3. Fiscal Policy
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3. Fiscal Policy
3.1 What is Fiscal Policy?
Fiscal policy is the government's use of taxation, public spending and borrowing to influence the economy. It is decided by the Finance Ministry and presented to Parliament through the Union Budget.
Objectives
Economic growth and higher employment.
Price stability.
Reducing income and regional inequality.
Providing public goods such as defence, roads and health.
Stance of fiscal policy
Stance |
Meaning |
Expansionary |
More spending and/or lower taxes to raise demand. Used in a slowdown; it widens the deficit |
Contractionary |
Less spending and/or higher taxes to cool demand and control inflation |
Neutral |
Spending is matched by revenue; the budget has little effect on demand |
Remember
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3.2 The Union Budget
The Budget is the Annual Financial Statement under Article 112. It shows estimated receipts and expenditure for the coming financial year (1 April to 31 March). Since 2017 it is presented on 1 February, and the separate Railway Budget was merged with it in the same year.
Constitutional provisions
Article |
Provision |
112 |
Annual Financial Statement (Budget) |
113 |
Estimates of expenditure; Lok Sabha votes on Demands for Grants, while "charged" expenditure is only discussed |
114 |
Appropriation Bill: allows withdrawal from the Consolidated Fund |
115 |
Supplementary, additional or excess grants |
116 |
Vote on Account, Vote of Credit and Exceptional Grant |
117 |
Finance Bill: gives effect to tax proposals |
265 |
No tax can be levied or collected except by authority of law |
266 |
Consolidated Fund and Public Account of India |
267 |
Contingency Fund of India: held by the President for urgent, unforeseen expenditure |
Stages of the Budget in Parliament
Stage 1: Presentation of the Budget by the Finance Minister in the Lok Sabha, followed by the Budget speech.
Stage 2: General discussion.
Stage 3: Scrutiny by Departmental Standing Committees.
Stage 4: Voting on Demands for Grants (only the Lok Sabha votes).
Stage 5: Passing of the Appropriation Bill.
Stage 6: Passing of the Finance Bill.
Cut motions
Policy cut: reduces the demand to Re 1, showing disapproval of a policy.
Economy cut: reduces the demand by a stated amount to push for economy.
Token cut: reduces the demand by Rs 100 to raise a specific grievance.
3.3 Structure of the Budget
|
Revenue Budget |
Capital Budget |
Receipts |
Tax revenue and non-tax revenue |
Borrowings, recovery of loans, disinvestment |
Expenditure |
Day-to-day running costs: salaries, subsidies, interest, pensions |
Spending that creates assets or reduces liabilities: roads, dams, loan repayment |
Sources of receipts
Tax revenue: income tax, corporation tax, GST, customs duty and union excise duty.
Non-tax revenue: interest receipts, dividends and profits from PSUs, fees, fines and spectrum charges.
Capital receipts: market borrowings, treasury bills, external loans, loan recoveries and disinvestment (sale of government stake in PSUs).
Since 2017-18 the Plan and Non-Plan classification has been dropped; expenditure is shown as revenue and capital.
3.4 Deficits
Deficit |
Formula and Meaning |
Revenue deficit |
Revenue expenditure − Revenue receipts. Shows the government is borrowing even for running costs |
Fiscal deficit |
Total expenditure − Total receipts excluding borrowings. It equals the total borrowing requirement |
Primary deficit |
Fiscal deficit − Interest payments. Shows borrowing needed for current activities, apart from past debt |
Effective revenue deficit |
Revenue deficit − Grants for creating capital assets |
Remember
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3.5 FRBM Act
The Fiscal Responsibility and Budget Management (FRBM) Act, 2003 set rules for fiscal discipline.
Aim: remove the revenue deficit and bring the fiscal deficit down to 3% of GDP.
The Government must present documents such as the Medium-term Fiscal Policy Statement each year.
The N. K. Singh Committee (2016) reviewed the Act and suggested a debt-to-GDP ratio as the main anchor, with a 60% general government debt target (40% Centre and 20% States).
An escape clause lets the Government exceed the targets in special conditions such as a war, national calamity or a sharp slowdown.
The escape clause was used in 2020-21 during the COVID-19 crisis.
3.6 Taxation
Feature |
Direct Tax |
Indirect Tax |
Burden |
Falls on the person who pays it |
Can be passed on to the consumer |
Examples |
Income tax, corporation tax |
GST, customs duty, excise on some goods |
Nature |
Generally progressive |
Generally regressive |
Evasion |
Easier |
Harder |
Based on tax rate
Progressive: the rate rises as income rises.
Proportional: the same rate for everyone.
Regressive: the burden is heavier on lower incomes.
Goods and Services Tax (GST)
Introduced from 1 July 2017 by the 101st Constitutional Amendment Act, 2016.
Article 246A gives both Parliament and State legislatures power to make GST laws; Article 279A creates the GST Council.
The GST Council is chaired by the Union Finance Minister and includes State Finance Ministers.
It is a dual tax: CGST and SGST on intra-state supply, IGST on inter-state supply and UTGST in Union Territories.
GST is a destination-based tax, so the state where goods are consumed gets the tax on them.
Petroleum crude, diesel, petrol, natural gas and aviation turbine fuel were kept out of GST at the start, and alcohol for human consumption remains outside it.
Sharing of taxes with States
The Finance Commission (Article 280) recommends how central taxes are shared with states, every five years.
The 15th Finance Commission (2021-22 to 2025-26) kept the states' share of the divisible pool at 41%. The 16th Finance Commission, chaired by Arvind Panagariya, covers the period from 2026-27.
Cesses and surcharges are not part of the divisible pool, so the Centre does not share them with states.
3.7 Public Expenditure and Public Debt
Public expenditure
Revenue expenditure: salaries, pensions, subsidies, interest payments and grants to States.
Capital expenditure: building infrastructure and acquiring assets.
Developmental: economic services and social services. Non-developmental: defence, interest payments and administration.
Public debt
Internal debt: borrowing within India through government securities, treasury bills and small savings.
External debt: borrowing from foreign governments and institutions such as the World Bank and IMF.
Treasury bills are short-term (91, 182 and 364 days); dated securities are long-term, with maturities of 5 to 40 years.
Article 292 lets the Union borrow on the Consolidated Fund; Article 293 deals with borrowing by States.
Crowding out: heavy government borrowing raises interest rates and leaves less credit for private investment.
3.8 Types of Budgeting
Type |
Meaning |
Zero-based budgeting |
Every expense is justified afresh each year instead of being carried over from the last year |
Performance budgeting |
Links money allotted to the work and results expected |
Outcome budgeting |
Shows the outcomes expected from each scheme; presented from 2005-06 |
Gender budgeting |
Tracks how much of the budget helps women; introduced in 2005-06 |
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