< Previous | Contents | Next >
The real meaning, significance and impact of fiscal policy emerged in the wake of the Great Depression and the Second World War. Fiscal policy has been defined as ‘the policy of the government with regard to the level of government purchases, the level of transfers, and the tax structure’—probably the best and the most acclaimed definition among experts.21 Later, the impact of fiscal policy on macro-economy was beautifully analysed.22 As the policy has a deep impact on the overall performance of the economy, fiscal policy is also defined as the policy which handles public expenditure and tax to direct and stimulate the level of economic activity (numerically denoted by the Gross Domestic Product).23 It was J. M. Keynes, the first economist who developed a theory linking fiscal policy and economic performance.24
Fiscal policy is also defined as ‘changes in government expenditures and taxes that are designed to achieve macroeconomic policy goals’25 (such as growth, employment, investment, etc.). Therefore, we say that ‘fiscal policy denotes the use of taxes and government expenditures’.26
How the taxes and the government expenditures influence the overall economy, has been explained in a brief discussion here.27 Let us first discuss the taxes and their impact on the economy:
(i) Taxes have a direct bearing on people’s income affecting their levels of disposable incomes, purchase of goods and services, consumption and ultimately their standard of living;
(ii) Taxes directly affect the savings of individuals, families and firms which affect investment in the economy—as investment affects the output (GDP) thereby influencing the per capita income;
(iii) Taxes affect the prices of goods and services as factor cost (production cost) is affected thereby affecting incentives and behaviour of economic
activities, etc.
Government expenditures affect/influence the economy in two ways:
(i) There are some expenditure on government purchases of goods and services, for example construction of roads, railways, ports, foodgrains, etc., in the goods category and salary payments to government employees in the services category; and
(ii) There are some expenditure due to government’s income support, to the poor, unemployed and old-age people (known as government transfer payments).
India was declared to be a planned economy right after Independence. As development responsibilities of the government were very high, there was a need of huge funds in rupee as well as in foreign currency forms. India faced continuous crises in managing the required fund to support its Five Year Plans—neither foreign funds came nor internal resources could be mobilised in sufficient amount. (Due to lower tax collections, weaker banks that too privately owned, and negligible saving rate, etc.)28
By the late 1960s, the government headed for deficit financing and from the 1970s onwards, India started going for higher and higher fiscal deficits and became more and more dependent on increased deficit financing with every fresh year. We may classify dificit financing in India into three phases.
This phase had no concept of deficit financing and the deficits were shown as Budgetary Deficits. Major aspects of this phase were—
(i) Trying to borrow from inside and outside the economy but unable to meet the target.
(ii) In the 1950s, a serious attempt was made to increase tax collections and check revenue expenditures to be ultimately able to emerge as a surplus revenue budget economy. But huge cost was paid in the form of tax evasion, rise in corruption, stagnating standard of life and a neglected
social sector.
(iii) Taking recourse to heavy borrowings from the RBI and finally nationalisation of banks so that their money could be used by the government to support the plans. This not only increased the interest burden of the governments but also ruptured the whole financial system in coming years—banks did not remain commercial entities and became part of the government’s political statement.
(iv) Establishing giant PSUs with higher revenue expenditures (salaries) which increased the revenue expenditures of the future governments when the pensions and the PFs needed to be serviced.
(v) Unable to go for the required level of investment even after taking recourse to all the above given means.
This is considered the period of deficit financing, follow up of unsound fundamentals of economics and finally culminating in severe financial crisis by the year 1990–91. Major highlights of this phase may be summed up as follows—
(i) This phase saw the nationalisation policy and simultaneous revival of an increased emphasis on expansion of the PSU (two points should be noted here specially—first, many of the South East Asian economies have, officially declared their acceptance of capitalism and privatisation. Secondly, China had declared that investment in the government- controlled companies are a loss of money at this time).
(ii) Upcoming PSUs increased the total expenditure of the government’s revenue as well as capital.
(iii) Existing PSUs were taking their own due from the economy—the illogical employment creation excessively increased the burden of salaries, pensions and PF; many of them had started fetching huge losses by this time; as the public sector does not have profit as its primary goal; there was a lack of profit and loss analysis; as the PSUs had no connection between their need of labour force and the existing labour force. Ultimately, the responsibility of profit or loss did not remain the
onus of the officers, thus making them centres of intentional losses and an institutionalised centre of corruption; etc.
(iv) The governments have failed on both the fronts—checking population rise and mass employment generation—the burden of different subsidies went on increasing making them unmanageable and highly illogical. Self-employment programmes could not pick up, or better said, it was politically suitable to go for piece-meal wage-employment programmes with different names.
(v) Planned development remained highly centralised and devoid of any place for local aspirations—frustrations of masses started showing up in the form extremist and radical organisations raising their heads creating a law and order problem and excessive expenditure on them. The outcome was a burdened police force and lagging judicial set up.
(vi) The plan expenditure which governments were going for were through investments in the PSUs which were not committed to profit motive, deficit financing for the PSUs was not based on sound economics. Majority of the plan expenditure in a sense turned out to be non- economic, i.e., non-plan expenditure at the end.
Due to the above-given reasons, it was tough to say whether it was sound to go for huge fiscal deficits in India.29
The Third Phase (1991 onwards)
This started with the initiation of the economic reforms process under the conditionalities put forth by the IMF (controlling fiscal deficit was one amongst them). As the economy moved from government dominance to market dominance, things needed a restructuring and public finance also needed a touch of rationality.