Economic Liberalization, Fiscal Performance, Government Debt and Tax Reforms: Indian Experience

By Kulkarni, Prashant; Murthy N. K., Anantha | Indian Journal of Economics and Business, June 2010 | Go to article overview

Economic Liberalization, Fiscal Performance, Government Debt and Tax Reforms: Indian Experience


Kulkarni, Prashant, Murthy N. K., Anantha, Indian Journal of Economics and Business


Abstract

The process of liberalization post 1991 paved the way for the emergence of deregulated markets in India. It represented a shift from the import substitution oriented industrialization to the export promoting industrialization. The commanding role assumed by the state in the earlier era gave way to the market dominated economy. However certain indicators of public finance remain a cause of concern. We examine the relationship between fiscal deficit, government debt and taxes in this era of economic liberalization.

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The process of liberalization post 1991 resulted in the emergence of deregulated markets in India. Despite healthy performance by various fiscal indicators, concerns exist on the state of the economy. The fragile fiscal situation is hampering the progress of what otherwise was a sound and healthy economy. Fiscal deficit hovers around 6% of the GDP. The Fiscal Responsibility Management Bill (FRMB) passed in late 2003 mandated the reduction of fiscal deficit by 0.3% and revenue deficit by 0.5%. But now, it still seems out of reach. Tax collections are falling short of targets almost every year. The level of public debt is high. The tax GDP ratio stands at around 6%. This is relatively low in comparison to developed countries, some of which maintain a tax GDP ratio of more than 20%. Public debt to GDP ratio touched 80% some time back which was much higher compared to the levels that caused the breakdown in both Argentina and Turley. But India seems unaffected by this. The immunity of Indian economy to such crises prompts us to undertake this study.

OBJECTIVES

The following can be summarized as the objectives of the study

1. Examining the determinants of fiscal policy

2. Understanding the implications of Tax/GDP ratio on the country's growth

3. Explore how size of public debt can have an impact on tax structure

4. Move in direction of understanding the degree to which various determinants influence fiscal deficit.

REVIEW OF LITERATURE

Rangarajan and Srivatsava (2003), shows that four fifths of the effects of public indebtedness was negated on account GDP growth being faster than real interest rates.

Surajit Das (2004) concludes that there is no reason to believe that the deficits would cause an increase in real interest rates. He bases this on Loanable Funds theory and observations of Samuelson on Discplacing private capital by government debt. Hausmann and Purfield (2002) contend that inflation benefits the economy by ensuring the solvency of public debt.

Feldstein (2004) contends high fiscal deficit reduces economic growth, lowers the real incomes and causes economic and financial crisis in countries like Argentina in South East Asian countries.

Swaminathan Aiyar (2004) feels that it is the trade invisibles that have cushioned the impact of fiscal deficit in India. Net invisibles by 2003 had come to represent nearly 4% of the GDP and this offset the impact of the deficit. These invisibles are made primarily by software exports and remittances from abroad by non resident Indians (NRIs). His contention is that invisibles are used to finance deficit rather channelizing for productive purposes.

Easterly and Schmitt-Hebbel (1994) estimate the relation between fiscal deficit and inflation. They conclude that seignorage is not an important as a steady state phenomenon but can be important in short run period. While their study focused on fiscal deficit and it's financing influencing inflation, the opposite causation is complex in nature. The actual relationship may depend upon empirical observations than on theoretical grounds.

Woo (2001) showed a negative relationship between fiscal deficit and financial market development. We find similar evidence from Aizenmann and Noy (2003).

[GRAPHIC OMITTED]

It is evident that tax GDP ratio has been uniform through the period of study. …

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