Module 66. Public Finance, Fiscal Policy and Taxation in India

Public finance, fiscal policy, and taxation form the cornerstone of a country’s economic governance. In India, these elements are intricately linked to the government’s efforts to achieve inclusive growth, maintain fiscal stability, and ensure equitable distribution of resources. Public finance deals with the income and expenditure of the government, fiscal policy refers to the use of taxation and public spending to influence economic activity, and taxation serves as the principal means of resource mobilisation. Together, they constitute the framework through which the Indian state manages its economic and developmental responsibilities.

Nature and Scope of Public Finance

Public finance encompasses the study of how governments raise revenue, allocate resources, and manage public expenditure. It includes the financial activities of the Union, State, and local governments. The primary objectives of public finance are:

• Allocation of resources for public goods and services such as education, defence, health, and infrastructure.
• Distribution of income and wealth through fiscal measures aimed at social equity.
• Stabilisation of the economy by addressing inflation, unemployment, and economic fluctuations.

In India, public finance operates within a federal framework, meaning financial powers are shared between the Centre and the States as per the Constitution. The Seventh Schedule of the Constitution divides subjects into Union, State, and Concurrent Lists, determining the areas in which each level of government can levy taxes and incur expenditure.
The management of public finance is guided by constitutional and institutional mechanisms such as the Finance Commission, the Comptroller and Auditor General (CAG), and the NITI Aayog. These institutions ensure fiscal discipline, equitable resource distribution, and efficient utilisation of public funds.

Fiscal Policy: Concept and Objectives

Fiscal policy refers to the government’s use of taxation, public expenditure, borrowing, and fiscal incentives to achieve macroeconomic objectives. It is a crucial tool for promoting growth, controlling inflation, generating employment, and ensuring price stability.
The main objectives of India’s fiscal policy include:

1. Economic Growth – Promoting capital formation and infrastructure development.
2. Price Stability – Controlling inflation through calibrated spending and taxation measures.
3. Employment Generation – Encouraging labour-intensive industries and public works programmes.
4. Equitable Distribution – Reducing income inequalities through progressive taxation and welfare spending.
5. Fiscal Consolidation – Ensuring sustainable debt levels and reducing fiscal deficits.

Fiscal policy in India is framed and implemented through the Union Budget, which presents the government’s annual estimates of revenue and expenditure. It is also influenced by the Fiscal Responsibility and Budget Management (FRBM) Act, 2003, which seeks to institutionalise fiscal discipline and reduce revenue and fiscal deficits to prudent levels.

Structure of Public Expenditure and Revenue

Public expenditure in India can be classified into revenue expenditure (recurring spending such as salaries, subsidies, and interest payments) and capital expenditure (investment in infrastructure and asset creation). The major heads of public spending include defence, education, health, agriculture, rural development, and infrastructure.
On the revenue side, the government’s income is categorised into:

• Tax Revenue – Revenue collected from direct and indirect taxes.
• Non-Tax Revenue – Income from dividends, interest receipts, fees, fines, and public sector undertakings.

Public borrowing and disinvestment are other important sources of financing government expenditure, especially in times of fiscal deficits.

Taxation System in India

Taxation forms the backbone of public finance and is the government’s primary tool for raising revenue. India’s taxation system comprises both direct taxes and indirect taxes.
1. Direct Taxes: These are taxes levied directly on individuals and corporations, reflecting their income or profits. The main forms of direct taxes include:

• Income Tax – Levied on individual and corporate income.
• Corporate Tax – Charged on the profits of companies.
• Capital Gains Tax – Applicable on gains from the sale of assets like property or shares.
• Wealth and Gift Taxes – Though largely abolished, they occasionally resurface in discussions on wealth inequality.

2. Indirect Taxes: These are levied on goods and services, collected from intermediaries but ultimately borne by consumers. The most significant reform in India’s indirect tax regime was the introduction of the Goods and Services Tax (GST) in 2017, which subsumed multiple central and state taxes such as excise duty, VAT, and service tax into a unified tax structure.
GST is levied under four main slabs—5%, 12%, 18%, and 28%—depending on the nature of goods or services. It is governed by the GST Council, a constitutional body chaired by the Union Finance Minister, ensuring cooperative fiscal federalism.

Fiscal Federalism and Resource Sharing

India’s federal structure necessitates a systematic sharing of financial resources between the Centre and the States. This is achieved through vertical devolution (distribution of central taxes between the Union and States) and horizontal devolution (distribution among states based on criteria such as population, income distance, and area).
The Finance Commission, constituted every five years under Article 280 of the Constitution, plays a pivotal role in recommending the formula for tax devolution and grants-in-aid. The 15th Finance Commission (2021–26), for instance, recommended that 41% of the divisible tax pool be shared with the States.

Deficits and Public Debt

Fiscal management in India is evaluated through various deficit indicators:

• Revenue Deficit – The excess of revenue expenditure over revenue receipts.
• Fiscal Deficit – The gap between total expenditure and total revenue excluding borrowings.
• Primary Deficit – Fiscal deficit minus interest payments.

Persistent high deficits can lead to increased public debt and inflationary pressures. Hence, the government undertakes fiscal consolidation measures, such as expenditure rationalisation and enhanced tax compliance, to ensure macroeconomic stability.

Role of Public Finance in Economic Development

Public finance plays a transformative role in achieving India’s socio-economic objectives:

• Infrastructure Development – Public investment in roads, railways, energy, and communication promotes industrial growth and employment.
• Poverty Alleviation and Welfare – Fiscal transfers finance programmes like MGNREGA, PM-KISAN, and National Rural Health Mission.
• Balanced Regional Growth – Fiscal instruments support backward states through grants and centrally sponsored schemes.
• Environmental Sustainability – Budgetary policies increasingly emphasise green finance, renewable energy, and carbon taxation.

Contemporary Fiscal Issues and Reforms

India’s fiscal system continues to evolve in response to changing economic realities. Key contemporary issues include:

• Fiscal Deficit Management – Balancing growth needs with fiscal prudence remains a challenge.
• Tax Base Expansion – Efforts to increase compliance through digitalisation and simplification of procedures.
• Public Sector Efficiency – Rationalising subsidies and improving public expenditure outcomes.
• State Finances – Managing state-level deficits, especially in the wake of increased welfare spending and loan waivers.
• Tax Reforms – Proposals for rationalising GST slabs, improving direct tax code efficiency, and enhancing fiscal transparency.

Recent innovations such as the Direct Benefit Transfer (DBT) mechanism and digital tax platforms like GSTN have improved efficiency, reduced leakages, and promoted transparency.