UNIT 4

GOVERNMENT BUDGET AND THE ECONOMY

CONTENT OF THIS UNIT

➢ Meaning of the term budget

➢ Objectives of the budget
➢ Structure of the budget and its classification
➢ Deficit and its types

Meaning of government budget

A government budget is an annual statement of the estimated receipts and expenditures of the
government over the fiscal year.

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 of the government.

In India, government budget is normally presented in the Parliament in the month of February
every year.

Government at all levels, whether central, state or a local level, prepare the budget. Budget is
prepared, keeping in view the general policy of government towards the welfare of people.

The budget, by being an annual statement of the estimated receipt s and expenditures of the
government is a tool for the government to implement its various policies.

A budget has 2 parts one part shows expenditure and the other part shows receipts. ie. the
sources of financing expenditure.

OBJECTIVES OF THE BUDGET

1. Reallocation of resources:
➢ Through its budgetary policy the government of a country directs the allocation of
resources in a manner such that there is a balance between the goals of profit
maximization and social welfare.
➢ Production of goods which are injurious to health (like cigarettes and whisky) is
discouraged through heavy taxation.
➢ On the other hand, production of socially useful goods (like Khadi) is encouraged
through subsidies.

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 ➢ Government provides certain goods and services which cannot be provided by the
market mechanism i.e. by exchange between individual consumers and producers.
Examples of such goods are national defense, roads, government administration
etc. which are referred to as public goods.
2. Redistribution of income and wealth:

➢ Another objective of the government is to reduce income inequalities to achieve the

goal of social equity and regional equalities. The government uses fiscal instruments of
taxation and subsidies with a view to improve the distribution of income and wealth in
the economy.
➢ Equalities in income distribution primarily require that the rate of growth of real income
of low-income sections of the society should be faster than the rate of growth of the
high-income sections of the society.
➢ To correct inequality the government pursues the policy of progressive taxation. It implies
greater tax burden on the rich than the poor.
Progressive taxation of income and wealth will help the government to mobilize more
resources. These resources can be spent on the social sector of the economy. Free
education, medical facilities drinking water, sanitation and transport facilities add to the
real income of the poor.
➢ In fact, those with low income group are exempted from payment of tax. On the
expenditure side government offers subsidies to the poor.
Subsidies are offered so that their real disposable income is raised. Also, essential food
items are sold to the Below poverty line families at subsidized rates
3. Economic Stability

The government tries to prevent business fluctuations and maintain economic stability.

➢ During the period of depression & inflation, govt. adopts the policy of deficit &
surplus budgeting respectively.
➢ During periods of inflation, government may discourage spending by increasing
taxes and reducing its own expenditure. This will decrease aggregate demand to
correct inflationary situation.
➢ During periods of recession (or high rate of unemployment), government can
reduce taxes to encourage demand as well as increase its own expenditure. •
Government can also use subsidies to encourage spending by people.
➢ The economic stability is indispensable for the stimulation of savings & investment
which further raises the level of economic growth & development.
4. Management of public enterprise:

➢ The budgetary policy of the government shows interest of the government to

increase the rate of growth through public enterprises. Often public-sector
enterprises are encouraged in areas of natural monopolies

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 ➢ Government undertakes commercial activities that are of the nature of natural
monopolies. heavy manufacturing etc through its public enterprises.
➢ The management of such enterprises comes under state regulation because it left
unregulated there is a tendency of the monopolist to curtail output in pursuit of
maximizing profits. This will lower social welfare.
Note: Natural monopolies refer to those areas of production where a single firm can produce
at a lower average cost than many competing firms. Example Railways.

5. Economic growth:

Economic Growth implies a sustainable increase in real GDP of an 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
➢ If the government provides tax rebates and other incentives for productive ventures and
projects, it can stimulate savings and Investments in an economy.
➢ Spending on infrastructure of an economy enhances the production activity in different
sectors of an economy.
➢ The government itself may set up production units and these will add to the production
potential and the volume of output.
➢ Government expenditure is a major factor that generates demand for different types of
good and services in an economy which induces growth in private sector too.

Other objectives of Budget

6. Generation of employment opportunities

7. Reducing regional Disparities

Public and Private goods

Public goods Private goods
Benefits of Public goods are available to all and are Anyone who does not pay for the goods can
not only restricted to one particular consumer. be excluded from enjoying its benefits.

Non rivalrous-public goods are non-rival. This Rivalrous-Private goods are rival in nature,
means it is equally available to all the people of as when it is consumed by one person, it
the society. Hence, its benefit can’t be reduced if reduces the amount of goods available to
any person consumes it. other persons.

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 Non excludable- As these goods are owned by the Excludable-The person who owns a private
government, no one can exclude the other person good can exclude another person from
from consuming it. (Even if some users do not pay, consuming it. For example: If the buyer of
it is difficult and sometimes impossible to collect the goods does not have enough money,
fees for the public good. These non paying users then the seller can exclude the buyer from
are known as ‘free-riders’) consuming it

Example- Bridge Example -Car

Public Provision and Public Production

PUBLIC PROVSION PUBLIC PRODUCTION

In this model, the government is responsible In this model, the government itself produces
for determining the need for a particular and provides the public good or service.
public good or service, such as healthcare or
education, and then contracts with private
entities to provide it. Public provision means
that they are financed through the budget
and can be used without any direct payment.
Delivering goods and services The government is responsible for the
production and delivery of the good or
The government has limited control over service, and it has direct control over the
how the private entities provide the goods or quality, delivery, and pricing of the public
services good or service.

COMPETITION---the government contracts No competition-

with private entities, which may compete there is no competition as the government is
with each other to provide the best service at the sole provider of the public good or
the lowest cost. service. This lack of competition can lead to
This competition can lead to better service inefficiencies and higher costs for the public.
and lower costs for the public.

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 STRUCTURE OF THE GOVERNMENT BUDGET
OR
COMPONENTS OF THE BUDGET

Revenue Budget

A revenue budget is a statement of the government's anticipated revenue receipts and

expenditures for a fiscal year. The revenue budget is for revenue items that are
recurring and non-redeemable.

• There are two parts to the revenue budget:

o Revenue receipts
o Revenue expenditures.

Capital Budget

Capital Budget comprises capital receipts and capital expenditure.

There are two parts to the capital budget

• Capital receipts
• Capital Expenditure

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Differentiate between revenue budget and capital budget

Revenue budget Capital budget

It includes revenue expenditure and revenue This includes capital receipts and capital
receipts expenditure
Revenue budget does not relate to asset- This relates to asset -liability status of the
liability status of the government government
Focuses on the welfare of the people Focuses on the GDP growth

Budget receipts:
It refers to the estimated receipts or inflow of money of the government from various sources
during a fiscal year. It reflects how and from where government intends to get money to
finance the expenditure.

It is of 2 types
Revenue receipts and capital receipts.

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REVENUE RECEIPTS

➢ Revenue receipts are those which do not create any liability for the government
➢ They do not cause any reduction in assets of the government.

For example, receipts of the government when it sells shares of companies like Maruti Udyog,
causes reduction in assets of the government. These are therefore not to be treated as revenue
receipts.

Revenue receipts may be divided into tax revenue and non- tax revenue.

tax revenue: A tax is a legally compulsory payment imposed by the government example
income tax and sales tax.

Taxes are of 2 types one is direct tax and other indirect tax.

Direct tax Indirect tax

These are imposed on income wealth These are imposed on income when it is
and property spent. (i.e) on goods and services
The tax liability and incidence (burden) The tax liability of an indirect tax is on the
of a direct tax is on the same person producers /sellers but the incidence
(burden) of the tax is passed on to the
consumers.
These cannot be escaped These can be escaped by not consuming
goods and services
Income tax , corporation tax, wealth tax Sales tax excise duty entertainment tax
are examples service tax are examples

NON- TAX REVENUE: Revenue receipts of the government from sources other than tax.

Types of non- tax revenue: Commercial and administrative revenue

Commercial revenue

➢ It is the revenue received by the government in the form of prices paid for government
supplied commodities and services. payments for postage, tolls ,electricity and railway
services

➢ Interest on loan

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 ➢ and dividend on investments made by the govt.

➢ Profits from PSUs

Administrative revenue:

It is that revenue that arises due to the administrative functions of the government.

➢ Fees: It is defined as a payment to the government for the services that it renders to the
people. Examples land registration fees, birth and death registration fees, passport
fees, court fees etc.

➢ Features of fees:

a) It is a compulsory payment
b) It provides specific benefit to the payer.
c) It is not a payment for commercial service. It is a payment for administrative and
judicial services provided to the people.
➢ Fines and Penalties: these are levied for infringement of the law.

➢ Forfeitures: Of basic surety or bonds are penalties imposed by courts for non-
compliance with orders or non- fulfillment of contract etc.

➢ Escheat: It refers to the claim of the government on the property of a person who dies
without having any legal heirs or without leaving a will.

➢ License fee: license fees are charged to give permission for something by the
government. Examples are driving license, and import license.

➢ Special assessment: it is a payment which is made by the owner of those properties

whose value has appreciated due to developmental activities of the government.
Example as a result of construction of roads or provision of sewerage system, value of
the neighboring property may appreciate. The government may recover part of its
developmental expenditure from the owner of such property by way of special
assessment.

➢ Gifts and grants

Government receives gifts and grants from within the country and abroad. This is
generally received during natural calamities like flood ,earthquakes, war situations etc.

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 Capital receipts
The capital receipts of the government refer to all those receipts which either create a liability
or cause reduction in the asset value. ie government is under obligation to return the amount
in the future. It is non- repetitive and non-routine in nature.

There are 2 types of capital receipts

DEBT CREATING CAPITAL RECEIPTS

➢ The capital receipts of the government refer to all loans raised by the government from
the public. (these are market loans) borrowings by the government from the Reserve
Bank of India, and other parties, through the sale of treasury bills, loans received from
foreign governments, and bodies, (example world bank, etc)

NON DEBT CREATING CAPITAL RECEIPTS: This refers to those capital receipts other than
borrowings and therefore does not give rise to debt.

➢ For example. Proceeds from sale of shares in Public sector undertakings (PSUs) which is
referred to as disinvestment.
➢ Recoveries of loans granted to state and union territory governments and other parties,
small savings and deposits in the public provident fund etc.

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Revenue receipts Capital receipts
These do not create liability to the These either increase the liability of the
government. Government or decrease the asset
Revenue receipts are recurring They are non-recurring in nature
There are 2 types of revenue receipts tax and There are three kinds of non-tax receipts
non-tax revenue Borrowings, recovery of loans and
Tax revenue (income tax and sales tax) disinvestments
Non- tax revenue (commercial and
administrative revenue)

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 BUDGET EXPENDITURE:
It refers to the estimated expenditure to be incurred by the government during the fiscal year.

REVENUE EXPENDITURE

Revenue expenditure is that expenditure incurred for the normal running of the government
departments and provision of various services, interest charges on debt incurred by the
government subsidies. In short revenue expenditure refers to estimated expenditure of the
government in a fiscal year which does not either create assets or cause a reduction in liabilities

➢ All grants given to state governments

➢ Salaries,

➢ pensions

➢ interest payments

➢ subsidies,

➢ grants etc.

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CAPITAL EXPENDITURE:

An expenditure which leads to creation of assets or reduction in liabilities is treated as capital

expenditure.

These expenditures are incurred over a long period of time and add to the capital stock to the
economy thereby raising its capacity to produce. For example expenditure on purchasing land,
expenditure on construction of government hospitals schools, bridges,roads, other infrastructure
(create asset) repayment of loans by government (reduces liability)

In short, capital expenditure refers to the estimated expenditure of the government in a fiscal
year which either creates assets or causes a reduction in liabilities.

Examples of capital expenditure

Purchase of Purchase of Loans given by central

Investment
land and machinery and government to state
in shares
building equipments government

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Differentiate between revenue and capital expenditure

Revenue expenditure Capital expenditure

These are short period expenditures They are long period expenditure
These are recurring These are non-recurring
Revenue expenditure neither creates the Capital expenditures either increase the
assets nor decrease the liability assets or decrease liabilities
These do not create any physical or financial These lead to creation of physical or
assets financial assets
Expenditure on defence law and order Capital expenditure is expenditure
administration etc are examples of revenue incurred on scientific research
expenditure organization, on roads, bridges building
dams etc

PLAN AND NON PLAN EXPENDITURE:

Plan expenditure: It refers to that public expenditure which represents current development
and investment outlays that arise due to planned purposes,

In other words, it refers to that expenditure which is incurred by the government to fulfill its
planned development programmes. The assistance provided by the central government for the
plans of states and union territories is also a plan expenditure

Our assistance provided by our central government for our plans of the state and union territories
programmes under the current five-year plans. Example: expenditure on agriculture, power
communication, industry, transport, health and education atomic energy, public utilities,

Non plan expenditure: Expenditure other than the expenditure related to the current five year
plan is treated as non plan expenditure.

Example: Expenditure on maintenance of assets expenditure in case of natural calamities, etc

DEVELOPMENTAL AND NON DEVELOPMENTAL EXPENDITURE

Developmental expenditure:

Expenditure on activities which are directly related to economic and social development of the
country is called development expenditure

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It includes loans given by the government to non departmental enterprises (like Air India, Indian
Airlines), local bodies and other parties, expenditure on agriculture, industry, roads, canals,
generation of power, social welfare, scientific research etc.

➢ Examples: Expenditure on agriculture and industrial development education , health,

etc.

Non developmental expenditure:

Expenditure on essential general services of the government is called non development

expenditure

Expenditure on defence, administration interest payment, famine relief subsidies on food etc.
payment of old age pensions etc.

DEVELOPMENT EXPENDITURE

Plan expenditure on Plan expenditure on Non Loans by the

Departmental Departmental Enterprises Government to Non
Enterprises of the of the Government e.g. Air Departmental
Government e.g. India, Indian Airlines Enterprises for the
railways, post and purpose of development
telegraph

NON- DEVELOPMENT EXPENDITURE

Expenditure on Expenditure on Subsidy on

Defence interest Payment Expenditure on Loans for non- food and
by government tax collection by developmenta cloth for
government l purposes poorer
section of the
society

Types of Budget
The budget is divided into three types.

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Balanced budget – A government budget is assumed to be balanced if the expected
expenditure is similar to the anticipated receipts for a fiscal year.

Surplus budget – A budget is said to be surplus when the expected revenues surpass
the estimated expenditure for a particular business year. Here, the budget becomes
surplus when taxes imposed are higher than the expense.

Deficit budget- A budget is on deficit if the expenditure surpasses the revenue for a
designated year.

Budget DEFICIT

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Budget Deficit refers to a situation when budget expenditures of the government are greater
than the budget receipts.

It is the excess of total expenditure (Revenue expenditure and Capital expenditure) over and
above the total receipts (Revenue receipts and Capital receipts) of the government

There are 3 types of deficit.

1) Fiscal deficit,

2) Revenue deficit and

3) Primary deficit.

Revenue Deficit is the excess of revenue expenditure over revenue receipts.

It does not include items of Capital receipts and Capital expenditure

Revenue Deficit = Revenue Expenditure – Revenue Receipts, when RE > RR

Implications / Significance:

➢ A high Revenue deficit gives warning to the government to either to cut its expenditure
or increase its tax/non- tax receipts

➢ The government is compelled to cope with high revenue deficits through capital receipts
like borrowings, sale of assets or disinvestment.

➢ (Especially in less developed countries like India, often the situation arises when the
government has to incur huge expenditure on administration and maintenance and it is
difficult to force the poor people to pay taxes so the government has to resort to
borrowings or disinvestment)

➢ Revenue deficits may thus increase the liabilities of the government or reduce its assets.
Borrowings increase the liability of the government and disinvestment reduces the assets

➢ It can also increase the revenue deficit further in future through expenditure on interest
payments on the borrowings. The whole financial system of the economy may get
destabilized.

Fiscal deficit:

Meaning : Fiscal deficit in a government budget refers to the excess of total expenditure
over the sum of revenue receipts and non- debt capital receipts. Total expenditure
includes both revenue and capital expenditure.

Formula: Fiscal Deficit = Total Expenditure (Revenue + Capital) – Total Receipts other
than borrowings (Revenue + Capital receipts other than borrowings

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 OR

Total budget expenditure – total budget non- debt receipts. .

Fiscal deficit = total borrowings and other liabilities of the government.

➢ For example, fiscal deficit in the Indian Government Budget for the year 2012-2013 was
Rs 514 thousand crore. It is nearly 35 % of total budget expenditure. It means that to
meet its nearly 35% of the expenditure the government had to resort to borrowing. It
shows that the government is living beyond its means.

➢ Fiscal deficit within a limit does not create any problem. The safe level of fiscal deficit
is considered to be 5% of GDP. It fiscal deficit is high it would create a lot of problems.

Implication/ Significance:

I. Fiscal Deficit is estimated to know about the extent of borrowing requirements by the
government. Greater fiscal deficit implies greater borrowings by the government

II. It shows the extent of dependence of the government on borrowings to meet its total/
budget expenditure.

III. Future liability increases because the government has to pay the interest and loans. It
accumulates financial burden for future generations. It is for the future generations to
repay loans as well as mounting interest.

IV. Payment of interest increases the Revenue Expenditure and this may lead to higher
Revenue deficit. This may lead to more borrowings thereby resulting in a vicious circle
which may result in a debt trap

VII A large fiscal deficit may also cause inflation because of increased supply of money.

VIII Fiscal deficit can also increase foreign dependence if the government borrows from the
Rest of the World. It increases our dependence on other countries and leads to economic
slavery.

Primary deficit: Meaning

It is that part of fiscal deficit which indicates borrowing requirements to make up the shortfall in
receipts on account of expenditure other than interest payments.

➢ Formula: Primary deficit = Fiscal deficit – interest payments

OR

➢ Fiscal Deficit = Primary Deficit + Interest payment

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Implication/ Significance:

i) It indicates how much of government borrowing is going to meet expenses other than
the interest payments

ii) It reflects the extent to which current government policy is adding to future burdens
arising/stemming from the past policy

iii) It is used as a basic measure of fiscal irresponsibility.

iv) A low primary deficit is a sign of fiscal discipline or fiscal responsibility on the part
of the government.

v) Zero primary deficit means the government has to resort to borrowing only to
fulfill its earlier commitments of interest payments. It is not adding to the existing
loans for the purpose other than meeting its existing obligation of interest payment.
It is a sign of fiscal discipline or fiscal responsibility on the part of the government.

HOW MAY A DEFICIT BE FINANCED?

By monetary expansion

Monetary expansion means printing money to the extent of the deficit.

It generally leads to inflation if our increased supply of money is not matched by an equivalent
supply of goods and services in the economy.

Borrowing:

The process of monetary expansion involves the government borrowing from the central bank
through the issue of treasury bills to the central bank. The central bank purchases the treasury
bills in return for cash, which the government uses to fund the deficit.

The deficit may be funded by borrowing from the public through market loans etc.

The value of the balanced budget multiplier is defined as the ratio of increase in income to
increase in government expense financed by taxes it is always equal to unity.

Example to Show the Estimation of Various Types of Budget Deficits

Items Rs (Crores)
1) Revenue Receipts 6,02935
2) Revenue Expenditure 658119
3) Capital Receipts 1,47949
4) Capital Expenditure 92,765
5) Total Receipts (1 + 3) 750884

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 6) Total Expenditure (2 + 4) 7508844
7) Recoveries of loans and other receipts 14662
8) Borrowings and other liabilities 1,33287
9) Interest payment 1,90807

Revenue deficit = 2-1 658119 – 6 02935 = 55184 crores

Fiscal deficit = 6-(1+7) = 750884 –(602935 +14662) = 133287 crore

Fiscal deficit is the same as borrowings = item number 8 133287 crore.

Primary deficit = Fiscal deficit – interest payments

133287 – 190807 = 57520 crore.

1) A government budget shows a primary deficit of Rs 4,400 Crores. Expenditure on interest

payment is Rs 400 Crores. How much is the fiscal deficit

Ans) Fiscal deficit = Primary deficit + Interest payment

= 4,400 + 400 = Rs 4,800 Crores

2)In a government budget, Revenue deficit is Rs 50,000 Crores. Borrowings are Rs 75,000
Crores. How much is the Fiscal deficit

Ans) Fiscal deficit = Borrowings

= Rs 75,000 Crores

3)Calculate Budgetary deficit from the following

1) Revenue Expenditure Rs 60.000 Crores

2) Capital Expenditure Rs 30,000 Crores
3) Revenue Receipts Rs 50,000 Crores
4) Capital Receipts Rs 25,000 Crores
(Ans: Rs 15,000 Crores)

4)Giving reasons Categorize the following into Revenue receipts and capital receipts

1) Recovery of loans – Capital Receipts as it leads to reduction in assets.

2) Corporation Tax – Revenue receipt as it neither creates liability nor leads to reduction
in assets

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 3) Dividends on investment made by the government - Revenue receipt as it neither
creates liability nor leads to reduction in assets

4) Sale of public sector undertaking - Capital Receipts as it leads to reduction in assets

5) Borrowings from the market/ Reserve Bank – Capital Receipts as it increases the
liability

6) Disinvestment – Capital Receipt as it reduces the assets of the government.

7) Gifts and Grants received by the Government - Revenue receipt as it neither creates
liability nor leads to reduction in assets

5)Giving reasons Categorize the following into Revenue expenditure and capital expenditure

1) Subsidies – Revenue expenditure because it does not reduce liability or does not
increase the assets of the government.

2) Grants given to State Governments - Revenue expenditure because it does not reduce
liability or does not increase the assets of the government.

(As a matter of convention, all grants given by Central Government to the State
Governments and the governments of Union Territories are treated as Revenue
Expenditure, even when some grants may result in creation of assets)

3) Repayment of loans – Capital expenditure because it leads to reduction in liability

4) Construction of School building – Capital expenditure because it adds to the asset of

the government

5) Payment of Interest – Revenue expenditure because it does not reduce liability or does
not increase the assets of the payer.

6) Expenditure on purchasing land - Capital expenditure because it adds to the asset of

the government.

7) Loans by Central Government to State Government - Capital expenditure because it

adds to the asset of the government.

HOTS
1. Can there be a fiscal deficit without a revenue deficit?

Yes, because fiscal deficit is worked out by accounting the revenue and capital receipt and
expenditure of the government. So that even when revenue receipts and revenue
expenditures are in state of balance there could be excess of capital expenditure over
capital receipts causing fiscal deficit.

2. Are fiscal deficits inflationary

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Fiscal deficits are not necessarily inflationary though, they are generally regarded as
inflationary. When the government expenditure increases or tax reduces there is
government deficit and is a corresponding increase in aggregate demand. As the money
supply in the economy increases the demand for good also increases. This gives rise to
inflation in the economy.
But on the other hand, initially if the resources are underutilized and output is below
the full employment level then with an increase in government expenditure more factor
resources get employed which is able to meet the increasing demand.
In this situation high fiscal deficit is accompanied by high demand greater output levels
and less inflation. Hence whether fiscal deficits are inflationary or not depends on how
close is the original output level to the full employment level.

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