NCERT Gist: Government Budget and the Economy | Additional Study Material for UPSC PDF Download

Components of the Government Budget

→ 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.
→ Further, the budget must distinguish expenditure on the revenue account from other expenditures. Therefore, the budget comprises of the (a) Revenue Budget and the (b) Capital Budget.

Revenue Account:

→ The Revenue Budget shows the current receipts of the government and the expenditure that can be met from these receipts.
Revenue Receipts: Revenue receipts are receipts of the government which are non-redeemable, that is, they cannot be reclaimed from the government. They are divided into tax and non-tax revenues.
→ Tax revenues consist of the proceeds of taxes and other duties levied by the central government.
→ Tax revenues, an important component of revenue receipts, comprise of direct taxes - which fall directly on individuals (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.
→ Other direct taxes like wealth tax, gift tax and estate duty (now abolished) have never been of much significance in terms of revenue yield and have thus been referred to as “paper taxes”.
→ 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 organizations are also included.The estimates of revenue receipts take into account the effects of tax proposals made in the Finance Bill.

Revenue Expenditure

→ It means the 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).
→ 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.

Capital Account

→ Capital Budget is an account of the assets as well as liabilities of the central government, which takes into consideration changes in capital.
→ It consists of capital receipts and capital expenditure of the government.
→ All those receipts of the government which create liability or reduce financial assets are termed as capital receipts.
→ The main items of capital receipts include:
- Loans raised by the government from the public which are called market borrowings
- Borrowing by the government from the Reserve Bank and commercial banks and other financial institutions through the sale of treasury bills
- Loans received from foreign governments and international organisations
- Recoveries of loans granted by the central government
→ Capital expenditures 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, and equipment, investment in shares, and loans and advances by the central government to state and union territory governments, PSUs and other parties.

Measures of Government Deficit

→ When a government spends more than it collects by way of revenue, it incurs a budget deficit.
→The revenue deficit refers to the excess of government’s revenue expenditure over revenue receipts.
In other words, Revenue deficit = Revenue expenditure - Revenue receipts

Types of Deficits

→ Fiscal Deficit: Fiscal deficit is the difference between the government’s total expenditure and its total receipts excluding borrowing.
Gross fiscal deficit = Total expenditure - (Revenue receipts + Non-debt creating capital receipts)
Alternatively, Gross fiscal deficit = Net borrowing at home + Borrowing from RBI + Borrowing from abroad
→ Revenue deficit is a part of fiscal deficit (Fiscal Deficit = Revenue Deficit + Capital Expenditure - non-debt creating capital receipts). A large share of revenue deficit in fiscal deficit indicates that a large part of borrowing is being used to meet its consumption expenditure needs rather than investment.
→ Primary Deficit: Generally borrowing requirement of the government includes interest obligations on accumulated debt. The goal of measuring primary deficit is to focus on present fiscal imbalances. To obtain an estimate of borrowing on account of current expenditures exceeding revenues, we need to calculate what has been called the primary deficit.
Gross primary deficit = Gross fiscal deficit - Net interest liabilities → Net interest liabilities consist of interest payments minus interest receipts by the government on net domestic lending.
→ Debt: Budgetary deficits must be financed by taxation, borrowing or printing money.
Governments have mostly relied on borrowing, giving rise to what is called government debt.
→The concepts of deficits and debt are closely related. Deficits can be thought of as flows which add to the stock of debt. If the government continues to borrow year after year, it leads to the accumulation of debt and the government has to pay more and more by way of interest. These interest payments themselves contribute to the debt.
→ Two more issues are relevant here:
1. Whether government debt is a burden?
2. The issue of financing the debt.
→ Unlike any one trader, the government can raise resources through taxation and printing money. By borrowing, the government transfers the burden of reduced consumption on future generations. This is because it borrows by issuing bonds to the people living at present but may decide to pay off the bonds some twenty years later by raising taxes.
→ These may be levied on the young population that has just entered the workforce, whose disposable income will go down and hence consumption. Thus, national savings, it was argued, would fall.
Traditionally, it has been argued that when a government cuts taxes and runs a budget deficit, consumers respond to their after -tax income by spending more.
It is possible that these people are short-sighted and do not understand the implications of budget deficits. They may not realise that at some point in the future, the government will have to raise taxes to pay off the debt and accumulated interest. Even if they comprehend this, they may expect the future taxes to fall not on them but on future generations.
→ One of the main criticisms of deficits is that they are inflationary.This is because when government increases spending or cuts taxes, aggregate demand increases → Firms may not be able to produce higher quantities that are being demanded at the ongoing prices. Prices will, therefore, have to rise. However, if there are unutilised resources, output is held back by lack of demand
A high fiscal deficit is accompanied by higher demand and greater output and, therefore, need not be inflationary.

Crowding out effect:

There is a decrease in investment due to a reduction in the amount of savings available to the private sector. This is because if the government decides to borrow from private citizens by issuing bonds to finance its deficits, these bonds will compete with corporate bonds and other financial instruments for the available supply of funds.
If some private savers decide to buy bonds, the funds remaining to be invested in private hands will be smaller.
Thus, some private borrowers will get ‘crowded out’ of the financial markets as the government claims an increasing share of the economy’s total savings.
→ Also, if the government invests in infrastructure, future generations may be better off, provided the return on such investments is greater than the rate of interest. The actual debt could be paid off by the growth in output. The debt should not then be considered burdensome. The growth in debt will have to be judged by the growth of the economy as a whole.
→ Government deficit can be reduced by an increase in taxes or reduction in expenditure.
In India, the government has been trying to increase tax revenue with greater reliance on direct taxes (indirect taxes are regressive in nature - they impact all income groups equally).There has also been an attempt to raise receipts through the sale of shares in PSUs. However, the major thrust has been towards reduction in government expenditure. This could be achieved through making government activities more efficient through better planning of programmes and better administration.