Government Budgets

A changing fiscal framework

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Primary surplus

Mains level : Paper 3- Change in government's fiscal policy stance

The article examines the changes in government’s fiscal policy stance which supports the debt-financing and apparent contradiction displayed by increased excise duty.

Increase in excise duty

  • Well before India began to globalise there was a time when each Union Budget announced sales tax increases on tobacco products.
  • The rise in tax was expected to be a shot in the arm for the revenue-starved government of our poor country.
  • India is less poor now, having risen to the rank of an emerging market economy.
  • Yet, COVID-19 has wreaked havoc.
  • As opposed to a Budget estimate of 3.5% for fiscal deficit, the revised estimates show a 2.7 times larger deficit of 9.5% for FY 2020-21. 
  • A comparison of the government’s revised Budget estimates with the original Budget estimates reveals a fall in receipts from every source of taxation except excise.
  • The revised Budget shows a rise of ₹94,000 crore on account of excise duties alone.
  • Presumably, the increase comes from the much-debated excise duty increases on petroleum and diesel.
  • The excise duty rise will hardly compensate for the huge falls in other tax revenues.
  • The larger excise duty collection is not large enough to have significantly reduced the inflated fiscal deficit figure.

Implications of hike in excise duty

  • Given the nature of the products on which the excise duty has gone up, prices of commodities will rise in general.
  • With annual output shrinking by an estimated 7.7%, it is straightforward to conclude that unemployment has risen significantly.
  • The accompanying price rise will be the unemployed persons’ worst nightmare.
  • The result will be severe inequality.

Change in economic policy framework

  • The Economic Survey 2020-21 considers Olivier Blanchard’s prescription that a fiscal deficit automatically transformed to government debt.
  • Such debts along with their servicing liabilities have a tendency to magnify over the years where present borrowings keep increasing to repay past borrowings and service charges.
  • This leaves little room for growth-enhancing expenditure and reduces a government’s creditworthiness in the eyes of lenders.
  • Debt-financed fiscal spending could well be a driver of growth.
  • It can improve the standard of living of the entire population, without necessarily removing inequality.
  • A government’s fiscal expenditure, Professor Blanchard points out, has stronger multiplier effects during recessions than during booms
  • The inequality, however, could well be benignant, for even though the rich will grow richer, the poor will escape out of poverty.

Condition for debt-financed fiscal spending

  • Debt or the fiscal deficit constitutes the government’s spendable resources.
  • What will prevent the government from sinking into a debt trap?
  • Professor Blanchard shows that the debt-to-GDP ratio can be prevented from exploding if the rate of growth of GDP happens to be higher than the sovereign rate of interest.
  • This is the case in developed economies.
  • In such economies, debt financed government expenditure will create a positive primary surplus out of which interest payments can be made to keep the debt-GDP ratio under control.
  • There will, of course, be a maximum value that this ratio can attain, a value that is higher the larger is the excess of the growth rate over the interest rate.

Contradiction in fiscal policy and fiscal regime

  • According to the Economic Survey, India’s average interest rate and growth rate over the last 25 years (leaving out FY 2020-21) have been 8.8% and 12.8% respectively.
  • Hence, Professor Blanchard’s condition is satisfied.
  • This, of course, is not to support excise duty increases, for it goes against the very principle of the Blanchard argument.
  • Therefore, there appears to be a contradiction between the government’s announced fiscal policy stance and the fiscal regime it is actually running.

Consider the question”The Economic Survey 2020-2021 calls for the debt-financed fiscal spending. Do you think that this view is suitable for India economy? What are the risks involved?”

Conclusion

The government must consider the implications of increased excise on the economy and should focus on removing the contradiction in its fiscal policy and fiscal regime.

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