the government and with the increasing participation of government in economic activities of the country, the volume of public expenditure in a highly populated country like India is increasing at a galloping rate. In 1992-93, the public expenditure as percentage of GDP was around 30 per cent.

Public expenditure is of two different types, i.e., developmental and non-developmental expenditure. Developmental expenditure of the Government is mostly related to the developmental activities viz., development of infrastructure, industry, health facilities, educational institutions etc.

The non-developmental expenditure is mostly a maintenance type of expenditure and which is related to maintenance of law and order, defence, administrative services etc. The public expenditure incurred by the Government of India has been creating a serious impact on the production and distribution pattern of the economy.

Following are some of the important features of the policy of public expenditure formulated by the Government of India:

(a) Development of infrastructure:

Development of infrastructural facilities which include development of power projects, railways, road, transportation system, bridges, dams, irrigation projects, hospitals, educational institutions etc. involves huge expenditure by the Government as private investors are very much reluctant to invest in these areas considering the low rate of profitability and high risk involved in it.

(b) Development of public enterprises:

Development of heavy and basic industries are very important for the development of underdeveloped country. But the establishment of these industries involves huge investment and a considerable proportion of risk. Naturally private sector cannot take the responsibility to develop these industries.

Development of these industries has become a responsibility of the Government of India particularly since the introduction of Industrial Policy, 1956. A significant portion of public expenditure has been utilised for the establishment and improvement of these public enterprises.

(c) Support to Private Sector:

Providing necessary support to the private sector for the establishment of industry and other projects is another important objective of public expenditure policy formulated by the Government of India.

(d) Social Welfare and Employment Programmes:

Another important feature of public expenditure policy pursued by the Government of India is its growing involvement in attaining various social welfare programmes and also on employment generation programmes.

(iii) Policy of Deficit Financing of Government of India:

Following the policy of deficit financing as introduced by J.M. Keynes, the Government of India has been adopting the policy for financing its developmental plans since its inception. The deficit financing in India indicates taking loan by the Government from the Reserve Bank of India in the form of issuing fresh dose of currency.

Considering the low level of income, low rate of savings and capital formation, the Government is taking recourse to deficit financing in increasing proportion. Deficit financing is a kind of forced savings.

Accordingly, Dr. V.K.R.V. Rao observed, “Deficit financing is the name of volume of those forced savings which are the result of increase in prices during the period of the government investment. Thus deficit financing helps the country by providing necessary funds for meeting the requirements of economic growth but at the same time it also create the problem of inflationary rise in prices. Thus the deficit financing must be kept within the manageable limit.”

During the First, Second, Third and Fourth Plan deficit financing as percentage of total plan resources was to the extent of 17 per cent, 20 per cent, 13 per cent and 13.5 per cent respectively. But due to adverse consequence of deficit financing through inflationary rise in price level, the extent of deficit financing was reduced to only 3 per cent during the Fifth Plan.

But due to resource constraint, the extent of deficit financing again rose to 14 per cent and 16 per cent of total plan resources respectively.

Thus knowing fully the evils of deficit financing, planners are still maintaining a high rate of deficit financing in the absence of increased tax revenue due to large scale tax evasion and negative contribution of public enterprises. But considering the present inflationary trend in prices, the Government should give lesser stress on deficit financing.

(iv) Public Debt Policy of the Government of India:

As the taxation has got its limit in a poor country like India due to poor taxable capacity of the people, thus the Government is taking recourse to public debt for financing its developmental expenditure. In the post-independence period, the Central Government has been raising a good amount of public debt regularly in order to mobilise a huge amount of resources for meeting its developmental expenditure. Total public debt of the Central Government includes internal debt and external debt.

Internal Debt:

Internal debt indicates the amount of loan raised, by the Government from within the country. The Government raises internal public debt from the open market by issuing bonds and cash certificates and 15 years annuity certificates. The Government also borrows for a temporary period from RBI (treasury bills issued by RBI) and also from commercial banks.

External Debt:

As the internal debt is insufficient thus the Government is also collecting loan from external sources, i.e., from abroad, in the form of foreign capital, technical knowhow and capital goods. Accordingly, the Central Government is also borrowing from international financing agencies for financing various developmental projects.

These agencies include World Bank, IMF, IDA, IFC etc. Moreover, the Government is also collecting inter-governmental loans from various developed countries of the world for financing its various infrastructural projects.

The volume of public debt in India increased at a considerable rate i.e. from Rs 204 crore during the First Plan to Rs 2,135 crore during the Fourth Plan and then to Rs 1,03,226 crore during the Seventh Plan. During the Eighth Plan, the volume of internal debt of the Central Government was amounted to Rs 1,59,972 crore and that of external debt was to the extent of Rs 2,454 crore.

At the end of the second year of the Twelfth Plan, i.e., in 2013-14, total outstanding loan (liabilities) of the Central Government stood at Rs 55,87,000 crore.

---

Essay # 5. Merits or Advantages of Fiscal Policy of India:

Following are some of the important merits or advantages of fiscal policy of Government of India:

(i) Capital Formation:

Fiscal policy of the country has been playing an important role in raising the rate of capital formation in the country both in its public and private sectors. The gross domestic capital formation as per cent of GDP in India increased from 8.4 per cent in 1950-51 to 19.9 per cent in 1980-81 and then to 39.1 per cent in 2007-08. Therefore, it has created a favourable impact on the public and private sector investment of the country.

(ii) Mobilisation of Resources:

Fiscal policy of the country has been helping to mobilise considerable amount of resources through taxation, public debt etc. for financing its various developmental projects. The extent of internal resource mobilisation for financing plan increased considerably from 70 per cent in 1965- 66 to around 90 per cent in 1997-98.

(iii) Incentives to Savings:

The fiscal policy of the country has been providing various incentives to raise the savings rate both in household and corporate sector through various budgetary policy changes, viz., tax exemption, tax concession etc. The saving rate increased from a mere 8.6 per cent in 1950-51 to 37.7 per cent in 2007-08.

(iv) Inducement to Private Sector:

Private sector of the country has been getting necessary inducement from the fiscal policy .of the country to expand its activities. Tax concessions, tax exemptions, subsidies etc. incorporated in the budgets have been providing adequate incentives to the private sector units engaged in industry, infrastructure and export sector of the country.

(v) Reduction of Inequality:

Fiscal policy of the country has been making constant endeavour to reduce the inequality in the distribution of income and wealth. Progressive taxes on income and wealth tax exemption, subsidies, grant etc. are making a consolidated effort to reduce such inequality. Moreover, the fiscal policy is also trying to reduce the regional disparities through its various budgetary policies.

(vi) Export Promotion:

The Fiscal policy of the Government has been making constant endeavour to promote export through its various budgetary policy in the form of concessions, subsidies etc. As a result, the growth rate of export has increased from a mere 4.6 per cent in 1960-61 to 10.4 per cent in 1996-97.

(vii) Alleviation of Poverty and Unemployment:

Another important merit of Indian fiscal policy is that it is making constant effort to alleviate poverty and unemployment problem through its various poverty eradication and employment generation programmes, like, IRDP, JRY, PMRY, SJSRY, EAS, NREGA etc.

---

Essay # 6. Shortcomings of Fiscal Policy in India:

Following are the major shortcomings of the fiscal policy of the country:

(i) Instability:

Fiscal policy of the country has failed to attain stability on various fronts. Growing volume of deficit financing has created the problem of inflationary rise in price level. Disequilibrium in its balance of payments has also affected the external stability of the country.

(ii) Defective Tax Structure:

Fiscal policy has also failed to provide a suitable tax structure for the country. Tax structure has failed to raise the productivity of direct taxes and the country has been relying much on indirect taxes. Therefore, the tax structure has become burdensome to the poor.

(iii) Inflation:

Fiscal policy of the country has failed to contain the inflationary rise in price level. Increasing volume of public expenditure on non-developmental heads and deficit financing has resulted in demand-pull inflation. Higher rate of indirect taxation has also resulted in cost-push inflation. Moreover, the direct taxes has failed to check the growth of black money which is again aggravating the inflationary spiral in the level of prices.

(iv) Negative Return of the Public Sector:

The negative return on capital invested in the public sector units has become a serious problem for the Government of India. In-spite of having a huge total investment to the extent of Rs 4,21,089 crore in 2007 on PSUs the return on investment has remained mostly negative or lower. In order to maintain those PSUs, the Government has to keep huge amount of budgetary provisions, thereby creating a huge drainage of scarce resources of the country.

(v) Growing Inequality:

Fiscal policy of the country has failed to contain the growing inequality in the distribution of income and wealth throughout the country. Growing trend of tax evasion has made the tax machinery ineffective for the purpose. Growing reliance on indirect taxes has made the tax structure regressive.

---

Essay # 7. Suggestions for Necessary Reforms in Fiscal Policy:

Following are some of the important measures suggested for necessary reforms of the fiscal policy of the country:

(i) Progressive Taxes:

The tax structure of the country should try to infuse more progressive elements so that it can put heavy burden on the rich and less burden on the poor. Necessary amendments should be made in respect of irrigation tax, sales tax, excise duty, land revenue, property taxes etc.

(ii) Agricultural Taxation:

The tax net of the country should be extended to the agricultural sector for rapping a huge amount of revenue from the rich agriculturists.

(iii) Broad-based Tax Net:

Tax net of the country should be broad-based so that it can cover increasing number of population having the taxable capacity.

(iv) Checking Tax Evasion:

Adequate measures be taken to check the problem of tax evasion in the country. Tax laws should be made stricter for prosecuting the tax evaders. Tax machinery should be made more efficient and honest to gear up its operations. Tax rate should be reduced to encourage the growing trend of tax compliance.

(v) Increasing Reliance on Direct Taxes:

Tax machinery of the country should attach much more reliance on direct taxes instead of indirect taxes. Accordingly, the tax machinery should try to introduce wealth tax, estate duty, gift tax, expenditure tax etc.

(vi) Simplified Tax Structure:

Tax structure and rules of the country should be simplified so that it can encourage tax compliance among the people and it can remove the unnecessary harassment of the tax payers.

(vii) Reduction of Non-Development Expenditure:

The fiscal policy of the country should try to reduce the non-developmental expenditure of the country. This would reduce the volume of unproductive expenditure and can reduce the inflationary impact of such expenditure.

(viii) Checking Black Money:

The fiscal policy of the country should try to check the problem of black money. In this direction schemes like VDIS should be repeated. Tax rates should be reduced. Corruption and political interference should be abolished. Smuggling and other nefarious activities should be checked.

(ix) Raising the Profitability of PSUs:

The Government should try to restructure its policy on public sector enterprises so that its efficiency and rate of return on capital invested can be raised effectively. PSUs should be managed in rational manner with least government interference and on commercial lines. Accordingly, the policy of budgetary provisions for maintaining the PSUs should gradually be eliminated.

---

Essay # 8. Measures of Fiscal Policy Reforms:

The Government of India has introduced several fiscal policy reforms which constitute the main basis of the stabilisation policy of the country.

Following are some of the important measures of fiscal policy reforms adopted by the Government of India in recent years:

(i) Reduction of Rates of Direct Taxes:

The peak rate of income tax was reduced to 30 per cent in 1997-98 budget. This has resulted in an increase in the share of direct taxes in total revenue of the country from 19 per cent in 1990-91 to around 61 per cent in 2008-09.

(ii) Simplification of Tax Procedure:

In recent years as per the recommendation of Raja Chelliah or Taxation Reform Committee, several steps have been taken to simplify the tax procedure in the successive budgets. The 1998-99 budget has introduced a series of tax simplification measures, viz., “Saral”, “Samadhan” and “Samman”, which is considered as an important step in right direction.

(iii) Reforms in Indirect Taxes:

These reforms include introduction of advalorem rates, MODVAT scheme etc.

(iv) Fall in the volume of Government Expenditure:

Several measures were undertaken recently by the government. Accordingly, total expenditure of the Government under various heads has been reduced. As a result, total public expenditure as per cent of GDP has declined from 19.7 per cent of GDP in 1990-91 to 16.9 per cent in 2008-09.

(v) Reduction in the Volume of Subsidies:

Central Government has been making huge payments in the form of subsidies, i.e., food subsidies, fertiliser subsidies, export subsidies etc. Steps have been taken to reduce these subsidies in a phased manner.

(vi) Reduction in Fiscal Deficit:

The Central Government has been trying seriously to contain the fiscal deficit in its annual budget. Accordingly, it has reduced the extent of fiscal deficit from 7.7 per cent of GDP in 1990-91 to 6.1 per cent in 2008-09. But fiscal stabilisation necessitates containing the fiscal deficit at least to 3 per cent of GDP.

(vii) Reduction in Public Debt:

Recently, the Central Government has been trying to reduce the burden of public debt. Accordingly, the external debt as per cent of GDP which was 5.4 per cent in 1990-91 gradually declined to 4.9 per cent in 2008-09. The internal debt as per cent of GDP has declined from 48.6 per cent in 1990-91 to 37.9 per cent in 2008-09.

Similarly, the total outstanding loan or liabilities as per cent of GDP also declined from 63.0 per cent in 2003-04 to 58.9 per cent in 2008-09.

(viii) Disinvestment in Public Sector:

Another important fiscal policy reforms introduced by the Government of India is to disinvest the shares of the public sector enterprises. The government has disinvested as part of its stake in 39 selected PSUs since the disinvestment process began in 1992. Till 2006-07, it has raised around Rs 51,608 crore through disinvestment of share of PSUs.

In the mean time, the Government has constituted a Disinvestment Commission to advise it on how to go about disinvesting the shares of PSUs. The Commission, in its first three reports has given its recommendations on 15 PSUs out of 50 referred to it.

The Commission submitted at least eight reports covering 43 PSUs and also undertook diagnostic studies in 1998-99 in respect of these undertakings for giving recommendations.