MACROECONOMICS GOVERNMENT BUDGET AND THE ECONOMY

Government Budget and the Economy

What is Budget?

Budget is derived from the French word ‘baguette’ which means a ‘bag full of proposals’. It means a
summary of likely incomes and expenditures for a given period of time. This budget could be a
government budget or a family budget. A family budget is a summary/document of the estimated income
and expenditure to be incurred by a family for a given period, whereas government budget is a statement
of the estimates of the government’s receipts and expenditure during the financial year. There are three
types of budget which are as follows:
 Balanced budget
 Surplus budget
 Deficit budget

Objectives of Government Budget

 Redistribution of income and wealth: Government, through
fiscal tools of taxation transfer payment, brings fair
distribution of income.
 Reallocation of resources: Through the budgetary policy, the
government can reallocate resources so that social and
economic objectives can be met.
 Economic growth: Growth rate of a country depends on the
rate of savings and investment.
 Generation of employment: Government needs to promote labour intensive technology and public
work programmes to undertake employment specific projects.
 Economic stability: Government tries to maintain price and employment stability. It stimulates
inducement to invest and increase the rate of growth and development.
 Management of public enterprises: Public sector enterprises are encouraged in area of natural
monopolies.

Components of a Government Budget

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MACROECONOMICS GOVERNMENT BUDGET AND THE ECONOMY

Revenue Budget
Revenue budget is the statement of estimated revenue receipts and estimated revenue expenditure
during a fiscal year.

 Revenue Receipt
Receipts which do not create liability for the government or do not lead to reduction in assets are
known as revenue receipts. They are non-redeemable as they cannot be reclaimed from the
government. Tax revenue and non-tax revenue are the two sources of the government.
o Tax revenue: Tax revenue is the most important source of income for the government. It consists
of the proceeds of taxes and other duties levied by the government. A tax is a compulsory payment
imposed on individuals or companies by the government to meet expenditures. It comprise of
direct taxes and indirect taxes.
o Direct taxes: Direct taxes are those taxes which are imposed on an individual and firms. Final
burden cannot be shifted on to others such as income tax, wealth tax and corporation tax.
o Indirect taxes: Indirect taxes are those taxes which are imposed on an individual but are paid by
another person either partly or wholly. Hence, the impact and incidence of taxes are on different
persons. Customs and excise duties are examples of indirect taxes. Here, the producer bears the
impact and the incidence of tax on the consumer.
o Non-tax revenue: Revenue to the government from sources other than taxes is known as non-tax
revenue. It is collected in order to provide administrative services to the people. Non-tax revenue of
the Central Government are - (i) interest receipts on loans provided to the States and Union
territories. (ii) Dividend and profits received from public enterprises such as postal services,
railways etc.

 Revenue Expenditure
An expenditure which is incurred for purpose other than for the creation of physical or financial assets
of the Central Government is known as revenue expenditure. For example: Salaries, pensions, interest
payments and subsidies. It comprise of plan revenue expenditure and non-plan revenue expenditure.
o Plan revenue expenditure relates to central plans and central assistance for state and union
territory plans such as salaries and pensions
o Non-plan expenditure covers a vast range of general, economic and social services of the
government such as subsidies, defence services and interest payments on market loans

Capital Budget
Capital budget is the statement of estimated capital receipts and estimated capital expenditure during a
fiscal year.

 Capital Receipts
All those receipts of the government which create liability or reduce financial assets are termed as capital
receipts. They are obtained by the government by raising funds through borrowings, recoveries of loans
and disposing of assets.

 Capital expenditure
Capital expenditures are government expenditures which result in creation of physical or financial
assets or reduction in financial liabilities. It is classified into plan capital expenditure and non-plan
capital expenditure.
o Plan capital expenditure relates to central plan and central assistance for state and union territory
plans such as revenue counterpart.
o Non-plan capital expenditure covers various general, social and economic services provided by the
government such as relief expenditure for the earthquake victims.

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MACROECONOMICS GOVERNMENT BUDGET AND THE ECONOMY

Measures of Government Budget

When a government spends more than it collects by way of revenue, it incurs budget deficit. Deficit
budget is a situation when the budget expenditures of the government are greater than the government
receipts. Various measures which capture budget deficit are as follows:

 Revenue deficit is the excess of government’s revenue expenditure over revenue receipts.
Revenue deficit = Revenue expenditure – Revenue receipt
Where, revenue expenditures are interest payments and non-interest expenditure
Revenue receipts are tax revenue and non-tax revenue

 Fiscal deficit is the excess of total expenditure (revenue and

capital expenditure) over the total receipts (revenue and capital
receipts) excluding borrowings.
Fiscal deficit = Total budget expenditure – Total budget receipt
(excluding borrowings)

 Primary deficit is the difference between the fiscal deficit and

interest payment.
Primary deficit = Fiscal deficit – Interest payment

Fiscal Policy
Fiscal policy refers to revenue and expenditure policy of the
government which helps to correct the situations of excess
and deficient demand. It is also called budgetary policy of the
government.

Components of fiscal policy are as follows:

 Government expenditure is increased to adjust deficient
demand and decreased to adjust excess demand
 Tax burden is decreased to adjust deficient demand and
increased to adjust excess demand
 Public borrowing is increased to adjust excess demand
and decreased to adjust deficient demand
 Borrowing from RBI is increased to adjust deficient
demand and decreased to adjust excess demand

Changes in Government Expenditure

Effect of increase in government spending and the taxes remain constant. When the government
purchased G exceeds taxes T, the government runs a deficit budget. G is a component of aggregate
spending which increases the planned aggregate expenditure. At the given level of output, demand
exceeds supply and firms expand their production. The aggregate demand schedule shifts upto AD. As
the government expenditure increases from G0 to G1, it causes an equilibrium income to increase from Y0
to Y1. Now, the new equilibrium point is at E1.

Increase in Taxes
Government levy new taxes and enhance the rate of the prevailing ones. It will reduce the disposable
income of the people, and therefore the aggregate demand is reduced.

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