GOVERNMENT BUDGET

CHAPTER 5
 BASIC CONCEPTS

· MIXED ECONOMY: a mixed economy has a blend of the features of

both public sector and private sector.

• According to the Article 112 in the constitution the statement of

estimated receipts and expenditures of the Govt should be
presented before the parliament before it is passed in the budget.

• Financial Year: 1st April to 31st March.

 BUDGET
it is annual financial statement of estimated revenues and
expenditures of the forthcoming financial year.

· COMPONENTS OF BUDGET:
· REVENUE BUDGET – found in revenue account
· CAPITAL BUDGET – studies the assets and liabilities of the
Government.
OBJECTIVES OF GOVERNMENT BUDGET

· Allocation function of the government

· Redistribution function
· Stabilization function
ALLOCATION FUNCTION

• Government provides certain goods and services which

cannot be provided by the market mechanism.
• Goods provided by the government are called as public
goods.
• Goods provided by the private parties are called private
goods.
DIFFERENCES BETWEEN PUBLIC
GOODS AND PRIVATE GOODS
PUBLIC GOODS PRIVATE GOODS
• Benefits available to all Benefits only a few
• Consumption is non rivalrous Consumption is rivalrous
• Consumption by one does not
reduces its availability to others Consumption by one reduces its availability
to others

• You can enjoy their benefits even

if few users don’t pay. Eg: free riders They can be enjoyed only if you pay for the
good
• Public goods are non excludable Private goods are excludable
Few concepts of public goods:

· Free Riders: refers to people who don’t pay but use a

public good. Eg: ticket less travelling in trains and in
public buses.
· Public provision: it is financed through budget
anyone can use it without direct payment. Eg: public
parks, toll free roads, etc.
· Public Production : when goods are directly produced
by the govt they are called as goods of public
production. Eg: goods produced by PSUs, HMT,
RAILWAYS, DEFENSE GOODS.
REDISTRIBUTION FUNCTION OF
BUDGET
• The total income produced in the country either goes to the
private sector or the public sector
• What reaches the private household or private firms is
called personal income and personal disposable income.
• The govt redistributes income by collecting taxes from the rich and
redistributes to the poor and establishes a FAIR SOCIETY
STABILISATION FUNCTION OF THE GOVERNMENT

• The govt aims to create stability in the economy.

• It aims to reduce the fluctuation in prices in income
and employment levels.
• The above depend on aggregate demand so the
government takes suitable measures to reduce or
increase aggregate demand and restores stability
either by controlling inflation or deflation or
whatever the situation may be.
COMPONENTS OF BUDGET
Government
Budget

Revenue Capital
Budget Budget

Revenue Revenue Captial Capital

Receipts Expenditure Receipts Expenditure

Plan
Plan Capital
Tax Revenue Revenue
Expenditure
Exdpenditure
Non Plan Non Plan
Non Tax
Revenue Capital
Revenue
Expenditure Expenditure
CLASSIFICATION OF RECEIPTS

• REVENUE RECEIPTS : they are divided into Tax and Non-tax

revenues. Receipts refer to income. Revenue receipts refer to
income collected by the Govt from Tax Sources and non-tax
sources.
• CAPITAL RECEIPTS: studies the loans and other financial
accommodations of the Govt. We also need to remember
that loans are a liability as they need to be repaid.
REVENUE RECEIPTS-
• Revenue receipts are of 2 types:-
1. TAX REVENUES
2. NON TAX REVENUES
• TAX REVENUE:-They are an important component of revenue receipts.
Tax revenues are non redeemable (it need not be returned or repayed
back)
• They are divided into DIRECT TAXES AND INDIRECT TAXES.
DIRECT TAXES
• Direct taxes include income tax, corporate tax interest tax .
• other direct taxes include property tax, gift tax, estate duties (they are
an insignificant source of income to the Govt as the cost of collecting
these taxes is more than the revenue collected so they are called
paper taxes)
• and gift tax is abolished now
Indirect taxes
• Excise duties- taxes levied at the stage of production on goods
produced within the country
• Custom duties-taxes on imports and exports
• Service tax: - levied by service providers like restaurants, insurance
services, entertainment etc.
contd
• Through the redistribution objective there is progressive taxation in
our country.
• Under progressive taxation as the income of the individual increases
the amount of tax paid to the Government also increases.
• Firms are taxed on a proportional basis where the amount of tax they
pay depends on their profits.
• Necessities of life attract a lower tax rate and comforts and semi
luxuries are moderately taxed and luxuries and tobacco and
petroleum products are taxed heavily.
NON TAX REVENUES OF THE
GOVERNMENT: -
• Includes interest receipts (interest earned) on loans granted.
• Profits earned by govt from its various investments or public sector
undertakings.
• Fees, fines, and penalties.
• Grant in aid from different countries and international organizations.
• Revenue from the sale of forest products
 CAPITAL RECEIPTS

• Consists of loans and other assets of the government.

• Also consists of acts of Govt like disinvestment, sale of its
assets, taking of fresh loans etc.
• Most of capital receipts will have to be repaid(loans), or it
creates liabilities or reduces assets(disinvestment)
PUBLIC EXPENDITURE

• These are expenditures of the government which result in creation of

physical or financial assets or reduction in financial liabilities or it is
incurred on day to day functionning of the economy.
• This includes expenditure on acquisition of land, building, machinery,
investment in shares and loans and advances by central govt to states
or UTs, to PSUs and others.
• PUBLIC EXPENDITURE IS CLASSIFIED INTO 2 CATEGORIES
1. REVENUE EXPENDITURE
2. CAPITAL EXPENDITURE
REVENUE EXPENDITURE

• It refers to expenditure incurred for purposes other than creating

physical and financial assets
• It includes expenses incurred by the govt on the normal functioning of
the economy towards provision of socio-economic services.
• Revenue expenditure may be towards payment of salaries to govt
staff, administration, law and order, pensions, taking care of schools,
colleges, hospitals, drinking water facilities, defense services
(pensions, salaries and other perks to defense personnel). Etc.
CLASSIFICATION OF REVENUE
EXPENDITURE
Revenue Expenditure is classified into
• PLAN EXPENDITURE
• NON PLAN EXPENDITURE
PLAN REVENUE EXPENDITURE
• It is revenue expenditure as planned by the central plans. It includes
• Central assistance for states and UTs
• Includes general, social, economic services of the Government (setting up
of educational institutions, health care centers, drinking water facilities,
drainages etc).
NON PLAN REVENUE EXPENDITURE

• 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

• These are expenditures of the government which result in creation of

physical or financial assets or reduction in financial liabilities.
• This includes expenditure on acquisition of land, building, machinery,
investment in shares and loans and advances by central govt to states
or UTs, to PSUs and others.
Classification of capital expenditure

• PLAN CAPITAL EXPENDITURE

• NON PLAN CAPITAL EXPENDITURE.
PLAN CAPITAL EXPENDITURE:-
• Includes assistance to the central plans and plans of the states and
UTs.
• The expenditure in this direction is planned and year marked for a
specific purpose.
• Includes setting up of industries, banks, infrastructure projects,
flyovers, underpasses, irrigation projects etc.
NON PLAN CAPITAL EXPENDITURE

• Includes capital expenditure on various general, social and economic

services provided by the government.
• Non Plan capital expenditure will include loans to foreign govts, states
and UTs, money spent on modernisation , etc.
BUDGET

• Budget is not just a statement of receipts and payments but it is a

national policy statement.
• It shapes the economic life of a country.
• The FRBMA (Fiscal Responsibility Budget Management Act) aims to
reduce expenditures of the Govt. it has made 3 policy statements:
1.Three year target to see if revenue receipts can finance revenue
expenditure.
2. To utilise capital receipts and market borrowings in a productive manner.
3. Fiscal Policy Strategy Statement to see fiscal measures are implemented
in an appropriate manner..
TYPES OF BUDGET
BUDGET CAN BE CLASIFIED INTO:
• Balanced Budget (R=E)
• Surplus Budget (R>E)
• Deficit Budget (R<E)
• Budget deficit
• When the government spends more than its revenue then there is a
deficit. The budget deficits can be classified into
• Revenue deficit
• Fiscal deficit
• Primary deficit
Types of budgetary deficit

• Revenue deficit=revenue expenditure-revenue receipts.

• Revenue deficit=revenue expenditure>revenue receipts.

• Fiscal deficit-it is the difference between the governments total

expenditure and its total receipts excluding borrowing.

• GROSS FISCAL DEFICIT=total expenditure - (revenue receipts +non

debt creating capital receipts)
Types of budgetary deficit cont..

• Non debt creating capital receipts refer to sale of some assets,

disinvestment or recovery of old loans. They are called non debt as they
are not borrowings and they don’t give rise to debt.

• Net borrowings from home refers to directly borrowings from public

through debt instruments eg. borrowing from debt instruments like
small savings, indirectly from commercial banks through SLR.

• 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:

• Gross fiscal deficit can be financed from :- Net borrowings at home +

borrowings from RBI + borrowings from abroad.
Types of budgetary deficit cont..

• 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

• It is a single comprehensive tax started from 1st July 2017.

• Covers from the point of supply of a goods and services till it reaches the
consumer.
• It is applicable to the entire country as one rate of tax on one type of good.
• It has replaced all central and state govt taxes.
• Tobacco and tobacco products will attract both GST and central excise
duties.
• State Govt will continue to levy VAT on consumption of liquor.
• GST rates are 3%,5%,12%,18% and 28%.
• Today GST is the most comprehensive tax in our country.
 PROPORTIONAL INCOME TAX

• A proportional tax is an income tax system where the same

percentage of tax is levied on all taxpayers, regardless of their income.
• A proportional tax applies the same tax rate across low, middle and
high-income taxpayers. Eg.it is considered as an automatic stabilizer.
Irrespective of a change in GDP this does not have an impact on the
demand as it’s a flat rate.
• Eg:- a 10% tax rate for all irrespective of income is an example of
proportional tax.
• It is followed in Mongolia, Romania, etc
EFFECT OF INCREASING Govt / PUBLIC EXPENDITURE
EFFECT OF INCREASING Govt / PUBLIC
EXPENDITURE
• The above diagram shows the effect of increasing public or govt
expenditure on income. Here the y-axis measures the expenditure of Govt
leading to an impact on aggregate demand and x-axis measures the
income.
• When the governmental expenditure increases there is an increase in the
equilibrium level from E to E’. This leads to generation of more employment
and more income. The income therefore increases from Y to Y’.
• Even in the General Theory of Employment, Interest and Money, Keynes
has given importance to the fiscal policy. Using the fiscal policy tools like
expenditure and taxes the government can increase the output and income
and stabilize the ups and downs in the economy.
EFFECT OF REDUCTION IN TAXES
EFFECT OF REDUCTION IN TAXES

• 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.