Tag: Business economics

Fiscal Policy is changing the government’s budget to influence aggregate demand. i.e., changing taxes and spending.

These are intentional government policies to increase or decrease government spending or taxation. For example, Keynesian economists might favour a deliberate increase in the size of the fiscal deficit when private sector demand and confidence is low during an economic recession.

Discretionary fiscal policy means the government make changes to tax rates and or levels of government spending. For example, cutting VAT in 2009 to provide boost to spending.

Expansionary fiscal policy is cutting taxes and/or increasing government spending. Lower taxes increase disposable income and in theory, should encourage people to spend.

Discretionary fiscal policy is different to automatic fiscal stabilisers. Automatic stabilisers occur where in a recession a government automatically spends more because there are more claiming unemployment benefits. However, the government may feel these automatic stabilisers are insufficient and so they decide to increase public work spending schemes too.

Types

There are two types of discretionary fiscal policy. The first is expansionary fiscal policy. It’s when the federal government increases spending or decreases taxes. When spending is increased, it creates jobs. It happens directly through public works programs or indirectly through contractors. Spending on public works construction is one of the four best ways to create jobs.

Job creation gives people more money to spend, boosting demand. According to Keynesian economic theory, that increases economic growth.

Supply-side economics says that a tax cut is the best way to stimulate the economy. Stronger economic growth will make up for the government revenue lost. That’s because it generates a larger tax base. But tax cuts only work if taxes were high in the first place. According to the underlying economic theory, the Laffer Curve, the highest tax rate must be above 50% for supply-side economics to work. Tax cuts are not the best way to create jobs.

Expansionary fiscal policy creates a budget deficit. This is one of its downsides. It’s because the government spends more than it receives in taxes. Often there’s no penalty until the debt-to-GDP ratio nears 100%. At that point, investors start to worry the government won’t repay its sovereign debt. They won’t be as eager to buy Treasurys or other sovereign debt. They will demand higher interest rates. This makes the debt even more expensive to pay back. It can create a downward spiral. For example, look at the Greek debt crisis.

Contractionary fiscal policy is when the government cuts spending or raises taxes. It slows economic growth. A spending cut means less money goes toward government contractors and employees. That then reduces job growth.

Discretionary fiscal policy should work as a counterweight to the business cycle. During the expansion phase, Govt. should cut spending and programs to cool down the economy. If done well, the reward is an ideal economic growth rate of around 2% to 3% a year.

In economics, tax incidence or tax burden is the effect of a particular tax on the distribution of economic welfare. Economists distinguish between the entities who ultimately bear the tax burden and those on whom tax is initially imposed. The tax burden measures the true economic weight of the tax, measured by the difference between real incomes or utilities before and after imposing the tax, taking into account how the tax leads prices to change. If a 10% tax is imposed on sellers of butter, for example, but the market price rises 8% as a result, most of the burden is on buyers, not sellers. The concept of tax incidence was initially brought to economists’ attention by the French Physiocrats, in particular François Quesnay, who argued that the incidence of all taxation falls ultimately on landowners and is at the expense of land rent. Tax incidence is said to “fall” upon the group that ultimately bears the burden of, or ultimately suffers a loss from, the tax. The key concept of tax incidence (as opposed to the magnitude of the tax) is that the tax incidence or tax burden does not depend on where the revenue is collected, but on the price elasticity of demand and price elasticity of supply. As a general policy matter, the tax incidence should not violate the principles of a desirable tax system, especially fairness and transparency.

1. The Nature of a Tax:

The nature of a tax as to whether it is a tax on the production or sale of some commodities or it is a personal income or property tax. Tax shifting can easily take place in the case of taxes on the production and sale of commodities. The taxes on pro­duction or sale of commodities are called indirect taxes. The important examples of indirect taxes are excise duties and sales tax. On the other hand, the burden of direct taxes such as income and wealth taxes cannot be shifted.

2. Market Conditions:

Whether commodity is being produced under conditions of perfect competition, monopolistic competition or monopoly goes to determine the extent to which the burden of the tax can be shifted. A monopolist who has a full control over the supply of a commodity is in a better position to shift the burden of a tax on the commodity produced.

Likewise, a producer working under monopolistic competition who produced a product somewhat different from others exercises a good deal of influence over the price of its product and therefore can pass on a part of the burden of the tax to the buyers.

Even the firms working under perfect competition can shift the tax burden as the tax levied on a commodity raises its supply price for all of them. The difference in the three market forms lies in the extent to which the burden of the tax can be shifted.

3. Physical Conditions of Production:

The shifting of the tax burden on a commodity also depends upon whether the commodity is being produced under increasing, constant or diminishing returns. This will be explained in detail a little later.

Factors Determining Incidence of Indirect (Commodity) Taxes:

The questions of tax shifting especially arise in the case of indirect taxes, that is, taxes on the production and sale of goods such as excise duties and sales tax. In this regard, whether and to what extent a tax on commodity can be shifted depends on the price elasticity of demand for and supply of a commodity.

It is these elasticity’s of demand and supply that determine the bargaining strengths of the sellers and buyers of the taxed commodity. Sellers can shift the tax burden to the buyers if they are able to re­duce the supply of the commodity and thereby raise its price.

Thus, the power to shift the tax depends on the elasticity of supply of the taxed commodity. The elas­ticity of reducing supply of a commodity will be relatively smaller if there is excess capacity in the industry producing it. Fur­ther, the elasticity of supply of a commod­ity will be larger in the long run than in the short run.

Apart from the elasticity of supply, power to transfer the tax burden depends on the-elasticity of demand for a commod­ity. The greater the elasticity of demand of the buyers, the smaller the extent to which the tax will be shifted to them.

1. Elasticity of Demand:

Elasticity of demand affects the shifting process. If the taxed com­modity is having perfectly elastic demand price cannot be raised at all.

Hence the incidence will be wholly on the seller. On the other hand, when the demand is perfectly inelastic, the incidence will be wholly on the buyer. In between these two extremes, the incidence of tax will be shared by the buyer and seller.

2. Elasticity of Supply:

Price is determined by the interaction between demand and supply of a commodity. Hence incidence of a tax will be fully borne by the buyer, when the taxed commodity is having perfectly elastic supply. Likewise, when the supply of a commodity is perfectly inelastic, the whole incidence will be on the seller.

3. Price acts an Engine of Shifting:

Price act as a media of shifting. It is the vehicle, which carries money burden of tax from the point of view of legal liability. If the tax is shifted through a raise in price, it is called forward shifting. If the price cannot be rise, tax cannot be shifted. Hence the character of price flexibility is the most important factor that determines the shift- ability of a tax.

4. Tax Area:

The nature of the area in which the tax is imposed also affect shifting of a tax. If the tax is imposed on a commodity, having local market, it will be difficult to shift the tax by raising the price.

In such a case, people can avoid the tax by purchasing a commodity from neighborhood market, where it is cheap. This also gives rise to smug­gling of commodities from non-tax levying locality to avoid taxes.

5. Time Period:

Time factor influence the shift ability of a tax. In the short period supply is inelastic. Hence, during this period greater part of tax bur­den will be borne by the seller.

In the long-run, supply is more elastic. Hence, there is a better scope for shifting tax burden upon the buy­ers. Therefore, in the short period, shifting of a tax is difficult, where as in the long period it is easy to do.

6. Coverage of Tax:

If the tax is general in character, falling on wide range of commodi­ties, it is easy to shift the burden.

For example, if the tax levied on tooth paste is general in nature, covering all brands and kinds, it will be readily shifted.

However, if a tax is imposed on one brand of tooth paste, excluding the other brands, it is not possible to shift the tax burden. So we can say that shifting of a tax is rendered easier in general tax than in non-general taxes.

7. Availability of Substitutes:

Taxes imposed on a commodity having no close substitutes, can be easily shifted to the buyer. Here the buyer cannot find an alternative product as substitute to satisfy his demand.

Hence, he will be ready to purchase the taxed commodity by giving higher prices. On the other hand, if the taxed product has close substitute, shifting the money burden to buyers, is difficult.

Any rise in price due to tax will be opposed by the buyer, and he will go for the non-taxed substi­tutes. So the seller will himself bear the burden of tax, instead of attempting to shift it.

8. Nature of Demand for Commodities:

By this, we mean whether the taxed commodity is falling under the category of necessaries, comforts or luxuries. The nature of demand is different for different commodities. In the case of necessary goods, demand is inelastic.

Hence the burden of tax is higher upon the buyer, than on seller. In the case of comforts, demand is more elas­tic, hence burden of tax will be divided between buyer and seller. Coming to the case of luxuries, demand is elastic. Hence the bur­den of tax is more on the seller. It cannot be easily shifted to the consumers.

9. Business Conditions:

Shifting of a tax is influenced by the existing business condition in the economy. During periods of rising prices and economic prosper­ity, taxes can be shifted more easily. However, during periods of depression, forward shifting of tax liability is very difficult. Depres­sion is a situation of falling prices. Seasonal changes also will affect the shifting of tax.

10. Types of Tax:

Shifting depends upon nature or type of tax imposed. If a tax is imposed on the excess profits of a firm under monopoly or imperfect competition, the incidence will not be shifted. On the other hand, if the tax is levied on the output of the firm, a part of incidence can be shifted on to the consumers.

11. The Policy of the Government:

Shift ability of a tax is determined by the tax laws and public policy. In India, a tax law clearly indicates the price to be charged and to be printed on the product cover. For example, sales tax legislation stipu­lates that the burden of sales tax is to be borne by the consumers.

Likewise, government fixes maximum retail price and through law makers it binding to print it on the product. Then those who charge higher prices are legally punished. Hence, whenever a tax is im­posed the law abiding citizen will pay it rationally.

On the other hand, if prices are increased due to the attempt to shift some taxes to be paid by the seller, awareness of tax laws helps the consumer to resist it.

12. Market Conditions:

Shifting of a tax is influenced by the conditions of market for the product taxed.

The theory of shifting can be analyzed under:

(a) Per­fection competition,

(b) Monopoly, and

(c) Monopolistic competition.

(a) Shifting Under Perfect Competition:

Given the assumptions of perfect competition, the price is deter­mined by the interaction of demand and supply. The demand curve faced by each firm is perfectly elastic. Hence, a tax imposed cannot be shifted forward by increasing the price of the taxed commodity.

Likewise, the tax cannot be shifted backward because the supply of the factors is also perfectly elastic. However, the incidence of tax can be shifted in the long-run by reducing the supply and thereby raising the price of the commodity.

Moreover, if the taxed commodity is perishable, its supply curve is perfectly inelastic and the entire tax burden will be borne by the sellers. If the taxed commodity is of durable nature, the entire tax burden can be shifted forward to the buyers.

(b) Shifting under Monopoly:

Under conditions of monopoly, a tax on the monopolist will certainly increase the cost of production. But the incidence sharing between the monopolists and consumers will depend upon the respective elasticity of demand and supply of the commodity produced by the monopolist.

Theoretically, the profit will be at the maximum, when marginal revenue equals marginal cost and price is higher than ei­ther. Any tax on the monopolist which raises his marginal cost would cause him to reduce his output and raise his price.

The extent to which the monopolist would succeed in shifting the burden of a tax depends on three factors.

They are:

(1) The nature of the tax

(2) The nature of the demand for the article

(3) The cost condition under which production takes place.

If a tax is levied upon profit or sales, the monopolists cannot shift the burden on to the consumers. This is because the position of costs and revenue curves cannot be changed according to his favour.

If the taxed commodity is having inelastic demand, the entire burden of tax will fall on con­sumers. Contrary, if the demand for the taxed commodity is elastic, the entire burden of tax will fall on monopolies.

Likewise if the supply of monopolist product is inelastic, the burden of tax will fall on the monopolist. If supply is elastic, the entire burden of tax will be on the consumer. On the other hand if the demand for the monopolist prod­uct is more elastic than its supply, the burden of tax will fall more on the monopolist, than on consumers.

In a situation, when demand is less elastic than its supply, the monopolist will bear less burden of tax than the consumers. A monopolist can be taxed in three differ­ent ways. A tax can be imposed, proportionate to output, a tax can be imposed independent of output produced or a tax can be im­posed which diminish with an increase in output.

When the tax is independent of production and is levied on profit, it is difficult to shift. The output before the levy of tax would have been adjusted, to yield the minimum profit. The monopolist may have a greater profit after paying the tax by leaving the price unchanged.

When a tax is im­posed in proportion to output, a partial shifting of the tax is possible, as it increases the marginal cost of the monopolists firm. When the tax diminishes with the increase in output, the monopolist will in­crease his output and reduce the price of the commodity, produced by him. In this case the monopolist will bear the entire burden of the tax.

Any definite conclusion cannot be arrived at in the matter of the shifting of the tax under monopoly conditions. The reason is that, perfect monopoly is a very rare phenomenon. Moreover, the mo­nopolist usually will not charge the theoretical monopoly price.

The monopolist will always fix a price lower than this level, owing to the threat of governmental intervention or emergence of competitive ele­ment.

(c) Shifting Under Monopolistic Competition:

Monopolistic competitions is characterized by few firms in produc­tion arena, existence of product differentiation and a situation in which price is determined by the price leaders. In such markets one or two firms may act as the price leaders.

Hence if a tax imposed, affects the cost of production of the price setters, burden can be shifted to the consumers, if the demand for the product is inelastic. However, if the imposition of tax affects the cost of production of only small firms, it cannot be easily shifted to the consumers.

Here the small firms are bound to follow the price determined by the price leaders. Hence small firms have to bear the tax burden. But the process of shifting in its ultimate analysis will be determined by the elasticities of demand and supply of taxed commodity.

(d) Shifting Under Different Cost Conditions:

Commodities can be produced under decreasing, increasing or con­stant cost conditions. The nature of the cost condition also influences the shifting of a tax.

(i) Decreasing cost condition:

If costs are decreasing, any decline in demand and consequent reduction in output will increase cost per unit. If under this condition, a tax is imposed on the producer and the producer attempting to shift the burden by raising the price, the demand for his product will decline and the cost per unit will rise. In that case, price will have to be raised by more than the amount of the tax, to cover increase in cost resulting from output restriction.

(ii) Increasing Cost:

If costs are increasing, a decline in output will lower cost per unit. A tax imposed under this condition, will raise the price of the commodity by an amount less than the amount of tax. As such, only a part of the tax burden will be shifted to the buyers.

This happen because imposition of a tax, will reduce the demand for the taxed commodity. Consequently, supply will have to be reduced. This reduction in supply leads to lower average cost.

(iii) Constant cost:

If a tax is shifted under constant cost conditions, price will rise exactly by the amount of the tax. However, fall in output will vary according to the nature of demand. The supply curve under constant cost condition will be perfectly elastic and as such price will rise to the full amount of the tax. In this situa­tion, entire burden will fall on consumers.

The demand and supply theory of tax shifting is abstract and is entirely based on deductive reasoning. Observations and experimen­tation were never used to approve or disapprove the theory.

The theory ignores the effect of government expenditure. Public expenditure is an important macroeconomic variable affecting the shifting of tax. However, the effects of government expenditure are complicated and very difficult to measure.

Moreover, the demand and supply theory of tax shifting consti­tute only a part of the general theory of value. The modern industrial productive sector is a combination of competitive and monopolistic practices.

Moreover, government function has embraced different economic spheres. Government’s role in development activities of the economy, provision of public goods, price control and other regu­latory measures do affect the working of the price system.

A com­prehensive theory of shifting alone can take into consideration, all these factors influencing the economy. Hence the demand and sup­ply theory cannot be considered as full-fledged incidence theory.

The theory also does not take into consideration the indirect money burden arising from the imposition of a tax. For a balanced analysis of the effect of tax, both direct and indirect money burden should be taken into consideration.

In this sense, the theory is one sided. Shifting power depend upon strength of bargaining power of sellers and buyers. The theory has given insufficient weightage to the strategic factor like bargaining power.

A theory of tax shifting cannot be considered comprehensive and complete unless the above said factors are duly considered in the analysis. In spite of these limitations, the demand and supply theory of incidence is the best available tool to analyses the inci­dence problem in taxation.

Fiscal responsibility implies a government pursues the appropriate level of government spending and tax to:

• Maintain sustainable public finances.
• Ensure fiscal policy aids the optimal rate of economic growth.
• Maintain appropriate levels of public investment.

This means that if the economic cycle is at a stage of ‘normal growth’ then government tax receipts must be greater than government spending. If a government is running a budget deficit, then it will be forced to cut spending or increase taxes to meet the shortfall.

The Fiscal Responsibility and Budget Management Act, 2003 (FRBMA) is an Act of the Parliament of India to institutionalize financial discipline, reduce India’s fiscal deficit, improve macroeconomic management and the overall management of the public funds by moving towards a balanced budget and strengthen fiscal prudence. The main purpose was to eliminate revenue deficit of the country (building revenue surplus thereafter) and bring down the fiscal deficit to a manageable 3% of the GDP by March 2008. However, due to the 2007 international financial crisis, the deadlines for the implementation of the targets in the act was initially postponed and subsequently suspended in 2009. In 2011, given the process of ongoing recovery, Economic Advisory Council publicly advised the Government of India to reconsider reinstating the provisions of the FRBMA. N. K. Singh is currently the Chairman of the review committee for Fiscal Responsibility and Budget Management Act, 2003, under the Ministry of Finance (India), Government of India.

Enactment

The Fiscal Responsibility and Budget Management Bill (FRBM Bill) was introduced in India by the then Finance Minister of India, Mr.Yashwant Sinha in December 2000.

• Firstly, the bill highlighted the terrible state of government finances in India both at the Union and the state levels under the statement of objects and reasons.
• Secondly, it sought to introduce the fundamentals of fiscal discipline at the various levels of the government.

The FRBM bill was introduced with the broad objectives of eliminating revenue deficit by 31 March 2006, prohibiting government borrowings from the Reserve Bank of India three years after enactment of the bill, and reducing the fiscal deficit to 2% of GDP (also by 31 March 2006). Further, the bill proposed for the government to reduce liabilities to 50% of the estimated GDP by year 2011. There were mixed reviews among economists about the provisions of the bill, with some criticising it as too drastic. Political debate ensued in the country. Several revisions later, it resulted in a much relaxed and watered-down version of the bill (including postponing the date for elimination of revenue deficit to 31 March 2008) with some experts, like Dr Saumitra Chaudhuri of ICRA Ltd. (and now a member of Prime Ministers’ Economic Advisory Council) commenting, “all teeth of the Fiscal Responsibility Bill have been pulled out and in the current form it will not be able to deliver the anticipated results.” This bill was approved by the Cabinet of Ministers of the Union Government of India in February, 2003 and following the due enactment process of Parliament, it received the assent of the President of India on 26 August 2003. Subsequently, it became effective on 5 July 2004. This would serve as the day of commencement of this Act.

Objectives

The main objectives of the act were:

• To introduce transparent fiscal management systems in the country
• To introduce a more equitable and manageable distribution of the country’s debts over the years
• To aim for fiscal stability for india in the long run

Additionally, the act was expected to give necessary flexibility to Reserve Bank of India for managing inflation in India.

Fiscal management principles

The Central Government, by rules made by it, was to specify the following:

• A plan to eliminate revenue deficit by 31 March 2008 by setting annual targets for reduction starting from day of commencement of the act.
• Reduction of annual fiscal deficit of the country
• Annual targets for assuming contingent liabilities in the form of guarantees and the total liabilities as a percentage of the GDP

Features of the FRBM Act

• It was mandated by the act that the following must be placed along with the Budget documents annually in the Parliament:
• Macroeconomic Framework Statement
• Medium Term Fiscal Policy Statement and
• Fiscal Policy Strategy Statement
• It was proposed that the four fiscal indicators i.e, revenue deficit as a percentage of GDP, fiscal deficit as a percentage of GDP, tax revenue as a percentage of GDP, and total outstanding liabilities as a percentage of GDP be projected in the medium-term fiscal policy statement.

Solvency, in finance or business, is the degree to which the current assets of an individual or entity exceed the current liabilities of that individual or entity. Solvency can also be described as the ability of a corporation to meet its long-term fixed expenses and to accomplish long-term expansion and growth. This is best measured using the net liquid balance (NLB) formula. In this formula solvency is calculated by adding cash and cash equivalents to short-term investments, then subtracting notes payable.

According to the classical economists, however, fiscal policy should have the minimum range of operations and the budget should be balanced annually. They firmly stuck to the doctrine of laissez faire and Say’s law of markets. As such, they believed that when supply creates its own demand, general overproduction or involuntary unemployment is well-nigh impossible.

According to Adam Smith, economic equilibrium and progress are attained through inherent and self-oriented endogenous forces of the economic system. In classical opinion, thus, when full employment is supposed to reach automatically, productivity of government services in the economic field is nil.

And, since government services are rendered at the cost of the national product (because any government spending causes transfer of resources from the private sector to the government thereby causing reduction in the output of private enterprises), it amounts to a cut in the aggregate national product.

Thus, when government’s productivity is zero in a free enterprise economy, it is desirable that government confines itself only to its primary functions of protection and security of life and property and does not interfere with the free working of the economic system.

Even if government efforts are productive, it cannot increase national income and level of economic activity above the level reached without its intervention. Thus, when full employment, optimal allocation of resources and equitable distribution can be achieved automatically through the operation of free economic forces, fiscal operations have to be of a non-regulatory, non-interfering nature.

As such, the smallest budget was considered to be the best in the classical era. Further, the classicists condemned all budget deficits which necessitated borrowing by the government, for they led to inflation and even if they did not, they caused reduction in the accumulation of private capital (because, the resources in private hands were depleted due to government borrowings), thus, inhibiting the rate of progress.

As such, classicists firmly advocated a balanced budget, in the sense that current annual revenue and expenses of the government must be equal. It, thus, does not provide for borrowings. The balanced budget principle was thus recognised as a principle of sound finance in orthodox economics.

Under the theory of sound finance, classicists favoured a balanced budget criterion for the following reasons:

(i) If the budget is unbalanced, the government has to borrow. The government’s market borrowings cause reduction in loanable funds available to private productive employment and investment activities.

(ii) Unbalanced budgets imply a wide extension of state functions beyond the capacity of the government, which may invite irresponsible governmental action.

(iii) Unbalanced budgets may generate inflation on account of large and unproductive public expenditure.

(iv) A balanced budget, on the other hand, is a limited budget designed in a rational way.

(v) Economic stability is secured by the adoption of a balanced budget policy. Unbalanced budgets, on the other hand, cause economic uncertainty and promote instability.

(vi) A series of unbalanced budgets imply an increase in the burden of public debt.

Furthermore, when the public debts mature, the government will have to impose additional taxes to obtain resources for their repayment. Thus, additional taxation would again tend to have an adverse effect on the incentive to work and save. It would also cause the accentuation of income distribution.

Moreover, government borrowings cause the rate of interest in the money market to rise, as the demand for loanable funds rises. A rise in the rate of interest adversely affects investment activity in the private sector.

In short, according to the principles of sound finance, a budget must be balanced annually and the gap between. revenue and expenditure should be minimum. That is, a government should tax the least and spend the least, and it should not resort to borrowing as far as possible.

Thus, classical economists firmly advocated a laissez faire policy and were confident of the unhampered optimum operations of the free enterprise economic system. Neo-classical economists however, realized the socially undesirable effects of unregulated free enterprise on the economic system.

Marshall stated that in conditions of laissez faire, maximum social advantage is hardly realized. It was argued that careful state action for raising income and public spending was essential to attain maximum social welfare under the concept of welfare state developed in the neo-classical era.

Under the welfare state criterion, it was accepted that the state should take up the responsibility of correcting the misallocation of resources guided by private profit motive. The state has, therefore, to discourage private investment in certain sectors of the economy through fiscal restrictions and encourage private as well as public investment in essential sectors through appropriate public spendings. Pigou and Marshall, in this regard, favoured equimarginal social sacrifice and benefits as essential in the government budget.

The concept of fiscal policy, however, received a new vista with the inception of “new economics” (Keynesian economics) in modern times. Keynesian theory shattered the basic foundations of the classical doctrine when the former asserted that the competitive process of free enterprise economy does not necessarily ensure an effective demand such as to absorb all productive resources at full employment, supply does not create its own demand and the economy may attain equilibrium at underemployment level.

Unemployment may persist due to secular forces causing under-consumption and over-saving in an advanced economy, thereby creating a condition of plenty in the midst of poverty on account of deficiency of aggregate demand. Keynes, therefore, regarded the inevitability of a positive fiscal policy as follows.

At a level of income corresponding to full employment, the gap between total income and total consumption is so high in a mature economy that private investment is inadequate to fill it. If unemployment is to be avoided, the gap must be filled either by government expenditure or by increasing the propensity to consume.

But, in a capitalist economy, which is characterized by wide inequalities in the distribution of income and other institutional factors which make for a high propensity to save, the propensity to consume cannot easily be raised enough to have a significant effect on employment.

Therefore, the chief responsibility for maintaining high levels falls on the public sector expenditure, designed to narrow the gap between income and consumption at full employment. Further, in Keynes’ view, a depression in an advanced industrial economy occurs due to the deficiency of aggregate demand.

Thus, during a depression, when the aggregate spending is inadequate to achieve full employment, the government must increase spending directly by undertaking public works programmes on a large scale and indirectly by inducing people to spend more.

In short, the Keynesian fiscal policy for attaining full employment implies a technique by which total outlay in manipulated, i.e., when private outlays are deficient, public outlays should be increased which ensures the full use of economic resources available in the country.

Functional finance

Though the lead in the development of “functional finance” concept was taken by Keynes, credit goes to Prof. A.P. Lerner for coining this concept. Lerner puts that: The principle of judging fiscal measures by the way they work or function in the economy, we may call functional finance.

He contends that the fiscal operation of the government — taxing, borrowing; public spending, management of public debt, etc., deficit financing, etc. — should be designed with the objective of fulfilling certain functions which have an immediate bearing and far-reaching effects on the economic system as a whole.

In economic philosophy, the term functional finance embraces public expenditure, public revenue and debt management which were regarded as fiscal instruments effectively used to achieve objectives like attainment and maintenance of full employment with economic stability.

As Prof. Chelliah points out, the functional concept of fixed policy, thus, implies that:

(i) the fiscal operations of the government should be conducted on a functional basis and public finance should not be considered as being induced solely by the need for securing social goods meant for collective consumption

(ii) the budget need not always be balanced. As a matter of fact, the fiscal norm of functional finance is the complete antithesis of the orthodox rule of balanced budget. The functional finance norm suggests the formation of large budgets with a wider functional coverage of government spending to promote basic economic goals, e.g., (a) to obtain optimal allocation and efficient use of scarce resources at full-employment level, (b) to achieve economic stability and bring about an equitable distribution of income and wealth in the best possible manner.

Quite contrary to the classical notion, the concept of functional fiscal policy suggests that the state need not and should not assume a passive role in the economic affairs of the country.

It implies that public spending may be incurred not merely for the sake of its direct benefits, but for the sake of indirect effect it produces in raising the level of income, output and employment; and the public revenue may be raised not to meet an anticipated expenditure, but to curtail excessive demand and curb inflationary potentials in the economy. Taxation is, thus, regarded as an important and effective weapon in the hands of government to promote economic progress with stability.

Lerner suggests the following rules for government’s responsibility and activity under functional finance:

(i) The government budget should be directed towards the achievement of full employment and price stability. For this purpose, the government budget need not necessarily be balanced.

(ii) The government should incur public debt by borrowing money from the private sector only during inflation when it is, absolutely essential to mop up the excessive purchasing power from the public, thereby reducing the pressure of excess monetary demand.

(iii) During depression only, public expenditure in excess of current public revenue may be met by deficit financing, i.e., printing additional currency notes.

In short the main tenet of functional finance is the formation of unbalanced budget from time to time for perfecting the counter-cyclical goal of fiscal policy. A surplus budget is recommended during inflation and a deficit budget for recovery through excessive public spending during a deflation or depression.

Functional finance, thus, deliberately aims at unbalancing the budgets with a view to attaining and maintaining full employment level in a developed economy. In an underdeveloped economy, however, the main problem is not one of full employment but that of rapid economic growth. In a developing economy, thus, the functional aspect of fiscal policy is to be conceived in the context of a planned process of economic development.

Public Debt refers to “Obligation of Government particularly those evidenced by securities, to pay certain sums to the holders at some future date.

In simple words, Public Debt can be defined as the amount of debt taken by government from internal as well as external sources to meet out its deficit. Government needs to borrow when current revenue falls short of public expenditure.

Government debt, also known as public interest, public debt, national debt and sovereign debt, contrasts to the annual government budget deficit, which is a flow variable that equals the difference between government receipts and spending in a single year. The debt is a stock variable, measured at a specific point in time, and it is the accumulation of all prior deficits.

Government debt can be categorized as internal debt (owed to lenders within the country) and external debt (owed to foreign lenders). Another common division of government debt is by duration until repayment is due. Short term debt is generally considered to be for one year or less, and long-term debt is for more than ten years. Medium term debt falls between these two boundaries. A broader definition of government debt may consider all government liabilities, including future pension payments and payments for goods and services which the government has contracted but not yet paid.

Governments create debt by issuing government bonds and bills. Less creditworthy countries sometimes borrow directly from a supranational organization (e.g. the World Bank) or international financial institutions.

1. Internal and External Debt:

Public loans floated within the country are called internal debt. Public borrowings from other countries are referred as external debt. External debt represents a claim of foreigners against the real income (GNP) of the country, when it borrows from other countries and has to repay at the time of maturity.

External public debt permits import of real resources. It enables the country to consume more than it produces.

The following points of distinction between internal and external debts are noteworthy:

1. An internal loan may be voluntary or compulsory, but an external loan is normally voluntary in nature. Only in the case of a colony, an external loan can be raised by compulsion.
2. An internal loan is controllable and can be estimated before hand with certainty, while external loans are always uncertain and cannot be estimated so confidently. Its realisation is very much conditioned by international politics and foreign policies of the lending government.
3. Internal loan is in terms of the domestic currency, while external loans are in terms of foreign currencies.

An important feature of external debt is, that usually foreign exchange resources of the borrowing country increase when the loans are received in terms of foreign currencies. But, when there is repayment of such loans, i. e., debt servicing charges, foreign exchange reserve is depleted to that extent.

Sometimes, however, external loans are repayable in the borrowing country’s domestic currency, so that foreign exchange resources are least affected. For instance, in the post-independence period India received loans from U.S.A. under P.L. 480, which were repayable in Indian rupees.

Since under internal debts, borrowing takes place within the country, the availability of total resources does not arise. Simply the resources are transferred from the bond-holders individuals and institutions to the public treasury, and the government can spend, these for public purposes.

Similarly, payment of interest for repayment of principal of internal loans would transfer resources from tax-payers to bond-holders. An internally- held public debt, thus, represents only a commitment to effect a certain transfer of purchasing power among the people within the country. It has, therefore, no direct net money burden as such. It amounts to only a redistribution of income in the community from one section to the other.

External debt, on the other hand, leads to a transfer of wealth from the lender nation to the borrower nation. When the loan is made through the means of external loans the resources available to the borrowing nation increase.

However, when a foreign loan is repaid or interest is paid on such loans, there would be a transfer of resources from the debtor to the creditor countries, causing a decline in total resources of the debtor country.

The Structure of the Internal Public Debt:

The structure of the internal public debt may be constituted by various types of loan instruments/obligations of the government. It may be classified as follows:

In particular, for instance, the government of India’s debt obligations includes:

(1) Dated and non-terminable Rupee loans consisting:

(a) Marketable long-term loans including the portion subscribed by the State Bank of India out of the rupee counterpart funds;

(b) Dated loans issued by the Government to the Reserve Bank of India in exchange for ad hoc Treasury Bills outstanding; and

(c) Miscellaneous debt such as the Prize Bonds issued in 1961.

(2) Treasury Bills: The short-term issues (90/ 180 days) of the Government in order to bridge the gap between revenue and expenditure.

(3) Small Savings: A non-inflationary means of finance effectuated/tapped through instruments such as Post Office Savings Bank Deposits, Cumulative Time Deposits, Post Office Recurring Deposits, National Defence Certificates, 15-year Annuity Certificates, National Savings Certificates, National Savings Annuity Scheme, National Development Banks, National Savings Account, Indira Vikas Patra, Kisan Vikas Patra.

(4) Other miscellaneous obligations of the Central Government constituting the internal public debt in India are: Compulsory Deposit Scheme, Gold Bonds, Public Provident Funds, and items of unfunded debts and special securities issued to the United States Embassy for the Rupee Counterpart funds since 1961, unclaimed balance of State Provident Funds, and other accounts such as General Family Pension Fund, the Hindu Family Annuity Fund, the Postal Insurance, Life Insurance, Life Annuity Fund, etc. and unclaimed balance in respect of three-year Interest-free Prize Bonds.

2. Productive and Unproductive Debt:

Public debt is said to be productive or reproductive, when government loans are invested in productive assets or enterprises such as railways, irrigation, multipurpose projects etc., which yield a sufficient income to the public authority to pay out annual interest on the debt as well as help in repaying the principal in the long run.

As such, a productive public debt is self-liquidating in nature; so the community experiences no net burden of such debt.

An unproductive debt, on the other hand, is one which does not add to the productive assets of a country. When the government borrows for unproductive purposes like financing a war, or for lavish expenditure on public administration, etc., such public loans are regarded as unproductive.

Unproductive loans do not add to the productive capacity of the economy, so they are not self-liquidating. Unproductive public loans thus cast a net burden on the community, as for their servicing and repayment purpose, government will have to resort to additional taxation.

3. Compulsory and Voluntary Debt:

When government borrows from people by using coercive methods, loans so raised are referred to as compulsory public debt. Under the Compulsory Deposit Scheme in India, tax-payers have to compulsorily deposit a prescribed amount and defaulters are punished. This is a case of compulsory debt.

Usually, public borrowings are voluntary in nature. When the government floats a loan by issuing securities, members of the public and institutions like commercial banks may subscribe to them.

4. Redeemable and Irredeemable Debts:

On the criterion of maturity, public debts may be classified as redeemable or irredeemable. Loans which the government promises to pay off at some future date are called redeemable debts. For redeemable debts, the government has to make some arrangement for their repayment. They are, therefore, terminable loans.

Whereas loans for which no promise is made by the government regarding the exact date of maturity, and all that the government does is to agree to pay interest regularly for the bonds issued, are called irredeemable debts.

Their maturity period is not fixed. They are generally of a long duration. Under such loans, society is burdened with a perpetual debt, as tax-payers would have to pay heavily in the end. Therefore, redeemable debts are preferred on grounds of sound finance and convenience.

5. Short-term, Medium-term and Long-term loans:

According to their duration, redeemable loans may further be classified as short-term, medium-term or long­-term debts. Short-term debts mature within a short period say, of 3 to 9 months. For instance, Treasury Bills are an instrument of credit extensively used as a means of short-term (usually 90 days) borrowing by the government, generally, for covering temporary deficits in the budgets. Interest rates on such loans are generally low.

Long-term debts, on the other hand, are those repayable after a long period of time, generally, ten years or more. For development finance, such loans are usually raised by the government. Long-term loans usually bear a high rate of interest.

Similarly, loans of medium-term (in between short-term and long-term) are floated by the government, bearing intermediate interest rates. For war finance, or to meet expenditure on education, health, relief work, etc., such loans are generally preferred.

6. Funded and Unfunded Debt:

Funded debt is, in fact, a long-term debt, exceeding the duration of at least a year. It comprises securities which are marketable on the stock exchange. Funded debt in its proper sense is, however, an obligation to pay a fixed sum of interest, subject to the option of the government to repay the principal. In such debts, the creditor bond-holder has no right to anything but the interest.

Unfunded debts, on the other hand, are for a comparatively short duration. They are generally redeemable within a year. Unfunded debts are, thus, incurred always in anticipation of public revenue, a temporary measure to meet current needs.

Public finance deals with the question how the Government raises its resources to meet its ever-rising expenditure. As Dalton puts it,” public finance is “concerned with the income and expenditure of public authorities and with the adjustment of one to the other.”

Accordingly, effects of taxation, Gov­ernment expenditure, public borrowing and deficit financing on the economy constitutes the subject matter of public finance. Thus, Prof. Otto Eckstein writes “Public Finance is the study of the effects of budgets on the economy, particularly the effect on the achievement of the major economic objects growth, stability, equity and efficiency.”

Further, it also deals with fiscal policies which ought to be adopted to achieve certain objectives such as price stability, economic growth, more equal distribution of income. Economic thinking about the role that public finance is expected to play has changed from time to time according to the changes in economic situ­ation.

Before the Great Depression that gripped the Western industrialised countries during the thirties, the role of public finance was considered to be raising sufficient resources for carrying out the Government functions of civil administration and defence from foreign countries. During this period, the classical economists considered it prudent to keep expenditure to the minimum so that taxing of the people is avoided as far as possible.

Further, it was thought that Government budget must be balanced. Public borrowing was recommended mainly for production purposes. During a war, of course, public borrowing was considered legitimate but it was thought that the Government should repay or reduce the debt as soon as possible.

Economists have a strict definition of a public good, and it does not necessarily include all goods financed through taxes. To understand the defining characteristics of a public good, first consider an ordinary private good, like a piece of pizza. A piece of pizza can be bought and sold fairly easily because it is a separate and identifiable item. However, public goods are not separate and identifiable in this way.

Even though new technology typically creates positive externalities through which one-third to one-half of the social benefit of new inventions spills over to others, the inventor still receives some private return. But what about a situation where the positive externalities are so extensive that private firms could not expect to receive any of the social benefit? This kind of good is called a public good.

Instead, public goods have two defining characteristics: they are nonexcludable and nonrivalrous. The first characteristic, that a public good is nonexcludable, means that it is costly or impossible to exclude someone from using the good. If Larry buys a private good like a piece of pizza, then he can exclude others, like Lorna, from eating that pizza. However, if national defense is being provided, then it includes everyone. Even if you strongly disagree with America’s defense policies or with the level of defense spending, the national defense still protects you. You cannot choose to be unprotected, and national defense cannot protect everyone else and exclude you.

The second main characteristic of a public good that it is nonrivalrous means that when one person uses the public good, another can also use it. With a private good like pizza, if Max is eating the pizza, then Michelle cannot also eat it it the two people are rivals in consumption. With a public good like national defense, Max’s consumption of national defense does not reduce the amount left for Michelle, so they are nonrivalrous in this area.

A number of government services are examples of public goods. For instance, it would not be easy to provide fire and police service so that some people in a neighborhood would be protected from the burning and burglary of their property, while others would not be protected at all. Protecting some necessarily means protecting others, too.

Positive externalities and public goods are closely related concepts. Public goods have positive externalities, like police protection or public health funding. Not all goods and services with positive externalities, however, are public goods. Investments in education have huge positive spillovers but can be provided by a private company. Private companies can invest in new inventions such as the Apple iPad and reap profits that may not capture all of the social benefits.

Key Character

• A public good has two key characteristics: it is nonexcludable and nonrivalrous. These characteristics make it difficult for market producers to sell the good to individual consumers.
• Nonexcludable means that it is costly or impossible for one user to exclude others from using a good.
• Nonrivalrous means that when one person uses a good, it does not prevent others from using it.

It is apparent that public goods will not be adequately supplied by the private sector. The reason is plain: because people can’t be excluded from using public goods, they can’t be charged money for using them, so a private supplier can’t make money from providing them. … Because public goods are generally not adequately supplied by the private sector, they have to be supplied by the public sector.

Economists have often jumped from the observation that public goods are susceptible to underproduction to the conclusion that the government should tax people and use the revenues to provide public goods.

Public goods are regularly supplied by private actors without government coercion. For example:

• Having one’s downtown be free of impoverished beggars is a benefit that is both non-rivalrous and non-excludable, yet privately funded homeless shelters and soup kitchens are common.
• A beautiful, well-kept garden provides a vista that multiple users can enjoy without depletion (non-rivalrous) and from which passersby cannot easily be barred (non-excludable), yet many homeowners in populated areas expend significant sums, not to mention hours of hard labor, tending their yards.
• A highly educated citizenry tends to make better political decisions and to generate a richer cultural environment—both benefits that are non-rivalrous and largely non-excludable—yet people routinely spend great sums educating their children.
• Private groups regularly clean up roadsides, even though the benefit they are creating is not depleted as more drivers use the road (non-rivalrous) and cannot be limited to people who contribute to the clean-up (non-excludable).
• Millions of people make donations on “crowd-funding” websites like Kickstarter to finance projects like community theatre spaces, thereby creating the non-excludable, non-rivalrous benefit of more cultured communities.

Overcoming the Free-Rider

Direct provision of a public good by the government can help to overcome the free-rider problem which leads to market failure

• The non-rival nature of consumption provides a strong case for the government rather than the market to provide and pay for public goods.
• Many public goods are provided more or less free at the point of use and then paid for out of general taxation or another general form of charge such as a license fee.
• State provision may help to prevent the under-provision and under-consumption of public goods so that social welfare is improved.
• If the government provides public goods, they may be able to do so more efficiently because of economies of scale.

Public goods an example of market failure

• Pure public goods are not normally provided by the private sector because they would be unable to supply them for a profit.
• It is up to the government to decide what output of public goods is appropriate for society.
• To do this, it must estimate the social benefits from making public goods available.

Free Rider Problem

• Because public goods are non-excludable it is difficult to charge people for benefitting form a good or service once it is provided
• The free rider problem leads to under-provision of a good and thus causes market failure

Quasi-Public Goods

A quasi-public good is a near-public good i.e. it has many but not all the characteristics of a public good. Quasi-public goods are:

• Semi-non-rival: up to a point, extra consumers using a park, beach or road do not reduce the space available for others. Eventually beaches become crowded as do parks and other leisure facilities. Open access Wi-Fi networks become crowded
• Semi-non-excludable: it is possible but often difficult or expensive to exclude non-paying consumers. E.g. fencing a park or beach and charging an entrance fee; building toll booths to charge for road usage on congested routes
• The air waves – a public good or quasi public good?
• The airwaves used by mobile phone companies, radio stations and television companies are owned by the government.
• Do they count as a pure public good? One person’s use of the airwaves rarely limits how other people can benefit from utilising them.
• At peak times, the airwaves become crowded

Public expenditure is spending made by the government of a country on collective needs and wants such as pension, provisions (such as education, healthcare and housing), security, infrastructure, etc. Until the 19th century, public expenditure was limited as laissez faire philosophies believed that money left in private hands could bring better returns. In the 20th century, John Maynard Keynes argued the role of public expenditure in determining levels of income and distribution in the economy. Since then, government expenditures has shown an increasing trend. Sources of government revenue include taxes, and non-tax revenues.

In the 17th and the 18th centuries, public expenditure was considered a wastage of money. Thinkers believed government should stay with their traditional functions of spending on defense and maintaining law and order.

Causes of growth of public expenditure

There are several factors that have led to an enormous increase in public expenditure through the years

1) Defense expenditure due to modernization of defense equipment by the navy, army and air force to prepare the country for war or for prevention causes-for-growth-of-public-expenditure.

2) Population growth: It increases with the increase in population, more of investment is required to be done by government on law and order, education, infrastructure, etc. investment in different fields depending on the different age group is required.

3) Welfare activities: Welfare, mid-day meals, pension provisions etc.

• Provision of public and utility services: Provision of basic public goods given by government (their maintenance and installation) such as transportation.
• Accelerating economic growth: In order to raise the standard of living of the people.
• Price rise: Higher price level compels the government to spend an increased amount on purchase of goods and services.
• Increase in public revenue: With the rise in public revenue government is bound to increase the public expenditure.
• International obligation: maintenance of socio-economic obligation, cultural exchange etc. (these are indirect expenses of government)

4) Wars and social crises: Fighting amongst people and communities, and prolonged drought or unemployment, earthquake, hurricanes or tornadoes may lead to an increase in public expenditure of a country. This is because it will involve governments to re-plan and allocate resources to finance the reconstruction.

5) Creation of super national organizations: E.g., the United Nations, NATO, European community and other multinational organizations that are responsible for the provision of public goods and services on an international basis, have to be financed out of funds subscribed by member states, thereby adding to their public expenditure.

6) Foreign aid: Acceptance by the richer industrialized countries of their responsibility to help the poor developing countries has channelled some of the increased public expenditure of the donor country into foreign aid programmes.

7) Inflation: This is the general rise in the price level of goods and services. It increases the cost of all activities of the public sector and thus a major factor in growth in money terms of public expenditure.

Principle of maximum social advantage

The criteria and pre-conditions for arriving at this solution are collectively referred to as the principle of maximum social advantage. Taxation (government revenue) and government expenditure are the two tools. Neither of excess is good for the society, it has to be balanced to achieve maximum social benefit. Dalton called this principle as “Maximum Social Advantage” and Pigou termed it as “Maximum Aggregate Welfare”.

Dalton’s Principle of Maximum Social Advantage maximum satisfaction should be yield by striking a balance between public revenue and expenditure by the government. Economic welfare is achieved when marginal utility of expenditure = marginal disutility of taxation. He explains this principle with reference to

• Maximum Social Benefit (MSB)
• Maximum Social Sacrifice (MSS)

India’s social security system is composed of a number of schemes and programs spread throughout a variety of laws and regulations. Keep in mind, however, that the government-controlled social security system in India applies to only a small portion of the population.

Furthermore, the social security system in India includes not just an insurance payment of premiums into government funds (like in China), but also lump sum employer obligations.

Generally, India’s social security schemes cover the following types of social insurances:

• Pension
• Health Insurance and Medical Benefit
• Disability Benefit
• Maternity Benefit

The Code on Social Security, 2020

Foreign companies should note that when The Code of Social Security, 2020, one of the four new labor codes introduced by the Ministry of Labor and Employment comes into force, it will subsume the following enactments:

• The Employees’ Compensation Act, 1923
• The Employees’ State Insurance Act, 1948
• The Employees’ Provident Funds and Miscellaneous Provisions Act, 1952
• The Employment Exchanges (Compulsory Notification of Vacancies) Act, 1959
• The Maternity Benefit Act, 1961
• The Payment of Gratuity Act, 1972
• The Cine- Workers Welfare Fund Act, 1981
• The Building and Other Construction Workers Welfare Cess Act, 1996
• The Unorganised Workers’ Social Security Act, 2008

Rules for the new labor codes on industrial relations, social security, and occupational safety health & working conditions (OSH) are likely to be finalized by the end of January, according to Labor Secretary Apurva Chandra. If that is the case, it may result in implementation of the labor codes by April 1, 2021, which was the deadline put by the labor ministry. However, this timeline is subject to change, depending on interventions made by key stakeholders and lobby groups and other exigencies, such as the impact of the ongoing pandemic.

The Labor Secretary was also quoted in the media saying that the draft model standing orders for the manufacturing, mining, and service sectors will be finalized by February. These draft orders set the standards for service conditions and employees’ conduct in the respective sectors and were notified on December 31, 2020 to seek feedback (within a period of 30 days from the date of notification).

Pension or Employees’ Provident Fund

The Employees’ Provident Fund Organization (EPFO), under the Ministry of Labor and Employment, ensures superannuation pension and family pension in case of death during service. Presently, only about 35 million out of a labor force of 400 million have access to formal social security in the form of old-age income protection in India. Out of these 35 million, 26 million workers are members of the Employees’ Provident Fund Organization, which comprises private sector workers, civil servants, military personnel, and employees of State Public Sector Undertakings (PSUs).

The schemes under the EPFO apply to businesses with at least 20 employees. Contributions to the Employees’ Provident Fund (EPF) Scheme are obligatory for both the employer and the employee when the employee is earning up to INR 15,000 (US$205) per month, and voluntary, when the employee earns more than this amount. If the pay of any employee exceeds this amount, the contribution payable by the employer will be limited to the amount payable on the first INR 15,000 only.

Three schemes are supervised by the Employees’ Provident Fund Organization:

• The Employees’ Provident Fund Scheme, 1952;
• The Employees’ Pension Scheme, 1995; and,
• The Employees’ Deposit Linked Insurance Scheme, 1976.

Four main types of pension (all monthly) are offered:

• Pension upon superannuation or disability
• Widows’ pension for death while in service
• Children’s pension
• Orphan’s pension

Health Insurance and Medical Benefit

India has a national health service, but this does not include free medical care for the whole population. The Employees’ State Insurance (ESI) Act, 1948 created a fund to provide medical care to employees and their families, as well as cash benefits during sickness and maternity, and monthly payments in case of death or disablement for those working in factories and establishments with 10 or more employees. (As on March 31, 2017, the total number of ESI beneficiaries were 123.7 million.)

Coverage under the ESI scheme has extended to hotels, shops, cinemas and preview theaters, restaurants, newspaper establishments, and road-motor transport undertakings. The scheme has also been extended to private educational and medical institutions that have employed 10 or more employee. This is applicable in certain states and union territories only.

The ESI (Central) Amendment Rules, 2016 – notified on December 22, 2016 – expanded coverage to include employees earning INR 21,000 (US$287) or less in a month from January 1, 2017; previously, the wage limit for ESI subscribers was INR 15,000 per month.

An employee who earns less than INR 21,000 per month contributes 1.75 percent of their salary towards the ESI while the employer pays 4.75 percent making a total contribution of 6.5 percent. The company or establishment can apply for an ESI registration within 15 days from the time the ESI Act becomes applicable to that entity. The Employees’ State Insurance (Central) Amendment Rules, 2017 was notified on January 20, 2017 detailing new maternity benefits for women who have insurance.

Sickness benefit under ESI coverage is 70 percent of the average daily wage and is payable for a maximum of 91 days in a year. To qualify for sickness benefit, the insured worker is required to contribute for 78 days in a contribution period of six months. There are provisions for extended sickness benefits and corresponding eligibility criteria.

ESI also provides disablement benefit, which is applicable from day one of entering insurable employment for temporary disablement benefit. In case of permanent disablement benefit, it is paid at the rate of 90 percent of wage in the form of monthly payment, depending upon the extent of loss of earning capacity as certified by a Medical Board.

Besides sickness and disability pay outs, the ESI provides for dependents’ benefits (DB). The DB paid is at the rate of 90 percent of the wage in the form of monthly payment to the dependents of a deceased insured person – in cases where the death has occurred due to employment injury or occupational hazards.

Other benefits that are offered with ESI are:

• Medical benefits;
• Maternity benefits;
• Unemployment allowance;
• Confinement expenses;
• Funeral expenses;
• Physical rehabilitation;
• Vocational training; and
• Skill upgradation training under Rajiv Gandhi Shramik Kalyan Yojana (RGSKY).

A one-time relaxation has been extended to employers who could not file the return of ESI contribution for the contribution period from April 1, 2020 to September 30, 2020 due to the extenuating circumstances faced by enterprises last year. The new deadline to file this return is January 15, 2021. This does not impact employees contributing to and receiving benefits from the ESI. Also, no further relaxations have been provided for older or newer contribution periods.

Disability Benefit

The Employee’s Compensation Act, 1923, formerly known as the ‘Workmen’s Compensation Act, 1923’, requires the employer to pay compensation to employees or their families in cases of employment related injuries that result in death or disability.

In addition, workers employed in certain types of occupations are exposed to the risk of contracting certain diseases, which are peculiar and inherent to those occupations. A worker contracting an occupational disease is deemed to have suffered an accident out of and in the course of employment, and the employer is liable to pay compensation for the same. Injuries resulting in permanent total and partial disablement are listed in parts I and II of Schedule I of the Employee’s Compensation Act, while occupational diseases have been defined in parts A, B, and C of Schedule III of the Employee’s Compensation Act.

Last year, the central government changed the wage amount to be considered for calculation of compensation to workers under the Employee’s Compensation Act, 1923 vide notification S.O.71 (E) dated January 3, 2020. Now, it will be INR 15,000 (US$205), according to the notification by the Ministry of Labor and Employment. The previous wage amount considered for the calculation of compensation was just INR 8,000 (US$109).

Compensation calculation depends on the situation of occupational disability:

(a) Death

50 percent of the monthly wage multiplied by the relevant factor or an amount of INR 120,000 (US$1,640), whichever is more.

(b) Total permanent disablement

60 percent of the monthly wage multiplied by the relevant factor or an amount of INR 120,000 (US$1,640), whichever is more.

The relevant factor for computation is mentioned in Schedule IV of the Employee’s Compensation Act.

Maternity Benefit

The Maternity Benefit (Amendment) Act, 2017 came into force on April 1, 2017, and increases some of the key benefits mandated under the previous Maternity Benefit Act of 1961. The amended law provides women in the organized sector with paid maternity leave of 26 weeks, up from 12 weeks, for the first two children. For the third child, the maternity leave entitled will be 12 weeks. India now has the third most maternity leave in the world, following Canada (50 weeks) and Norway (44 weeks).

The Act also secures 12 weeks of maternity leave for mothers adopting a child below the age of three months as well as to commissioning mothers (biological mothers) who opt for surrogacy. The 12-week period in these cases will be calculated from the date the child is handed over to the adoptive or commissioning mother.

In other provisions, the law mandates that every establishment with over 50 employees must provide crèche facilities within easy distance, which the mother can visit up to four times a day. For compliance purposes, companies should note that this particular provision will come into effect from July 1, 2017.

The Maternity Benefit (Amendment) Act introduces the option for women to negotiate work-from-home, if they reach an understanding with their employers, after the maternity leave ends.

Under the pre-existing Maternity Benefit Act of 1961, every woman is entitled to, and her employer is liable for, the payment of maternity benefit at the rate of the average daily wage for the period of the employee’s actual absence from work. Apart from 12 weeks of salary, a female worker is entitled to a medical bonus of INR 3,500.

The 1961 Act states that in the event of miscarriage or medical termination of pregnancy, the employee is entitled to six weeks of paid maternity leave. Employees are also entitled to an additional month of paid leave in case of complications arising due to pregnancy, delivery, premature birth, miscarriage, medical termination, or a tubectomy operation (two weeks in this case).

In addition to the above, the 1961 Act states that no company shall compel its female employees to do tasks of a laborious nature or tasks that involve long hours of standing or which in any way are likely to interfere with her pregnancy or the normal development of the fetus, or are likely to cause her miscarriage or otherwise adversely affect her health.

Gratuity

The Payment of Gratuity Act, 1972 directs establishments with 10 or more employees to provide the payment of 15 days of additional wages for each year of service to employees who have worked at a company for five years or more.

Gratuity is provided as a lump sum payout by a company. In the event of the death or disablement of the employee, the gratuity must still be paid to the nominee or the heir of the employee.

The employer can, however, reject the payment of gratuity to an employee if the individual has been terminated from the job due to any misconduct. In such a case of forfeiture, there must be a termination order containing the charges and the misconduct of the employee.

Gratuity is calculated through the formula mentioned below:

Gratuity = Last Drawn Salary × 15/26 × Tenure of Service, where:

• The ratio 15/26 represents 15 days out of 26 working days in a month.
• Last Drawn Salary = Basic Salary + Dearness Allowance.
• Tenure of Service is rounded up or down to the nearest full year. For example, if the employee has a total service of 10 years, 10 months and 25 days, 11 years will be factored into the calculation.

The budget is an estimate of income and expenditure for a definite duration. In economics, budget is a systematic list of revenue and expenditure or we can say it’s a plan for income and expenditure.

The word ‘budget’ has been borrowed from the English word “Bowgette” which traces its origin from the French word “Bougette”.  Word “Bougette” has arrived from the word, ‘Bouge’ which means a leather bag.

The Union Budget of India, also referred to as the Annual Financial Statement in the Article 112 of the Constitution of India, is the annual budget of the Republic of India. The Government presents it on the first day of February so that it could be materialised before the beginning of new financial year in April. Until 2016 it was presented on the last working day of February by the Finance Minister in Parliament. The budget, which is presented by means of the Finance bill and the Appropriation bill has to be passed by Lok Sabha before it can come into effect on 1 April, the start of India’s financial year.

An interim budget is not the same as a ‘Vote on Account’. While a ‘Vote on Account’ deals only with the expenditure side of the government’s budget. An interim budget is a complete set of accounts, including both expenditure and receipts. An interim budget gives the complete financial statement, very similar to a full budget. While the law does not disqualify the Union government from introducing tax changes, normally during an election year, successive governments have avoided making any major changes in income tax laws during an interim budget.

As of September 2017, Morarji Desai has presented 10 budgets which is the highest count followed by P Chidambaram’s 9 and Pranab Mukherjee’s 8. Yashwant Sinha, Yashwantrao Chavan and C.D. Deshmukh have presented 7 budgets each while Manmohan Singh and T.T. Krishnamachari have presented 6 budgets.

Reason OF Union Budget

The Government performs two important functions by making a budget every year:

1. The Government estimates the expected expenditures for developmental works in different sectors of the economy e.g. Industry, Manufacturing, Education, Health, Transport, etc.
2. To meet the expenditures for the coming financial year, the Government tries to work out the sources of revenue. ( i.e. by imposing new taxes or increasing or decreasing the previous rates of taxes, or to remove or impose subsidy on any commodity.

Components of the Union (Central) Budget of India:

The budget is divided into two parts:

(i) Revenue Budget and

(ii) Capital Budget.

The Revenue Budget comprises revenue receipts and expenditure met from these revenues. The revenue receipts include both tax revenue (like income tax, excise duty) and non-tax revenue (like interest receipts, profits). Capital Budget consists of capital receipts {like borrowing, disinvestment) and long period capital expenditure (creation of assets, investment).

Capital receipts are receipts of the government which create liabilities or reduce financial assets, e.g., market borrowing, recovery of loan, etc. Capital expenditure is the expenditure of the government which either creates assets or reduces liability. Capital budget is an account of assets and liabilities of the government which takes into consideration changes in capital.

Structure or components of a government budget broadly consists of two parts Budget Receipts and Budget Expenditure as shown in the following chart with their classification.

Types of Budget

1. Traditional or General Budget: The initial structure of the present-day general budget is known as the Traditional Budget. The main aim of the General Budget is to set up financial control over the Executive and the Legislative. This budget contains the details of income and expenditure of the Government.

This budget contains the details of the expenditure in different sectors done by the Government. However, the result of this expenditure is not explained in this budget. Thus, the main idea behind the traditional budget that is to solve the problems of independent India and to achieve the developmental targets was defeated.

As a result, the need and importance of drafting a ‘Performance Budget was accepted and it was presented as a complimentary budget to the earlier Traditional budget.

2. Performance Budget: When the outcome of any activity is taken as the base of any budget, such a budget is known as ‘Performance Budget’. For the first time in the world, the performance budget was made in the USA. An Administrative Reforms Commission was set up in 1949 in America under Sir Hooper. This commission recommended for making a ‘Performance Budget’ in the USA. In the Performance Budget, it is the compulsion of the government to tell that ‘what is done’, ‘how much done’ by it for the betterment of the people. In India, the Performance Budget is also known as the ‘Outcome Budget’.
3. Zero Based Budget: There are two primary reasons for adopting this type of Budget in India.

(i) The continuous revenue deficit in the budget of the country.

(ii) Poor implementation of the Performance Budget.

In the zero-based budget, neither expenses incurred during the previous financial years are not considered nor the expenditure of the last financial year used for the coming years.

Under Zero-based budgets, every activity is decided based on Zero basis i.e. the previous expenditures are not considered. This budget is also known as ‘Sun Set Budget’ which means the finance department has to present the zero-based budget before the end of the financial year.

Outcome Budget: In India, development-related schemes such as MGNREGA, NRHM, Mid Day Meal, PMGSY, Digital India, Prime Minister Skill Development Council, etc. are started every year. The large sum of money is spent on these schemes every year. However, at present, the government doesn’t have any parameters to measure the results of these schemes.

Budget Deficit

A budget deficit occurs when government expenditures exceed revenues from taxes and other sources. Although the concept of a budget deficit applies to any organization with operating revenues and expenses, the term is most commonly applied to government budgets.

Components

1. Revenues

For national governments, a majority of revenue comes from income taxes, corporate taxes, consumption taxes, and social insurance taxes. For non-governmental organizations and companies, revenues come from the sale of goods and services.

2. Expenses

For governments, expenses include government spending on healthcare, infrastructure, defense, subsidies, pensions, and other items that contribute to the health of the overall economy. For non-governmental organizations and companies, expenses include the amount that is spent on daily operations and factors of production, including rent and wages.

Implications

Contrary to what it may sound like, a budget deficit is not always a negative indicator of economic health. Some of the implications of a budget deficit are described below:

1. Increase aggregate demand

A budget deficit implies a reduction in taxes and an increase in government spending, which results in an increase in the aggregate demand of the country and subsequent economic growth, ceteris paribus.

2. Boost the economy during a recession

During a recession, the economy tends to experience a decrease in investment spending from the private sector, along with lower aggregate consumption and demand. A government may choose to borrow and run a deficit to combat the situation by taking measures to spend effectively.

3. Increase government spending

Government spending serves many purposes, including investments in infrastructure, healthcare, human capital, unemployment benefits, pension programs, and so on. A nation’s government may choose to spend more than its revenues allow by running a deficit.

4. Fiscal policy

A budget deficit may be used to finance an expansionary fiscal policy, which involves lowering income and corporate taxes (therefore reducing revenue for the government) and increasing government spending on infrastructure and investments to attract foreign capital and boost economic growth.

5. Higher taxes in the future

A current budget deficit that runs persistently often implies that the government will need to increase taxes in the future to pay off the accumulated debt since taxes are one of the primary sources of revenue for the government.

6. Higher interest rates and bond yields

In order to borrow large amounts, governments often offer higher interest rates to investors and international banks that lend them money. Increased government borrowing results in higher interest rates and bond yields since investors and banks require compensation for the risk through interest payments.

Theories

1. Ricardian Equivalence Theory

The Ricardian Equivalence Theory argues that using budget deficit or borrowing to stimulate the economy exerts no effect. It relies on many assumptions, including one that states that the government will increase taxes to pay off the current deficit.

According to the theory, households take it into account while making investment and saving decisions and choose to save more to compensate for the future increase in taxes. Therefore, consumption in the economy decreases, and the increase in government spending financed by a deficit does not impact the economy.

2. Crowding Out Theory

The Crowding Out Theory states that an increase in government spending and borrowing leads to a decrease in investments from the private sector. It is because governments borrow by selling bonds to the private sector and by borrowing from foreign sources, such as other countries and international banks.

However, it often results in higher interest rates, as well as higher spending on bonds by the private sector which leads to lower funds for private sector investments and a higher cost of borrowing (due to higher interest rates).

Therefore, the increase in government spending is often met with a relatively smaller decrease in private sector investments, which offsets the overall effect of the expansionary move.

Types of Budget Deficit

There are three types of budget deficit, which are explained below

• Fiscal Deficit
• Revenue Deficit
• Primary Deficit

Fiscal Deficit

Fiscal deficit is defined as the excess of total expenditures over the total receipts excluding the borrowings in a year. In other words, this can be defined as the amount that the government needs to borrow in order to meet all expenses.

The more the fiscal deficit more will be the amount borrowed. Fiscal deficit helps in understanding the shortfall that the government faces while paying for the expenditures in the absence of lack of funds.

The formula for calculating fiscal deficit is as follows

Fiscal deficit = Total expenditures – Total Receipts excluding borrowings.

Impact of Fiscal Deficit

The following impacts of fiscal deficit can be seen

• Unnecessary expenditure: A high fiscal deficit leads to unnecessary expenditure done by the government that leads to potential inflationary pressure on the economy.
• Printing more currency by RBI for meeting the deficit, also called deficit financing leads to the availability of more money in the market, leading to inflation.
• Borrowing more will hinder the future growth of the economy as most of the revenue will be utilised towards meeting debt payments.

Remedial measures for Fiscal Deficit

• Reduced public expenditure
• Reduction in bonus, leave encashments and subsidies
• Increase tax to generate revenue
• Disinvestment of public sector units

Revenue Deficit

Revenue expenditure is defined as the excess of total revenue expenditure over the total revenue receipts. In other words, the shortfall of revenue receipts as compared to the revenue expenditure is known as revenue deficit

Revenue deficit signals to the economists that the revenue earned by the government is insufficient to meet the requirements of the expenditures required for the essential government functions.

The formula for revenue deficit can be expressed as

Revenue Deficit = Total Revenue expenditure – Total Revenue receipts

Impact of Revenue Deficit

• Reduction in assets: For meeting the shortfall in the form of revenue deficit, the government has to sell some assets.
• It leads to conditions of inflation in the economy
• A large number of borrowing leads to a greater debt burden on the economy.

Remedial measures for Fiscal Deficit

• By reducing unnecessary spending.
• By raising the rate of taxes and applying new taxes, wherever possible.

Primary Deficit

Primary deficit is said to be the fiscal deficit of the current year minus the interest payments that are pending on previous borrowings, or it can be said that primary deficit is the requirement of borrowing without the interest payment.

Primary deficit, therefore, shows the expenses that government borrowings are going to fulfil while not paying for the income interest payment.

A zero deficit shows that there is a requirement for availing credit or borrowing for clearing the interest payments pending.

The formula for the primary deficit is expressed as follows

Primary Deficit = Fiscal Deficit – Interest Payments

Measures to reduce the primary deficit can be similar to the steps taken to reduce the fiscal deficit as the primary deficit is any borrowings that are above the existing deficit or borrowings.