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Public Finance, Taxes and Fiscal Policy

Public Finance studies the finances of the government, i.e., government’s receipts (revenue receipts and capital receipts) and government’s expenditure (revenue expenditure and capital expenditure). Government’s revenue is called Public Revenue and government’s expenditure is called Public Expenditure.

The classical theory and practice of economics were based on “Laissez Faire” or free economy, in which there was no outside intervention in the free play of market forces and consumers and producers took their decisions freely. The classical economists considered that government as best which governed the least. But with the advent of democratic welfare states and Keynesian economics based on “pump priming” and “multiplier effect” to bring back the depression hit global economy to normalcy, the significance of public finance increased much.

Public Revenue

The tax sources of public revenue include direct and indirect taxes, which can generally be understood as tax on individuals/groups and commodities respectively. In economic literature we use the concept of “shiftability” or “transferability” to differentiate between the direct and indirect taxes. Direct taxes are not shiftable or transferable from the point of levy to other point while indirect taxes are shiftable or transferable. There are two technical terms to explain shiftability or transferability of taxes- the “impact” of taxes, which is the first point of levy of taxes and the “incidence” of taxes, which is the final resting point of taxes. In case of direct taxes the incidence and impact of tax remain at the same point while in the case of indirect taxes the impact is at one point and incidence is other point. The shifting of taxes takes place through price mechanism.

Income tax, corporate tax, gift tax, capital gains tax are direct taxes while excise duty, customs, service tax, sales tax are indirect taxes.

Trends in tax collection

The gross tax collections are reasonably on track. The growth in direct tax collections of the Centre kept pace with the previous year, with a growth of 13.7 per cent. The budgeted growth for indirect taxes for the full year 2017-18 is 7.6 per cent; the actual growth till November is 18.3 per cent.

The States’ share in taxes grew by about 25 per cent during 2017-18 (Apr-Nov), much higher than the growth in centre’s net tax revenue at 12.6 per cent and of gross tax revenue at 16.5 per cent.

Non- tax sources of revenue

Non- tax sources of revenue of the government include various fees and charges (leasing of FM or broadband spectrum, lease of mining rights, registration of companies), receipts from public enterprises and commercial departments of government (post and telecommunications, railways etc. for example), market borrowing from small savings and Treasury Bills or Government Bonds, receipt of interest etc and issue of new money (seigniorage).

The non-tax revenues have visibly under-performed. However, non-debt capital receipts, mainly proceeds from disinvestment, are doing well. As against last year’s achievement of Rs. 46,247 crore realized from 16 transactions of disinvestment, the budget estimate for 2017-18 was set at Rs. 72,500 crore, split into Rs. 46,500 crore from disinvestment of Central Public Sector Enterprises (CPSEs),Rs. 15,000 crore from strategic disinvestment and Rs. 11,000 crore from listing of insurance companies. An amount of about Rs. 52,378.2 crore has been realized during April-November 2017, that includes Rs.30,867.0 crore through minority stake sale in CPSEs, Rs. 4,153.6 crore through disinvestment of strategic holdings in SUUTI and Rs.17,357.5 crore through listing of insurance companies.

Revenue Account and Capital Account

Budget divides receipts in revenue account receipts and capital account receipts. All recurring receipts like taxes and earnings from the PSUs and commercial undertakings are receipts on revenue account while all long term receipts or receipts in the form of assets are called capital receipt, which include PSU disinvestment proceeds, market borrowing and receipt of principal amount loaned out.

Public Expenditure

Public expenditure of recurring nature which does not create any asset is called “revenue expenditure” such as subsidies, interest payments, wages, salary, pension etc. The asset creating expenditure, which are meant for acquiring land, building, plant, machinery and equipment etc, is called “capital expenditure”.

The total expenditure of the Government increased by 14.9 per cent during 2017-18 (Apr-Nov), as compared to 12.6 per cent in the same period of the previous year. The revenue expenditure grew by 13.1 per cent and capital expenditure by 29.3 per cent during the first eight months of the current year. The advancing of the budget cycle and processes by almost a month gave considerable leeway to the spending agencies to plan in advance and start implementation early in the financial year, leading to progression of Central expenditure at a robust pace.

Fiscal Policy

Fiscal policy collectively refers to the set of policies related to “Public Revenue” and “Public Expenditure”. These policies are manipulated or handled according to the requirements of the economy. An “expansionary fiscal policy” (adopted during recession) reduces taxes while increases expenditures whereas a “contractionary fiscal policy” increases taxes and reduces expenditure (adopted during inflation and boom). The fiscal policy in modern times is also categorized as “cyclic fiscal policy” and “counter-cyclic fiscal policy.” Generally governments in the past adopted “cyclical fiscal policy”, which means that they adopted expansionary fiscal policy when economic was growing reasonable fast because in this case governments have more space for increased public expenditure and tax cuts because with higher growth its tax and non-tax revenues are high. Contrary to this they cut government expenditure to reduce burden on budget and raised taxes during recession to increase government’s revenue. Both these responses refer to cyclic fiscal policy; however, these cyclic fiscal policy measures may be convenient, but are not expedient. For example during the growth phase government should save resources while during recession it should increase public expenditure and cut taxes to buoy the falling economy. Such a fiscal policy is called counter-cyclic fiscal policy.

Fiscal health

Fiscal health of a country is said to be good if the divergence between total receipts and total expenditure is small and manageable, public debt is low and tax collection is sufficient.

Fiscal health is measured with the help of “deficit concepts”, debt-GDP ratio and Tax-GDP ratio.

Fiscal Deficit is the broadest measure of deficit in public finance.

Fiscal Deficit = Total Expenditure on revenue account and capital account —- Total Receipt on revenue account and capital account

Or

Fiscal Deficit = Total expenditure —- Total non-debt creating receipts

Revenue Deficit = Total Expenditure of Revenue account of the budget —- Total Receipt on revenue account of the budget

Primary Deficit = Fiscal Deficit —- Interest Payments

Fiscal Consolidation

Fiscal consolidation refers to measures taken by the government to reduce the divergence between its expenditure and receipts. Kelkar Committee, however, pointed out that fiscal consolidation should be revenue-led (increasing tax proceeds by reforms) and not by a cut in expenditure, which by its very nature is recessionary.

India passed a Fiscal Responsibility and Budget Management Act in 2003 which is being implemented since April 2004 in order to reduce fiscal deficit and revenue deficit within a given strategy and time frame (fiscal roadmap). According to the original FRBM Act fiscal deficit was to be cut to 3% of GDP while revenue deficit to zero. The effectiveness of FRBM Act could be seen by a continuous reduction in fiscal deficit and revenue deficit in central budget. The fiscal deficit for 2013-14 was 4.4% of GDP. The Indian government has always attached utmost priority to prudent fiscal management and controlling fiscal deficit. Fiscal Deficit was brought down to 4.1% in 2014-15 to 3.9% in 2015-16, and to 3.5% in 2016-17. Revised Fiscal Deficit estimates for 2017-18 are Rs5.95 lakh cr at 3.5% of GDP.

Data on 23 States shows that both revenue and fiscal deficits as percentage of the corresponding budget estimates is lower in the current year, compared to the previous year.

The net market borrowings by the State Governments, as reported by the Reserve Bank of India (RBI), during April-December of the current and previous years stood at Rs. 2493.0 billion and Rs. 2351.6 billion respectively.

Coupled with the Central Government’s target for reducing fiscal deficit by 0.3 percentage points of GDP, the State fiscal targets for 2017-18 meant that the General Government targeted to achieve an overall improvement in their fiscal position in the current year, boosted by a compression in revenue expenditure and a modest improvement in capital expenditure.

N.K Singh Committee on review of FRBM Act

The FRBM Review Committee headed by former Revenue Secretary, NK Singh was appointed by the government to review the implementation of FRBM. In its report submitted in January 2017, titled, ‘The Committee in its Responsible Growth: A Debt and Fiscal Framework for 21st Century India’, the Committee suggested that a rule based fiscal policy by limiting government debt, fiscal deficit and revenue deficits to certain targets is good for fiscal consolidation in India.

Main recommendations of the NK 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.

Justifying the target of 2.5% to be realized in the next six years, the Committee observed that debt sustainability analysis (DSA) conducted for the central government suggests such a target (for fiscal deficit) will help to achieve the public debt target of 40% for the centre 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 to follow the golden rule here ie., not to finance government’s day to day expenditure through borrowings. Revenue deficit implies financing of government’s day today activities from borrowings.

In the 2014-15 budget speech, Finance Minister Arun Jaitley announced the constitution of Expenditure Management Commission (EMC). The Commission had been conceived as a recommendation body with the primary responsibility of suggesting major expenditure reforms that will enable the government to reduce and manage its fiscal deficit at more sustainable levels. The EMC was formed as a five-member body composed of the former Reserve Bank Of India (RBI) Governor Bimal Jalan, who has been appointed to Head the Commission, former Finance Secretary Sumit Bose, former Deputy RBI Governor Subir Gokarn and two other members. The commission was mandated to evaluate proposals for reducing the three major subsidies (i.e. food, fertilizer and oil). The commission was to submit an interim report before the presentation of the Budget for 2015-16. The final report was to be submitted before the 2016-17 budget. But the Commission took a little more time.

Bimal Jalan Commission: Expenditure Management

The expenditure management commission, headed by former Reserve Bank of India (RBI) governor Bimal Jalan, submitted its first interim report in January 2017 to Finance Minister Arun Jaitley. The finer details will take time till Finance Minister and a team of policymakers examine it and make it public. However, the broad proposals suggest ways for the government to reduce administrative costs and disburse funds for various schemes more efficiently. The commission might submit a few more interim reports to the government, before presenting a final report sometime in 2018. The panel is studying various government schemes, programmes, acquisitions and projects for which the Centre is spending substantially.

It is anticipated that the commission might have suggested the Centre not to carry forward pending expenditure from a particular year to subsequent years to show better expenditure or fiscal deficit numbers. The panel, however, for the time being may not be looking on to the allocation of expenditure towards particular schemes. Rather, it may is recommend ways in which the sum allocated can be spent in the most cost-effective manner. The three broad areas the commission has examined are the delivery mechanism of programmes, the technology being used to implement these, and the accounting methods used by the government.

The government follows the cash-based accounting system, through which income is counted when cash (or a check) is actually received, and expenses are counted when actually paid. An alternative method is an accrual-based system, wherein transactions are counted as they happen, regardless of when the money is actually received or paid. The Commission studied the pros and cons of both methods. Their recommendations in this regard, however, are not yet known. The terms of reference of the commission, constituted on September 4, 2016, include reviewing all matters related to central government spending, including suggesting space for increased developmental spending and reviewing the budgeting process and norms under the Fiscal Responsibility and Budget Management Act and suggesting ways to meet a reasonable proportion of spending on services through user charges. It is also to recommend ways to achieve a reduction in financial costs through better cash management, greater use of information technology and improved financial reporting systems.

 

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