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CHAPTER
GOVERNMENT BUDGET AND
THE ECONOMY
1. MEANING OF GOVERNMENT BUDGET
 Government budget is an annual statement, showing item wise estimates
of receipts and expenditures during a Fiscal year.

 The receipts and expenditures, shown in the budget are not actual figures, but
the estimated values for the coming fiscal year.

 The fiscal year starts from 1st April to 31st March.

SOME IMPORTANT POINTS OF GOVERNMENT BUDGET-

 Estimated expenditures & receipts are planned as per the objectives of the
government.

 In India, the budget is presented in the parliament on such a day, as the

President may direct.

 It is required to be approved in the parliament, before it is implemented.

2. OBJECTIVES OF GOVERNMENT BUDGET-

 Government prepares the budget for fulfilling certain objectives.

 These objectives are the direct outcome of government’s economic, social &
political policies.

The various objectives of government budget are-

1. Reallocation of resources:
Through the budgetary policy, Government aims to reallocate resources in
accordance with the economic (profit maximization) and social (public welfare)
priorities of the country. Government can influence allocation of resources
through:

i. Tax concessions or subsidies:

 To encourage investment, government can give tax concessions,
subsidies etc. to producers.

 Example subsidies on use of khadi products &heavy taxes on use of

harmful consumption goods like liquor or cigarettes etc.

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ii. Directly producing goods & services:

 There are many non-profitable economic activities which are not under
taken by the private sector like water supply or sanitation.

 Such activities are under taken by government itself in public interest and
to create social welfare.

2. Reducing inequalities in income and wealth:

 Economic inequalities are an inherent part of every economic system.

 Government aims to reduce such inequalities of income and wealth

through its budgetary policies.

 Government aims to influence distribution of income by imposing taxes on

rich and spending more amounts on welfare of the poor.

 It would reduce the income of rich and raise standard of living of poor,
thus reducing income inequalities in the distribution of income.

3. Economic Stability:
 Economic stability means absence of large scale fluctuation in prices.

 Such fluctuations create uncertainties in the economy.

 Government can exercise control over these fluctuations through taxes

and expenditure.

i. Inflationary tendencies emerge when aggregate demand is higher than the

aggregate supply. Government can bring down the aggregate demand by
curtailing its own expenditure.

ii. Deflationary tendencies emerge when aggregate demand is less than aggregate
supply. Government can increase its expenditure and reduce its taxes and give
subsidies.

In short, policies of surplus budget during inflation and deficit budget during deflation
help to maintain stability of prices in the economy.

4. Management of public enterprises:

 There are large numbers of public sector industries (especially the natural
monopolies), which are established and managed for public welfare.

 Budget is prepared with the objective of making various provisions for

managing such enterprises and providing those financial help.

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5. Economic growth:
 Economic growth implies a sustainable increase in the real GDP of the
economy, i.e an increase in volume of goods and services produced in an
economy.

 Budget can be an effective tool to ensure the economic growth in a country.

i. If the government provides tax rebates and other incentives for productive
ventures and projects, it can stimulate savings in the economy.

ii. Expenditure on infrastructure of an economy enhances the production activity in

different sectors of the economy. Government expenditure is a major factor that
generates demand for different types of goods and services in the economy which
induces growth in private sector too.

6. Reducing regional disparities:

 The government budget aims to reduce regional disparities through its
taxation and expenditure policy for encouraging setting up of production
units in economically backward regions.

3. COMPONENTS OF BUDGET-
Components of budget refer to structure of the budget. Two main components of budget
are –

i. Revenue budget: It deals with the revenue aspect of the government budget. It
explains how revenue is generated or collected by the government and how it is
allocated among various expenditure heads. Revenue budget has two parts:

(i) Revenue receipt (ii) Revenue expenditures

ii. Capital budget: It deals with the capital aspect of the government budget and it
consist of:

(i) Capital receipt (ii) Capital expenditures

4. BUDGET RECIEPTS -
Budget receipts refer to the estimated money receipts of the government from all
sources during a given fiscal year. Budget receipts may be further classified as –

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(i) Revenue receipts (ii) Capital receipt

BUDGET
RECIEPTS

REVENUE CAPITAL
RECEIPTS RECEIPTS

NON-TAX OTHER
TAX REVENUE BORROWINGS RECIEPTS
REVENUE LOANS

5. Revenue receipts –
 Revenue receipts refer to those receipts which neither create any
liability nor cause any reduction in the assets of the government.

A receipt is a revenue receipt, if it satisfies the following two essential conditions:

(i) The receipt must not create a liability for the government.

(ii) The receipt must not cause decrease in asset.

6. Two sources of Revenue Receipts –

(i) Tax revenue (ii) Non-tax revenue

7. Tax Revenue –
 Tax revenue refers to sum total of receipts from taxes and other
duties imposed by the government.

 Tax is a compulsory payment made by people and companies to the

government without reference to any direct benefit in return.

 These are spent by the government for common benefit of the people in
the country.

Taxes can be further classified as-

(i) Direct tax (ii) Indirect tax

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 Direct taxes
It refers to those taxes that are imposed on property and income of individuals and
companies and are paid directly by them to the government.

 Indirect taxes
It refers to those taxes which affect the income and property of individuals and
companies through their consumption pattern. They are imposed on goods and
service.

 How to classify a Tax as direct tax or indirect tax?

(i) A tax is direct tax, if its burden cannot be shifted.

(ii) A tax is indirect tax, if its burden can be shifted.

COMPARISON BETWEEN DIRECT TAXES AND INDIRECT TAXES

Basis Direct tax Indirect tax
1. Impact These are levied on individuals and These are levied on goods and
companies. services.
2. Shift of The burden of direct taxes cannot The burden of these taxes can be
burden be shifted so impact and incidence shifted so, impact and incidence is
of these taxes are on same person. on different persons.
3. Nature Progressive in nature. Proportional in nature.
4. Coverage They have limited reach as they do They have wide coverage as they
not reach all sections of the reach all sections of the society.
economy.

8. Non-Tax Revenue-
Non-Tax revenue refers to receipts of the government from all sources other than
those of tax receipts. The main sources of non-tax revenue are:

I. Interest:
 Government receives interest on loans given by it to state governments, union
territories, private enterprises and general public.

 Interest receipts from these loans are an important source of non-tax revenue.

II. Profits and Dividends:

 Government earns profit through public sector undertakings like Indian
railways, LIC, BHEL, etc.

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 It earns profit from the sale proceeds of the products of such public
enterprises. Government also gets dividend from its investments in other
companies.

III. Fees:
 Fees refer to charges imposed by the government to cover the cost of
recurring services provided by it.

 Such services are generally in public interest and fees are paid by those,
who receive such services.

 It is also a compulsory contribution like tax. Court fees, registration fees,

import fees, etc. are some examples of fees.

IV. License Fee:

 It is a payment charged by the government to grant permission for
something.

 For example, license fee paid for permission of keeping a gun or to obtain
National permit for commercial vehicles.

V. Fines and Penalties:

 They refer to those payments which are imposed on law breakers, For
example fine for jumping red light or penalty for non-payment of tax.

 Fines are different from taxes as the former is levied to maintain law and
order, whereas, the latter is imposed to generate revenue.

VI. Escheats:
 It refers to claim of the government on the property of a person who dies
without leaving behind any legal heir or a will.

VII. Gifts and Grants:

 Government receives gifts and grants from foreign governments and
international organizations.

 Sometimes, individuals and companies also voluntarily gift money to the

government.

 Such gifts are not a fixed source of revenue and are generally received
during national crisis such as war, flood, etc.

VIII. Forfeitures:
 These are in the form of penalties which are imposed by the courts for
non-compliance of orders or non-fulfillment of contracts etc.

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IX. Special Assessment:

 It refers to the payment made by owners of those properties whose value
has appreciated due to developmental activities of the government.

 For example, if value of a property near a Metro Station has increased,

then a part of developmental expenditure is recovered from owners of such
property in the form of special assessment.

9. Capital receipts-
 Capital receipts refer to those receipts which either create a liability or
cause a reduction in the assets of the government.

 They are non-recurring and non-routine in nature.

A receipt is a capital receipt if it satisfies any one of the two conditions:

(i) The receipts must create a liability for the government.

(ii) The receipts must cause a decrease in the assets

Sources of Capital Receipts

Capital receipts are broadly classified into three groups:

 Borrowings: Borrowings are the funds raised by government to meet excess

expenditure. Government borrows funds from:

(i) Open Market (Public) (ii) Reserve Bank of India (RBI)

(iii) Foreign governments (iv) International institutions

Borrowings are capital receipts as they create a liability for the government.

 Recovery of Loans:
Government grants various loans to state governments or union territories.
Recovery of such loans is a capital receipt as it reduces the assets of the
government.

 Other Receipts: These include:

(i) Disinvestment:
Disinvestment refers to the act of selling a part or the whole of shares of
selected public sector undertakings (PSU) held by the government.
They are termed as capital receipts as they reduce the assets of the
government.
(ii) Small Savings:
Small savings refer to funds raised from the public in the form of Post
Office deposits, National Saving Certificates, Kisan Vikas Patras etc.
They are treated as capital receipts as they lead to increase in liability.

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Comparison between Revenue Receipts and Capital Receipts

Basis Revenue Receipts Capital Receipts
1. Meaning They neither create any liability nor They either create any liability or
reduce any asset of the reduce any asset of the
government. government.
2. Nature They are regular and recurring in They are irregular and non-
nature. recurring in nature.
3. Future There is no future obligation to In case of certain capital receipts
obligation return the amount. (like borrowings), there is future
obligation to return the amount
along with interest.
4. Examples Tax Revenue (like Income tax, Borrowings, Disinvestment, etc.
Goods and Services Tax, etc.) and
Non-tax revenue (like interest, fees,
etc.)

10. Budget Expenditure –

Budget expenditure refers to the estimated expenditure of the government during a
given fiscal year. It can be broadly categorized as:

(i) Revenue expenditure (ii) Capital expenditure

11. Revenue Expenditure

Revenue expenditure refers to the expenditure which neither creates any asset
nor causes reduction in any liability of the government.

 It is recurring in nature.
 It is incurred on normal functioning of the government and the provisions for
various services.

Expenditure is revenue expenditure, if it satisfies the following two essential conditions:

(i) The expenditure must not create an asset of the government.

(ii) The expenditure must not cause decrease in any liability.

12. Capital Expenditure

Capital expenditure refers to the expenditure which either creates an asset or
causes a reduction in the liabilities of the government.

 It is non-recurring in nature.
 It adds to capital stock of the economy and increases its productivity through
expenditure on long period development programs, like Metro or Flyover.

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Expenditure is a capital expenditure, if it satisfies any one of the following two conditions:

(i) The expenditure must create an asset for the government.

(ii) The expenditure must cause a decrease in the liabilities.

Comparison between Revenue Expenditure and Capital Expenditure

Basis Revenue Expenditure Capital Expenditure
1. Meaning Revenue expenditure neither Capital expenditure either creates
creates any asset nor reduces any an asset or reduces a liability of
liability of the government. the government.
2. Purpose It is incurred for normal running of It is incurred mainly for acquisition
government departments and of assets and granting of loans and
provision of various services. advances.
3. Nature It is recurring in nature as such It is non-recurring in nature.
expenditure is spent by government
on day-to-day activities.
4. Examples Salary, pension, Interest, etc. Repayment of borrowings;
Expenditure on acquisition of
capital asset, etc.

How to classify Expenditure as Revenue or Capital Expenditure?

 An expenditure is a capital expenditure, if it either creates an asset or reduces a

liability.
 An expenditure is revenue expenditure, if it neither creates any asset nor reduces
any liability.

13. MEASURES OF GOVERNMENT DEFICIT

Budgetary deficit is defined as the excess of total estimated expenditure over total
estimated revenue. When the government spends more than it collects, then it incurs a
budgetary deficit. With reference to budget of Indian government, budgetary deficit can
be of 3 types:

(1) Revenue Deficit (2) Fiscal Deficit (3) Primary Deficit

14. Revenue Deficit

Revenue deficit is concerned with the revenue expenditures and revenue receipts of the
government. It refers to excess of revenue expenditure over revenue receipts
during the given fiscal year.

Revenue Deficit = Revenue Expenditure - Revenue Receipts

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Revenue deficit signifies that government's own revenue is insufficient to meet the
expenditures on normal functioning of government departments and provisions for
various services.

Implications of Revenue Deficit

 It indicates the inability of the government to meet its regular and recurring
expenditure in the proposed budget.

 It implies that government is dissaving, i.e. government is using up savings of

other sectors of the economy to finance its consumption expenditure.

 It also implies that the government has to make up this deficit from capital receipts,
i.e through borrowings or disinvestments. It means, revenue deficit either leads to
an increase in liability in the form of borrowings or reduces the assets through
disinvestment.

 Use of capital receipts for meeting the extra consumption expenditure leads to
inflationary situation in the economy. Higher borrowings increase the future
burden in terms of loan amount and interest payments.

 A high revenue deficit gives a warning signal to the government to either curtail
its expenditure or increase its revenue.

Measure to Reduce Revenue Deficit

 Reduce Expenditure:
Government should take serious steps to reduce its expenditure and avoid
unproductive or unnecessary expenditure.

 Increase Revenue:
Government should increase its receipts from various sources of tax and non-tax
revenue.

15. Fiscal Deficit

 Fiscal deficit presents a more comprehensive view of budgetary imbalances. It is
widely used as a budgetary tool for explaining and understanding the budgetary
developments in India.
 Fiscal deficit refers to the excess of total expenditure over total receipts
(excluding borrowings) during the given fiscal year.

Fiscal Deficit = Total Expenditure- Total Receipts excluding borrowings*

The extent of fiscal deficit is an indication of how far the government is spending beyond
its means.

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Implications of Fiscal Deficit

The implications of fiscal deficit are as follows:

I. Debt Trap:
 Fiscal deficit indicates the total borrowing requirements of the government.
Borrowings not only involve repayment of principal amount, but also require
payment of interest.

 Interest payments increase the revenue expenditure, which leads to revenue

deficit.

 It creates a vicious circle of fiscal deficit and revenue deficit, wherein

government takes more loans to repay the earlier loans.

 As a result, country is caught in a debt trap.

II. Inflation:
 Government mainly borrows from Reserve Bank of India (RBI) to meet its
fiscal deficit.

 RBI prints new currency to meet the deficit requirements.

 It increases the money supply in the economy and creates inflationary

pressure.

III. Foreign Dependence:

 Government also borrows from rest of the world, which raises its
dependence on other countries.

IV. Hampers the future growth:

 Borrowings increase the financial burden for future generations.

 It adversely affects the future growth and development prospects of the

country.

Sources of financing fiscal deficit are:

 Borrowings:
Fiscal deficit can be met by borrowings from the internal sources (public,
commercial banks etc.) or the external sources (foreign governments,
international organizations etc.)

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 Deficit Financing (Printing of new currency):

 Government may borrow from RBI against its securities to meet
the fiscal deficit.RBI issues new. Currency for this purpose. This
process is known as deficit financing.

16. Primary Deficit

Primary deficit refers to difference between fiscal deficit of the
current year and interest payments on the previous borrowings.

Primary Deficit = Fiscal Deficit - Interest Payments

Implications of Primary Deficit

 It indicates how much of the government borrowings are going to
meet expensesother than the interest payments.

 The difference between fiscal deficit and primary deficit shows the
amount of interest payments on the borrowings made in past.

 So, a low or zero primary deficits indicates that interest

commitments (on earlier loans) have forced the government
to borrow.

Primary Deficit is the root Cause of Fiscal Deficit

 In India, interest payments have considerably increased in the
recent years. High interest payments on past borrowings have
greatly increased the fiscal deficit.

 To reduce the fiscal deficit, interest payments should be reduced

through repayment of loans as early as possible.

Comparison between Primary Deficit and Fiscal Deficit

Basis Primary Deficit Fiscal Deficit
1. Meaning It shows the difference between It shows the excess of total
fiscal deficit and interest payment. expenditure over total receipts
excluding borrowings.
2. Indicator It indicates the total borrowing It indicates the total borrowing
requirements of the government, requirements of the government
excluding interest. including interest.
3. Formula Primary deficit = Fiscal deficit - Fiscal Deficit = Total Expenditure -
Interest payment Total Receipts excluding borrowings

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