NCERT Textbook: Government Budget & the Economy | Indian Economy for UPSC CSE PDF Download

 Page 1


Chapter 5
Chapter 5
Governmen Governmen Governmen Governmen Government t t t t Budget Budget Budget Budget Budget
and the Economy and the Economy and the Economy and the Economy and the Economy
We introduced the government in chapter one as denoting
the state. We stated that apart from the private sector,
there is the government which plays a very important role.
An economy in which there is both the private sector and
the Government is known as a mixed economy.  There are
many ways in which the government influences economic
life.  In this chapter, we will limit ourselves to the functions
which are carried on through the government budget.
This chapter proceeds as follows. In section 5.1 we
present the components of the government budget to bring
out the sources of government revenue and avenues of
government spending. In section 5.2 we discuss the topic of
balanced, surplus or deficit budget to account for the
difference between expenditures and revenue collection.  It
specifically deals with the meaning of different kinds of
budget deficits, their implications and the measures to
contain them. Box. 5.1 deals with fiscal policy and a simple
description of the multiplier. The role the government plays
has implications for its deficits which further affect its debt-
what the government owes. The chapter concludes with an
analysis of the debt issue.
5.1 GOVERNMENT BUDGET — MEANING AND ITS COMPONENTS
There is a constitutional requirement in India (Article 112) to
present before the Parliament a statement of estimated receipts
and expenditures of the government in respect of every financial
year which runs from 1 April to 31 March. This ‘Annual Financial
Statement’ constitutes the main budget document of the
government.
Although the budget document relates to the receipts
and expenditure of the government for a particular financial
year, the impact of it will be there in subsequent years.
There is a need therefore to have two accounts- those that
relate to the current financial year only are included in the
revenue account (also called revenue budget) and those that
concern the assets and liabilities of the government into
the capital account (also called capital budget). In order to
understand the accounts, it is important to first understand
the objectives of the government budget.
Reprint 2024-25
Page 2


Chapter 5
Chapter 5
Governmen Governmen Governmen Governmen Government t t t t Budget Budget Budget Budget Budget
and the Economy and the Economy and the Economy and the Economy and the Economy
We introduced the government in chapter one as denoting
the state. We stated that apart from the private sector,
there is the government which plays a very important role.
An economy in which there is both the private sector and
the Government is known as a mixed economy.  There are
many ways in which the government influences economic
life.  In this chapter, we will limit ourselves to the functions
which are carried on through the government budget.
This chapter proceeds as follows. In section 5.1 we
present the components of the government budget to bring
out the sources of government revenue and avenues of
government spending. In section 5.2 we discuss the topic of
balanced, surplus or deficit budget to account for the
difference between expenditures and revenue collection.  It
specifically deals with the meaning of different kinds of
budget deficits, their implications and the measures to
contain them. Box. 5.1 deals with fiscal policy and a simple
description of the multiplier. The role the government plays
has implications for its deficits which further affect its debt-
what the government owes. The chapter concludes with an
analysis of the debt issue.
5.1 GOVERNMENT BUDGET — MEANING AND ITS COMPONENTS
There is a constitutional requirement in India (Article 112) to
present before the Parliament a statement of estimated receipts
and expenditures of the government in respect of every financial
year which runs from 1 April to 31 March. This ‘Annual Financial
Statement’ constitutes the main budget document of the
government.
Although the budget document relates to the receipts
and expenditure of the government for a particular financial
year, the impact of it will be there in subsequent years.
There is a need therefore to have two accounts- those that
relate to the current financial year only are included in the
revenue account (also called revenue budget) and those that
concern the assets and liabilities of the government into
the capital account (also called capital budget). In order to
understand the accounts, it is important to first understand
the objectives of the government budget.
Reprint 2024-25
5.1.1 Objectives of Government Budget
The government plays a very important role in increasing the welfare of
the people. In order to do that the government intervenes in the economy
in the following ways.
Allocation Function of Government Budget
Government provides certain goods and services which cannot be provided
by the market mechanism i.e. by exchange between individual consumers
and producers. Examples of such goods are national defence, roads,
government administration etc. which are referred to as public goods.
To understand why public goods need to be provided by the
government, we must understand the difference between private goods
such as clothes, cars, food items etc. and public goods. There are two
major differences. One, the benefits of public goods are available to all
and are not only restricted to one particular consumer. For example, if
a person eats a chocolate or wears a shirt, these will not be available to
others. It is said that this person’s consumption stands in rival
relationship to the consumption of others. However, if we consider a
public park or measures to reduce air pollution, the benefits will be
available to all. One person’s consumption of a good does not reduce the
amount available for consumption for others and so several people can
enjoy the benefits, that is, the consumption of many people is not
‘rivalrous’.
Two, in case of private goods anyone who does not pay for the goods
can be excluded from enjoying its benefits. If you do not buy a ticket,
you will not be allowed to watch a movie at a local cinema hall. However,
in case of public goods, there is no feasible way of excluding anyone
from enjoying the benefits of the good. That is why public goods are
called non-excludable.   Even if some users do not pay, it is difficult and
sometimes impossible to collect fees for the public good. These non-
paying users are known as ‘free-riders’. Consumers will not voluntarily
pay for what they can get for free and for which there is no exclusive
title to the property being enjoyed. The link between the producer and
consumer which occurs through the payment process is broken and the
government must step in to provide for such goods.
There is, however, a difference between public provision and public
production. Public provision means that they are financed through the
budget and can be used without any direct payment. Public goods may
be produced by the government or the private sector. When goods are
produced directly by the government it is called public production.
Redistribution Function of Government Budget
From chapter two we know that the total national income of the country
goes to either the private sector, that is, firms and households (known
as private income) or the government (known as public income). Out of
private income, what finally reaches the households is known as personal
income and the amount that can be spent is the personal disposable
income. The government sector affects the personal disposable income
of households by making transfers and collecting taxes. It is through
this that the government can change the distribution of income and
bring about a distribution that is considered ‘fair’ by society. This is the
redistribution function.
67 67 67 67 67
Government Budget
and the Economy
Reprint 2024-25
Page 3


Chapter 5
Chapter 5
Governmen Governmen Governmen Governmen Government t t t t Budget Budget Budget Budget Budget
and the Economy and the Economy and the Economy and the Economy and the Economy
We introduced the government in chapter one as denoting
the state. We stated that apart from the private sector,
there is the government which plays a very important role.
An economy in which there is both the private sector and
the Government is known as a mixed economy.  There are
many ways in which the government influences economic
life.  In this chapter, we will limit ourselves to the functions
which are carried on through the government budget.
This chapter proceeds as follows. In section 5.1 we
present the components of the government budget to bring
out the sources of government revenue and avenues of
government spending. In section 5.2 we discuss the topic of
balanced, surplus or deficit budget to account for the
difference between expenditures and revenue collection.  It
specifically deals with the meaning of different kinds of
budget deficits, their implications and the measures to
contain them. Box. 5.1 deals with fiscal policy and a simple
description of the multiplier. The role the government plays
has implications for its deficits which further affect its debt-
what the government owes. The chapter concludes with an
analysis of the debt issue.
5.1 GOVERNMENT BUDGET — MEANING AND ITS COMPONENTS
There is a constitutional requirement in India (Article 112) to
present before the Parliament a statement of estimated receipts
and expenditures of the government in respect of every financial
year which runs from 1 April to 31 March. This ‘Annual Financial
Statement’ constitutes the main budget document of the
government.
Although the budget document relates to the receipts
and expenditure of the government for a particular financial
year, the impact of it will be there in subsequent years.
There is a need therefore to have two accounts- those that
relate to the current financial year only are included in the
revenue account (also called revenue budget) and those that
concern the assets and liabilities of the government into
the capital account (also called capital budget). In order to
understand the accounts, it is important to first understand
the objectives of the government budget.
Reprint 2024-25
5.1.1 Objectives of Government Budget
The government plays a very important role in increasing the welfare of
the people. In order to do that the government intervenes in the economy
in the following ways.
Allocation Function of Government Budget
Government provides certain goods and services which cannot be provided
by the market mechanism i.e. by exchange between individual consumers
and producers. Examples of such goods are national defence, roads,
government administration etc. which are referred to as public goods.
To understand why public goods need to be provided by the
government, we must understand the difference between private goods
such as clothes, cars, food items etc. and public goods. There are two
major differences. One, the benefits of public goods are available to all
and are not only restricted to one particular consumer. For example, if
a person eats a chocolate or wears a shirt, these will not be available to
others. It is said that this person’s consumption stands in rival
relationship to the consumption of others. However, if we consider a
public park or measures to reduce air pollution, the benefits will be
available to all. One person’s consumption of a good does not reduce the
amount available for consumption for others and so several people can
enjoy the benefits, that is, the consumption of many people is not
‘rivalrous’.
Two, in case of private goods anyone who does not pay for the goods
can be excluded from enjoying its benefits. If you do not buy a ticket,
you will not be allowed to watch a movie at a local cinema hall. However,
in case of public goods, there is no feasible way of excluding anyone
from enjoying the benefits of the good. That is why public goods are
called non-excludable.   Even if some users do not pay, it is difficult and
sometimes impossible to collect fees for the public good. These non-
paying users are known as ‘free-riders’. Consumers will not voluntarily
pay for what they can get for free and for which there is no exclusive
title to the property being enjoyed. The link between the producer and
consumer which occurs through the payment process is broken and the
government must step in to provide for such goods.
There is, however, a difference between public provision and public
production. Public provision means that they are financed through the
budget and can be used without any direct payment. Public goods may
be produced by the government or the private sector. When goods are
produced directly by the government it is called public production.
Redistribution Function of Government Budget
From chapter two we know that the total national income of the country
goes to either the private sector, that is, firms and households (known
as private income) or the government (known as public income). Out of
private income, what finally reaches the households is known as personal
income and the amount that can be spent is the personal disposable
income. The government sector affects the personal disposable income
of households by making transfers and collecting taxes. It is through
this that the government can change the distribution of income and
bring about a distribution that is considered ‘fair’ by society. This is the
redistribution function.
67 67 67 67 67
Government Budget
and the Economy
Reprint 2024-25
68 68 68 68 68
Introductory Macroeconomics
Stabilisation Function of Government Budget
The government may need to correct fluctuations in income and employment.
The overall level of employment and prices in the economy depends upon the
level of aggregate demand which depends on the spending decisions of millions
of private economic agents apart from the government. These decisions, in turn,
depend on many factors such as income and credit availability. In any period,
the level of demand may not be sufficient for full utilisation of labour and other
resources of the economy. Since wages and prices do not fall below a level,
employment cannot be brought back to the earlier level automatically. The
government needs to intervene to raise the aggregate demand.
On the other hand, there may be times when demand exceeds available output
under conditions of high employment and thus may give rise to inflation. In
such situations, restrictive conditions may be needed to reduce demand.
The intervention of the government whether to expand demand or reduce it
constitutes the stabilisation function.
5.1.2 Classification of Receipts
Revenue Receipts: Revenue receipts are those receipts that do not lead to a
claim on the government. They are therefore termed non-redeemable. They are
divided into tax and non-tax revenues. Tax revenues, an important component
of revenue receipts, have for long been divided into direct taxes (personal income
tax) and firms (corporation tax), and indirect taxes like excise taxes (duties levied
on goods produced within the country), customs duties (taxes imposed on goods
imported into and exported out of India) and service tax
1
. Other direct taxes like
wealth tax, gift tax and estate duty (now abolished) have never brought in large
amount of revenue and thus have been referred to as ‘paper taxes’.
The redistribution objective is sought to be achieved through progressive
income taxation, in which higher the income, higher is the tax rate. Firms are
taxed on a proportional basis, where the tax rate is a particular proportion of
profits. With respect to excise taxes, necessities of life are exempted or taxed at
low rates, comforts and semi-luxuries are moderately taxed, and luxuries, tobacco
and petroleum products are taxed heavily.
Non-tax revenue of the central government mainly consists of interest receipts
on account of loans by the central government, dividends and profits on
investments made by the government, fees and other receipts for services rendered
by the government. Cash grants-in-aid from foreign countries and international
organisations are also included.
The estimates of revenue receipts take into account the effects of tax proposals
made in the Finance Bill
2
.
Capital Receipts:  The government also receives money by way of loans or
from the sale of its assets. Loans will have to be returned to the agencies from
which they have been borrowed. Thus they create liability. Sale of government
assets, like sale of shares in Public Sector Undertakings (PSUs) which is referred
1
The India Tax system witnessed a dramatic change with the introduction of the GST
(Goods and Services Tax) which encompasses both goods and services and was be implemented by
the Centre, 28 states and 7 Union territories from 1 July, 2017.
2
A Finance Bill, presented along with the Annual Financial Statement, provides details on the
imposition, abolition, remission, alteration or regulation of taxes proposed in the Budget.
Reprint 2024-25
Page 4


Chapter 5
Chapter 5
Governmen Governmen Governmen Governmen Government t t t t Budget Budget Budget Budget Budget
and the Economy and the Economy and the Economy and the Economy and the Economy
We introduced the government in chapter one as denoting
the state. We stated that apart from the private sector,
there is the government which plays a very important role.
An economy in which there is both the private sector and
the Government is known as a mixed economy.  There are
many ways in which the government influences economic
life.  In this chapter, we will limit ourselves to the functions
which are carried on through the government budget.
This chapter proceeds as follows. In section 5.1 we
present the components of the government budget to bring
out the sources of government revenue and avenues of
government spending. In section 5.2 we discuss the topic of
balanced, surplus or deficit budget to account for the
difference between expenditures and revenue collection.  It
specifically deals with the meaning of different kinds of
budget deficits, their implications and the measures to
contain them. Box. 5.1 deals with fiscal policy and a simple
description of the multiplier. The role the government plays
has implications for its deficits which further affect its debt-
what the government owes. The chapter concludes with an
analysis of the debt issue.
5.1 GOVERNMENT BUDGET — MEANING AND ITS COMPONENTS
There is a constitutional requirement in India (Article 112) to
present before the Parliament a statement of estimated receipts
and expenditures of the government in respect of every financial
year which runs from 1 April to 31 March. This ‘Annual Financial
Statement’ constitutes the main budget document of the
government.
Although the budget document relates to the receipts
and expenditure of the government for a particular financial
year, the impact of it will be there in subsequent years.
There is a need therefore to have two accounts- those that
relate to the current financial year only are included in the
revenue account (also called revenue budget) and those that
concern the assets and liabilities of the government into
the capital account (also called capital budget). In order to
understand the accounts, it is important to first understand
the objectives of the government budget.
Reprint 2024-25
5.1.1 Objectives of Government Budget
The government plays a very important role in increasing the welfare of
the people. In order to do that the government intervenes in the economy
in the following ways.
Allocation Function of Government Budget
Government provides certain goods and services which cannot be provided
by the market mechanism i.e. by exchange between individual consumers
and producers. Examples of such goods are national defence, roads,
government administration etc. which are referred to as public goods.
To understand why public goods need to be provided by the
government, we must understand the difference between private goods
such as clothes, cars, food items etc. and public goods. There are two
major differences. One, the benefits of public goods are available to all
and are not only restricted to one particular consumer. For example, if
a person eats a chocolate or wears a shirt, these will not be available to
others. It is said that this person’s consumption stands in rival
relationship to the consumption of others. However, if we consider a
public park or measures to reduce air pollution, the benefits will be
available to all. One person’s consumption of a good does not reduce the
amount available for consumption for others and so several people can
enjoy the benefits, that is, the consumption of many people is not
‘rivalrous’.
Two, in case of private goods anyone who does not pay for the goods
can be excluded from enjoying its benefits. If you do not buy a ticket,
you will not be allowed to watch a movie at a local cinema hall. However,
in case of public goods, there is no feasible way of excluding anyone
from enjoying the benefits of the good. That is why public goods are
called non-excludable.   Even if some users do not pay, it is difficult and
sometimes impossible to collect fees for the public good. These non-
paying users are known as ‘free-riders’. Consumers will not voluntarily
pay for what they can get for free and for which there is no exclusive
title to the property being enjoyed. The link between the producer and
consumer which occurs through the payment process is broken and the
government must step in to provide for such goods.
There is, however, a difference between public provision and public
production. Public provision means that they are financed through the
budget and can be used without any direct payment. Public goods may
be produced by the government or the private sector. When goods are
produced directly by the government it is called public production.
Redistribution Function of Government Budget
From chapter two we know that the total national income of the country
goes to either the private sector, that is, firms and households (known
as private income) or the government (known as public income). Out of
private income, what finally reaches the households is known as personal
income and the amount that can be spent is the personal disposable
income. The government sector affects the personal disposable income
of households by making transfers and collecting taxes. It is through
this that the government can change the distribution of income and
bring about a distribution that is considered ‘fair’ by society. This is the
redistribution function.
67 67 67 67 67
Government Budget
and the Economy
Reprint 2024-25
68 68 68 68 68
Introductory Macroeconomics
Stabilisation Function of Government Budget
The government may need to correct fluctuations in income and employment.
The overall level of employment and prices in the economy depends upon the
level of aggregate demand which depends on the spending decisions of millions
of private economic agents apart from the government. These decisions, in turn,
depend on many factors such as income and credit availability. In any period,
the level of demand may not be sufficient for full utilisation of labour and other
resources of the economy. Since wages and prices do not fall below a level,
employment cannot be brought back to the earlier level automatically. The
government needs to intervene to raise the aggregate demand.
On the other hand, there may be times when demand exceeds available output
under conditions of high employment and thus may give rise to inflation. In
such situations, restrictive conditions may be needed to reduce demand.
The intervention of the government whether to expand demand or reduce it
constitutes the stabilisation function.
5.1.2 Classification of Receipts
Revenue Receipts: Revenue receipts are those receipts that do not lead to a
claim on the government. They are therefore termed non-redeemable. They are
divided into tax and non-tax revenues. Tax revenues, an important component
of revenue receipts, have for long been divided into direct taxes (personal income
tax) and firms (corporation tax), and indirect taxes like excise taxes (duties levied
on goods produced within the country), customs duties (taxes imposed on goods
imported into and exported out of India) and service tax
1
. Other direct taxes like
wealth tax, gift tax and estate duty (now abolished) have never brought in large
amount of revenue and thus have been referred to as ‘paper taxes’.
The redistribution objective is sought to be achieved through progressive
income taxation, in which higher the income, higher is the tax rate. Firms are
taxed on a proportional basis, where the tax rate is a particular proportion of
profits. With respect to excise taxes, necessities of life are exempted or taxed at
low rates, comforts and semi-luxuries are moderately taxed, and luxuries, tobacco
and petroleum products are taxed heavily.
Non-tax revenue of the central government mainly consists of interest receipts
on account of loans by the central government, dividends and profits on
investments made by the government, fees and other receipts for services rendered
by the government. Cash grants-in-aid from foreign countries and international
organisations are also included.
The estimates of revenue receipts take into account the effects of tax proposals
made in the Finance Bill
2
.
Capital Receipts:  The government also receives money by way of loans or
from the sale of its assets. Loans will have to be returned to the agencies from
which they have been borrowed. Thus they create liability. Sale of government
assets, like sale of shares in Public Sector Undertakings (PSUs) which is referred
1
The India Tax system witnessed a dramatic change with the introduction of the GST
(Goods and Services Tax) which encompasses both goods and services and was be implemented by
the Centre, 28 states and 7 Union territories from 1 July, 2017.
2
A Finance Bill, presented along with the Annual Financial Statement, provides details on the
imposition, abolition, remission, alteration or regulation of taxes proposed in the Budget.
Reprint 2024-25
69 69 69 69 69
Government Budget
and the Economy
to as PSU disinvestment, reduce the total amount of financial assets of the
government. All those receipts of the government which create liability or reduce
financial assets are termed as capital receipts. When government takes fresh
loans it will mean that in future these loans will have to be returned and interest
will have to be paid on these loans. Similarly, when government sells an asset,
then it means that in future its earnings from that asset, will disappear. Thus,
these receipts can be debt creating or non-debt creating.
5.1.3. Classification of Expenditure
Revenue Expenditure
Revenue Expenditure is expenditure incurred for purposes other than
the creation of physical or financial assets of the central government. It
relates to those expenses incurred for the normal functioning of the
government departments and various services, interest payments on
debt incurred by the government, and grants given to state governments
and other parties (even though some of the grants may be meant for
creation of assets).
Budget documents classify total expenditure into plan and non-plan
expenditure
3
. This is shown in item 6 on Table 5.1 within revenue
expenditure, a distinction is made between plan and non-plan. According
to this classification, plan revenue expenditure relates to central Plans
(the Five-Year Plans) and central assistance for State and Union Territory
plans. Non-plan expenditure, the more important component of revenue
expenditure, covers a vast range of general, economic and social services of the
3
A case against this kind of classification has been put forth on the ground that it has
led to an increasing tendency to start new schemes/projects neglecting maintenance of
existing capacity and service levels. It has also led to the misperception that non-plan
expenditure is inherently wasteful, adversely affecting resource allocation to social sectors
like education and health where salary comprises an important element.
Government Budget
Revenue
Budget
Capital
Budget
Revenue
Receipts
Revenue
Expenditure
Capital
Receipts
Capital
Expenditure
Non-tax
Revenue
Tax
Revenue
Plan Revenue
Expenditure
Non-plan Revenue
Expenditure
Non-plan Capital
Expenditure
Plan Capital
Expenditure
Chart 1: The Components of the Government Budget
Reprint 2024-25
Page 5


Chapter 5
Chapter 5
Governmen Governmen Governmen Governmen Government t t t t Budget Budget Budget Budget Budget
and the Economy and the Economy and the Economy and the Economy and the Economy
We introduced the government in chapter one as denoting
the state. We stated that apart from the private sector,
there is the government which plays a very important role.
An economy in which there is both the private sector and
the Government is known as a mixed economy.  There are
many ways in which the government influences economic
life.  In this chapter, we will limit ourselves to the functions
which are carried on through the government budget.
This chapter proceeds as follows. In section 5.1 we
present the components of the government budget to bring
out the sources of government revenue and avenues of
government spending. In section 5.2 we discuss the topic of
balanced, surplus or deficit budget to account for the
difference between expenditures and revenue collection.  It
specifically deals with the meaning of different kinds of
budget deficits, their implications and the measures to
contain them. Box. 5.1 deals with fiscal policy and a simple
description of the multiplier. The role the government plays
has implications for its deficits which further affect its debt-
what the government owes. The chapter concludes with an
analysis of the debt issue.
5.1 GOVERNMENT BUDGET — MEANING AND ITS COMPONENTS
There is a constitutional requirement in India (Article 112) to
present before the Parliament a statement of estimated receipts
and expenditures of the government in respect of every financial
year which runs from 1 April to 31 March. This ‘Annual Financial
Statement’ constitutes the main budget document of the
government.
Although the budget document relates to the receipts
and expenditure of the government for a particular financial
year, the impact of it will be there in subsequent years.
There is a need therefore to have two accounts- those that
relate to the current financial year only are included in the
revenue account (also called revenue budget) and those that
concern the assets and liabilities of the government into
the capital account (also called capital budget). In order to
understand the accounts, it is important to first understand
the objectives of the government budget.
Reprint 2024-25
5.1.1 Objectives of Government Budget
The government plays a very important role in increasing the welfare of
the people. In order to do that the government intervenes in the economy
in the following ways.
Allocation Function of Government Budget
Government provides certain goods and services which cannot be provided
by the market mechanism i.e. by exchange between individual consumers
and producers. Examples of such goods are national defence, roads,
government administration etc. which are referred to as public goods.
To understand why public goods need to be provided by the
government, we must understand the difference between private goods
such as clothes, cars, food items etc. and public goods. There are two
major differences. One, the benefits of public goods are available to all
and are not only restricted to one particular consumer. For example, if
a person eats a chocolate or wears a shirt, these will not be available to
others. It is said that this person’s consumption stands in rival
relationship to the consumption of others. However, if we consider a
public park or measures to reduce air pollution, the benefits will be
available to all. One person’s consumption of a good does not reduce the
amount available for consumption for others and so several people can
enjoy the benefits, that is, the consumption of many people is not
‘rivalrous’.
Two, in case of private goods anyone who does not pay for the goods
can be excluded from enjoying its benefits. If you do not buy a ticket,
you will not be allowed to watch a movie at a local cinema hall. However,
in case of public goods, there is no feasible way of excluding anyone
from enjoying the benefits of the good. That is why public goods are
called non-excludable.   Even if some users do not pay, it is difficult and
sometimes impossible to collect fees for the public good. These non-
paying users are known as ‘free-riders’. Consumers will not voluntarily
pay for what they can get for free and for which there is no exclusive
title to the property being enjoyed. The link between the producer and
consumer which occurs through the payment process is broken and the
government must step in to provide for such goods.
There is, however, a difference between public provision and public
production. Public provision means that they are financed through the
budget and can be used without any direct payment. Public goods may
be produced by the government or the private sector. When goods are
produced directly by the government it is called public production.
Redistribution Function of Government Budget
From chapter two we know that the total national income of the country
goes to either the private sector, that is, firms and households (known
as private income) or the government (known as public income). Out of
private income, what finally reaches the households is known as personal
income and the amount that can be spent is the personal disposable
income. The government sector affects the personal disposable income
of households by making transfers and collecting taxes. It is through
this that the government can change the distribution of income and
bring about a distribution that is considered ‘fair’ by society. This is the
redistribution function.
67 67 67 67 67
Government Budget
and the Economy
Reprint 2024-25
68 68 68 68 68
Introductory Macroeconomics
Stabilisation Function of Government Budget
The government may need to correct fluctuations in income and employment.
The overall level of employment and prices in the economy depends upon the
level of aggregate demand which depends on the spending decisions of millions
of private economic agents apart from the government. These decisions, in turn,
depend on many factors such as income and credit availability. In any period,
the level of demand may not be sufficient for full utilisation of labour and other
resources of the economy. Since wages and prices do not fall below a level,
employment cannot be brought back to the earlier level automatically. The
government needs to intervene to raise the aggregate demand.
On the other hand, there may be times when demand exceeds available output
under conditions of high employment and thus may give rise to inflation. In
such situations, restrictive conditions may be needed to reduce demand.
The intervention of the government whether to expand demand or reduce it
constitutes the stabilisation function.
5.1.2 Classification of Receipts
Revenue Receipts: Revenue receipts are those receipts that do not lead to a
claim on the government. They are therefore termed non-redeemable. They are
divided into tax and non-tax revenues. Tax revenues, an important component
of revenue receipts, have for long been divided into direct taxes (personal income
tax) and firms (corporation tax), and indirect taxes like excise taxes (duties levied
on goods produced within the country), customs duties (taxes imposed on goods
imported into and exported out of India) and service tax
1
. Other direct taxes like
wealth tax, gift tax and estate duty (now abolished) have never brought in large
amount of revenue and thus have been referred to as ‘paper taxes’.
The redistribution objective is sought to be achieved through progressive
income taxation, in which higher the income, higher is the tax rate. Firms are
taxed on a proportional basis, where the tax rate is a particular proportion of
profits. With respect to excise taxes, necessities of life are exempted or taxed at
low rates, comforts and semi-luxuries are moderately taxed, and luxuries, tobacco
and petroleum products are taxed heavily.
Non-tax revenue of the central government mainly consists of interest receipts
on account of loans by the central government, dividends and profits on
investments made by the government, fees and other receipts for services rendered
by the government. Cash grants-in-aid from foreign countries and international
organisations are also included.
The estimates of revenue receipts take into account the effects of tax proposals
made in the Finance Bill
2
.
Capital Receipts:  The government also receives money by way of loans or
from the sale of its assets. Loans will have to be returned to the agencies from
which they have been borrowed. Thus they create liability. Sale of government
assets, like sale of shares in Public Sector Undertakings (PSUs) which is referred
1
The India Tax system witnessed a dramatic change with the introduction of the GST
(Goods and Services Tax) which encompasses both goods and services and was be implemented by
the Centre, 28 states and 7 Union territories from 1 July, 2017.
2
A Finance Bill, presented along with the Annual Financial Statement, provides details on the
imposition, abolition, remission, alteration or regulation of taxes proposed in the Budget.
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Government Budget
and the Economy
to as PSU disinvestment, reduce the total amount of financial assets of the
government. All those receipts of the government which create liability or reduce
financial assets are termed as capital receipts. When government takes fresh
loans it will mean that in future these loans will have to be returned and interest
will have to be paid on these loans. Similarly, when government sells an asset,
then it means that in future its earnings from that asset, will disappear. Thus,
these receipts can be debt creating or non-debt creating.
5.1.3. Classification of Expenditure
Revenue Expenditure
Revenue Expenditure is expenditure incurred for purposes other than
the creation of physical or financial assets of the central government. It
relates to those expenses incurred for the normal functioning of the
government departments and various services, interest payments on
debt incurred by the government, and grants given to state governments
and other parties (even though some of the grants may be meant for
creation of assets).
Budget documents classify total expenditure into plan and non-plan
expenditure
3
. This is shown in item 6 on Table 5.1 within revenue
expenditure, a distinction is made between plan and non-plan. According
to this classification, plan revenue expenditure relates to central Plans
(the Five-Year Plans) and central assistance for State and Union Territory
plans. Non-plan expenditure, the more important component of revenue
expenditure, covers a vast range of general, economic and social services of the
3
A case against this kind of classification has been put forth on the ground that it has
led to an increasing tendency to start new schemes/projects neglecting maintenance of
existing capacity and service levels. It has also led to the misperception that non-plan
expenditure is inherently wasteful, adversely affecting resource allocation to social sectors
like education and health where salary comprises an important element.
Government Budget
Revenue
Budget
Capital
Budget
Revenue
Receipts
Revenue
Expenditure
Capital
Receipts
Capital
Expenditure
Non-tax
Revenue
Tax
Revenue
Plan Revenue
Expenditure
Non-plan Revenue
Expenditure
Non-plan Capital
Expenditure
Plan Capital
Expenditure
Chart 1: The Components of the Government Budget
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Introductory Macroeconomics
government. The main items of non-plan expenditure are interest payments,
defence services, subsidies, salaries and pensions.
Interest payments on market loans, external loans and from various reserve
funds constitute the single largest component of non-plan revenue expenditure.
Defence expenditure, is committed expenditure in the sense that given the national
security concerns, there exists little scope for drastic reduction. Subsidies are an
important policy instrument which aim at increasing welfare. Apart from providing
implicit subsidies through under-pricing of public goods and services like education
and health, the government also extends subsidies explicitly on items such as
exports, interest on loans, food and fertilisers. The amount of subsidies as a
percent of GDP was 2.02 per cent in 2014-15 and is 1.8 percent of GDP in 2015-16,
1 percent in 2018-19, 3.6 percent in 2020-21 and 1.2 percent in 2022-23 (B.E).
Capital Expenditure Capital Expenditure Capital Expenditure Capital Expenditure Capital Expenditure
There are expenditures of the government which result in creation of
physical or financial assets or reduction in financial liabilities. This
includes expenditure on the acquisition of land, building, machinery,
equipment, investment in shares, and loans and advances by the central
government to state and union territory governments, PSUs and other
parties. Capital expenditure is also categorised as plan and non-plan in
the budget documents. Plan capital expenditure, like its revenue
counterpart, relates to central plan and central assistance for state
and union territory plans. Non-plan capital expenditure covers various
general, social and economic services provided by the government.
The budget is not merely a statement of receipts and expenditures.
Since Independence, with the launching of the Five-Year Plans, it has
also become a significant national policy statement. The budget, it has
been argued, reflects and shapes, and is, in turn, shaped by the country’s
economic life. Along with the budget, three policy statements are
mandated by the Fiscal Responsibility and Budget Management Act,
2003 (FRBMA)
4
. The Medium-term Fiscal Policy Statement sets a three-
year rolling target for specific fiscal indicators and examines whether
revenue expenditure can be financed through revenue receipts on a
sustainable basis and how productively capital receipts including market
borrowings are being utilised. The Fiscal Policy Strategy Statement sets
the priorities of the government in the fiscal area, examining current
policies and justifying any deviation in important fiscal measures. The
Macroeconomic Framework Statement assesses the prospects of the
economy with respect to the GDP growth rate, fiscal balance of the central
government and external balance
5
.
5.2 BALANCED, SURPLUS AND DEFICIT BUDGET
The government may spend an amount equal to the revenue it collects. This is
known as a balanced budget. If it needs to incur higher expenditure, it will have
4
Box 5.2  provides a brief account of this legistation and its implication for Government
finances.
5
The 2005-06 Indian Budget introduced a statement highlighting the gender sensitivities
of the budgetary allocations. Gender budgeting is an exercise to translate the stated gender
commitments of the government into budgetary commitments, involving special initiatives
for empowering women and examination of the utilisation of resources allocated for women
and the impact of public expenditure and policies of the government on women. The 2006-
07 budget enlarged the earlier statement.
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