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Public Finance and Fiscal Policy. Pinaki Chakraborty National Institute of Public Finance and Policy New Delhi, India

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Public Finance and Fiscal Policy Pinaki Chakrabory Naional Insiue of Public Finance and Policy New Delhi, India Srucure of presenaion Role of Sae Public Finance & Fiscal Policy Issues
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Public Finance and Fiscal Policy Pinaki Chakrabory Naional Insiue of Public Finance and Policy New Delhi, India Srucure of presenaion Role of Sae Public Finance & Fiscal Policy Issues relaed o Public Expendiure Issues relaed o ax policy Issues Relaed o Deb Managemen Fiscal Policy in Macroeconomic Seing Issues Relaed o Fiscal Space, revenue mobilizaion, spending & susainabiliy Role of Sae Fiscal asks of he sae - in is hree branches (following Musgrave): Allocaion - provision of public goods and aking care of exernaliies - posiive and negaive Redisribuion Sabilizaion The Expansion of he Role of Sae Three Major Facors Srucural changes in he economy Democraizaion of sociey Concern for social jusice Underlying Facors: Srucural changes - leading o urbanizaion and decline of self-sufficien agriculural households - and family - culural and welfare concerns of he sociey also broaden in he process of civilizaion (Wagner's law). Concerns raised by expansion of public secor - doubs abou efficiency in he use of resources - also emergence of deficis in governmen budges led o quesions abou susainabiliy of a large public secor - hence he cry for downsizing. How valid are hese quesions and moves? Wha are he implicaions? Role of governmen in developing economies: Argumens for minimal governmen - such as ha wha governmen does, he privae secor can do beer are no always sound. While reliance on marke is mosly beneficial, seleced governmen acions do spur developmen. Role of governmen in developing economies (Cond ) The role of he governmen should be o help in esablishing infrasrucure in is broades sense: Educaional Technological Financial Physical Environmenal Social Fiscal policy can play a vial role in each. Insrumens o perform he role - Taxaion and borrowing o draw resources for providing public goods & services - Expendiure programmes - Quasi-fiscal inervenion, - regulaions ec. - Direc involvemen in economic aciviy Taxaion as an Insrumen and Is Objecive Need o raise revenue irrespecive of he forms of governmen Raise revenues equiably or fairly Minimize he cos of raising axes Desire o encourage (discourage) paricular economic aciviy, paricular groups and regions Level, Srucure and Need: Some Major Poins Tax Levels Alhough around 20 per cen of GDP is colleced as axes, ax-raio differs across counries from 10 o 40 per cen of GDP Broadly he ax raios vary due o income levels, counries wih higher income generally has higher ax raios Counries wih rich naural resources also have higher ax raios visà-vis oher counries wih similar levels of per-capia income Tax Srucure and revenue need differ across counries for many facors including, economic srucure, Locaion of he counry capaciy o adminiser Public service delivery need Differing ax policy issues in Developing Counries Informal economy a much larger fracion of GDP High fracion of revenues coming from few large farms Lack of informaion on poenial ax payers for boh direc and indirec axes Weak domesic financial insiuions. Use of non-radiional sources of revenue: seignorage, ariffs, fees Equiy, Fairness and cos of collecion As axes impose real cos o he sociey, good ax policy ry o minimize he cos. Taxes influence he before-ax disribuion of income by changing economic incenives and also influence he afer ax disribuion of income hrough progressive income axaion. Though, equiy and efficiency, primarily should guide ax policy design, adminisraive feasibiliy is anoher key crieria in designing a ax sysem. Anoher principle is ha ax policy should no make frequen changes in he ax srucure, because i increases Enforcemen and compliance cos Increase he efficiency cos, as i affecs producion and business decisions Cos of ax Minimizing he deadweigh loss Arising ou of he negaive consequences of ax induced changes in behaviour Cos Collecion cos Developed counries a 1 per cen of oal ax In developing counries a much higher rae Compliance cos Tax payers incur in meeing heir ax obligaion over and above he acual paymen of axes Third pary also may incur he compliance cos Compliance coss are generally regressive and are ypically much higher wih respec o axes colleced from smaller firms Minimizing Cos of Taxaion Three General Rules Tax base should be as broad as possible I is disorion minimizing Seing ax raes as low as possible, given he revenue need for governmen operaion The efficiency cos of ax arises from heir effec on relaive prices, and size of his effec is direcly relaed o he ax rae Careful aenion should be given o axes on producion Taxaion on producion affec he locaion of business, aler he ways in which producion akes place, changes he form in which business conduced Producion ax is easy o adminiser and less expensive o collec Fairness Concern Horizonal and verical equiy Horizonal equiy requires ha hose who are in similar circumsances o pay similar amoun of axes Verical equiy requires appropriae differences among ax payers in differen economic circumsances. To deermine fairness, one mus consider economic incidence of axaion From he perspecive of social and economic inequaliy, boh expendiure and ax policy should be considered o undersand heir effecs on disribuion of income Economic Incidence of Taxaion Tax burden fall on individuals as Consumers Producers Supplier of facors of producions No on corporaions and oher insiuions Liabiliy o pay does no necessarily mean bearing of economic incidence of axes Alhough, VAT law requires paymen of axes in enire producion and disribuion chain, he real economic incidence fall on he consumer Same is he case wih he moor fuel ax There are incidence when he economic incidence is unclear For example, propery ax, may be he owner of he land and capial or by he user or reners of he propery depending on marke condiion Marke condiion is criical who acually bears he ax incidence depending on he supply and demand elasiciy Using he ax sysem for non-ax objecives The ax sysem can be used o encourage or discourage cerain aciviies Correc for marke failure, such as posiive or negaive exernaliies, for example polluion Counries use ax provisions o encourage larger families, reiremen savings, capial invesmen, home ownership, ec., which may no have marke failures Providing ax incenive for paricular aciviies Many counries have ax expendiure budge o accoun for cos of provision ha are used o promoe non-ax objecives Globalizaion and ax base Apar from raes, base also depends on he naure of he economy Increasing global inegraion reduced he ax base in developing counries especially hose axes which are easy o collec Globalizaion may enail a negaive fiscal shock o developing counries, shrinking he ax revenue from radiional axes. Rely on alernaive hard o collec sources such as Value Added Taxes (VAT), income axes, sales axes, ec., hen from easy o collec axes. These hard o collec axes, unlike ariff adminisered a cenralized locaions (seapors, airpors, ec.) and implici axaion by means of seigniorage and financial repression, need significan invesmen in ax collecion infrasrucure, and spending resources on monioring and enforcemen. Expendiure Programme The need Provisioning of Public Goods Public Service Delivery Subsidies and Transfers Public secor Invesmen Governmen as an Employer of las resor Public producion versus provision. Issues Relaed o Borrowing and Deb Managemen Defici and is macroeconomic implicaions The objecive of deb managemen Deb managemen under alernaive ineres rae policy Issues relaed o deb susainabiliy Deb Resrucuring Plan and Rule Based Fiscal Conrol Financing paern Three Sources of financing of defici: Inernal marke borrowing Borrowing from he cenral bank (Moneizaion) Exernal borrowing Why he Mode of Financing of Defici is imporan? Each Financing mode has is own macroeconomic impac. Bond Financing may lead o credi squeeze via higher ineres rae Seigniorage Financing may lead o an increase in money supply and hereby inflaion Exernal Financing may widen he curren accoun deficis and exchange rae managemen difficul Why emphasis on bond financing? To reduce moneisaion and hus creaion of reserve money ino he sysem Greaer auonomy o cenral bank o pursue independen moneary policy Acivaion of inernal deb marke by widening invesors base for governmen securiies Reduce dependence on capive marke for governmen securiies Increase profiabiliy of banks Increase he share of financial savings in he economy o promoe growh The oucome of bond financing Reserve money ino he sysem has no declined due o high inflow of forex reserve Banks are sill he dominaing players in he governmen securiies marke Banks are invesing over and above heir requiremen in governmen securiies, hus holding excess reserves Banks earning has increased from is invesmen vis-a-vis lending operaion Share of financial savings in oal savings has been increasing hisorically (reasoning of financial deregulaion unclear) The Objecive of Deb Managemen Minimizing he cos of deb servicing, Coordinaion beween moneary and fiscal policy objecives. Mos imporanly, mainaining he moneary sabiliy Inflaionary Financing and Coordinaion beween moneary and fiscal policy Inflaionary financing is an implici ax levied by governmen. I consiss of he amoun of real resources appropriaed by he governmen by means of base money creaion In he conex of developing counries (especially in he absence of well developed capial markes and exernal borrowing), inflaionary financing migh be followed in pursui of growh hrough capial formaion. However, inflaionary financing may increase he general price level and hus reduces he real value of moneary uni. Coninued.. In developing counries in he absence of maured financial marke moneary policy accommodaes fiscal policy, by supporing governmen borrowing programme. Moneary policy objecive of conrolling of money supply ges compromised. Cenral bank auonomy and delinking of moneary and fiscal policy is he imporan aspec of reform in deb managemen pracices. Deb Managemen Under Alernaive Policy Regime Under adminisered ineres rae regime Ineres rae is fixed (much lower han he marke rae) Capive invesmen is he main sources of mopping up of resources GS remains o be an unaracive insrumen of invesmen Deb Managemen Under Alernaive Policy Regime Under deregulaed ineres rae regime Ineres rae is marke deermined Marke raes of ineres on GS should widen invesors base for GS Reduce moneisaion of defici Increase financialisaion of savings Issues Relaed o Deb Susainabiliy and Sae Deb Issues Relaed o Susainabiliy/ Unsusainabiliy Theory does no provide any precise level of public deb which is susainable / unsusainable. High deb o GDP raio may no he a maer of concern provided i remains consan. If deb o GDP raio remains consan ha provides a counry he scope for deb financing of deficis wihou incurring he risk of high inflaion (Congdon: 1987). If he deb keeps growing, a counry can sill run high fiscal defici a counry can sill run high fiscal deficis wihou deb o GDP raio reaching an explosive sage. Iniial condiion of defici and deb is imporan. Broad Definiion of Susainabiliy/ Unsusainabiliy The Movemen of Deb o GDP Raio is he Key In a general erm deb o GDP Raio 1: Unsusainable Deb may become unsusainable even before deb o GDP Raio becomes 1, if he counry runs large primary deficis. Defining Susainabiliy Condiion If he real rae of growh of he economy is more han he real raes of ineres deb is susainable (wih a primary budge balance). Deb susainabiliy Condiion proposed by Domar (1944) says problem of deb susainabiliy is associaed wih he raes of growh of naional income: Domar Susainabiliy Condiion: = ( α r Where =ax rae, α= rae of borrowing r= rae of growh of he economy.i= rae of ineres on governmen borrowing / ) * i Deriving deb Susainabiliy Condiion: g d = p b i g d + = 1 * p b b i g b d + + = * p b b i g b + + = 1 1 * p g b i b b = 1 1 * Deb Susainabiliy Condiion Coninued p y y g y b i y b y b + + = 1 1 * 1 ) 1 ( + = y k y p y y g y k b i y b y b = ) (1 * if i k deb is susainable. Deb Susainabiliy Condiion Coninued: 1.Where k is he real raes of growh of he economy and i is he real raes of ineres. 2. Even if he susainabiliy condiion is mainained, deb could become unsusainable if a counry runs an increasing primary defici. A sable deb-gdp raio requires a declining primary defici, ideally a primary surplus. 3. Unsusainabiliy arises when he real raes of ineres exceeds he real raes of economic growh and he primary balance is in defici or a surplus no large enough o cover he excess of real ineres rae over he growh raes. How o Achieve Susainabiliy: By increasing he real rae of growh: In a neoclassical growh model, economy grows a a naural rae, i is difficul o aler / enhance he rae in he shor run eiher by fiscal or moneary policy By Reducing he real rae of ineres: Ineres rae is also a naural rae no exclusively under he conrol of he fiscal auhoriy. By achieving primary surplus: Achieving primary balance depends on he fiscal auhoriy and much easier o achieve compared o growh rae or ineres rae aleraion.
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