FISCAL POLICIES OF DEVELOPING ECONOMIES

8/14/2019 FISCAL POLICIES OF DEVELOPING ECONOMIES

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Fiscal Policiesof

Developing Economies


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Fiscal policy is the use of government spending and revenue collection to

influence the economy or the overall effect of the budget outcome on

economic activity. The two main instruments of fiscal policy are government

spending(G) and taxation(T).. Changes in the level and composition of

taxation and government spending can impact on the following variables inthe economy:

Aggregate Demand and the level of economic activity;

The pattern of resource allocation;

The distribution of income.

The three possible stances of fiscal policy are:-neutral stance: G = T

expansionary stance: G > T

Contractionary stance: G < T

What is fiscal policy?


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Objectives & tools of fiscal policy

In developing countries, fiscal policy is used to create an environment for rapid

economic growth. The various aspects of this are:

1. Mobilization of resources

2. Acceleration of economic growth

3. Minimization of the inequalities of income and wealth

4. Increasing employment opportunities5. Price stability

Various tools of fiscal policy, the following are the most important:

Reflationary Fiscal Policy

It may be used to boost the level of economic activity during periods of recessionor deceleration in economic activity.

Deflationary Fiscal Policy

During a boom, i.e., when the economy is growing beyond its capacity, inflation

and balance of payment problems might result.


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Major issues in fiscal policy of developing

economies

Developing economies two main issues in relation with its fiscal policy. Its

govt. has to keep in mind these two aspects of fiscal policy while planning

for its budget. These two issues are:-

Creation of fiscal space :-For developing countries, fiscal space may seem

a more immediate issue than in advanced economies because there are

more pressing needs for expenditure today.

Reduction of fiscal deficit :- if fiscal deficit is not reduced then the country

will be struck in a web of further interest payments on its net borrowings andhave a deficiency of funds to allocate towards productive proposals.


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What is Fiscal Space?

Fiscal space can be defined as the availability of budgetary room that allows a

government to provide resources for a desired purpose without any prejudice to

the sustainability of a governments financial position. It must do this withoutcompromising macroeconomic stability and fiscal sustainabilitymaking sure

that it has the capacity in the short term and the longer term to finance its

desired expenditure programs as well as to service its debt.


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Creation of fiscal space

Fiscal space can be created majorly from two methods:

1. Creating Fiscal Space Without New Borrowing

2. Governments can generate fiscal space by increasing their un-utilized

borrowing capacity.

Creating Fiscal Space Without New BorrowingThe most attractive way for countries to create fiscal space is within existing

borrowing parameters.Fiscal space can be created without the issuance of

new debt by

1. improving the efficiency of public expenditure;

2. increasing revenue mobilization;3. mobilizing grant aid.


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Efficiency and Effectiveness of Fiscal Space

The efficiency and effectiveness ofpublic expenditure or creation of fiscal

space is critical to outcomes in developing economies

cost-overruns,

poor project management,poor maintenance

inefficient creation and maintenance of infrastructure assets.

Leakages increases in health and education spending better

outcomes..

If institutional weaknesses and problems of governance that causepoor outcomes are not addressed, even spending on potentially high return

programs will have little impact on growth. The net impact will be to erode the

governments solvency and reduce its fiscal space.


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Fiscal Deficit

Fiscal deficit is basically the situation in which govt.s budgeted expenditure is

more than its revenue. Fiscal deficit can be reduced by taking up two main

measures or by the combination of both. These measures are:

Reduction of govt. spending

Increase in govt. revenue

Fiscal policy in developing countries has been broadly successful in

achieving economic stabilization in part through reductions in fiscal

deficits. The median fiscal deficit in developing countries was reduced from 6

percent in the early 1980s to 2 percent in the late 1990s and median inflationwas reduced from 15 to 5 percent over the same period.


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Cost of reducing fiscal deficit

The success of fiscal policy in relation to its stabilization objective may

have come at the cost of long-term economic growth.

In developing economies reduction of the fiscal deficit was largely achieved

through expenditure adjustments. They relied on expenditure reductionsrather than revenue enhancement as the principal means of fiscal adjustment

over this period. The largest share of expenditure adjustment in these

countries was accomplished by cuts on infrastructure. There are no clear

trends in the share of public expenditure allocated to education they appear

to have been protected from cuts - but expenditure on health as a share of

GDP shows a clear and sharp increase post-1990.


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Selecting the Apt. Fiscal Policy Design

1. Physical and human capital formation and the economys long-term potential

growth trajectory

2. The efficiency of expenditures and complementarities among productive

expenditure categories.

The developing economies should choose that fiscal policy design that enables

both the short-term stabilization objective as well as longer-term growth and

poverty reduction objectives to be achieved. Fiscal policy is important because

of its impact on


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Limitations of Fiscal Policy

Fiscal policy has been a great success in developed countries but only

partially so in developing countries. Following are some of the reasons that

are hindrances for its implementation in developing countries:

1. Lack of statistical information as regards the income, expenditure, savings,investment, employment etc. makes it difficult for the public authorities to

formulate a rational and effective fiscal policy.

2. Fiscal policy cannot succeed unless people understand its implications and

cooperate with the government in its implication. This is due to the fact that,

in developing countries, a majority of the people are illiterate.3. Large-scale tax evasion, by people who are not conscious of their roles in

development, has an impact on fiscal policy.


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4. Fiscal policy requires efficient administrative machinery to be

successful. Most developing economies have corrupt and

inefficient administrations that fail to implement the requisite

measures vis--vis the implementation of fiscal policy.

5. The resources available with the government are meager since tax

bases are small and tax administration weak.

6. Much of tax revenue comes from inefficient and distortionary

indirect taxes such as excise duties. International trade is heavilytaxed. Effective personal income taxes are low and easily evaded

and corporate taxes are high.


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ChinaChallenges

1) Unemployment, poverty, and social unrest

2) Negative economic effects of corruption

3) HIV-AIDS and epidemic disease

4) Water resources and pollution

5) Increasing energy consumption and prices;

6) Fragility of the financial system and state-owned enterprises

7) Possible shrinkage of foreign direct investment

8) Potential conflict with Taiwan.


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Fiscal policy

2002 and 2009 Chinese government continued to pursue a proactive

fiscal policy to boost domestic demand.

Lowering the securities stamp tax rate

Customs tariffs were reduced

The banking and insurance business tax was further lowered

The increase in expenditures is caused by the following factors:

Continued investment in projects funded by government bonds,western region development and technical innovation;

Increased investment in agriculture, science and education.


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A several million dollar fund for having the top innovators of the world

VATwhich represents more than 40 percent of total tax revenuethegovernment has been piloting a reform to allow credits for the tax paid oncapital inputs, with a view to progressively moving from a production-type toa consumption-type VAT

Personal income tax is also in need of reform, in particular: (i) the top rateshould be aligned to the EIT rate; and (ii) the number of tax schedules andthe number of rates within each schedule should be reduced.

Therefore, the budget deficit

Chinas medium-term fiscal sustainability is strongly underpinned by sustainedeconomic growth and a steady increase in revenue as well as the peoplesconfidence in the government.


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Russia Russias fiscal policy was prudently conservative, but the future fiscal

risks are significant.

Reduce spending volatility by diverting a stable flow of oil revenues to thebudget and allocating the rest to a stabilization fund impact on thedomestic economy and its competitiveness.

Three fiscal challengesuncertain revenues, rising expenditures, andthe specter of renewed debt Oil revenues, booming today, could becomea drag on economic performance.

Issue 1- Uncertain Revenues

The share of oil revenue in total fiscal revenue increased substantiallyfrom 10 percent of GDP to about 30 percent.

Instead of diversifying, Russia has specialized in oil, which now accountsfor about 60 percent of exports This has not been a problem in the faceof high oil prices, but it could become a major vulnerability if oil pricesbegin a rapid descent.


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Issue 2: Russia will confront major public spending

Aging population - higher pension health services, Changing demand structure for education

Social expenditures are likely to increase by 3.5 percentage points of GDP

Issue 3- Increasing Debt

Gross debt increasing, oil funds shrinking, budget transfers will exceed oil

revenues transfers from the National Welfare Fund are not enough to cover the

non oil primary (non interest) fiscal deficit.

Unless the government undertakes fiscal measures to ensure sustainability,Russia will once again become a net debtor in the long term.

Oil fund assets and its other foreign exchange assets by the end of the planning

horizon in 2040, reaching zero net debt. After that, Russia could again fall into

debt


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India FRBMA Mandated annual targets for reduction in fiscal deficit

Although changed situation now, because of changing global economicenvironment

Ways

Improvement in tax-GDP ratio

Decrease in non-developmental expenditure,

Moderate growth in non-tax revenue Governments Strategy to Pursue Fiscal Consolidation till last year

Taxation

Direct

Focus

Moderate rates and a broad base

Removal of exemptions and improvement in tax administration

Examples - Property tax, Income Tax, Service tax


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Indirect taxes

Unlike Direct Taxes, Indirect Taxes are not levied on individuals, buton goods and services. Customers indirectly pay this tax in the form of

higher prices.

Examples - VAT (Value Added Tax), Sales tax, Excise tax, Stamp duties

and Expenditure tax.

Goods and services tax (GST) from April 1 2010. Converge almost all

indirect taxes at the Centre and states level.

Minimum Alternate Tax (MAT) applied low or no taxable income, however thebooks of accounts reflect accounting profits abolished

Fringe Benefit Tax (FBT) on ESOPs abolished

New Tax Code


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New Tax Code

Replace 1961 indirect tax laws, become a lawonly in 2011

Securities Transaction Tax (STT) abolition

Long term and short-term definition by theperiod of holding of a capital asset will beremoved.

All capital gain income has to be aggregatedwith other income and taxed as per slab ratesapplicable to the taxpayer

However the cost of acquisition and cost ofimprovement will be adjusted on the basis ofcost inflation index to reduce the inflationarygains?

The base date for calculation of cost ofacquisition of a capital asset has been proposedto be shifted from 01-01-1981 to 01-04-2000.This would be a big disadvantage to people whohad brought the assets very long ago.

The reason is that you would have brought it forvery low prices but the capital gains will becalculated based on the price of the asset on01-04-2000.

Upto 160

000

Nil Nil

1 60 001 to

3 00 000

10% 10% of the

amount

exceeding

lower limit3 00 001 to

5 00 000

20 % 10% of the

amount

exceeding

lower limit

5 00 001 to

10 00 000

30% 10% of the

amount

exceeding

1 60 000

10 00 001

to 25 00

000

30% 84 000 +20

% of the

amount

exceeding

10 000`Above 25

00 001

30% 3 84 000 +

30% of the

amount

exceeding

25 00 000


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Example For ease of understanding

Suppose you have bought some shares on March 20, 1995 for Rs 60,000 and their valueas on April 1, 2000 was Rs 1 lakh. Now if you sell these shares anytime on or after April 1,2011 for say, Rs 2.5 lakh, your cost of acquisition for the purpose of indexation will betaken as Rs 1 lakh and not Rs 60,000

.

Consequently, the gain of Rs 40,000 (Rs 1,00,000 - 60,000) from 1995 till 2000 escapesthe tax net.

In the above example, the amount that will be taxable will be Rs 1.5 lakh (Rs 2.50 lakh saleprice less Rs 1 lakh which is the value on the base date).

It is possible to legally avoid even this tax by selling these shares a little before a April 1,

2011 (say, on March 25, 2011). Since the sale on March 25, 2011 will be governed by theprovisions of ITA61, the entire long-term capital gains will be tax-free.

Few concern that it would lead to stock market crash when it would be applied andmoreover the rules are same for both Indian and foreign investors this would increase theseverity

Capital losses will be allowed to be set-off only against capital gains

Would also effect the further investments in India

Maximize direct tax collections

Deficit reduction


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Current Policies

Prudent mix of fiscal and monetary policy.

Government Bonds

Ways & Means Advances

Inflation

Debt management Office(DMO)

Common Minimum Programme

National Rural Employment Guarantee Scheme

Sarva Shiksha Abhiyan


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National Rural Health Mission

Backward Regions Grants Fund (BRGF)

National Investment Fund (NIF)

Twelfth Finance Commission


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Sri guru gobind singh college of

commerce.

BBE dept.

3rd year

Thank

You..

FISCAL POLICIES OF DEVELOPING ECONOMIES

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