TABLE OF CONTENTS
1. Introduction
2. Research Questions
3. Objectives
4. Research Methodology
5. Analysis and Interpretation
6. Conclusion
7. References
INTRODUCTION
Fiscal policy is the use of government spending and taxation to influence the economy. When the
government decides on the goods and services it purchases, the transfer payments it distributes,
or the taxes it collects, it is engaging in fiscal policy. The primary economic impact of any
change in the government budget is felt by particular groups—a tax cut for families with
children, for example, raises their disposable income. Discussions of fiscal policy, however,
generally focus on the effect of changes in the government budget on the overall economy.
Although changes in taxes or spending that are “revenue neutral” may be construed as fiscal
policy—and may affect the aggregate level of output by changing the incentives that firms or
individuals face—the term “fiscal policy” is usually used to describe the effect on the aggregate
economy of the overall levels of spending and taxation, and more particularly, the gap between
them.
Fiscal policy is the means by which a government adjusts its spending levels and tax rates to
monitor and influence a nation's economy. It is the sister strategy to monetary policy through
which a central bank influences a nation's money supply. These two policies are used in various
combinations to direct a country's economic goals.
Government's revenue (taxation) and spending policy designed to (1) counter economic
cycles in order to achieve lower unemployment, (2) achieve low or no inflation, and (3) achieve
sustained but controllable economic growth. In a recession, governments stimulate
the economy with deficit spending (expenditure exceeds revenue). During period of expansion,
they restrain a fast growing economy with higher taxes and aim for a surplus (revenue exceeds
expenditure).
RESEARCH QUESTIONS
1. How the fiscal policy of India evolved since independence?
2. What were the changes and the impact of fiscal policy after liberalisation in 1991?
OBJECTIVES
This research is an attempt to highlight the importance of fiscal policy in economics.
The basic idea is to analyse the overall objective fiscal policy with respect to India.
RESEARCH METHODOLOGY
The research methodology adopted is predominantly doctrinal. Static data and relevant
information provided on various sites has been used. On the basis of the information obtained, an
analysis has been made and arrived to a conclusion. Books and information available on different
websites have been relied upon in making this project.
ANALYSIS AND INTERPRETATION
Fiscal policy is an aspect of public finance, of making and financing government expenditures. It
is distinguished from other aspects of public finance in being concerned with decisions about
certain “over-all” variables—such as total expenditures, total revenues, and total surplus or
deficit—in terms of their “over-all” effects—such as their effects on national income, total
employment, and the general level of prices.
The management of their total revenues and expenditures and of the relation between them has
become one of the principal instruments by which governments seek to achieve a high level of
economic activity and general price stability. This effort encounters many problems—including
the compatibility of these two objectives with each other and with other goals, the uncertainty of
the size and timing of the necessary actions, and the difficulty of making and carrying out
decisions in a large and political organization. Nevertheless, there is widespread confidence that
the fiscal instrument is sufficiently powerful, and its use sufficiently understood, to make a
substantial contribution to successful economic performance.
The distinction between fiscal policy and the other aspects of public finance that deal with
particular expenditures and taxes and their particular consequences is an abstraction from the
complexity of the real world. In fact, decisions about the “overall” variables are made up of
decisions about particulars. Also, any decision that has “over-all” effects will also have particular
effects on particular individuals, industries, or sectors of the economy.
While the boundary between fiscal policy and other aspects of public finance is necessarily
arbitrary, the concept of fiscal policy is useful for analysis and for policy making. Every
particular expenditure, tax, and debt issue may have a different over-all effect from every other.
Yet for certain purposes it may be both convenient and safe to regard some large categories of
expenditures, taxes, and debt issues, or even their totals, as single variables. In fact, it may be
impossible to do otherwise, since existing knowledge is too crude to permit distinction among all
possible variables.
It is necessary to distinguish fiscal policy not only from other aspects of public finance but also
from monetary policy, which also consists of overall measures usually evaluated in terms of
over-all effects—on national income, total employment, or the price level, for example. This
distinction can be drawn in various ways, depending upon the definition given to monetary
policy. The distinction and connection are clearest if monetary policy is defined as policy with
respect to the quantity of money. Fiscal policy can then be defined as policy with respect to total
government sources and uses of funds and their composition. Certain sets of actions are a
mixture of both monetary and fiscal policy—such as an increase of government expenditures
financed by an increase in government borrowing, which in turn causes or is permitted to cause
an increase in the money supply. Even in the mixed cases it is possible to distinguish between the
monetary and fiscal aspects and to consider what effects flow from each. Its relation to monetary
policy is one of the central problems of fiscal policy; this will be discussed below.
Pre-Keynesian theory - Fiscal policy began to assume a leading role in economic thinking,
economic controversy, and economic policy only in the 1930s. But as long as there have been
governments there has been fiscal policy, and a substantial body of doctrine about it existed long
before the 1930s. Although we shall be concerned here mainly with “modern,” i.e., post-1930,
fiscal policy, a few words should be said about earlier ideas and practice. Modern thinking about
fiscal policy, after first abandoning much of prior doctrine, has since rein-corporated a great deal
of it.
Neither fiscal theory nor fiscal practice before the 1930s was primarily concerned with
maintaining high employment and stabilizing the rate of growth of total national output.
Economic thinking and policy in general were much less dominated by the high employment
problem than they later came to be and were more focused on problems of long-run growth,
efficiency in the use of employed resources, and equity in the distribution of income. It was
believed that in the long run the economy would tend to produce at a rate determined by “real”
factors—the supply of labor and capital and the state of technology. Prices and wage rates would
tend to adjust to changes in total money expenditures for goods and services so as to leave real
output unchanged.
This view still left the possibility that variations in the general level of prices would have
unwanted distributional effects in the long run and would cause unemployment in the short run.
This was commonly regarded as a monetary problem, which could be handled by appropriate
management of the quantity of money. At the same time, certainly by the 1920s, the possible
contribution of budget policy, particularly variation of public works expenditures, to short-run
economic stabilization, was widely but not universally recognized. However, a well-developed
theory of how budget policy worked was lacking. There was uncertainty and disagreement about
whether budget policy was an independent instrument of economic stabilization or only a
particular way of carrying out monetary policy which might nevertheless be helpful in special
circumstances. Moreover, the small size of government budgets relative to national incomes
severely limited the possibility of a major contribution of budget policy to economic
stabilization.
Before the depression, attention in economic thinking about fiscal policy focused on its
consequences for the distribution of the total output among uses, rather than on its consequences
for the level of output in the short run. The main consequences of fiscal policy were considered
to be its effects on (a) the division of output between consumption and investment and (b) the
division of output between public and private use. Standards of good fiscal policy were largely
derived from the desired objectives for these two divisions of the national output. (There was, of
course, a vast literature on aspects of public finance other than “fiscal policy” which was
concerned with other consequences.)
A major theme was the connection among budget balancing, saving, investment, and economic
growth. If government expenditures were larger than tax receipts, the deficit would have to be
financed by borrowing. The government’s borrowing would absorb part of the nation’s current
private saving, which would therefore not be available to finance private investment. Investment
would be lower than if the budget had been balanced, and consequently the rate of economic
growth would also be lower.
This argument that total savings will be larger if there is a budget surplus than if there is a deficit
is true only if the taxes used to achieve the surplus depress private savings by an amount less
than the tax collections. Kinds of taxes are conceivable of which this would not be true.
However, it is not necessary to adopt such taxes. Indeed, the same argument that calls for
balancing the budget and running a surplus in order to promote economic growth also calls for
avoiding kinds of taxation that depress private saving.
The conclusion that government budgets should be balanced was also reached by consideration
of the proper division of the national product between private and public uses. The requirement
that government expenditures should be financed by taxation was considered necessary to
prevent a politically dangerous and economically wasteful excess of government spending.
Ultimately the citizen might be thought of as buying services from the government and as
obtaining the right amount when he acquires the amount whose cost he is willing to pay in taxes.
It is not demonstrable a priori that the total amount of government expenditures that would be
made if they had to be paid for in taxes is the “best” amount, or even better than the amount that
would be made if they could be financed by borrowing. Government expenditures have a real
cost in private expenditures that must be forgone, however they are financed. The “discipline”
argument for budget balancing is that citizens will not accurately appraise this real cost if they
can borrow to pay it. Once this possibility of error is admitted, it becomes a question of fact in
what direction the errors run. If the citizens may underestimate costs which are financed by
borrowing, so may they overestimate costs financed by taxation and either overestimate or
underestimate the benefits of expenditures.
As has been noted, consideration of the desirable division of the national product between
consumption and investment and between public and private uses led economists before the
1930s to budget balancing as a basic principle of fiscal policy. But the common popular support
for the budget-balancing idea was probably not chiefly based on the economists’ argument. The
idea that government budgets should be balanced has a direct and intuitive appeal as a particular
application of principles of conduct accepted as having moral and utilitarian validity in a much
broader field. The “folk wisdom” basis of popular thinking about budgets probably explains the
strong resistance of that thinking to the revolutionary change in economists’ views of the matter
that began in the 1930s.
Post-Keynesian theory - Earlier thinking about fiscal policy was challenged in the 1930s at its
root—namely, the proposition that fiscal policy does not affect total national output. Successful
challenge to this proposition brought the level of total output and total employment to the
forefront of the objectives of fiscal policy. It also radically altered thinking about policy to
achieve the traditional objectives.
The revolution in thinking about fiscal policy can be dated from the publication of John Maynard
Keynes’s General Theory of Employment, Interest and Money in 1936. This work had its
precursors and was subsequently explained, extended, refined, and in part controverted by others.
But the General Theory was the turning point. All serious argument about fiscal policy since it
was published, even the argument that completely denied the Keynesian conclusions, has been
influenced by it.
The first step in the new approach to fiscal policy was to loosen the link between the quantity of
money and total money expenditures or total money income. If the ratio of total money income
to the supply of money was fixed (or if not fixed, at least determined by factors that fiscal policy
could not influence), fiscal policy that did not affect the supply of money would not affect total
money income.
The new theory provided a way for fiscal policy to affect total money income, without a change
in the supply of money. This, of course, implied a change in the ratio of money income to money
supply. For example, suppose the government increases its expenditures without equally
increasing taxes and without increasing the supply of money. The increase in government
expenditures will initially increase the incomes of individuals and businesses. Since there has
been no increase in the money supply, the ratio of their money holdings to their incomes has
declined. Older theory would have emphasized reactions to a decline in this ratio which took the
form of attempts of individuals and businesses to build up their money holdings by cutting their
expenditures, which would in turn reduce total income. The newer theory emphasized two other
possibilities. One was that money holdings were already “redundant,” so that there would be no
felt need to increase money holdings as incomes increased. The other possibility was that
individuals and businesses would try to build up their money holdings by selling interest-bearing
securities (rather than by cutting their expenditures). This would reduce the prices of such
securities, and raise the interest rates they yielded, until a point was reached at which people
would no longer consider it worthwhile to sell securities at low prices, or give up interest, in
order to get more money.
In the early years of the “new fiscal theory” there was some disposition to carry the argument
even further. That is, not only was the effectiveness of fiscal policy asserted, but the
effectiveness of monetary policy was denied. If people were willing to absorb a change in their
money holdings without any reaction, or if they reacted in a way that affected only interest rates,
which did not in turn affect either private investment or saving, there would be no route by which
a change in the money supply could affect total money income.
Controversy between the pre-Keynesian view and the extreme post-Keynesian view raged for
some years in the late 1930s. But in time a consensus emerged on an intermediate position. The
ratio of total money income to the money supply is not fixed, but can be affected by changes in
interest rates, which can be changed by fiscal policy; but the ratio is not infinitely variable, and a
change in the money supply will affect money income, either through an effect on interest rates
and investment, or directly. Under this formulation the national money income may be affected
by fiscal policy, or by monetary policy, or by various combinations of the two. Wide
disagreement remains, however, about the probable magnitudes of the effects of each kind of
action.
The foregoing discussion has run entirely in terms of the effect of fiscal action upon total money
income and money expenditures. It will be recalled that earlier thinking held that variations in
money income and expenditures would not in any case affect real output and employment,
except temporarily, but would affect only prices and wage rates. The Keynesian analysis
assumed that as long as employment was below some level, considered the full employment
level, wage rates would be stable and variations in money income would be directly reflected in
employment and real output. Some of Keynes’s early followers tended to argue as if this
assumption, made for purposes of analysis, were also descriptive of the real world. However,
there has since been a general recognition that the actual situation is more complicated. There is
no single point of “full employment” below which variations in money income affect only
employment and output without affecting prices and wage rates and above which only prices and
wage rates, but not employment and output, would be affected. At least over a considerable
range of employment levels, variations in money income will affect both prices and output,
although the price effect will presumably be larger and the output effect smaller, the higher the
initial level of employment. This makes the choice of the “desired” behaviour of money income
difficult, but it still leaves the behaviour of money income an important objective of fiscal
policy.
Basic Concepts
At the outset, it is important to clarify certain basic concepts. The most elementary is perhaps the
difference between revenue and capital flows, be they receipts or expenditures. While there are
various complex legal and formal definitions for these ideas, presenting some simplified and
stylised conceptual clarifications is deemed appropriate. A spending item is a capital expenditure
if it relates to the creation of an asset that is likely to last for a considerable period of time and
includes loan disbursements. Such expenditures are generally not routine in nature. By the same
logic a capital receipt arises from the liquidation of an asset including the sale of government
shares in public sector companies (disinvestments), the return of funds given on loan or the
receipt of a loan. This again usually arises from a comparatively irregular event and is not
routine. In contrast, revenue expenditures are fairly regular and generally intended to meet
certain routine requirements like salaries, pensions, subsidies, interest payments, and the like.
Revenue receipts represent regular „earnings‟, for instance tax receipts and non-tax revenues
including from sale of telecom spectrums. There are various ways to represent and interpret a
government‟s deficit. The simplest is the revenue deficit which is just the difference between
revenue receipts and revenue expenditures. Revenue Deficit = Revenue Expenditure – Revenue
Receipts (that is Tax + Non-tax Revenue) A more comprehensive indicator of the government‟s
deficit is the fiscal deficit. This is the sum of revenue and capital expenditure less all revenue and
capital receipts other than 6 loans taken. This gives a more holistic view of the government‟s
funding situation since it gives the difference between all receipts and expenditures 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 reduced 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.
India’s fiscal policy architecture
The Indian Constitution provides the overarching framework for the country’s fiscal policy.
India has a federal form of government with taxing powers and spending responsibilities being
divided between the central and the state 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 centre’s 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) every 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 legislature 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 defence, 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 both the Centre and the states include forests,
economic and social planning, education, trade unions and industrial disputes, price control and
electricity. There is now increasing 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 fiveyear plans
for ensuring long-term economic objectives. This process is steered by the Planning Commission
for which there is no specific provision in the Constitution. The main 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. Furthermore, they are
usually routed through central ministries to state governments for achieving certain desired
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 deterioration of the
fiscal situation in the 1980s resulted in the balance of payments crisis of 1991, which would be
discussed later. Following economic liberalisation 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 Responsibility 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 person or organisation that ultimately pays the tax (in a legal
sense).1 Taxes on personal and corporate 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 property, capital gains and other sources (like interest and
dividends).2 Other direct taxes include the wealth tax and the securities transactions tax. Some
1
Economic theory indicates that the incidence of a tax depends on various factors. In the case of commodity taxes
these include the respective elasticities of supply and demand.
2
A capital gain (or loss) arises when a person sells off a capital asset. The gain (or loss) is the difference between
the price at which the asset was purchased and the price at which it is sold and represents an appreciation (or fall) in
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, gift 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 seller from
the buyer. The legal responsibility of paying the tax to government lies with the seller, but the
tax is paid by the buyer. The current central level indirect taxes are the central excise (a tax on
manufactured goods), the service tax, the customs duty (a tax on imports) and the central 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 multiple 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 of Indian fiscal policy till 1991
India commenced on the path of planned development with the setting up of the Planning
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 cater 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
value. Often an adjustment to the basic value of the asset is made to include factors like cost inflation or economic
depreciation due to wear and tear.
small scale industries and sometimes influencing the trends in economic activities towards
desired goals (Rao and Rao, 2006).
In terms of tax policy, 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 percent in 1950-51 to
16.1 percent in 1987-88.3 For the central government this ratio was 4.1 percent of GDP in 1950-
51 with the larger share coming from indirect taxes at 2.3 percent of GDP and direct taxes at 1.8
percent 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 (Rao and Rao, 2006).
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 found
the system inefficient and inequitable given the narrow tax base and inadequate reporting of
property income and 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 Kaldo’s 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 rates were high, given a large number of special
allowances and depreciation, effective tax rates were much lower. The Direct Taxes 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
3
The Indian financial year commences on the 1st of April of a calendar year and ends on the 31st of March of the
next calendar year.
number of tax brackets was reduced from eight to four and the highest income tax rate was
brought down to 50 percent (Rao and Rao, 2006).
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 structure at this time was complicated
and tended to distort economic decisions. Some commodities had specific duties while others
had ad valorem rates.4 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 imposing 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 convert 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 (Rao and Rao, 2006).
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 finished 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 government presented its
Long-Term Fiscal Policy stressing on the need to reduce tariffs, have fewer rates and eventually
remove quantitative 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 (Rao and Rao,
2006).
4
Specific duties are levied in terms of a certain amount for every unit, for instance a tax amount per litre of alcohol
or per hundred cigarettes. Ad valorem taxes are based on the value of the article or service to be taxed at a certain
rate. For instance a ten percent ad valorem sales or consumption tax rate would mean that if a good worth Rs. 100
were purchased, a tax of Rs. 10 would be paid.
In 1970-71, direct taxes contributed to around 16 percent of the central government’s revenues,
indirect taxes about 58 percent and the remaining 26 percent came from non-tax revenues
(Figure 1). 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 (Figure 2).
CONCLUSION
The major developments in India’s fiscal policy from the early stages of planned development in
the 1950s, through the country‟s 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 fiscal consolidation. India‟s fiscal policy in the
phase of planned development commencing from the 1950s to economic liberalisation in 1991
was largely characterised by a strategy of using the tax system to transfer private resources to the
massive investments in the public sector industries and also achieve greater income equality. The
result was high maximum marginal income tax rates and the consequent tendency of tax evasion.
The public sector investments and social expenditures were also not efficient. Given these
apparent inadequacies, there were limited attempts to reform the system in the 1980s. However,
the path of debt-induced growth that was pursued partly contributed to the balance of payments
crisis of 1991.
Following the crisis of 1991, the government charted out a path of economic liberalisation. Tax
reforms focussed on lowering of rates and broadening of the tax base. There were attempts to
curb subsidies and disinvest the government holdings in the public sector industries. While
initially the fiscal deficit and public debt were brought under control, the situation again started
to deteriorate in the early 2000s. This induced the adoption of fiscal responsibility legislations at
the central and state levels. There were also reforms in the state level tax system with the
introduction of VAT. Consequently there were major improvements in the public finances. This
probably contributed to the benign macro-fiscal environment of high growth, low deficits and
moderate inflation that prevailed around 2008. The global financial crisis brought an end to this
phase as the government was forced to undertake sharp counter-cyclical measures to prop up
growth in view of the global downturn. Measures included, excise duty cuts, fiscal support to
selected export industries and ramping up public expenditure.
The Indian economy weathered the global crisis rather well with growth going down to 5.8
percent in the second half of 2008-09 and then bouncing back to 8.5 percent in 2009-10. In view
of the recovery, a slow exit from the fiscal stimulus was attempted in a manner whereby fiscal
consolidation was achieved without hurting the recovery process. Recent policy documents like
the 12th Plan Approach Paper and the government’s Fiscal Policy Strategy Statement of 2011-12
appear to indicate that the fiscal consolidation mindset is fairly well institutionalised in the
country’s policy establishment (Planning Commission, 2011; Ministry of Finance, 2011). This is
partly reinforced by institutional structures like fiscal responsibility legislations and the regular
Finance Commissions that mandate the federal fiscal transfer regime. In the future, it appears
that the government would focus on tax reforms and better targeting of social expenditures to
achieve fiscal consolidation while maintaining the process of inclusive growth.
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