Government Budget
Government Budget
Government Budget
CHAPTER 5
BASIC CONCEPTS
· COMPONENTS OF BUDGET:
· REVENUE BUDGET – found in revenue account
· CAPITAL BUDGET – studies the assets and liabilities of the
Government.
OBJECTIVES OF GOVERNMENT BUDGET
Revenue Capital
Budget Budget
Plan
Plan Capital
Tax Revenue Revenue
Expenditure
Exdpenditure
Non Plan Non Plan
Non Tax
Revenue Capital
Revenue
Expenditure Expenditure
CLASSIFICATION OF RECEIPTS
• Includes expenditure for which it is not planned for during the five
year plans.
• Includes interest payments on loans borrowed, defense services,
subsidies, salaries and pensions.
CAPITAL EXPENDITURE
• Gross fiscal deficit is a key variable in judging the financial health of the
public sector and stability of the economy
Types of budgetary deficit cont..
• The finance experts are of the opinion that the fiscal deficit has to be
financed through borrowings, thus it indicates the total borrowing
requirements of the government from all sources . Thus the gross
fiscal deficit can be financed by:
• From the Gross fiscal deficit it can be understood that revenue deficit is
a part of fiscal deficit, it is clear in the formula given below
• FISCAL DEFICIT = Revenue deficit + Capital Expenditure – Non debt
creating capital receipts.
• PRIMARY DEFICIT : FISCAL DEFICIT – INTEREST PAYMENTS
OR
• Gross primary deficit = Gross fiscal deficit-net interest liabilities.
• Net interest liabilities consist of interest payments - (minus) interest
receipts by government on net domestic lending.
PUBLIC DEBT
• The budgetary deficit must be financed by the taxes, or by borrowings
or by printing new currency.
• Govt has generally resorted to borrowings which is giving rise to what is
called as public debt.
• The concepts of deficits and debts are closely related.
• Deficits can be thought as a flow which is added to the stock of debt.
• If the Govt continues to borrow year after year, it leads to the
accumulation of debt and the Govt has to pay more and more interest.
• The interest payments itself contribute to debt.
PERSPECTIVES ON THE APPROPRIATE
AMOUNT OF GOVT DEBT
There are 2 inter linked aspects to this:
1. Whether Govt debt is a burden?
2. The issue of financing the debt.
Whether Govt debt is a burden? And issue of financing the debt
What is true of one small trader’s debt or an individual’s debt may not
be true of the govt’s debt situation
• Dealing with the whole is different from dealing with part.
• Unlike traders or other individuals, the Govt can raise resources from
printing currency and even through borrowings.
• By borrowing the Govt transfers the burden of reduced consumption
on the future generations.
Whether Govt debt is a burden? And issue of financing the debt
• This is because the Govt borrows by issuing bonds to people living at present
but may decide to payoff the bonds some twenty years later by raising taxes.
• The taxes may be levied on the young population that have just entered the
workforce. This will bring down their disposable income and hence their
consumption would fall.
• It is also argued that the national savings too would fall because of this.
(because taxes are increased)
• Thus it is understood that the Govt borrowing could reduce the savings of
the private sector.
• This will reduce capital formation. Hence it can be concluded that debt is a
burden on the future generations.
Contd
• Traditionally it is argued that the Govt cuts taxes and runs a budgetary
deficit.
• The consumers respond to their after tax income by increased
expenditure or spending
• It is possible that these people are short sighted and do not
understand the implications of budgetary deficits.
• They may not understand that the Govt at some point in future will
raise the taxes to pay off its debt and accumulated interest.
• Even if they understand this they may comprehend that the taxes may
fall on the future generations and not them.
Contd
• A counter argument is that the consumers are forward thinking and
will base their spending not only on current income but also on their
expected future income.
• They will also understand that borrowing today means higher taxes in
the future.
• Further the consumer will be concerned about the future generations
because they are the children and grand children of the present
generation and the family which is a relevant decision making unit,
continues living.
contd
• They (families) will increase savings(fearing high taxes in future) now which will
fully offset the increased govt dissaving so that national savings do not change.
• This view is called as Ricardian Equivalence.
• David Ricardo first argued in the 19th century that in the face of high deficits,
people save more. It is called equivalence because it argues that taxation and
borrowing are equivalent means of financing expenditure. (it means that the
deficits can either be financed through tax revenues or borrowing)
• When the Govt increases spending by borrowing today,(through bonds for
example) this will be repayed by the taxes in future.
• It will have the same impact on the economy as an increase in Govt
expenditure that is financed by a tax increase today.
contd
• It is also argued that “debt does not matter because we owe it to
ourselves”.
• This is because although there is a transfer of resources between
generations, purchasing power remains within the country.
• However, any debt that is owed to foreigners involves a burden since
we have to pay the foreigners with interest.
OTHER PERSPECTIVES ON DEFICITS
AND DEBTS
• Deficits are inflationary: this is because when Govt increases
spending or cuts taxes the aggregate demand increases. Firms will not
be able to cater to the increased demand and this will push up the
prices.
• BUT if there are unused resources or output which is held or unsold
then the increased demand can be catered to by increasing the
supply. Then there will not be any inflation .
OTHER PERSPECTIVES ON DEFICITS
AND DEBTS
• Another perspective is that when the taxes are increased the
investment of the private sector reduces due to the reduction in the
savings of the private sector(because of increase in taxes).
• Another perspective is that investment of Govt on infrastructure will
make the future generation better off so debt should not be
considered a burden but an engine of growth.
DEFICIT REDUCTION
• Deficit can be reduced by increasing taxes
• In India, the Govt has been trying to increase the tax revenues by
levying more indirect taxes which by nature are very regressive.
• Sale of shares of the PSU
• Major trust is on reducing expenditure.
DEFICIT REDUCTION
• Reduction in expenditure can be achieved by making govt activities
more efficient.
• Better planning and better administration.
• Some areas where govt operated before can be withdrawn(subsidies)
• But withdrawal from priority areas like poverty allocation. Education,
agriculture can have adverse effect on the economy and growth.
FISCAL RESPONSIBILITY AND
BUDGET MANAGEMENT ACT
(FRBMA)
• Enacted in August 2003 is a major turning point in fiscal reforms. It urges the govt to follow
a prudent fiscal policy.
• FEATURES OF FRBMA
• To reduce fiscal deficit up to 3% of GDP by August 2009 and revenue deficit by March 31st
2009. If this is not achieved through tax revenues there should be reduction in expenditure.
• deficits sometimes may exceed on ground of national security or a calamity this is
exceptional.
• Govt not to borrow from RBI apart from loans.
• Insists on greater tranparency in fiscal operations.
• Indian economy has transformed after the enactment of FRBMA and most states are
cooperating in this direction and has made India a middle-income country.
GST
• Taxation and public expenditure are the important tools of the fiscal policy of the
government which are used to stabilize the level of output and employment.
• Fiscal policy through variations in government expenditure and taxation
profoundly affects National income, employment, output and prices.
• When there is a cut in the taxes the disposable income(Y-T) of the population
increases. This will lead to an increase in the consumption expenditure, this will in
turn increase the output, employment and income.
• The tax multiplier is a negative multiplier. It is smaller in absolute value compared
to the government spending multiplier. This is because an increase in government
spending directly affects the output, employment and income. Whereas the taxes
enter the multiplier process through their impact on disposable income which
influences household consumption.