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Equality here means equality or justice. It means that the broadest shoulders must bear the heaviest burden. (2) Canon of Certainty: Adam Smith further said, “The tax which each individual has to pay ought to be certain and not arbitrary. The time of payment, the amount to be paid ought all to be clear and plain to the contributor and to every other person.” The individual should know exactly what, when and how he is to pay a tax otherwise it will cause unnecessary suffering. Similarly, the State should also know how much it will receive from a tax. (3) Canon of Convenience: Smith wrote, “Every tax ought to be levied at the time or in the manner which it is most likely to be convenient to pay it.” Obviously, there is no sense in fixing a time and method of payment which are not suitable. Land revenue in India is realised after the harvest has been collected. This is the time when cultivators can conveniently pay. (4) Canon of Economy: Lastly, Adam Smith held that “every tax ought to be so contrived as both to take out and keep out of the pockets of the people as little as possible over and above what it brings into the public treasury of the State.” This means that the cost of collection should be as small as possible. If the bulk of the tax is spent on its collection, it will take much out of the people’s pockets but bring very little into the State’s pocket. It is not a wise tax. 9.3.4 Kinds of Tax A tax is a mandatory fee or financial charge levied by any government on an individual or an organization to collect revenue for public works providing the best facilities and infrastructure. The following are the kinds of tax: • Direct and indirect taxes In the literature of public finance, taxes have been classified in various ways according to who pays for them, who bears the ultimate burden of them, the extent to which the burden can be shifted, and various other criteria. Taxes are most commonly classified as either direct or indirect, an example of the former type being the income tax and of the latter the sales tax. There is much disagreement among economists as to the criteria for distinguishing between direct and indirect taxes, and it is unclear into which category certain taxes, such as corporate 201 CU IDOL SELF LEARNING MATERIAL (SLM)

income tax or property tax, should fall. It is usually said that a direct tax is one that cannot be shifted by the taxpayer to someone else, whereas an indirect tax can be. • Direct taxes Direct taxes are primarily taxes on natural persons (e.g., individuals), and they are typically based on the taxpayer’s ability to pay as measured by income, consumption, or net wealth. What follows is a description of the main types of direct taxes. Individual income taxes are commonly levied on total personal net income of the taxpayer (which may be an individual, a couple, or a family) in excess of some stipulated minimum. They are also commonly adjusted to take into account the circumstances influencing the ability to pay, such as family status, number and age of children, and financial burdens resulting from illness. The taxes are often levied at graduated rates, meaning that the rates rise as income rises. Personal exemptions for the taxpayer and family can create a range of income that is subject to a tax rate of zero. Sub-categories of Direct Taxes The following are the sub-categories of direct taxes: Income tax: This is the tax that is levied on the annual income or the profits which is directly paid to the government. Everyone who earns any kind of income is liable to pay income tax. For individuals below 60 years of age, the tax exemption limit is Rs.2.5 lakh per annum. For individuals between the age of 60 and 80, the tax exemption limit is Rs.3 lakh. For individuals above the age of 80, the tax exemption limit is Rs.5 lakh. There are different tax slabs for different income amounts. Apart from individuals, legal entities are also liable to pay taxes. These include all Artificial Judicial Persons, Hindu Undivided Family (HUF), Body of Individuals (BOI), Association of Persons (AOP), companies, local firms, and local authorities. Capital gains: Capital gains tax is levied on the sale of a property or money received through an investment. It could be from either short-term or long-term capital gains from an investment. This includes all exchanges made in kind that is weighed against its value. Securities transaction Tax: STT is levied on stock market and securities trading. The tax is levied on the price of the share as well as securities traded on the ISE (Indian Stock Exchange). 202 CU IDOL SELF LEARNING MATERIAL (SLM)

Prerequisite Tax: These are taxes that are levied on the different benefits and perks that are provided by a company to its employees. The purpose of the benefits and perks, whether it is official or personal, is to be defined. Corporate tax: The income tax paid by a company is defined as the corporate tax. It is based on the different slabs that the revenue falls under. The sub-categories of corporate taxes are as follows: • Dividend distribution tax (DDT): This tax is levied on the dividends that companies pay to the investors. It applies to the net or gross income that an investor receives from the investment. • Fringe benefit tax (FBT): This is tax levied on the fringe benefits that an employee receives from the company. This include expenses related to accommodation, transportation, leave travel allowance, entertainment, retirement fund contribution by the employee, employee welfare, Employee Stock Ownership Plan (ESOP), etc. • Minimum Alternative Tax (MAT): Companies pay the IT Department through MAT which is governed by Section 115JA of the IT Act. Companies that are exempt from MAT are those that are in the power and infrastructure sectors. • Indirect taxes Indirect taxes are levied on the production or consumption of goods and services or on transactions, including imports and exports. Examples include general and selective sales taxes, value-added taxes (VAT), taxes on any aspect of manufacturing or production, taxes on legal transactions, and customs or import duties. GST: This is a consumption tax that is levied on the supply of services and goods in India. Every step of the production process of any goods or value-added services is subject to imposition of GST. It is supposed to be refunded to the parties that are involved in the production process (and not the final consumer). GST resulted in the elimination of other kinds of taxes and charges such as Value Added Tax (VAT), octroi, customs duty, Central Value Added Tax (CENVAT), as well as customs and excise taxes. The products or services that are not taxed under GST are electricity, alcoholic drinks, and petroleum products. These are taxed as per the previous tax regime by the individual state governments. • Other taxes 203 CU IDOL SELF LEARNING MATERIAL (SLM)

Other taxes are minor revenue generators and are small cess taxes. The various sub-categories of other taxes are as follows: Property tax: This is also called Real Estate Tax or Municipal Tax. Residential and commercial property owners are subject to property tax. It is used for the maintenance of some of the fundamental civil services. Property tax is levied by the municipal bodies based in each city. Professional tax: This employment tax is levied on those who practice a profession or earn a salaried income such as lawyers, chartered accountants, doctors, etc. This tax differs from state to state. Not all states levy professional tax. Entertainment tax: This is tax that is levied on television series, movies, exhibitions, etc. The tax is levied on the gross collections from the earnings. Entertainment tax also referred as amusement tax. Registration fees, stamp duty, transfer tax: These are collected in addition to or as a supplement to property tax at the time of purchasing a property. Education cess: This is levied to fund the educational programs launched and maintained by the government of India. Entry tax: This is tax that is levied on the products or goods that enter a state, specifically through e-commerce establishments, and is applicable in the states of Delhi, Assam, Gujarat, Madhya Pradesh, etc. Road tax and toll tax: This tax is used for the maintenance of roads and toll infrastructure. • Proportional, progressive, and regressive taxes Taxes can be distinguished by the effect they have on the distribution of income and wealth. A proportional tax is one that imposes the same relative burden on all taxpayers—i.e., where tax liability and income grow in equal proportion. A progressive tax is characterized by a more than proportional rise in the tax liability relative to the increase in income, and a regressive tax is characterized by a less than proportional rise in the relative burden. Thus, progressive taxes are seen as reducing inequalities in income distribution, whereas regressive taxes can have the effect of increasing these inequalities. The taxes that are generally considered progressive include individual income taxes and estate taxes. Income taxes that are nominally progressive, however, may become less so in the 204 CU IDOL SELF LEARNING MATERIAL (SLM)

upper-income categories—especially if a taxpayer is allowed to reduce his tax base by declaring deductions or by excluding certain income components from his taxable income. Proportional tax rates that are applied to lower-income categories will also be more progressive if personal exemptions are declared. Income measured over the course of a given year does not necessarily provide the best measure of taxpaying ability. For example, transitory increases in income may be saved, and during temporary declines in income a taxpayer may choose to finance consumption by reducing savings. Thus, if taxation is compared with “permanent income,” it will be less regressive (or more progressive) than if it is compared with annual income. 9.4 BUDGET A Budget is a plan expressed in quantitative usually monetary terms, covering a specified period of time, usually one year. Many companies refer to their annual budget as a profit plan since it shows the planned activities that the company expects to undertake in its responsibility centres in order to obtain its profit goals. 9.4.1 Definition To quote Gladstone, “Budgets are not merely matters of arithmetic but in a thousand ways go to the root of prosperity of individuals and relation of classes and the strength of kingdom”. Prof. Dimock says, “A budget is a balanced estimate of expenditure and receipts for a given period of time. In the hands of the administration, the budget is record of past performance, a method of current control and a projection of future plans”. 9.4.2 Objectives of Budget • Reallocation of Resources – It helps to distribute resources keeping in view the social and economic advantages of the country. The factors that influence the allocation of resources are. • Allowance or Tax concessions – The government gives allowance and tax concessions to manufacturers to encourage investment. • Direct production of goods and services – The government can take the production process directly if the private sector does not show any interest. • Minimise inequalities in income and wealth – In an economic system, income and wealth inequality is an integral part. So, the government aims to bring equality by imposing a tax on the elite class and spending extra on the well-being of the poor. 205 CU IDOL SELF LEARNING MATERIAL (SLM)

• Economic Stability – The budget is also utilised to avoid business fluctuations to accomplish the aim of financial stability. Policies such as deficit budget during deflation and excess budget during inflation assist in balancing the prices in the economy. • Manage Public Enterprises – Many public sector industries are built for the social welfare of the people. The budget is planned to deliver different provisions for operating such business and imparting financial help. • Economic Growth – A country’s economic growth is based on the rate of investment and saving. Therefore, the budgetary plan focuses on preparing adequate resources for investing in the public sector and raise the overall rate of investments and savings. • Decrease regional differences – It aims to diminish regional inequalities by implementing taxation and expenditure policy and promoting the installation of production units in underdeveloped regions. 9.4.3 Importance of Budget Here are a few reasons why it’s important for the government to have a budget: • Proper resource pool allocation- When it comes to budgeting, identifying areas of weakness helps the government to allocate resources in a useful and sustainable manner. This is one of the most fundamental objectives behind framing a government budget. It’s important for the government to ensure that funds reach where it’s required the most. Therefore using past data to identify sections. in need of economic welfare policies and implementing those policies helps the government demonstrate efficient governance and achieve economic stability in the country. • Ensuring economic growth -A budget allows the government to regulate the imposition of taxes in various sectors. Investment and expenditure are some of the most prominent factors contributing to the growth of a nation’s economy. The government can encourage people to emphasize more on savings and investments by providing tax rebates and subsidies. • Growth of business and trading -Businesses and enterprises look forward to the government budget as resources being allocated to various sectors are revealed. The government can encourage business owners to revise their policies accordingly and contribute to the country’s economic prosperity. 206 CU IDOL SELF LEARNING MATERIAL (SLM)

• Mitigating economic divide- Economic disparity and inequality is an imminent threat to any country’s economy. The government can address these kinds of threats by introducing public and economic welfare policies for the underprivileged sections of the society through the budget. • Administering Operation of PSUs- Industries operating in the public sector contribute immensely to the country’s economy by providing employment to a lot of people and generating revenues. A budget helps the government focus appropriately on companies in the public sector by introducing policies to aid their growth. 9.4.4 Kinds of Budget A government budget is an annual financial statement which outlines the estimated government expenditure and expected government receipts or revenues for the forthcoming fiscal year. Depending on the feasibility of these estimates, budgets are of three types -- balanced budget, surplus budget and deficit budget. Mentioned below are brief explanations of these three types of budgets: • BALANCED BUDGET- A government budget is said to be a balanced budget if the estimated government expenditure is equal to expected government receipts in a particular financial year. Advocated by many classical economists, this type of budget is based on the principle of “living within means.” They believed the government’s expenditure should not exceed their revenue. Though an ideal approach to achieve a balanced economy and maintain fiscal discipline, a balanced budget. • SURPLUS BUDGET -A government budget is said to be a surplus budget if the expected government revenues exceed the estimated government expenditure in a particular financial year. This means that the government’s earnings from taxes levied are greater than the amount the government spends on public welfare. A surplus budget denotes the financial affluence of a country. Such a budget can be implemented at times of inflation to reduce aggregate demand. • DEFICIT BUDGET -A government budget is said to be a deficit budget if the estimated government expenditure exceeds the expected government revenue in a particular financial year. This type of budget is best suited for developing economies, such as India. Especially helpful at times of recession, a deficit budget helps generate additional demand and boost the rate of economic growth. Here, the government incurs the excessive expenditure to improve the employment rate. This results in an increase 207 CU IDOL SELF LEARNING MATERIAL (SLM)

in demand for goods and services which helps in reviving the economy. The government covers this amount through public borrowings (by issuing government bonds) or by withdrawing from its accumulated reserve surplus. • REVENUE BUDGET - consists of the revenue receipts of the government (tax revenues and other revenues) and the expenditure met from these revenues. Tax revenues comprise proceeds of taxes and other duties levied by the Union. Other revenues are receipts of the government mainly consisting of interest and dividend on investments made by the government, and fees and receipts for other services rendered by the government. Revenue expenditure is expenditure for the normal running of government departments and various services, interest charges on debt incurred by government, subsidies and so on. • CAPITAL BUDGET- consists of capital receipts and payments. It also incorporates transactions in the Public Account. Capital receipts are loans raised by the government from the public (which are called market loans), borrowings by the government from the Reserve Bank and other parties through sale of treasury bills, loans received from foreign bodies and governments, and recoveries of loans granted by the Central government to state and Union Territory governments and other parties. Capital payments consist of capital expenditure on acquisition of assets like land, buildings, machinery, and equipment, as also investments in shares, loans and advances granted by the Central government to state and Union Territory governments, government companies, corporations and other parties. • PERFORMANCE BUDGET- also referred to as performance-based budgeting is a practice of preparing the budget based on the evaluation of the productivity of the different operations in an organization. Operations which are contributing the most to the profitability, the larger share of the budget is allocated to that division. It leads to optimum utilization of resources such as finance, skills of the staff, use of the productive time etc. • ZERO-BASED BUDGETING -(ZBB) is an approach to making a budget from scratch. The budget is not based on previous budgets. Instead, the budget starts at zero. With zero-based budgeting, you need to justify every expense before adding it to the official budget. The goal of zero-based budgeting is to reduce spending by looking at where costs can be cut. Your employees might be involved in creating a zero-based budget. You can ask employees what kind of expenses they will have and figure out 208 CU IDOL SELF LEARNING MATERIAL (SLM)

where you can reduce business expenses. If an expense does not benefit the business, or if it can be done in-house, it is axed from the budget. 9.4.5 Limitations of Budget 1. The budgets are prepared on the basis of estimates. If the estimates are wrong, the budgets will be misleading. Hence, the success of budgetary control is fully depending upon the degree of accuracy of estimates. 2. Future is uncertainty and cannot be predictable accurately. A budget is prepared for future period. Hence, the budget does not show reality. 3. A budgetary programme is a rigid one. The deviations are finding out by comparing actual performance with budgeted figures. The deviations are accruing due to changed conditions. If so, the management cannot fix responsibility on any employees. 4. The budgets may be revised from time to time because of changed conditions. If so, it leads to more administration expenses. 5. If the budgets are revised frequently, the employees can lose their faith in budgeting. 6. Budgets may serve as constraints on managerial initiative because every employee tries to achieve the budgeted figures. 7. A budget cannot be used as a substitute for management. According to Welsch, “A budget is not designed to reduce the managerial function to a formula. It is a managerial tool”. 8.A small business organization cannot afford the employment of budgetary control as a cost control technique since it involves more expenses. 9. The preparation of budgets requires specialized staff. Such specialized staff is not available adequately to the organization. 10. The cost of installing and operating a budgetary control system should be commensurate with the benefits derived there from. But, in practice, it is not like so. 9.5 FISCAL POLICY Fiscal policy means the use of taxation and public expenditure by the government for stabilization or growth of the economy. According to Culbarston, “By fiscal policy we refer to government actions affecting its receipts and expenditures which ordinarily as measured by 209 CU IDOL SELF LEARNING MATERIAL (SLM)

the government’s receipts, its surplus or deficit.” The government may change undesirable variations in private consumption and investment by compensatory variations of public expenditures and taxes. Fiscal policy also feeds into economic trends and influences monetary policy. When the government receives more than it spends, it has a surplus. If the government spends more than it receives it runs a deficit. To meet the additional expenditures, it needs to borrow from domestic or foreign sources, draw upon its foreign exchange reserves or print an equivalent amount of money. This tends to influence other economic variables. 9.5.1 Definition Arthur Smithies points out, “Fiscal policy is a policy under which the government uses its expenditure and revenue programmes to produce desirable effects and avoid undesirable effects on the national income, production and employment”. 9.5.2 Objectives of Fiscal Policy Before moving on the discussion on objectives of India’s Fiscal Policies, firstly know that the general objective of Fiscal Policy. General objectives of Fiscal Policy are given below: 1. To maintain and achieve full employment. 2. To stabilize the price level. 3. To stabilize the growth rate of the economy. 4. To maintain equilibrium in the Balance of Payments. 5. To promote the economic development of underdeveloped countries. Fiscal policy of India always has two objectives, namely improving the growth performance of the economy and ensuring social justice to the people. The fiscal policy is designed to achieve certain objectives as follows:- 1. Development by effective Mobilisation of Resources: The principal objective of fiscal policy is to ensure rapid economic growth and development. This objective of economic growth and development can be achieved by Mobilisation of Financial Resources. The central and state governments in India have used fiscal policy to mobilise resources. The financial resources can be mobilised by:- 210 CU IDOL SELF LEARNING MATERIAL (SLM)

a. Taxation: Through effective fiscal policies, the government aims to mobilise resources by way of direct taxes as well as indirect taxes because most important source of resource mobilisation in India is taxation. b. Public Savings: The resources can be mobilised through public savings by reducing government expenditure and increasing surpluses of public sector enterprises. c. Private Savings: Through effective fiscal measures such as tax benefits, the government can raise resources from private sector and households. Resources can be mobilised through government borrowings by ways of treasury bills, issuance of government bonds, etc., loans from domestic and foreign parties and by deficit financing. 2. Reduction in inequalities of Income and Wealth: Fiscal policy aims at achieving equity or social justice by reducing income inequalities among different sections of the society. The direct taxes such as income tax are charged more on the rich people as compared to lower income groups. Indirect taxes are also more in the case of semi-luxury and luxury items which are mostly consumed by the upper middle class and the upper class. The government invests a significant proportion of its tax revenue in the implementation of Poverty Alleviation Programmes to improve the conditions of poor people in society. 3. Price Stability and Control of Inflation: One of the main objectives of fiscal policy is to control inflation and stabilize price. Therefore, the government always aims to control the inflation by reducing fiscal deficits, introducing tax savings schemes, productive use of financial resources, etc. 4. Employment Generation: The government is making every possible effort to increase employment in the country through effective fiscal measures. Investment in infrastructure has resulted in direct and indirect employment. Lower taxes and duties on small-scale industrial (SSI) units encourage more investment and consequently generate more employment. Various rural employment programmes have been undertaken by the Government of India to solve problems in rural areas. Similarly, self-employment scheme is taken to provide employment to technically qualified persons in the urban areas. 5. Balanced Regional Development: there are various projects like building up dams on rivers, electricity, schools, roads, industrial projects etc run by the government to mitigate the regional imbalances in the country. This is done with the help of public expenditure. 6. Reducing the Deficit in the Balance of Payment: some time government gives export incentives to the exporters to boost up the export from the country. In the same way import 211 CU IDOL SELF LEARNING MATERIAL (SLM)

curbing measures are also adopted to check import. Hence the combine impact of these measures is improvement in the balance of payment of the country. 7. Increases National Income: it’s the strength of the fiscal policy that is brings out the desired results in the economy. When the government want to increase the income of the country then it increases the direct and indirect taxes rates in the country. There are some other measures like: reduction in tax rate so that more peoples get motivated to deposit actual tax. 8. Development of Infrastructure: when the government of the concerned country spends money on the projects like railways, schools, dams, electricity, roads etc to increase the welfare of the citizens, it improves the infrastructure of the country. An improved infrastructure is the key to further speed up the economic growth of the country. 9. Foreign Exchange Earnings: when the central government of the country gives incentives like, exemption in custom duty, concession in excise duty while producing things in the domestic markets, it motivates the foreign investors to increase the investment in the domestic country. 9.5.3 Importance of Fiscal Policy The purpose to define such a policy is to balance the effect of modified tax rates and public spending. For instance, the government may try and simulate a slow-growing economy by increased spending. This increased spending is a result of lowered taxes by the government. However, this lowering of tax rates may cause inflation to rise. This is due to the fact that the inflow of money in the system is high along with an increased consumer demand. These facts coupled together lead to a decrease in the value of money. This implies that more money is required to buy the same thing which was available for a lower price earlier. With more inflow of money in the economy due to a lesser amount of taxes, the demands of consumers for goods as well as services increases. This leads to growth in the businesses and turns the nation economy slow growing too active. However, this too needs to be controlled. A steady decrease in taxes and increased consumer spending may lead to too much money inflow into the system. This can lead to an increase in inflation and thus the cost of production rises. This implies that in effect the purchasing power of the consumer decreases. The fiscal policy needs to be closely monitored to ensure that the economy is productive and not infected by uncontrolled inflation. 212 CU IDOL SELF LEARNING MATERIAL (SLM)

9.5.4 Fiscal policy and AD Expansionary fiscal policy occurs when the Congress acts to cut tax rates or increase government spending, shifting the aggregate demand curve to the right. Contractionary fiscal policy occurs when Congress raises tax rates or cuts government spending, shifting aggregate demand to the left. Figure 9.3 uses an aggregate demand/aggregate supply diagram to illustrate a healthy, growing economy. The original equilibrium occurs at E0, the intersection of aggregate demand curve AD0 and aggregate supply curve AS0, at an output level of 200 and a price level of 90. One year later, aggregate supply has shifted to the right to AS1 in the process of long-term economic growth, and aggregate demand has also shifted to the right to AD1, keeping the economy operating at the new level of potential GDP. The new equilibrium (E1) is at an output level of 206 and a price level of 92. One more year later, aggregate supply has again shifted to the right, now to AS2, and aggregate demand shifts right as well to AD2. Now the equilibrium is E2, with an output level of 212 and a price level of 94. In short, the figure shows an economy that is growing steadily year to year, producing at its potential GDP each year, with only small inflationary increases in the price level. Figure 9.3 A Healthy, Growing Economy. Source: www.elearninghub.in In this well-functioning economy, each year aggregate supply and aggregate demand shift to the right so that the economy proceeds from equilibrium E0 to E1 to E2. Each year, the economy 213 CU IDOL SELF LEARNING MATERIAL (SLM)

produces at potential GDP with only a small inflationary increase in the price level. But if aggregate demand does not smoothly shift to the right and match increases in aggregate supply, growth with deflation can develop. In the real world, however, aggregate demand and aggregate supply do not always move neatly together, especially over short periods of time. Aggregate demand may fail to grow as fast as aggregate supply, or it may even decline causing a recession. This could be caused by a number of possible reasons: households become hesitant about consuming; firms decide against investing as much; or perhaps the demand from other countries for exports diminishes. For example, investment by private firms in physical capital in the U.S. economy boomed during the late 1990s, rising from 14.1% of GDP in 1993 to 17.2% in 2000, before falling back to 15.2% by 2002. Conversely, increases in aggregate demand could run ahead of increases in aggregate supply, causing inflationary increases in the price level. Business cycles of recession and boom are the consequence of shifts in aggregate supply and aggregate demand. As these occur, the government may choose to use fiscal policy to address the difference. Expansionary Fiscal Policy Expansionary fiscal policy increases the level of aggregate demand, through either increases in government spending or reductions in taxes. Expansionary policy can do this by: 1. Increasing consumption by raising disposable income through cuts in personal income taxes or payroll taxes; 2. Increasing investments by raising after-tax profits through cuts in business taxes; and 3. Increasing government purchases through increased spending by the federal government on final goods and services and raising federal grants to state and local governments to increase their expenditures on final goods and services. Contractionary fiscal policy does the reverse: it decreases the level of aggregate demand by decreasing consumption, decreasing investments, and decreasing government spending, either through cuts in government spending or increases in taxes. The aggregate demand/aggregate supply model is useful in judging whether expansionary or contractionary fiscal policy is appropriate. Consider first the situation in Figure 9.4 which is similar to the U.S. economy during the recession in 2008–2009. The intersection of aggregate demand (AD0) and aggregate supply 214 CU IDOL SELF LEARNING MATERIAL (SLM)

(AS0) is occurring below the level of potential GDP. At the equilibrium (E0), a recession occurs and unemployment rises. (The figure uses the upward-sloping AS curve associated with a Keynesian economic approach, rather than the vertical AS curve associated with a neoclassical approach, because our focus is on macroeconomic policy over the short-run business cycle rather than over the long run.) In this case, expansionary fiscal policy using tax cuts or increases in government spending can shift aggregate demand to AD1, closer to the full-employment level of output. In addition, the price level would rise back to the level P1 associated with potential GDP. Should the government use tax cuts or spending increases, or a mix of the two, to carry out expansionary fiscal policy? After the Great Recession of 2008–2009, U.S. government spending rose from 19.6% of GDP in 2007 to 24.6% in 2009, while tax revenues declined from 18.5% of GDP in 2007 to 14.8% in 2009. Fig 9.4 Expansionary fiscal Policy Source: www.economicdiscussions.net Figure 9.4 explains Expansionary Fiscal Policy. The original equilibrium (E0) represents a recession, occurring at a quantity of output (Yr) below potential GDP. However, a shift of aggregate demand from AD0 to AD1, enacted through an expansionary fiscal policy, can move the economy to a new equilibrium output of E1 at the level of potential GDP. Since the economy was originally producing below potential GDP, any inflationary increase in the price level from P0 to P1 that results should be relatively small. 215 CU IDOL SELF LEARNING MATERIAL (SLM)

This very large budget deficit was produced by a combination of automatic stabilizers and discretionary fiscal policy. The Great Recession meant less tax-generating economic activity, which triggered the automatic stabilizers that reduce taxes. Most economists, even those who are concerned about a possible pattern of persistently large budget deficits, are much less concerned or even quite supportive of larger budget deficits in the short run of a few years during and immediately after a severe recession. Contractionary Fiscal Policy Fiscal policy can also be used to slow down an overheating economy. Suppose the macro equilibrium occurs at a level of GDP above potential, as shown in Figure 3. The intersection of aggregate demand (AD0) and aggregate supply (AS0) occurs at equilibrium E0. In this situation, contractionary fiscal policy involving federal spending cuts or tax increases can help to reduce the upward pressure on the price level by shifting aggregate demand to the left, to AD1, and causing the new equilibrium E1 to be at potential GDP. Fig 9.5 Contractionary fiscal policy Source: www.economicdiscussions.net Figure 9.5 A Contractionary Fiscal Policy. The economy starts at the equilibrium quantity of output Yr, which is above potential GDP. The extremely high level of aggregate demand will generate inflationary increases in the price level. A contractionary fiscal policy can shift 216 CU IDOL SELF LEARNING MATERIAL (SLM)

aggregate demand down from AD0 to AD1, leading to a new equilibrium output E1, which occurs at potential GDP. Again, the AD–AS model does not dictate how this contractionary fiscal policy is to be carried out. Some may prefer spending cuts; others may prefer tax increases; still others may say that it depends on the specific situation. The model only argues that, in this situation, aggregate demand needs to be reduced. 9.6 OTHER MEASURES For opposing inflation, for completing monetary and fiscal measures other non-monetary measures must be adopted. 9.6.1 Price control and Rationing The term ‘price control’ implies the fixation of either the maximum or the minimum prices of some selected essential commodities. But the fixation of the maximum prices during inflation is more common than that of the minimum prices during deflation. Other weapons of price control are taxation (to raise prices) and subsidies (to reduce prices). The term ‘rationing’ denotes the imposition of restriction on the consumption of some essential, scarce commodities, such as rice, wheat, pulses, clothes, sugar, etc., during the period of rising prices. Rationing seems to be a ‘fair’ way of sharing out limited supplies of essential commodities since everyone gets the same amount at a fixed price. Price control and rationing are usually adopted during wartime to meet the shortages of essential goods and to control war time inflation. Even during peace time these may be adopted as anti-inflationary measures as found at present in our country. These measures have some objectives: (a) Maintaining stability of the prices of essential goods and preventing inflationary rise in prices, (b) Protecting the interest of consumers through the supply of essential goods at controlled prices, (c)Protecting the interest of the producers through the minimum guarantee prices for selected goods, especially agricultural products, (d) An equitable sharing out of the scarce, essential goods among the people, and 217 CU IDOL SELF LEARNING MATERIAL (SLM)

(e) Reducing the effects of inequality of wealth by fixing the per head quota of each of the essential goods. Limitations and Difficulties: Price control-cum-rationing is imposed in case of essential commodities to suppress the effects of inflation. But rationing and control is not possible in case of all commodities. There are certain disadvantages of this method of allocation. First, prices in uncontrolled sectors rise disproportionately. Secondly, it prevents people from buying desirable goods and services and thus reduces incentives to work. Thirdly, it distorts consumer preferences and induces people to spend more on uncontrolled goods. Fourthly, black markets come into existence and working of the free-market mechanism may be ham- pered. Finally, a considerable amount of manpower is kept in administering the controls. So, price control and rationing has a limited effect. Statistical evidence shows that they merely suppress the symptoms of inflation without curing the disease itself. 9.6.2 Wage Policy Another important measure is to adopt a rational wage and income policy. Under hyperinflation, there is a wage-price spiral. To control this, the government should freeze wages, incomes, profits, dividends, bonus, etc. But such a drastic measure can only be adopted for a short period as it is likely to antagonise both workers and industrialists. Therefore, the best course is to link increase in wages to increase in productivity. This will have a dual effect. It will control wages and at the same time increase productivity, and hence raise production of goods in the economy. 9.7 SUMMARY • Macroeconomic policy can be divided into monetary policy and fiscal policy. • Monetary policy is related to credit control measures adopted by the central bank. • In a developing economy, monetary policy does an important job in increasing economic growth by influencing cost and sufficiency of credit, by controlling the inflation and maintaining the equilibrium of balance of payment. • Public finance is concerned with the principles and practices of obtaining funds and spending the same for achieving the maximum social welfare and economic growth. • Public revenue refers to different sources of government income. 218 CU IDOL SELF LEARNING MATERIAL (SLM)

• A tax is a compulsory charge imposed by a government on an individual. • Canon of taxation was laid down by Adam Smith. • Government’s revenue and expenditure decisions are presented in the budget. • Fiscal policy is the set of principles and decisions of a government regarding the level of public expenditure and mode of financing them. 9.8 KEYWORDS • Fiscal Policy-Financial policy • Goals- objectives. • Public expenditure- government expenses • Public revenue- Government income • Public debt- borrowing 9.9 LEARNING ACTIVITY 1. Express your thoughts in relation to expansionary monetary policy. ___________________________________________________________________________ _______________________________________________________ 9.10 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. Define monetary policy 2. Define tax. 3. What are the canons of taxation? 4. Define budget 5. Define fiscal policy. Long Questions 1. Define monetary policy and its importance. 2. What are the instruments of monetary policy? 219 CU IDOL SELF LEARNING MATERIAL (SLM)

3. Write the scope of public finance? 220 4. What are the objectives of budget? 5. What is fiscal policy and write its objectives? B. Multiple Choice Questions 1. Monetary policy is controlled by___ a. central government b. state government c. local authority d. central bank 2. Monetary policy is usually effective in controlling___ a. deflation b. inflation c. Government d. Stagflation 3. Canons of taxation was proposed by___ a. Alfred Marshall b. J.M. Keynes c. J.B. Say d. Adam Smith 4. ______ means different sources of government’s income. a. Public debt b. public expenditure c. Public revenue d. Finance 5. A____ is a compulsory charge imposed by government. a. tax CU IDOL SELF LEARNING MATERIAL (SLM)

b. budget c. finance d. fiscal policy Answers 1-b, 2-d, 3-d, 4-c, 5-a 9.11 REFERNCES Reference books • Baird, C.W. (1977). Elements of Macro Economics, London: West Publishing Company. • Dernburg, T.F.& McDougal, D.M. (1983). Macro Economics. New York: McGraw Hill. • Gardner Ackley, G. (1985). Macro-Economic Theory. New York: McMillan. • Ghuman, R.S. (1998). Antar-RashtriyaArthVigyan, Patiala: Punjabi University. • Harvey, J.&Johnson, M. (1971). Introduction to Macro Economics, London: McMillan Textbooks • Jain, T.R. (1997). Macro Economics, New Delhi: V.K. Publications. • Jhingan, M.L. (2003). Macro-Economic Theory, New Delhi: Varinda Publishers. • Sharma, O.P. (2003). Macro Economics, Patiala: Punjabi University. • Vaish, M.C. (2008). Macro-Economic Theory. New Delhi: Oxford University Press. Websites • Economictimes.indiatimes.com • Theinvestorsbook.com 221 CU IDOL SELF LEARNING MATERIAL (SLM)