Practice Question on Fiscal Policy for UPSC, APPSC and other state PSC exams

• IGST: Integrated Goods and Services Tax • Levied on: Inter-state supply of goods/services • Collected by: Central Government • Apportioned: Between Centre and destination state • Mechanism: Prevents cascading in inter-state trade • Ensures: Seamless input tax credit across states • Rate: Equal to CGST + SGST combined • Import of goods/services also attract IGST

• Expansionary Fiscal Policy: Increase aggregate demand • Tools: – Increase government spending – Decrease taxes – Combination of both • Used during: Recession, economic slowdown, unemployment • Effect: Higher demand → Higher output → Higher employment • Risk: Inflation if economy near full capacity • Leads to: Higher fiscal deficit (budget deficit)

• Twin Deficit Hypothesis: Relationship between fiscal deficit and current account deficit • Theory: Higher fiscal deficit → Higher imports → Wider CAD • Mechanism: Govt borrowing → Higher interest rates → Capital inflows → Currency appreciation → Export decline/Import rise • Alternative view: Ricardian equivalence (deficits don’t matter) • Relevance: For open economies like India • Policy implication: Fiscal consolidation can improve external balance

• Effective Capital Expenditure = Capital Expenditure + Grants for Creation of Capital Assets • Rationale: Some revenue expenditure (grants to states) creates assets • Provides: Truer picture of asset-creating expenditure • Introduced: To show quality of government spending • BE 2025-26: Effective Capex higher than pure Capex • Interest-free loans to states for capex: Included • Shows: Government’s focus on infrastructure creation

• CGST (Central GST) + SGST (State GST): Levied on intra-state supplies • Both go to: Respective governments (Centre and State) • Rate split: e.g., 18% GST = 9% CGST + 9% SGST • Input Tax Credit: CGST credit against CGST; SGST credit against SGST; IGST can be used for both • For Union Territories: UTGST instead of SGST • Ensures revenue for both Centre and States from same transaction

• Total Expenditure BE 2025-26: ₹50.65 lakh crore • Growth over RE 2024-25: 7.4% • Revenue Expenditure: ₹39.44 lakh crore • Capital Expenditure: ₹11.21 lakh crore (3.1% of GDP) • Interest payments: ₹12.76 lakh crore (largest single item = 25% of total expenditure) • Quality of expenditure improving: Capex ratio increasing

• GST implemented: Midnight of 30 June/1 July 2017 • Constitutional Amendment: 101st Amendment Act 2016 • Article added: 246A (concurrent power to levy GST) • GST Council: Article 279A • Subsumed taxes: Central Excise, Service Tax, VAT, Entry Tax, etc. • Products outside GST: Petroleum, alcohol, electricity • Destination-based consumption tax with input tax credit

• Finance Bill: Contains tax proposals of the Budget • Must be passed: Within 75 days of introduction • If not passed: Provisional Collection of Taxes Act allows temporary collection • Money Bill (Article 110): Rajya Sabha has 14 days to make recommendations • Rajya Sabha cannot: Reject or amend Money Bills • Finance Act: Finance Bill after President’s assent • Implements tax changes proposed in Budget

• Consolidated Fund of India: Article 266(1) of Constitution • Contains: All revenues received, loans raised, recoveries of loans • Withdrawal: Only with Parliamentary authorization (Appropriation Act) • Not part of CFI: Public Account (deposits, provident funds, etc.) • Contingency Fund: Article 267 (for unforeseen expenditure) • All tax revenues go to CFI first • ‘Charged’ expenditure: Automatic withdrawal (President’s salary, judges’ salaries, debt servicing)

• Treasury Bills (T-Bills): Short-term money market instruments • Maturity periods: 91 days, 182 days, 364 days • Issued at: Discount to face value (zero-coupon) • Redeemed at: Face value (par) • Difference: Represents interest earned • Auction: Weekly by RBI • Minimum investment: ₹25,000 (in multiples of ₹25,000) • Risk: Virtually risk-free (sovereign guarantee)

• G-Secs: Debt instruments issued by Central/State governments • Types: – Dated securities (long-term, 1-40 years) – Treasury Bills (short-term: 91, 182, 364 days) – State Development Loans (SDLs) • Features: Sovereign guarantee, SLR eligible, tradable • Yield: Benchmark for interest rates in economy • Auction: Conducted by RBI • Investors: Banks, insurance companies, mutual funds, FPIs

• Public Debt Management: Reserve Bank of India (currently) • Legal basis: RBI Act 1934, Section 21 • Public Debt Management Agency (PDMA): Proposed but not yet established • Types of public debt: – Internal: Market borrowings, small savings, provident funds – External: Multilateral, bilateral, commercial borrowings • Debt instruments: G-Secs, T-Bills, State Development Loans • RBI conducts: Primary auctions, secondary market operations

• Counter-cyclical Policy: Govt acts opposite to business cycle • During recession: Expansionary policy (increase spending/cut taxes) • During boom: Contractionary policy (reduce spending/increase taxes) • Aim: Stabilize economic fluctuations • Automatic stabilizers: Progressive taxes, unemployment benefits • Discretionary measures: Stimulus packages, tax changes • Keynesian economics advocates counter-cyclical policy

• 16th Finance Commission constituted: December 2023 • Chairman: Dr. Arvind Panagariya (former NITI Aayog Vice Chairman) • Period covered: 2026-27 to 2030-31 • 15th FC (N.K. Singh): Recommended 41% devolution to states • 14th FC (Y.V. Reddy): Increased devolution from 32% to 42% • FC recommendations are advisory but conventionally accepted • Award period: 5 years

• Items NOT subsumed under GST (excluded): 1. Petroleum products (petrol, diesel, ATF, natural gas, crude) 2. Alcoholic liquor for human consumption 3. Electricity 4. Stamp duty on immovable property • Reason: High revenue significance for states • GST Council can include petroleum when consensus achieved • Currently taxed under old VAT/excise regime

• Fiscal Glide Path: Gradual reduction in fiscal deficit over time • Approach: Step-by-step (not sudden) reduction in deficit • Purpose: Achieve fiscal consolidation without disrupting growth • Current path: Reduce from 4.8% (FY25 RE) → 4.4% (FY26) → towards 3% • Announced by: Finance Minister in Budget speeches • FRBM mandates: Presenting medium-term fiscal targets • Allows markets to plan based on predictable trajectory

• Charged Expenditure: Not voted upon, automatically charged on CFI • Examples: – Emoluments of President – Salaries of Supreme Court/High Court judges – Salary and pension of CAG – Debt charges (interest, sinking fund) – Expenses of UPSC, Election Commission – Any sum directed by Constitution/Parliament • Purpose: Insulate certain offices from political pressure • Discussed in Parliament but not voted upon

• Fiscal Deficit = Total Expenditure – Total Receipts (excluding borrowings) • Or: FD = Revenue Deficit + Capital Expenditure – Non-debt Capital Receipts • Indicates: Total borrowing requirement of government • Components of receipts excluded: Market borrowings, external loans, recoveries • High FD → High borrowing → Higher interest burden → Crowding out private investment

• Gender Budgeting: First introduced in 2005-06 • Purpose: Analyze budget from gender perspective • Gender Budget Statement: Part A (100% women-specific) + Part B (30-99% women allocation) • Aim: Ensure adequate allocation for women’s welfare • Ministries: Identify gender-specific outlays • BE 2025-26: Significant allocation under GBS • Part of: Inclusive and equitable budgeting approach

• Tax Buoyancy = % change in tax revenue / % change in GDP • Measures: Responsiveness of tax revenue to GDP growth • Buoyancy > 1: Tax revenue grows faster than GDP (desirable) • Includes: Automatic growth + discretionary changes (rate hikes) • Different from Elasticity: Elasticity excludes discretionary changes • High buoyancy indicates: Efficient tax system, better compliance, economic formalization

• Fiscal Deficit BE 2025-26: 4.4% of GDP (₹15.69 lakh crore) • Fiscal Deficit RE 2024-25: 4.8% of GDP • Reduction: 0.4 percentage points • Fiscal consolidation roadmap: Reduce central govt debt to 50% of GDP by 2030-31 • Total expenditure BE 2025-26: ₹50.65 lakh crore • Total receipts (non-borrowing): ₹34.96 lakh crore

• Laffer Curve: Relationship between tax rates and tax revenue • Key insight: Tax revenue initially increases with tax rate, then decreases • Optimal rate: Point of maximum revenue • Beyond optimal: Higher rates → Lower compliance, evasion, reduced economic activity • Named after: Economist Arthur Laffer • Implication: Tax cuts can sometimes increase revenue • Supports: Supply-side economics

• FRBM Act enacted: August 2003 • Came into force: 5th July 2004 • Introduced by: Finance Minister Yashwant Sinha (Dec 2000) • Purpose: Institutionalize fiscal discipline and reduce fiscal deficit • Original target: Fiscal deficit ≤3% of GDP and Revenue deficit = 0 by March 2008 • Key amendments: 2004, 2012, 2015, 2018

• Contractionary Fiscal Policy: Reduce aggregate demand • Tools: – Decrease government spending – Increase taxes – Combination of both • Used during: Inflation, overheating economy • Effect: Lower demand → Price stability → Controlled inflation • Leads to: Lower fiscal deficit or budget surplus • Risk: May cause recession if overdone • Also called: Fiscal tightening/austerity

• Primary Deficit = Fiscal Deficit – Interest Payments • Indicates: Borrowing needs excluding debt servicing • Significance: Shows current year’s fiscal position without legacy of past borrowings • If Primary Deficit = 0: Govt borrows only to pay interest on past debt • Lower PD preferred for fiscal sustainability • BE 2025-26: Primary Deficit at 0.8% of GDP

• Annual Financial Statement: Article 112 of Constitution • Also called: Union Budget • Presented by: Finance Minister in Lok Sabha • Timing: 1st February (since 2017) • Earlier: Last working day of February • Components: Revenue Budget + Capital Budget • Must be passed by: Both Houses (Lok Sabha can override Rajya Sabha) • Money Bills: Article 110

• Revenue Deficit = Revenue Expenditure – Revenue Receipts • Indicates: Government borrowing for consumption (not asset creation) • Considered undesirable: Borrowing for day-to-day expenses • Revenue Expenditure: Salaries, subsidies, interest payments, pensions • Revenue Receipts: Tax revenue + Non-tax revenue • RD shows dissaving by government

• Appropriation Bill: Authorizes government to withdraw money from Consolidated Fund • Introduced: After Demands for Grants are voted • Money Bill: Article 110 • Cannot be amended or rejected by Rajya Sabha • Becomes Appropriation Act after President’s assent • Without this: Government cannot spend any money • Voting on Demands: Lok Sabha only (can reduce, not increase)

• Crowding Out Effect: High govt borrowing → Higher interest rates → Reduced private investment • Mechanism: Govt competes with private sector for limited loanable funds • Result: Private investment gets ‘crowded out’ • Relevance: During high fiscal deficit periods • Counter-argument: ‘Crowding In’ during recession (govt spending stimulates private investment) • FRBM aims to reduce this by limiting fiscal deficit

• India’s Tax-to-GDP ratio: ~11-12% (GTR to GDP) • Net Tax-to-GDP (Centre): ~8-9% • Comparison: OECD average ~34%, Emerging economies ~20-25% • Reasons for low ratio: Large informal sector, agriculture exemption, tax evasion, narrow base • Improvement needed for: Higher public spending, fiscal space • GST aimed to improve tax-to-GDP ratio through formalization

• Three mandatory statements under FRBM Act: 1. Macroeconomic Framework Statement 2. Medium-Term Fiscal Policy Statement 3. Fiscal Policy Strategy Statement • Added via 2012 Amendment: Medium-Term Expenditure Framework Statement • These ensure transparency and accountability • Project fiscal indicators for medium-term (3 years)

• GST Registration threshold (general): – Goods suppliers: ₹40 lakh (₹20 lakh in special category states) – Service providers: ₹20 lakh (₹10 lakh in special category states) • Special category states: NE states, J&K, Himachal, Uttarakhand • Composition scheme: ₹1.5 crore threshold • Mandatory registration: Inter-state suppliers, e-commerce operators, casual taxable persons • Below threshold: Optional registration available

• WMA: Short-term credit facility by RBI to governments • Recipients: Central Government and State Governments • Purpose: Bridge temporary mismatches in receipts and payments • Duration: Maximum 90 consecutive days • Interest rate: Repo rate • If WMA exceeded: Overdraft facility (higher interest) • Limit: Fixed by RBI in consultation with government • Not a source of financing fiscal deficit

• GST Council: Article 279A of Constitution • Composition: Union FM (Chairperson) + Union MoS Revenue + Finance Ministers of all States/UTs • Voting: Centre has 1/3rd weightage + States have 2/3rd weightage • Quorum: Half of total members • Decision: 3/4th majority of weighted votes • Recommendations on: GST rates, exemptions, threshold, model laws

• Outcome Budget: First presented in 2005-06 • Purpose: Link outlays (spending) with outcomes (results) • Focus: Shift from input-based to output-based budgeting • Components: Physical targets, financial outlays, achievements • Presented: Along with Annual Budget • Objective: Improve accountability and efficiency of public spending • Shows: What each rupee spent achieves • Part of: Public Financial Management reforms

• Zero-Based Budgeting: Every expenditure must be justified from zero each year • No automatic continuation: Previous year’s allocation not taken as base • Each program evaluated: Cost-benefit analysis required • Introduced in India: 1987-88 • Advantages: Eliminates wasteful spending, promotes efficiency • Challenges: Time-consuming, requires detailed analysis • Contrast: Traditional/Incremental budgeting (previous year + increment)

• Debt target: ~50% ± 1% of GDP • Target year: 2030-31 (March 2031) • Current level (2025-26): ~56% of GDP • Path: Gradual reduction through fiscal consolidation • Announced in: Budget 2025-26 (detailed FRBM statement) • Method: Keep fiscal deficit on declining path • NK Singh Committee: Recommended 40% for Centre, 20% for States • Total general government: 60% target

• GST Constitutional Amendment: 101st Amendment Act 2016 • Passed: 8th September 2016 • Key provisions: – Article 246A: Concurrent power to levy GST – Article 269A: GST on inter-state supply – Article 279A: GST Council – Schedule VII modified: Entries reallocated • Compensation to states: 5 years (ended June 2022) • One Nation One Tax principle

• Finance Commission: Article 280 of Constitution • Constituted by: President of India • Tenure: Every 5 years (or earlier as required) • First FC: 1951 (Chairman: K.C. Neogy) • Current: 16th FC (Chairman: Dr. Arvind Panagariya) • Recommends: Tax devolution, grants-in-aid, measures for augmenting Consolidated Fund • Quasi-judicial body for Centre-State fiscal relations

• Escape clause: Introduced via 2018 Amendment • Maximum deviation allowed: 0.5% of GDP (50 basis points) • Conditions for invoking escape clause: – National security/war – Natural calamity – Collapse of agriculture – Structural reforms in economy • When invoked: RBI can participate in primary auction of G-Secs (deficit financing formalized)

• FRBM Act enacted: 26th August 2003 • Rules notified and came into force: 5th July 2004 • Gap between enactment and implementation: Nearly 1 year • FRBM Rules specify operational details • Four fiscal indicators mandated: Revenue deficit, Fiscal deficit, Tax revenue, Outstanding liabilities (all as % of GDP)

• Indirect Taxes: Tax burden can be shifted to consumer – GST (Central + State) – Customs Duty – Excise on petroleum products • Pre-GST indirect taxes subsumed: Central Excise, Service Tax, VAT, Octroi, Entry Tax • Administered by: CBIC (Central Board of Indirect Taxes and Customs) • Regressive in nature: Same rate for all income levels • Share in GTR 2025-26: ~45%

• Capital Expenditure BE 2025-26: ₹11.21 lakh crore • As % of GDP: 3.1% • RE 2024-25: ₹10.18 lakh crore • Includes: Roads, railways, defence equipment, infrastructure • Interest-free loans to states for capex: ₹1.5 lakh crore • Asset Monetization Plan 2025-30: ₹10 lakh crore target • Focus: Infrastructure-led growth

• GST Council voting structure: – Central Government: 1/3rd (33.33%) weightage – State Governments collectively: 2/3rd (66.67%) weightage • Decision requires: 3/4th (75%) majority of weighted votes • Implication: Neither Centre alone nor few large states can block decisions • Consensus-based federal body • Ensures cooperative federalism in indirect taxation

• NK Singh Committee: Set up in May 2016 • Report submitted: January 2017 • Key recommendation on debt: General govt debt ≤60% of GDP • Breakup: Centre’s debt ≤40% of GDP + States’ debt ≤20% of GDP • Fiscal deficit target: 3% by 2020 reducing to 2.5% by 2023 • Revenue deficit target: 0.8% of GDP by 2023 • Proposed: Creation of autonomous Fiscal Council

• Interest Payments BE 2025-26: ₹12.76 lakh crore • Share in total expenditure: ~25% (largest single item) • Share in revenue receipts: ~37% • Second largest: Subsidies, Defence, Transfers to States • Interest burden high due to accumulated debt • Debt servicing leaves less for development spending • This is why fiscal consolidation is important

• Effective Revenue Deficit = Revenue Deficit – Grants for Creation of Capital Assets • Introduced via: FRBM Amendment 2012 • Rationale: Some revenue expenditure creates capital assets (grants to states for infrastructure) • ERD provides truer picture of revenue deficit • BE 2025-26: ERD at 0.3% of GDP (significantly lower than RD of 1.5%) • Shows quality of expenditure improving

• Direct Taxes: Tax burden cannot be shifted – Income Tax (on individuals) – Corporation Tax (on companies) – Capital Gains Tax – Securities Transaction Tax – Wealth Tax (abolished 2015) • Administered by: CBDT (Central Board of Direct Taxes) • Progressive in nature: Higher income → Higher tax rate • Share in GTR 2025-26: ~55%

• GST rate slabs: 0%, 5%, 12%, 18%, 28% • 0%: Essential items (fresh vegetables, milk, cereals, etc.) • 5%: Mass consumption items (packaged food, transport, etc.) • 12%: Processed food, computers, etc. • 18%: Standard rate (most services, electronics) • 28%: Luxury/demerit goods (cars, tobacco, aerated drinks) • Compensation Cess: On luxury/demerit goods (above 28%)

• 15th FC recommendation: 41% of divisible pool to states • 14th FC had recommended: 42% • Reduction of 1%: Due to creation of new UTs (J&K and Ladakh) • Divisible pool: Central taxes after deducting cess and surcharges • Criteria for horizontal devolution: Population, area, forest cover, income distance, demographic performance, tax effort • FC grants: Revenue deficit, local bodies, disaster management, sector-specific

• Automatic Stabilizers: Built-in mechanisms that stabilize economy without explicit policy action • Examples: – Progressive income tax (revenue falls automatically in recession) – Unemployment insurance (spending rises automatically in recession) – Welfare programs • During recession: Tax collections fall + welfare spending rises → Automatic stimulus • During boom: Tax collections rise + welfare spending falls → Automatic restraint • No legislative action required

• Net Tax Revenue BE 2025-26: ₹28.37 lakh crore • Growth over RE 2024-25: ~11% • Gross Tax Revenue: ₹38.40 lakh crore • Devolution to States: Deducted from GTR to arrive at Net Tax Revenue • Share of Direct Taxes: ~55% of GTR • Share of Indirect Taxes: ~45% of GTR • Major taxes: Income Tax, Corporation Tax, GST, Customs