FISCAL POLICY-Trends in Taxes,Expenditures,Deficits

Submitted by: Group 9

Alex

Amritha Varshini Gaddam

Kshama Poojary

Saloni Lhila

Sneha Jadhav

INTRODUCTION TO

FISCAL POLICY

FISCAL POLICY

TAX POLICY EXPENDITURE POLICY INVESTMENT/DISINVESTMENT

STRATEGIES SURPLUS/DEBT MANAGEMENT

TAXES & EXPENDITURES DECISIONS OF GOV

SOME BASIC CONCEPTS

Capital Expenditures

• A spending item

• Creation of asset for long-term

• Loan Disbursements

Capital Receipts

• Liquidation of assets

• Sale of Govt. shares in public sector company

• Return of loan/ receipt of loan

Revenue Expenditures

• Govt. Spending on salaries , subsidies pensions , interest payments

Revenue Receipts

• Regular Earnings

• Includes tax receipts & non tax receipts

• Sale of telecom spectrum

• Revenue Deficit = Revenue Expenditure – Revenue Receipts (that is Tax + Non-tax Revenue)

• Fiscal Deficit = Total Expenditure (that is Revenue Expenditure + Capital Expenditure) –(Revenue Receipts + Recoveries of Loans + Other Capital Receipts (that is all Revenue and Capital Receipts other than loans taken))

• “The gross fiscal deficit (GFD) of government is the excess of its total expenditure, current and capital, including loans net of recovery, over revenue receipts (including external grants) and non-debt capital receipts.”

• The net fiscal deficit is the gross fiscal deficit reduced by net lending by government

• The gross primary deficit is the GFD less interest payments while the primary revenue deficit is the revenue deficit less interest payments.

INDIA’S FISCAL POLICY

ARCHITECTURE

India federal Govt. –Central & State

Formation of Finance Commission (FC) every 5

years

Budget for Every Financial Year

Since 1950 : 5 year budget plans for long

term economic goals by PC

Fiscal impact of Planning Process: Division of Plan & Non plan components

Plan Components – long-term socio economic

goals of specific scheme & projects

Non plan components –Routine Govt.

expenditures like salaries , administration

Taxes and Expenditures

Taxes

Direct Taxes Indirect Taxes

Expenditures

Planned Non Planned

INCOME TAX-

This is a type of tax levied on the individuals whose income falls under the taxable category (2.5 lakhs per annum).

The Indian Income Tax Department is governed by CBDT and is part of the Department of Revenue under the

Ministry of Finance, Govt. of India.

Income tax is a key source of funds that the government uses to fund its activities and serve the public.

Current Rate: 10%,20%,30% depending upon the income

Corporate Income Tax –

This is the tax levied on the profits a corporate house earned in a year.

In India, the Corporate Income tax rate is a tax collected from companies.

Its amount is based on the net income companies obtain while exercising their business activity, normally during

one business year.

Current Rate: The Corporate Tax Rate in India stands at 34 percent.

Securities Transaction Tax-

Introduced in 2004, STT is levied on the sale and purchase of equities. more clearly,

The income a individual generate through the securities market be it through reselling of shares or through

debentures is taxed by the government of India and the same tax is called as Securities Transaction Tax.

Wealth Tax –The Wealth Tax Act, 1957 governs the taxation process associated with the Net Wealth that an Individual, a Hindu Undivided Family (HUF), or a Company possesses on the Valuation Date.At present the rate is 1 percent of the amount that is in excess of INR 15 lakhs

Value Added Tax-

When we pay an extra amount of price for the goods and services we consume or buy, that extra amount of money is

called as VAT.

This taxes is about to be replaced by Goods and Services Tax.

Current rate-

On agricultural goods-4%

On luxury items- 20%

Customs Duty –

Customs Duty is a type of indirect tax levied on goods imported into India as well as on goods exported from India.

In India, the basic law for levy and collection of customs duty is Customs Act, 1962. It provides for levy and collection

of duty on imports and exports.

Excise Duty –

An excise or excise tax is an inland tax on the sale, or production for sale, of specific goods or a tax on a good

produced for sale, or sold, within a country or licenses for specific activities.

Excises are distinguished from customs duties, which are taxes on import.

Service Tax-

Service Tax is a tax imposed by Government of India on services provided in India.

The service provider collects the tax and pays the same to the government. It is charged on all services except the

services in the negative list of services.

Current rate- 12.36%

EXPENDITURES

Central

National defense, foreign policy, railways, national

highways, shipping, airways, post and

telegraphs, foreign trade and banking.

Central & State

Forests, economic and social planning, education, trade unions and industrial disputes, price control and

electricity.

State

Law and order, agriculture, fisheries, water supply and

irrigation, and public health.

EVOLUTION OF INDIAN

FISCAL POLICY

1950-1991

EVOLUTION OF INDIA FISCAL POLICY

Planning commission was set up in 1950Adopted a Federal Constitution features giving the central government primacy in terms of planning for economic development

Planning process emphasized on strengthening public sector enterprises to achieve economic growth and Industrial Development

Main role of fiscal policy was to transfer private savings to cater to the growing consumption and investment needs of the public sector

TRENDS IN

TAXES AND EXPERNDITURES

1950-1991

• India's fiscal policy in the phase of planned development commencing from the 1950s to economic liberalization in 1991 was largely characterized by a strategy of using the tax system to transfer private resources to the massive investments in the public sector industries and also achieve greater income equality.

• The result was high maximum marginal income tax rates and the consequent tendency of tax evasion.

• The public sector investments and social expenditures were also not efficient.

Direct Taxes

• The combined Centre and State tax revenue to GDP ratio increased from 6.3

percent in 1950-51 to 16.1 percent in 1987-88.

• For the central government this ratio was 4.1 percent of GDP in 1950-51

with the larger share coming from indirect taxes at 2.3 percent of GDP and

direct taxes at 1.8 percent of GDP.

• The states had 0.6 percent of GDP as direct taxes and 1.7 percent of GDP

as indirect taxes in 1950-51.

• In 1970-71, direct taxes contributed to around 16 percent of the central government's revenues, indirect taxes about 58 percent and the remaining 26 percent came from nontax revenues.

• In 1973-74 despite Kaldor's recommendations income and corporate taxes at the highest marginal rate continued to be extraordinarily high. Eleven tax slabs, with rates from 10 to 85 per cent. The top marginal rate is effectively 97.75.

• The corporate income tax was differential for widely held and closely held companies with the tax rate varying from 45 to 65 percent for some widely held companies.

• During this time The Direct Taxes Enquiry Committee of 1971 found that

the high tax rates encouraged tax evasion.

• Following its recommendations in 1974-75 the personal income tax rate was

brought down to 77 percent but the wealth tax rate was increased.

• Later, In 1985-86 the number of tax brackets was reduced from eight to four

and the highest income tax rate was brought down to 50 percent.

LAFFER CURVE

• Invented by Arthur Laffer, this curve shows the relationship between tax

rates and tax revenue collected by governments.

• The curve suggests that, as taxes increase from low levels, tax revenue

collected by the government also increases. It also shows that tax rates

increasing after a certain point (T*) would cause people not to work as hard

or not at all, thereby reducing tax revenue.

• Eventually, if tax rates reached 100% (the far right of the curve), then all

people would choose not to work because everything they earned would go

to the government.

Indirect Taxes

• In indirect taxes, a major component was the central excise duty.

• This was initially used to tax raw materials and intermediate goods and not final consumer goods.

• But by 1975-76 it was extended to cover all manufactured goods.

• The excise duty structure at this time was complicated and tended to distort economic decisions.

• The tax also had a major „cascading effect‟ since it was imposed not just on final consumer goods but also on inputs and capital goods.

• The Indirect Tax Enquiry Report of 1977 recommended introduction of input tax credits to convert the cascading manufacturing tax into a manufacturing value added tax (MANVAT).

• In 1986 The modified value added tax (MODVAT) was introduced in a phased manner covering only selected commodities.

• The other main central indirect tax is the customs duty. Given that imports into India were restricted, this was not a very large source of revenue. The tariffs were high and differentiated.

• In 1985-86 the government presented its Long-Term Fiscal Policy stressing on the need to reduce tariffs, have fewer rates and eventually remove quantitative limits on imports.

• Due to revenue raising considerations the tariffs in terms of the weighted

average rate increased from 38 percent in 1980-81 to 87 percent in 1989-90.

• By 1990-91 the tariff structure had a range of 0 to 400 percent with over 10

percent of imports subjected to tariffs of 120 percent or more.

Expenditures and

Deficits

• India's expenditure norms remained conservative till the 1980s.

• From 1973-74 to 1978-79 the central government continuously ran revenue surpluses.

• Its gross fiscal deficit also showed a slow growth with certain episodes of downward movements

• The state governments also ran revenue surpluses from 1974-75 to 1986-87, barring only 1984-85.

• The central revenue deficit climbed from 1.4 percent of GDP in 1980-81 to 2.44 percent of GDP by 1989-90.

• Across the same period the centre‟s gross fiscal deficit (GFD) climbed from 5.71 percent to 7.31 percent of GDP.

• The external liabilities of the centre fell from 7.16 percent of GDP in 1982-83 to 5.53 percent of GDP by 1990-91.

• In absolute terms the liabilities were large.

• Across the same period the total liabilities of the centre and the states increased from 51.43 percent of GDP to 64.75 percent of GDP.

• This came at the cost of social and capital expenditures.

• The capital disbursements decreased from around 30 percent in 1980-81 to about 20 percent by 1990-91.

• In contrast, the interest component increased from around 8 percent to about 15 percent across the same period

• Within Revenue expenditures, in 1970-71, defence expenditures had the

highest share of 34 percent, interest component was 19 percent while

subsidies were only 3 percent.

• However, by 1990-91, the largest component was the interest share of 29

percent with subsidies constituting 17 percent and defence only 15 percent.

• Therefore, besides the burden of servicing the public debt, the subsidy

burden was also quite great.

Fiscal Policy

Re-Orientation

(1991-2008)

Liberalization, growth, inclusion and fiscal

consolidation (1991-2008)

• Balance of payments crisis of 1991

• Economic liberalization whereby the economy was opened up to foreign

investment and trade, the private sector was encouraged and the system of

quotas and licenses was dismantled.

Trends in Taxes, Expenditures

and Deficits

(1991-2008)

Direct Taxes

• In 1992-93, the personal income tax brackets were reduced to three with rates of 20, 30 and 40 percent

• Financial assets were removed from the imposition of wealth tax and the maximum rate of wealth tax was reduced to 1 percent.

• In 1993-94, the distinction between the closely held and the widely held companies was removed and the uniform tax rate was brought down to 40 percent.

• The Zero-tax companies System.

• In 1996-97, the Minimum Alternative Tax (MAT) was introduced. It required a company to pay a minimum of 30 percent of book profits as tax.

• In 1997-98, Personal income tax rates were reduced again to 10, 20, and 30

percent in 1997-98 and the uniform tax rate was further reduced to 35

percent with a 10 percent tax on distributed dividends.

• Further attempts to expand the tax base and increase revenues were the

introduction of the securities transaction tax (STT) in 2004 and the fringe

benefit tax (FBT) in the budget of 2005-06.

Fiscal Responsibility and Budget

Management Act, 2003

• The Fiscal Responsibility and Budget Management Act, 2003 (FRBMA)

is an Act of 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.

Indirect taxes

• The MODVAT credit system for excise was expanded to cover most

commodities and provide a comprehensive credit system by 1996-97.

• The eleven rates were merged into three with a few luxury items subject to

additional non-rebatable tax in 1999-2000.

• In 2000-01, the three rates were merged in to a single rate and renamed as

central VAT (CENVAT).

• There remained three additional excises of 8, 16 and 24 percent.

• In case of custom duties, in 1991-92 all duties on non-agriculture goods that

were above 150 percent were brought down.

• The “peak rate” was brought down to 40 percent in 1997-98, 30 percent in

2002-03, 25 percent in 2003-04, and 15 percent in 2005-06. The number of

major duty rates was also brought down from 22 in 1990-91 to 4 in 2003-04.

• This period also saw the introduction of the service tax in 1994-95, which

was subsequently expanded to cover more and more services.

• Despite the reforms in central taxes, even after the economic reforms of 1991, state government tax reforms were inadequate and sporadic.

• A major move in this direction was the coordinated simplification of the state sales tax system in 1999.

• This eventually led to the introduction of a VAT in 21 states in 2005.

• The value added tax gives credit to taxes paid on inputs and provides relief from cascading. Implemented at the retail level this replaced the cascading sales tax providing great relief to consumers and traders alike while enhancing the revenues of the state government.

• Goods and Services Tax (GST).

Expenditures

• The post 1991 expenditure strategy focussed on reducing subsidies and cutting down on non-capital expenditures.

• In 1995-96, of the central government‟s revenue expenditures, 9 percent went to subsidies, 13 percent to defence and 36 percent to interest.

• Five years later in 2000-01, defence and interest remained at 13 percent and 36 percent, respectively, while subsidies increased slightly to 10 percent .

• This reveals that the composition of government expenditure generally does not change very fast.

Deficits

• The rising revenues from tax administration reforms and expenditure control resulted in the deficits being brought under control.

• The central government's revenue deficit went down to 2.37 percent of GDP in 1996-97 while the GFD was 4.84 percent

• The debt to GDP ratio went down to 4.3 percent of GDP in 1995-96 and reached a further low point of 2.99 percent in 1999-00.

• By 2003-04 the combined liabilities of the centre and the states were up at 81.09 percent of GDP from 70.59 percent in 2000-01. The external liabilities were however kept under control at only 1.67 percent of GDP in 2003-04.

• FRBMA was adopted in 2003.

• This Act set overall limits to the fiscal deficit at 3 percent of GDP.

• The fiscal discipline legislations seemed to have had good impact at both the central and state levels.

• The year before the global financial crisis in 2007-08, the central government's revenue deficit came down to 1.06 percent of GDP while the GFD was 3.33 percent.

• The state governments achieved a revenue surplus of 0.58 percent of GDP and a GFD of 1.81 percent of GDP by 2006-07. Even in the year of the crisis, in 2008-09 they had a small revenue surplus of 0.19 percent of GDP and a GFD of 3.2 percent of GDP

The Crisis and return to

fiscal consolidation

• The global financial crisis that erupted around September 2008 saw Indian fiscal policy being tested to its limits.

• The policymakers had to grapple with the impact of the crisis that was affecting the Indian economy through three channels

Contagion risks to the financial sector

The negative impact on exports

The effect on exchange rates .

• The National Rural Employment Guarantee Act (NREGA) and the parliamentary elections of 2008 also resulted in further government expenditures.

• As the crisis unfolded, the government activated a series of stimulus packages .

• An overall central excise duty cut of 4 percent, additional plan expenditure of about Rs. 200 billion, state government borrowings for planned expenditure amounting Rs. 300 billion, interest subsidies for export finance, a further 2 percent reduction of central excise duties and service tax for export industries.

• Given its inherent strengths like a strong and prudently regulated financial sector and effective fiscal policy interventions, the Indian economy weathered the financial crisis rather well.

• GDP growth declined to 5.8 percent (year-on-year) in the second half of 2008-09 compared to 7.8 percent in the first half.

• By 2009-10 India‟s GDP was growing at 8 percent.

Fiscal consolidation

• The Thirteenth Finance Commission (13th FC) in its report was keenly conscious of the need to return to the path of fiscal prudence and provided a road map charting a set of desired fiscal deficit targets.

• The budget of 2010-11 adopted a calibrated exit policy targeting a fiscal deficit of 5.5 percent of GDP in 2010-11 from a level of 6.5 percent.

• In course of 2010-11 the non-tax revenues from auction of telecom spectrum (3G and broadband) resulted in higher than anticipated receipts.

• A conscious decision was taken to increase allocation to priority sectors while adhering to the fiscal deficit target.

Taxes

• The Budget of 2011-12 aimed at dovetailing both direct and indirect tax

policy with medium term objectives of fiscal consolidation and the proposed

adoption of major new tax legislations; the Direct Tax Code (DTC) for

direct taxes and the Goods and Services Tax (GST) in case of indirect taxes.

Expenditures

OVERALL

SCENARIO

(1950-2014)

Income tax trends

0

2000

4000

6000

8000

10000

12000

14000

Direct and Indirect Tax Revenue of Central Govt.

Direct Indirect Total

0

1000

2000

3000

4000

5000

6000

7000

8000

Direct and Indirect Tax Revenue of State Govt.

Direct Indirect Total

0

2000

4000

6000

8000

10000

12000

14000

16000

18000

Yea

r 1

1975-7

6

1976-7

7

1977-7

8

1978-7

9

1979-8

0

1980-8

1

1981-8

2

1982-8

3

1983-8

4

1984-8

5

1985-8

6

1986-8

7

1987-8

8

1988-8

9

1989-9

0

1990-9

1

1991-9

2

1992-9

3

1993-9

4

1994-9

5

1995-9

6

1996-9

7

1997-9

8

1998-9

9

1999-0

0

2000-0

1

2001-0

2

2002-0

3

2003-0

4

2004-0

5

2005-0

6

2006-0

7

2007-0

8

2008-0

9

2009-1

0

2010-1

1

2011-1

2

2012-1

3

2013-1

4

2014-1

5

Major Heads of Expenditure of Central Govt.

Revenue expendi-ture Defence expenditure Interest payments Subsidies

0

1000

2000

3000

4000

5000

6000

7000

8000

9000

10000

Planned and Non Planned Expenditures of Central Govt. in billion

Planned Developmental Expenditures Economic Services Social services Non planned / Non Developmental Ependitures

-1000

0

1000

2000

3000

4000

5000

6000

Yea

r 1

1975-7

6

1976-7

7

1977-7

8

1978-7

9

1979-8

0

1980-8

1

1981-8

2

1982-8

3

1983-8

4

1984-8

5

1985-8

6

1986-8

7

1987-8

8

1988-8

9

1989-9

0

1990-9

1

1991-9

2

1992-9

3

1993-9

4

1994-9

5

1995-9

6

1996-9

7

1997-9

8

1998-9

9

1999-0

0

2000-0

1

2001-0

2

2002-0

3

2003-0

4

2004-0

5

2005-0

6

2006-0

7

2007-0

8

2008-0

9

2009-1

0

2010-1

1

2011-1

2

2012-1

3

2013-1

4

2014-1

5

Deficit Indicators of Central Govt.

Gross fiscal deficit Revenue deficit Series 3

-1000

-500

0

500

1000

1500

2000

2500

3000

Yea

r 1

1975-7

6

1976-7

7

1977-7

8

1978-7

9

1979-8

0

1980-8

1

1981-8

2

1982-8

3

1983-8

4

1984-8

5

1985-8

6

1986-8

7

1987-8

8

1988-8

9

1989-9

0

1990-9

1

1991-9

2

1992-9

3

1993-9

4

1994-9

5

1995-9

6

1996-9

7

1997-9

8

1998-9

9

1999-0

0

2000-0

1

2001-0

2

2002-0

3

2003-0

4

2004-0

5

2005-0

6

2006-0

7

2007-0

8

2008-0

9

2009-1

0

2010-1

1

2011-1

2

2012-1

3

2013-1

4

Deficit Indicators of State Govt.

Gross Fiscal Deficit Revenue Deficit

CONCLUSION

• It now appears that fiscal prudence and the desire to limit the public debt through better revenue and expenditure outcomes has been fairly institutionalized in the Indian policy matrix.

• This is probably partly attributable to the anchoring role played by the FRBMA and the deficit reduction roadmaps put forward by the 13th FC.

• Looking ahead, the government would probably focus on reforms on both the tax and expenditure fronts.

• With regard to tax policy, changes can be expected in terms of legislation as well as administrative reforms to improve efficiency.

• Recent policy documents like the 12th Plan Approach Paper and the government's Fiscal Policy Strategy Statement of 2011-12 appear to indicate that the fiscal consolidation mindset is fairly well institutionalized in the country's policy establishment

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