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Trends in Fiscal Policy of India EssayABSTRACTThis bear witness traces the major developments in Indias financial policy from the early stages of aforethought(ip) development in the 1950s, through the countrys balance of payments crisis of 1991, the subsequent economic liberalisation and rapid growth phase, the response to the global financial crisis of 2008 and the recent post-crisis moves to return to a path of monetary consolidation. The initial years of Indias planned Development st yardgy were characterised by a conservative financial policy whereby deficits were kept under control. The assess system was ge atomic number 18d to transfer re microbes from the private sphere of influence to fund the large semipublic sector driven industrialization carry through and as well cover amicable welfare schemes. However, growth was anaemic and the system was accustomed to inefficiencies. In the 1980s some attempts were made to clean up particular sectors.solely the pu blic debt increased, as did the pecuniary deficit. Indias balance of payments crisis of 1991 led to economic liberalisation. The re reach of the task system commenced. The fiscal deficit was brought under control. When the deficit and debt situation once again threatened to go out of control in the early 2000s, fiscal discipline legalisations were instituted. The deficit was brought under control and by 2007-08 a benign macro-fiscal situation with high growth and moderate inflation prevailed. During the global financial crisis fiscal policy responded with counter-cyclical measures including levy cuts and increases in intakes. The post-crisis recovery of the Indian economy is witnessing a correction of the fiscal policy path towards a regime of prudence. In the future, the condense would probably be on bringing in new assess reforms and better targeting of social economic consumptions.INTRODUCTIONFiscal policy is the means by which a governance adjusts its levels of spendin g in order to monitor and influence a nations economy. It is the sister strategy to monetary policy with which a rally bank influences a nations money supply. These two policies are used in various combinations in an effort to moderate a countrys economic goals. Here we take a fancy at how fiscal policy works, how it must be monitored and how its implementation may affect different people in an economy. Fiscal policy deals with the taxation and expenditure decisions of the presidential term.Monetary policy, deals with the supply of money in the economy and the rate of interest.These are the primary(prenominal) policy approaches used by economic managers to steer the loose aspects of the economy. In just active modern economies, the giving medication deals with fiscal policy while the primal bank is responsible for monetary policy. Fiscal policy is composed of several parts.These include, tax policy, expenditure policy, investment or disinvestment strategies and debt or su rplus management. Fiscal policy is an important constituent of the overall economic modelling of a country and is therefore near linked with its general economic policy strategy. For example, if taxes were to increase, consumers would have less disposable income and in turn would have less money to spend on goods and services. This residuum in disposable income would go to the government instead of going to consumers, who would pass the money onto companies. Or, the government could choose to increase government spending by forthwith purchasing goods and services from private companies. This would increase the flow of money through the economy and would pointtually increase the disposable income available to consumers. Unfortunately, this process takes time, as the money needs to wind its way through the economy, creating a signifi batcht lag betwixt the implementation of fiscal policy and its effect on the economy.In broad term fiscal policy refers to that segment of national economic policy which is primarily concerned with the receipts and expenditure of rudimentary government. The importance of fiscal policy is high in underdeveloped countries. The assert has to play active and important role. In a democratic society direct methods are non approved. So, the government has to depend on corroborative methods of regulations. In this way, fiscal policy is a powerful weapon in the hands of government by means of which it can achieve the objectives of development.BASIC CONCEPTS A spending item is a capital expenditure if it relates to the creation of an asset that is likely to last for a considerable stop consonant of time and includes loan disbursements. Such expenditures are generally not routine in nature. By the same logic a capital receipt arises from the evacuation of an asset including the change of government shares in public sector companies (disinvestments), the return of funds given on loan or the receipt of a loan. This again usually ari ses from a comparatively irregular event and is not routine. In contrast, gross enhancement expenditures are fairly regular and generally intended to meet accredited routine requirements like salaries, pensions, subsidies, interest payments, and the like. Revenue receipts represent regular earnings for instance tax receipts and non-tax grosss including from sale of telecom spectrums.There are various ways to represent and interpret a governments deficit. The simplest is the revenue deficit which is just the difference between revenue receipts and revenue expenditures. Revenue Deficit = Revenue expending Revenue Receipts (that is nurture + Non-tax Revenue) A more comprehensive indicator of the governments deficit is the fiscal deficit. This is the sum of revenue and capital expenditure less all revenue and capital receipts other(a) than 6loans taken. This gives a more holistic view of the governments funding situation since it gives the difference between all receipts and expe nditures other than loans taken to meet such expenditures.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 cut down by net lending by government (Dasgupta and De, 2011). The gross primary deficit is the GFD less interest payments while the primary revenue deficit is the revenue deficit less interest payments.ARCHITECTUREThe Indian Constitution provides the overarching framework for the countrys fiscal policy. India has a federal form of government with taxing powers and spending responsibilities being divided between the rudimentary and the situat e governments according to the Constitution. There is also a third tier of government at the local level. Since the taxing abilities of the states are not necessarily commensurate with their spending responsibilities, some of the centres revenues need to be assigned to the state governments. To provide the basis for this assignment and give medium term guidance on fiscal matters, the Constitution provides for the formation of a Finance Commission (FC) all(prenominal) five years. Based on the report of the FC the central taxes are devolved to the state governments. The Constitution also provides that for every financial year, the government shall place before the law-makers a statement of its proposed taxing and spending provisions for legislative debate and approval.This is referred to as the Budget. The central and the state governments each have their own budgets. The central government is responsible for issues that usually concern the country as a whole like national defense, foreign policy, railways, national highways, shipping, airways, post and telegraphs, foreign trade and banking. The state governments are responsible for other items including, law and order, agriculture, fisheries, water supply and irrigation, and public health. Some items for which responsibility vests in two the Centre and the states include forests, economic and social planning, education, trade unions and industrial disputes, price control and electricity. There is now increase devolution of some powers to local governments at the city, town and village levels. The taxing powers of the central government encompass taxes on income (except agricultural income), excise on goods produced (other than alcohol), customs duties, and inter-state sale of goods.The state governments are vested with the power to tax agricultural income, land and buildings, sale of goods (other than inter-state), and excise on alcohol. Besides the annual budgetary process, since 1950, India has followed a system of five-year plans for ensuring long-term economic objectives. This process is steered by the Planning Commission for which there is no item provision in the Constitution. The main(prenominal) fiscal impact of the planning process is the division of expenditures into plan and non-plan components. The plan components relate to items dealing with long-term socioeconomic goals as determined by the ongoing plan process. They often relate to specific schemes and projects. raisemore, they are usually routed through central ministries to state governments for achieving certain want objectives. These funds are generally in addition to the assignment of central taxes as determined by the Finance Commissions.In some cases, the state governments also contribute their own funds to the schemes. Non-plan expenditures broadly relate to routine expenditures of the government for administration, salaries, and the like. While these institutional arrangements initially appeared adequate for driving the development agenda, the sharp disablement of the fiscal situation in the 1980s resulted in the balance of payments crisis of 1991, which would be discussed later. Following economic liberalization in 1991, when the fiscal deficit and debt situation again seemed to head towards unsustainable levels around 2000, a new fiscal discipline framework was instituted. At the central level this framework was initiated in 2003 when the Parliament passed the Fiscal responsibleness and Budget Management Act (FRBMA). taxes are the main source of government revenues. Direct taxes are so named since they are charged upon and collected directly from the psyche or organization that ultimately pays the tax (in a legal sense).Taxes on personal and embodied incomes, personal wealth and professions are direct taxes.In India the main direct taxes at the central level are the personal and corporate income tax. Both are till date levied through the same piece of legislation, the Income Tax Act of 1961. Income taxes are levied on various head of income, namely, incomes from business and professions, salaries, house shoes, capital gains and other sources (like interest and dividends).Other direct taxes include the wealth tax and the securities proceedings tax. Some other forms of direct taxation that existed in India from time to time but were removed as part of various reforms include the estate duty, cave in tax, expenditure tax and fringe benefits tax. The estate duty was levied on the estate of a deceased person.The fringe benefits tax was charged on employers on the value of in-kind non-cash benefits or perquisites received by employees from their employers. Such perquisites are now largely taxed directly in the hands of employees and added to their personal income tax. Some states charge a tax on professions. Most local governments also charge property owners a tax on land and buildings. Indirect taxes are charged and collected from persons other than those who finally end up paying the tax (again in a legal sense). For instance, a tax on sale of goods is collected by the vendor from the buyer. The legal responsibility of paying the tax to government lies with the seller, but the tax is give by the buyer.The current central level collateral taxes are the central excise (a tax on manufactured goods), the service tax, the customs duty (a tax on imports) and the central gross sales tax on inter-state sale of goods. The main state level indirect tax is the post-manufacturing (that is wholesale and retail levels) sales tax (now largely a value added tax with intra-state tax credit). The complications and economic inefficiencies of this fivefold cascading taxation across the economic value chain (necessitated by the constitutional assignment of taxing powers) are discussed later in the context of the proposed Goods and Services Tax (GST).EVOLUTION (TILL 1991)India commenced on the path of planned development with the setting up of the Plann ing Commission in 1950. That was also the year when the country adopted a federal Constitution with strong unitary features giving the central government primacy in terms of planning for economic development (Singh and Srinivasan, 2004). The subsequent planning process laid emphasis on strengthening public sector enterprises as a means to achieve economic growth and industrial development. The resulting economic framework imposed administrative controls on various industries and a system of licensing and quotas for private industries. Consequently, the main role of fiscal policy was to transfer private savings to append to the growing consumption and investment needs of the public sector. Other goals included the reduction of income and wealth inequalities through taxes and transfers, encouraging balanced regional development, fostering minuscule scale industries and sometimes influencing the trends in economic activities towards desired goals (Rao and Rao, 2006).In terms of tax p olicy, this meant that both direct and indirect taxes were focussed on extracting revenues from the private sector to fund the public sector and achieve redistributive goals. The combined centre and state tax revenue to GDP ratio increased from 6.3 pct in 1950-51 to 16.1 portion in 1987-88.For the central government this ratio was 4.1 part of GDP in 1950-51 with the larger share coming from indirect taxes at 2.3 pct of GDP and direct taxes at 1.8 part of GDP. Given their low direct tax levers, the states had 0.6 percent of GDP as direct taxes and 1.7 percent of GDP as indirect taxes in 1950-51. The government authorised a comprehensive review of the tax system culminating in the Taxation Enquiry Commission Report of 1953. However, the government then invited the British economist Nicholas Kaldor to examine the possibility of reforming the tax system. Kaldor establish the system inefficient and inequitable given the narrow tax base and inadequate reporting of property income a nd taxation.He also found the maximum marginal income tax rate at 92 percent to be too high and suggested it be reduced to 45 percent. In view of his recommendations, the government revived capital gains taxation, brought in a gift tax, a wealth tax and an expenditure tax (which was not continued due to administrative complexities) (Herd and Leibfritz, 2008). Despite Kaldors recommendations income and corporate taxes at the highest marginal rate continued to be extraordinarily high. In 1973-74, the maximum rate taking in to account the surcharge was 97.5 percent for personal income above Rs. 0.2 million. The system was also complex with as many as eleven tax brackets. 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. Though the statutory tax evaluate were high, given a large number of special allowances and depreciation, effective tax rates were much lower.The Direct T axes 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. The next major simplification was in 1985-86 when the number of tax brackets was reduced from eight to quaternion and the highest income tax rate was brought down to 50 percent. 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 mental synthesis at this time was complicated and tended to distort economic decisions. Some commodities had specific duties while others had ad valorem rates. 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. In effect, the tax on the input was again taxed at the next point of manufacture resulting in double taxation of the input.Considering that the states were separately dread sales tax at the post-manufacturing wholesale and retail levels, this cascading impact was considerable. The Indirect Tax Enquiry Report of 1977 recommended introduction of input tax credits to commute the cascading manufacturing tax into a manufacturing value added tax (MANVAT). Instead, the modified value added tax (MODVAT) was introduced in a phased manner from 1986 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. Items at later stages of production like ideal goods were taxed at higher rates than those at earlier stages, like raw materials. Rates also differed on the basis of perceived income elasticities with necessities taxed at lower rates than luxury goods.In 1985-86 the governmen t presented its Long-Term Fiscal Policy stressing on the need to reduce tariffs, have fewer rates and eventually remove numeric limits on imports. Some reforms were attempted but 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. Further complications arose from exemptions granted outside the budgetary process.In 1970-71, direct taxes contributed to around 16 percent of the central governments revenues, indirect taxes about 58 percent and the remaining 26 percent came from nontax revenues. By 1990-91, the share of indirect taxes had increased to 65 percent, direct taxes shrank to 13 percent and non-tax revenues were at 22 percent.COMPOSITION OF CENTRAL GOVERNMENT REVENUES (1970-71)SOURCE , http//dbie.rbi.org.in (Reserve Bank of India, 2011)COMPO STION OF CENTRAL GOVERNMENT REVENUES(1990-91)SOURCE , http//dbie.rbi.org.in (Reserve Bank of India, 2011)Indias 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. Thereafter, limited reforms in specific areas including trade liberalisation, export promotion and investment in modern technologies were accompanied by increased expenditures financed by internal and foreign borrowing (Singh and Srinivasan, 2004). 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 full point the centres gross fiscal deficit (GFD) climbed from 5.71 percent to 7.31 percent of GDP. Though the external liabilities of the centre fell from 7.16 percent of GDP in 198 2-83 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 interest component of aggregate central and state government disbursements reflects this quite clearly. 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 wa s also quite great.While Indias external debt and expenditure patterns were heading for unsustainable levels, the proximate causes of the balance of payments crisis came from certain unforeseen external and domestic political events. The First Gulf War caused a spike in oil prices leading to a sharp increase in the governments fuel subsidy burden. Furthermore, the assassination of former Prime Minister Rajiv Gandhi increased political uncertainties leading to the withdrawal of some foreign funds. The subsequent economic reforms changed the Indian economy forever.LIBERALIZATION ,GROWTH ,INCLUSION AND FISCAL CONSOLIDATION (1991-2008)Following the balance of payments crisis of 1991, the government commenced on a path of economic liberalisation whereby the economy was opened up to foreign investment and trade, the private sector was encouraged and the system of quotas and licences was dismantled. Fiscal policy was re-oriented to cohere with these changes.The Tax Reforms Committee provid ed a blue print for reforming both direct and indirect taxes. Its main strategy was to reduce the proportion of trade taxes in total tax revenue, increase the share of domestic consumption taxes by converting the excise into a VAT and enhance the contribution of direct taxes to total revenue. It recommended reducing the rates of all major taxes, minimizing exemptions and deductions, simplifying laws and procedures, improving tax administration and increasing computerisation and information system modernisation.As a part of the subsequent direct tax reforms, the personal income tax brackets were reduced to three with rates of 20, 30 and 40 percent in 1992-93. Financial assets were removed from the imposition of wealth tax and the maximum rate of wealth tax was reduced to 1 percent. Personal income tax rates were reduced again to 10, 20, and 30 percent in 1997-98. The rates have largely remained the same since with the exemption limit being increased and slab structure raised from tim e to time. A subsequent 2 percent surcharge to fund education was later made applicable to all taxes. The basic corporate tax rate was reduced to 50 percent and the rates for different closely held companies made uniform at 55 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 rate was further reduced to 35 percent with a 10 percent tax on distributed dividends in 1997-98 (Rao and Rao, 2006).Despite these reforms, the tax system continued to have preferential exemptions and deductions as tax incentives for various socio-economic goals including location of industries in backward areas, export promotion and technology development. This led to the phenomenon of zero-tax companies whereby imaginative arrangements were use to leverage all these tax incentives with an intent to minimise tax liabilities. To counter this trend,the borderline Alternative Tax (MAT) was introduce d in 1996-97. It required a company to pay a minimum of 30 percent of book profits as tax. 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 2005-06In 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 incorporated 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 private 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 to this rate.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. These four rates covered almost 90 percent of customs collected from items. This period also saw the introduction of the service tax in 1994-95, which was later expanded to cover more and more services. Given that the Indian economy was having an increasingly large service component this increasingly became a major source of revenue. Eventually, provisions were made for allowing input tax credits for both goods and services at the central indirect tax level.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 cascadi ng sales tax providing great relief to consumers and traders alike while enhancing the revenues of the state government. The administrative physical body of the VAT ensures reporting of inputs and outputs resulting in substantial reduction in tax evasion.The basic features of the tax include two rates of 4 percent for commons consumption commodities and inputs and 12.5 percent for the others. Some essential items are exempted and precious metals are taxed at 1 percent. The credit system covers inputs and purchases as also capital goods for manufacturers as well as dealers. Credit for capital goods taxes can be availed over three years of sales. The tax credit operates fully only for intra-state sales (Rao and Rao, 2006). This is a major hindrance to the formation of a smooth nationwide market and is to be addressed by the proposed Goods and Services Tax (GST).In consonance with the tax reform plans, the sources of central government revenue shifted from indirect taxes towards dire ct taxes. In 1995-96, about 54 percent of revenues came from indirect taxes while around 20 percent were from direct taxes (Figure 8). In 2000-01, the share of indirect taxes had gone down dramatically to around 45 percent while the contribution from direct taxes had increased to about 26 percent (Figure 9). By 2005-06, indirect taxes accounted for approximately 43 percent while the direct taxes share was about 35 percent.