Government Budgeting & Public Finance

Model Answer

Introduction

Public expenditure management (PEM) refers to the efficient use of government financial resources to achieve good governance, encompassing fiscal discipline, resource allocation, operational efficiency, and macroeconomic stability. Since the liberalization, privatization, and globalization (LPG) reforms of 1991, PEM has presented several challenges for the Government of India, particularly in the context of budget-making.

Challenges in Public Expenditure Management

1. Exposure to Global Economic Shocks

The integration of the Indian economy into the global market has made it vulnerable to external economic shocks, such as the 2008 global financial crisis, fluctuations in crude oil prices, and trade wars. These shocks significantly impact domestic budget estimates and economic stability.

2. Fiscal Policy Constraints

The government faces pressure to increase spending on infrastructure and welfare schemes while adhering to the Fiscal Responsibility and Budget Management (FRBM) Act, 2003, which mandates keeping the fiscal deficit within 3% of GDP. Balancing these demands is a considerable challenge.

3. Banking Sector Challenges

Post-liberalization, the government has had to recapitalize public sector banks, which struggle to operate profitably while ensuring financial inclusion. This creates a burden on public finances.

4. Privatization and Disinvestment Pressures

With the private sector’s capabilities expanding, there is growing demand for the privatization of inefficient public sector enterprises (PSEs). The government must navigate this transition while maintaining public service delivery.

5. Narrow Tax Base

Despite rising incomes, the income tax base has not expanded proportionately, limiting the government’s ability to increase social spending. The growing subsidy burden exacerbates this issue, diverting funds from capital investments.

6. Inadequate Institutional Capacity

Many government schemes suffer from poor implementation, leading to underutilization of allocated budgets. This inefficiency results in cost overruns and ineffective resource allocation.

Conclusion

The post-liberalization period has seen increased per capita income and government expenditure; however, the tax-to-GDP ratio has not improved correspondingly. This disparity has rendered public expenditure management a significant challenge for the Indian government. The Bimal Jalan Committee has recommended rationalizing subsidies and sticking to a disciplined fiscal path to unlock the growth potential of the Indian economy. Effective PEM is crucial for sustainable economic development and governance.

Model Answer

The Union Budget 2018-19 introduced notable changes to the taxation of capital gains and dividends, significantly impacting investors and the stock market.

Reintroduction of LTCG Tax

• The government reinstated a 10% Long-term Capital Gains (LTCG) tax on profits exceeding ₹1 lakh from the sale of listed equity shares. This move aimed to broaden the tax base and ensure fairness, as the previous tax exemption created disparities between equities and other asset classes.

Introduction of DDT on Mutual Funds

• The budget also introduced a 10% tax on dividends distributed by equity-oriented mutual funds. This aimed to close loopholes that allowed tax-free income distribution and prevent tax evasion, particularly in dividend stripping practices.

Advantages of These Changes

• • Broadened Tax Base: The government’s revenue potential increased by taxing equity gains and dividends, facilitating investments in infrastructure and development.
  • Market Stability: LTCG encouraged long-term investments, reducing speculative trading and promoting market stability.
  • Prevention of Tax Evasion: The DDT closed a loophole in mutual fund dividends, ensuring all dividend income is taxed, contributing to better compliance.
  • Global Alignment: These reforms harmonized India’s tax regime with international standards, attracting foreign investments.
    Source: Post-Budget Market Analyses 2018.

Disadvantages of These Changes

• • Investor Sentiment: The stock market initially reacted negatively to these tax changes, with middle-class investors feeling the impact of reduced post-tax returns.
  • Complex Compliance: Investors faced increased complexity in tax filings, leading to greater reliance on financial advisors.
  • Impact on Dividend Policies: Companies began retaining profits rather than distributing them, impacting shareholders’ income.
    Source: Financial Market Reports, 2018.

Conclusion

In conclusion, while the 2018-19 budget changes promoted equity and a broader tax base, they also led to market adjustments and increased compliance burdens. Policymakers must balance these effects to ensure sustainable financial growth.