MCom I Semester Business Environment Fiscal Policy Study Material Notes

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MCom I Semester Business Environment Fiscal Policy Study Material Notes

Table of Contents

MCom I Semester Business Environment Fiscal Policy Study Material Notes: Meaning of Fiscal Policy Definition of fiscal Policy Characteristics of fiscal policy objective of Fiscal policy Limitations of fiscal policy and Taxation Components of Budget Suggestions for Improving the Fiscal policy Long Answer Questions Short Answer Questions Objectives Questions :

 Fiscal Policy Study Material
Fiscal Policy Study Material

CTET Paper Level 2 Previous Year Science Model paper II in Hindi

Fiscal Policy

The Fiscal policy became popular after 1936, when the book entitled, “The General Theory of Employment, Interest and Money’ written by J.M. Keynes was published. Before 1930, the fiscal policy was related to the tax system of the government which was imposed on the people to meet government expenditure.

VIMP MEANING OF FISCAL POLICY

The Fiscal policy is that part of economic policy under which public revenue, public expenditure, public borrowings, financial administration and control are studied. The fiscal policy is an important instrument through which government interferes in a country’s economy. In a system of indicative planning reliance on fiscal policy as an instrument of development is considerable.

Fiscal Policy Study Material

DEFINITIONS OF FISCAL POLICY

Fiscal policy is that part of government economic policy which deals with taxation, expenditure, borrowing and the management of public debt in the economy. Some of the definitions of fiscal policy are as follows:

(1) The Planning Commission has stated in the Seventh Five Year Plan, “through it (Fiscal Policy) the government creates and sustains the public economy consisting of the provision of public services and public investment; at the same time it is an instrument for reallocation of resources according to the national priorities, redistribution, promotion of private savings and investments, and the maintenance of stability.”

(2) According to Arthur Smithies, “A policy under which the government uses its expenditure and revenue programmers to produce desirable effects and to avoid undesirable effects on national income, production and employment.”

(3) According to Prof. G.K. Shaw, “We define fiscal policy to encompass any decision to change the level of composition or timing of government expenditure or to vary the burden, structure or frequency of tax payment.”

(4) A.G. Buchlar opined, “By fiscal policy is meant the use of public finance or expenditure, taxes, borrowing and financial administration to further our national income objective.”

On the basis of above definitions we can say that, fiscal policy comprises the deliberate changes in the size, form and timing of taxation, government expenditure, and public debt operations to influence economic activity in the desired direction. The fiscal policy has a multidisc aims at improving the growth performance of the justice to the people, with performance of the economy and ensuring social

OBJECTIVES OF FISCAL POLICY

Main objectives of the fiscal policy are as follows:

1 To increase the rate of investment: The main objective of fiscal policy is to allocate mobilised resources in desirable channels of investment. The available resources must find their way into the socially necessary lines of development. The distribution of resources is to be determined according to the priorities of the plan. It is the function of the fiscal policy to ensure that they gravitate towards the desired areas of investment. Particularly when the autonomous tendency of resource allocation is unsatisfactory, the need for fiscal policy to attain a socially optimum pattern of investment is indispensable.

2. To increase employment opportunities: The objective of fiscal policy is to eliminate unemployment and increase job opportunities. Public expenditure should be directed to achieve the level of full employment in developing countries. expenditure on community development and welfare programmers increases employment. In the context of unemployment, the goal of fiscal policy should be the promotion of the highest possible rate of capital formation. It would the level of employment.

3. To control inflation: The develop problem of inflation. The fiscal policy is the best tool a pronounced inflationary trends, direct taxation can be screwed up and increased use of commodity taxation, by a wider coverage and higher rates, can also help to restrain consumption demand.

4. To increase and ensure redistribution on national income. Attainment of a wider measure of equality in incomes, wealth and opportunities must form an integral part of economic development and social advance. Existence of gross inequalities is a social evil and no measure of economic development will increase economic welfare unless an equitable distribution of the rising national product is assured. Instrument of taxation, therefore, must be used as a means of bringing about a redistribution of income in favor of the poorer sections of society.

But lessening inequalities through reducing higher incomes is only one form of fiscal operation. A complementary aspect of this policy consists of increasing and promoting public expenditure for promoting welfare of less privileged classes. Expenditure on agriculture, irrigation, education and medical and public health will improve the economic conditions of the weaker sections of society.

5. To encourage socially optional investment: It is essential to strike a balance between the two objectives of lessening economic inequalities and that of sustaining and strengthening incentives to invest in infrastructural capital formation. Expenditure on agriculture, irrigation, transportation, communication, education will help in economic development of the country.

Fiscal Policy Study Material

FISCAL POLICY AND TAXATION

The most important and effective instrument of fiscal policy is taxation. It is the most important source of revenue.

Importance of taxation in fiscal policy: Among the social and economic importance of taxation, the following principal may be mentioned :

1. Control on consumption : Taxation regulates the increasing demand for consumer goods. An increase in taxes brings about a cut in the private expenditure by curtailing the size of disposable income. Progressive taxation is as automatic stabilizer in the sense that yield from taxation goes on increasing with every increase in the income, heavy excise duties and sales taxes, though regressive in nature, also withdraw excess purchasing power from consumers without decreasing expansion of productive capacity. Thus, taxation takes away the excess purchasing power of people and controls consumption.

2. To encourage saving and investment: Taxation in the most effective means of increasing the total volume of savings and investments in any economy where the propensity to consume in normally high. The tax system must have an adequacy of both depth and range, it is to promote an accelerated pace of development. Consumption is not to be allowed to increase in proportion to increase in incomes. Thus, taxation must also mobilise any increase in economic surplus accruing to individuals, for achieving this purpose commodity taxes are quiet effective. In the field of direct taxation, higher rates in respect of personal income-tax should be accompanied by some relief for income which is saved and invested.

3. To receive the resources of the government : Taxation is the most important source of the revenue of the State. Government imposes direct and indirect taxes on income, land, production, wealth etc. and collects revenue. A large portion of income of very rich and prosperous people is spent on conspicuous consumption. This is unproductive expenditure and a waste from the point of national development. Economic growth can be accelerate portion of this. ‘surplus’ income is mobilized and made available to investment.

4. To Change the pattern of investment: In the pattern of investment: In a mixed economy, private important constituent of the economy. Therefore, fiscal policy should aim at maximum mobilization of resources for financing exp public sector but private sector should not be starved. The private sector make a significant contribution in the development of the economy and, there it must be given encouragement. Tax reliefs, rebates and liberal depreciau allowances should be granted to boost the private sector. Incentive to save an invest must not be killed by excessive taxation.

5. To reduce inequality : One of the main objectives of taxation is to reduce, if not to remove, inequalities of income and wealth. For this purpose, steeply progressive taxes must be levied on the affluent section of society. This is the trend in all democratic countries. This is why income tax, wealth tax, death duties are imposed at progressive rates. They do not bring about complete equality, that perhaps, is neither feasible nor desirable but inequalities are undoubtedly lessened so that the gulf between the ‘haves’ and ‘have nots’ is narrowed down. This effect will be further heightened if the revenues raised from the rich are spent for the benefit of the poor.

6. To increase in economic surplus : If an economy enjoys economic surplus after satisfying consumption needs it can be expected to develop economically. Economic surplus is the difference between current output and essential consumption. Some countries waste this economic surplus in unproductive consumption. It is the task of tax policy of a developing country to mobilize the economic surplus, direct it into productive investment and enlarge it.

7. To keep control on inflation :In underdeveloped economies, there is another objective that the tax system has to achieve, viz. price stability to ensure growth with stability. When these countries launch economic development programme, they have to face the problem of inflation or soaring prices. They should follow an integrated policy to solve this problem.

Fiscal Policy Study Material

LIMITATIONS OF FISCAL POLICY

Main limitations of fiscal policy are as follows:

1 Stable government plans : Government plans and programmes are stable. They can not be changed frequently.

2. No proper size and time : Fiscal policy of a country is effective only when all the measures are adopted in proper size and at proper time. It is very difficult job to determine the amount of public expenditure and investment, because it takes time to recognize the depression and boom period, In this way there is time lag between the occurence of trade cycles and measures adopted to control them. It affects the limitations of the fiscal policy.

3. Discouragement to private investment : Increase in public expenditure discourages private investment.

4. Fear of boom and sluggish periods : Public expenditure as a tool of fiscal policy should be adopted adequately otherwise it may create the situations of boom or sluggish periods.

5. No possibility in making frequent changes in public expenditure: Public expenditure as an instrument of fiscal policy can not be changed frequently

6. Stability in national income : The government withdraws a large portion of the income of society through taxation. The government increases public expenditure but national income does not increase in the same proportion because returns on increased portion of public expenditure are not visible.

7. Difficult to make changes in tax system : It is also the limitation of fiscal policy that tax system can not be changed easily.

8. Increasing income of extravagant: Fiscal measures depend on the redistribution of national income. If public expenditure benefits the extravagant. the fiscal policy is ineffective.

9. Separate public and private expenses : Private expenditure should not be included in public expenditure.

10. Need of public aid : Public aid is a necessity for effective implementation of fiscal policy.

In order that fiscal system of the country satisfies the principles of sound taxation as well as promotes development and employment, it is essential that fiscal-net is spread as wide as possible, its enforcement made fully effective and required changes in the existing fiscal-structure are brought about adequately.

Fiscal Policy Study Material

SUGGESTIONS FOR IMPROVING THE FISCAL POLICY

For an effective fiscal policy, few suggestions are given below:

1 New methods should be adopted to collect direct taxes for example voluntary disclosure of schemes for black money.

2. Reduce the burden of tax on poor section of society.

3. Agriculture taxation will not only raise a large revenue for the government, but also will bring the much needed balance in the tax structure of the country.

4. Taxation policy should be made stable.

5. The system of taxation should be simple, plain and intelligible to common understanding.

6. The amount of the tax paid is to be in proportion to the respective abilities of the tax payers.

7. Fiscal and monetary policies should be integrated

8. Since private investment is not adequate for the purpose, the government has to make up the deficiency of private investment by increasing public investment. The primary objective of fiscal policy should be to promote investment both in the private and public sector.

9. Export promotion and reduction of foreign help and aid.

Fiscal Policy Study Material

COMPONENTS OF BUDGET

Components of budget are as follows:

1 Policy regarding public debt : Public debt refers to borrowing by a government from within the country or from abroad, from private individuals or from banking and non-banking financial institutions. Underdeveloped countries, need foreign aid to sustain a high level of investment, purchase capital equipment and machinery from abroad and to cover a balance of payment gap. The external

As far as internal debt is concerned, the continuously rising magnitude has resulted in a rapid increase in debt servicing burden. The interest payment charges on the Central Government’s Public debt increased from 606 crores in 1970-71 to 5,39,034 crores in 2013-14.

2. Public expenditure policy: The government is firmly determined to bring the socialist pattern of society through various budgetary measures. It means India wants to ensure an equitable distribution of income and wealth and decentralisation of economic power. Public expenditure policy of the government can be divided into two groups:

(i) Revenue and capital expenditure : The major trend in public expenditure in India is the growing revenue expenditure of the government. In 1950-51 the total public expenditure in both revenue and capital accounts was 900 crore. It rose to 36,55,506 crore in 2013-14.

(ii) Plan and non-plan expenditure : The main reason for spectacular rise in the public expenditure during the planning period has been expansion in development activities over the years. The ratio of the development expenditure to the total expenditure was 36-2 percent in 1950-51. For a period of three decades, i.e., upto 1980-81, it increased considerably. However, since 1980-81 development expenditure declined. It was 60-3 percent in 1990-91. There was a significant decline in it during the liberalization phase. Since 1980-81 not only no developmental expenditure has increased in absolute term but the ratio of no development expenditure to total expenditure has also risen. Non-development expenditure is considerably desirable from administrative point of view and has a tendency to increase with the growth in population and per capita income. Defence, interest payments on public debt, tax collection charges and police roughly account for two-thirds of non-development expenditure. The expenditure on defence was 3,600 crore and expected to increase further to 2,03,672 crore in 2013-14. During 1980-81 to 2013-14 interest payments on debt increased from 2,957 to 5,39,034.

3. Taxation policy : The objectives of taxation policy are as follows:

(1) Unnecessary and luxurious consumption is to be reduced through taxation and the additional resources will be transferred from consumption to investment.

(ii) For accelerating economic growth, the government has to adopt a tax policy which may raise the rate of savings and capital formation in the country.

(iii) Through taxation inequalities in income and wealth can be reduced.

(iv) The governments in the developing countries have to intervene to make sure that the productive resources are utilised in strategic or key industries and in other essential economic activities.

For the achievement of these objectives, taxation is used for : (a) diversion of resources from private to public sector;

(b) diversion from consumption goods industries to investment goods industries, and

(c) diversion of demand for import of goods to export of goods. The central government collects the revenue from two kinds of taxes.

(1) Direct taxes : In the case of direct tax, the man who pays it is also intended to bear it. In the case of direct taxes, as Mr. Hicks explains, the abilities varies with the circumstances of tax-payer and the relation between we tax-payer and the revenue authorities is direct and personal. The impact and incidence of direct taxes, income tax is more important but the government collects more revenue from corporate taxes.

(ii) Indirect taxes : An indirect tax is expected to be shifted to other persons. The impact and incidence of indirect taxes are on different persong Indirect taxes are commodity taxes such as sales tax on the sale of the commodity and excise duty on the production of commodity. Indirect direct taxes are regressive, i.e., their burden is more on poor and less on rich.

4. Deficit financing : Deficit financing is said to have been practised whenever government expenditure exceeds the receipts from the public. Such an excess of government expenditure can be financed either by drawing down the cash balances of the government or by borrowing from the Reserve Bank of India. Both these methods of financing the deficit would have the effect of expanding money supply held by public. Deficit financing has been given a very important place in India’s five year plans and there was rather too much reliance on it.

Fiscal Policy Study Material

EXERCISE QUESTIONS

Long Answer Questions

1 Define the fiscal policy and discuss its main objectives.

2. Explain fiscal policy and describe its instruments.

4. What is fiscal policy? Explain the importance of taxation in it.

5. Explain the limitations of fiscal policy of India and give suggestions for improvement of fiscal policy.

6. Critically examine deficit financing in India.

Short Answer Questions

1 What do you understand by fiscal policy?

2. Write the objectives of fiscal policy.

3. Give the definition of fiscal policy.

4. What is the capital budget?

5. What do you understand by public debt policy?

6. What is taxation policy?

Fiscal Policy Study Material

Objective Questions

(1) Select the Correct Alternatives :

1 The instrument of the fiscal policy is :

(a) Deficit financing

(b) Unemployment

(c) Capital formation

(d) None of these.

2. Adverse effect on private investment is known as:

(a) Effect of fiscal policy

(b) Effect of public debt policy

(c) Limitations of fiscal policy

(d) None of these.

3. Among following whose object is to attain full employment:

(a) Monetary policy

(b) Fiscal policy

(c) Poverty

(d) None of these.

4. Tariff policy is known as:

(a) Fiscal policy

(b) Monetary policy

(c) Employment policy

(d) All of above.

[Ans. 1. (a), 2. (c), 3. (b), 4. (a).]

(II) Write True or False :

1 Fiscal policy is a budgetary policy which is directed by the Minister of Finance.

2 The objective of fiscal policy is to increase the rate of investment in private and public sectors of the economy.

3. Inflationary trends exist in the developing economy.

4. Under fiscal policy the government does not interfere directly.

(Ans. 1. True, 2. True, 3. True, 4. False.)

(III) Fill in the Blanks :

1 The primary objective of ………… is to promote investment both in the private and public sectors.

2………….. checks consumption of luxuries and the use of saving so made for economic development.

3. Taxation policy …….. the effects of inflation in the economy.

4. Under the fiscal policy, …………. can not be altered frequently.

(Ans. 1. taxation policy,  2. Fiscal policy, 3. controls,  4. Public expenditure.)

Fiscal Policy Study Material

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