"In addition to deficit reduction, what else can fiscal policy do in order to combat inflation? The second powerful tool available is to have a low tax/GDP ratio and a correspondingly low expenditure/GDP ratio. Shrinking government is deflationary.
The logic here works as follows. Suppose there is a government which has both taxes and expenditure set at 10% of GDP. A bigger or smaller deficit is not under discussion—we only think about a balanced budget. In this, suppose a decision is taken to raise taxes and expenditure by 1% of GDP. Here, 1% of GDP comes out of the pockets of households, and goes to government, which spends it all.
This expands aggregate demand, because if that last 1% of GDP had been left with households, they would have saved roughly one quarter of it. If that last 1% had been left in the pockets of households, a spending of roughly 0.75% of GDP would be spent. But if this last 1% of GDP goes into the hands of government, then the full 1% of it gets spent."
Suman Bery, Director-general, NCAER;
"Since one of the ongoing parlour games in Delhi over the past few months has been the tug-of-war between the finance ministry and the Planning Commission, it is interesting to keep score on how all that seems to be coming out. On the issue of gross budgetary support (GBS) to the Plan the Budget speech conceded a range of alternatives designed to accommodate the demands of the Planning Commission without appearing to give in; the larger tussle on the FRBMA lies ahead. The scheme to tap reserves for infrastructure has once again resurfaced, this time with the apparent endorsement of the finance ministry. One can only shake one’s head sadly about a policy framework which first has the Central Bank buy reserves, then has government pay the cost of sterilisation, then have government offer a guarantee to the private sector to borrow the same funds! There is an easier way, and it is called a flexible exchange rate with inflation targeting. But that would be too simple for the subtle Indian mind.
I started though by talking of some sins of commission. The itch to use tax policy to achieve micro goals, evident in the relief to small cars last time, was evident once again in the cute (and unwise) scheme to curb cement prices through tax rather than competition policy. The continuation of the interest rate subsidy on agricultural credit also flies in the face of what we know about credit rationing in rural credit. Similarly, the increase in the education cess smacked of lazy tax policy. Overall, this was a budget devoid of new ideas and initiatives. Just holding the line seems to have been taxing enough."
The Economist coverage;
"Responding to the domestic pressures, Mr Chidambaram produced a budget whose central theme was curbing price rises. It also gave a much-needed boost to spending on agriculture, education and health care. The stockmarket's first reaction was gloomy, made worse by plummeting markets around the world, and businessmen found little to cheer about. But, while defending the pursuit of growth, Mr Chidambaram was aiming at different targets—for economic and social as well as political reasons. He increased funds for education by 34%, while money for health and family welfare went up by 22%. By comparison, spending on defence will go up just 7.8%.
He devoted a big chunk—some 15 minutes—of his speech to agriculture, which is growing by only 2.7% a year, compared with a government target of 4%. That is a disappointment at a time when, according to the government's annual Economic Survey, published on February 27th, manufacturing and services are growing by over 11%, and merchandise exports by 36%."
More coverage at Ajay Shah’s blog
Related;
Ask not what budget can do for reforms, ask what we can do to reform way we look at it
Budget 2007: The Moment Of Truth
Podcasts
SUCH A LONG JOURNEY: India's Opening of its Capital Account by Suman Berry
India as an Emerging Economic Power: Potential and Constraints - Professor B.B. Bhattacharya
Reflections on India's Economic Development - Y.V. Reddy, Governor, Reserve Bank of India
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