INTRODUCTION
Is government involvement vital for economic growth? This question has surprisingly dominated both theoretical and empirical debate among economists for a long time. The traditional answer from economic theory to the more general question of whether fiscal policy can affect growth is that it can affect the short run growth of per-capital income. However, since mid 1980s, new endogenous growth models have proposed a number of channels through which fiscal policy could have permanent growth effects. The empirical evidence suggests that fiscal policy affects economic growth differently across the countries .So its effects need to be analysed carefully.
Ø GROWTH EFFECTS OF TAXES EXPENDITURE
Theoretically, most economists have agreed that public expenditures that are productive have positive impact on economic growth. Whereas unproductive public spending crowds-out productive private or public investment and hence negative impact on long run growth. On the other hand, the taxes which are distortionary (e.g. income Tax) affects decision to invest and have negative impact on growth. While, non-distortionary taxes (e.g. lump-sum taxes) may affect economic growth positively. Also even, where all government expenditure is productive the use of distortionary taxes to finance this generates negative growth effects.
Ø BUDGET DEFICIT AND GROWTH
Whether budget deficits affect growth, depend on whether Ricardian equivalence (RE) holds. If RE holds, deficits are analogous to lump-sum taxes and there are no long-run growth effects. However, where RE does not hold budget deficits are generally expected to be growth retarding ceteries paribus. However, in most cases, there is negative correlation between budget deficit and growth.
However, theoretically, these seem to sound well but empirically taxes and expenditure have proved inconsistency and incompatibility with the theoretical findings.
RELEVANCE OF FISCAL-GROWTH MODELS AND EMPIRICAL EVIDENCE TO LDCS, OECD COUNTRIES IN GENERAL AND INDIA IN PARTICULAR
Ø THE CASE FOR OECD COUNTRIES AND LDCS
The empirical fiscal-growth literature is of highly variable quality and has generally yielded non-robust result. However, to some extent, evidence that is comparatively more consistent is found to OECD countries and the theory has some relevance here. Nevertheless, prior to 1997 when gross budgetary constraint (GBC) was not used the result proved to be methodologically weak rendering results unreliable and non-robust.
There is very little reliable evidence available for LDCs. Evidence from LDCS/LICS suggest that fiscal growth effects has been observed to be much different from OECDS. However, one of the reasons of inconsistent results with LDCs is poor quality of data and hence unreliability of their data source. Besides regression specification of many studies are inadequate because of their failure to deal adequately with GBC.
Comparatively almost all of the methodologically more reliable evidence comes from OECD countries. Spending on health, education and defence has been found to raise growth across OECD countries. However, it is associated with lower growth in LDCs. Equally controversially income taxes appear but raise it in LDCs.
Whether OECD or LDCS empirical evidence on the impact of budget deficits have often revealed significantly negative growth effects (positive effects of surpluses)
Despite the methodological weakness, one of the more robust pieces of evidence from fiscal-growth regression is the negative association between growth and budget deficits, which is also supported by the third generation studies which incorporates GBCS.
Ø THE CASE FOR INDIA
India is a lower middle-income country, whose per capita income is $1024 per annum registering one of the highest growth rates in the world for the last seven consecutive years on an average. Over the years there have been many factors contributing to high or low economic growth scenario in India. In this context, fiscal variables are considered to be of prime significance. However, empirical evidence partially confirms it and contradicts the argument. India’s high growth has been associated with private sector led growth and government role has been of facilitator where it lacked growth rate decelerated. As it is evident, that domestic saving, particularly private saving has been the prime growth determinant.
Right from the beginning , during 1950-80, public spending was moderate, tax rates were very high, fiscal deficit was low, also efficiency and productivity were low, besides saving rate was only 10% in 1950’s, overall govt budgets were always in crisis finally, causing moderate or low growth rate of 3.5% over the period of time. When Indira Gandhi adopted ‘Garibi Hatao’ it did not work well and after the emergency was over, she focused much on growth, for this purpose adopted pro-business strategy, which was a grand success, and paved the path for growth momentum in India.
1980s saw the huge surge of public spending hence investment to GDP ratio improved, taxes were cut particularly in the second half of 1980s, comparatively productivity and public sector saving also improved and infrastructure was given special attention which witnessed crowding-in of private investment, causing the growth rate of GDP to surge to 5.5%.
On the other hand, close to 1980s fiscal deficit was mounting around 10% (One of the highest in the world) as monetisation of fiscal deficit had resulted in huge interest payment and ultimately public debt. In addition, there was high fiscal imbalance in such cases growth would have been unsustainable if 1991 reform had not been carried out.
From 1991-98 public spending fell, taxes were further cut, fiscal deficit witnessed some improvement, and there was hike in growth rate to 6.7% during this period. During 1998-2003 public spending further fell, taxes were cut, infrastructure investment also fell. In addition, rising fiscal deficit in the second half of the 1990s was not financing higher level of investment resulting the fall of overall growth rate to 5.7%. During 2003-08, public expenditure grew continuously, tax rates declined moderately and there were some indirect taxes reforms. Public sector savings improved to 3.2% of GDP. Overall growth rate improved and was all time highest 9.5% in 2005-06. This also shows domestic saving led growth. Financial years 2008-10 saw further rise in public spending in forms of stimulus packages, this caused growth to sustain despite the crisis.
In addition, from the data used during 1980-2000, empirical evidence in most cases is statically insignificant. Few cases suggest positive, whereas few cases suggesting negative correlation between fiscal policy and economic growth. Though there is consistency between revenue deficit and growth and confirms negative relation between the two.
CONCLUDING OBSERVATIONS
The effects of fiscal policy on economic growth are a controversial and long- standing topic in economic theory, empirical research, and economic policy making as it is evident from above discussion. The third generation empirical study conducted for OECD countries, which incorporates GBC, shows to some extent theoretical relevance and empirical consistency but the result is ambiguous to LDCs. In the Indian context, the dynamics between government spending and private sector behaviour show that raising public sector consumption to boost aggregate demand in the economy crowds out private consumption. The alternative of raising public sector capital expenditure in manufacturing also crowds out private investment. This is only the public sector capital expenditure in infrastructure that crowds-in private investment, a result consistent with endogenous growth theory. However, in most cases (the result is ambiguous in some cases) fiscal deficit particularly revenue deficit has been associated with negative growth and crowding-out effect on private investment. On the tax front, Laffer’s curve hypothesis has not worked well in India. After 1991, tax to GDP ratio has been falling. The authorities have claimed that reduction in tax rates have resulted in better compliance and improved tax buoyancy – a claim that is not proven factually. Better buoyancy has come about because there has occurred a sharp rise in the number of persons earning high income.
The results, therefore, suggest the need for a restructuring of the composition of government expenditure while containing fiscal deficit for the beneficial effect of government's infrastructure investment to be realised and the urgent need for correcting fiscal imbalance, fiscal consolidation and improving tax to GDP ratio in view of sustaining long-term growth strategy through fiscal policy.
Therefore, at this stage it would be dangerous to conclude from any observed relationship that fiscal policy would necessarily enhance or hinder growth.
