GOVERNMENT BUDGET AND THE ECONOMY

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R.S.SAINI

PGT - ECONOMICS

PM SHRI K. V. SILCHAR

OBJECTIVES OF GOVERNMENT BUDGET

Government prepares the budget for fulfilling certain objectives. These objectives are the direct outcome of the government’s economic, social and political policies. The various objectives of government budget are:

• Reallocation of Resources: Through the budgetary policy, Government aims to reallocate resources in accordance with the economic and priorities of the country. Government can influence allocation of resources through:
• Tax concession or subsidies: To encourage investment, government can give tax concession, subsidies etc. to the producers. For example, Government discourages the production of harmful consumption goods(like liquor, cigarettes etc.) through heavy taxes and encourages the use of “Khadi Products” by providing subsidies.
• Directly producing goods and services: If private sector does not take interest, government can directly undertake the production.

OBJECTIVES OF GOVERNMENT BUDGET

• Reducing Inequalities in income and wealth: Economic inequality is an inherent part of every economic system. Government aims to reduce such inequalities of income and wealth, through its budgetary policy. Government aims to influence distribution of income by imposing taxes on the rich and spending more on the welfare of the poor.
• Economic Stability: Government budget is used to prevent business fluctuation of inflation of deflation to achieve the objective of economic stability. The government aims to control the different phases of business fluctuations through its budgetary policy.
• Management of Public Enterprises: There are large numbers of public sector industries(especially natural monopolies), which are established and managed for social welfare of the public. Budget is prepared with the objectives of making various provisions for managing such enterprises and providing them financial help.

OBJECTIVES OF GOVERNMENTBUDGET

• Economic Growth: The growth rate of a country depends on rate of saving and investment. For this purpose, budgetary policy aims to mobilise sufficient resources for investment in the public sector. Therefore, the government makes various provisions in the budget to raise overall rate of savings and investment in the economy.
• Reducing regional disparities: The government budget aims to reduce regional disparities through its taxation and expenditure policy for encouraging setting up o production units in economically backward regions.

COMPONENTS OF GOVERNMENT BUDGET

COMPONENTS OF GOVERNMENT BUDGET

Two major components of Budget are:-

• Revenue Budget:- It deals with the revenue aspect to the government budget. It explains how revenue is generated or collected.
• Capital Budget:- Capital Budget consists of capital receipts and payments. It also incorporates transactions in the Public.

Components

The components of Budget can also be categorised according to receipts and expenditure .On this basis two broad components are :-

• Budget Receipts
• Budget Expenditure

Budget Receipts:-Budget receipts refers to the estimated money receipt of this government from all sources during a given fiscal year Budget.

Budget Receipts

Budget receipts refer to estimated money receipts of the government from all sources during the fiscal year.

Broadly, the budget receipts are classified as:

• Revenue Receipts, and
• Capital Receipts.

Following are the details:

Revenue Receipts

Revenue receipts are those money receipts of the government which show the following two characteristics:

• These receipts do not create any corresponding liability for the government. Example: Tax receipts. Tax is a revenue receipt because it does not involve any corresponding liability for the government. Tax is a unilateral (or one-sided) compulsory payment to the government.
• These receipts do not cause any reduction in assets of the government. Example: Tax receipts do not lead to any reduction in assets of the government. In contrast, if government receives money by selling its share of some company (say Air India), it causes reduction in assets of the government. These are therefore, not to be treated as revenue receipts.

In short, revenue receipts of the government are those money receipts which do not create a liability for the government and as well do not lead to reduction in assets of the government.

Revenue receipts are broadly classified as tax receipts and non-tax receipts

Tax Receipts

A tax is a compulsory payment to the government by the households, firms or other institutional units. The taxpayer cannot expect any service or benefit from the government, in return.

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A tax is a compulsory payment made by an individual, household or a firm to the government without reference to anything in return.

Types of Taxes

Taxes are broadly classified as:

• Progressive and Regressive Taxes,
• Value Added and Specific Taxes, and
• Direct and Indirect Taxes.

Progressive and Regressive Taxes

Taxes are classified as 'progressive' and 'regressive' depending on the real burden of taxation. Details are as under:

• Progressive Tax: A tax is said to be progressive when the rate of tax increases with an increase in income. So that, the real burden of the tax is more on the rich and less on the poor.
• Regressive Tax: A tax is said to be regressive when it causes a greater real burden on the poor than the rich.

Value Added Tax or VAT and Specific Taxes

Depending upon tax base, taxes can be classified as:

• Value Added Tax or VAT: Value added tax is an indirect tax which is imposed on 'Value Added' at the various stages of production. Value added refers to the difference between value of output and value of intermediate consumption. It is imposed at each stage of production. GST is an important form of value added tax.
• Specific Tax: When a tax is levied on a commodity on the basis of its units, size or weight, it is called the specific tax.

Direct and Indirect Taxes

Taxes are classified as direct and indirect depending on their final

burden.

• Direct Tax: A direct tax is the one the final burden of which is borne by the person on whom it is imposed. For example, income tax is imposed on the income of a person and he himself bears its burden. The burden of tax cannot be shifted to any other person. Income tax, corporation tax, gift tax, wealth tax, are examples of direct tax.
• Indirect Tax: An indirect tax is the one whose initial burden or impact is on one person but he succeeds in shifting the burden to another persons. GST is an important example. It is levied on the producers. They are to pay this tax to the government. But they charge this tax from the buyers by adding it to the price of the goods sold.

Direct Tax and Indirect Tax-The Difference

Non-tax Receipts

Non-tax receipts are those receipts which arise from sources other than taxes. Some of the non-tax receipts are as follows:

Fees: A fee is 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.

It is to be noted that fee is not a payment (price) for commercial service. It is a payment for administrative and judicial services provided to the people.

Non-tax Receipts

Fines: Fines are those payments which are made by the law breakers to the government. These are economic punishments for breaking laws. The aim is not to earn revenue, but to make people respectful to the laws.

Escheat: Escheat refers to that income of the state which arises out of the property left by the people without a legal heir. There are no claimants of such property. The government makes revenue out of it.

Non-tax Receipts

Special Assessment: Special assessment is that payment which is made by the owners of those properties whose value has appreciated due to developmental activities of the government. Example: When as a result of construction of roads or provision of sewerage system or construction of drains, etc. , value of the neighbouring property or its rental value appreciates, then a part of the developmental expenditure is recovered from the owners of such property by way of special assessment.

Income from Public Enterprises: Several enterprises are owned by the government.

Examples: Indian Railways, Nangal Fertilizer Factory, Indian Oil, Bhilai Steel Plant, etc. Profit of these enterprises are a source of revenue for the government.

Non-tax Receipts

Income from the Sale of Spectrum like 2G and 3G: Income from the sale of spectrum has emerged as a significant source of non-tax receipts of the government.

Grants/Donations: Grants are also a source of government revenue. It is very common for the people to offer donations and grants to the government when there are natural calamities like earthquake, floods and famines.

Capital Receipts

Capital receipts are those money receipts of the government which show the following two characteristics:

(i) These receipts create a liability for the government. For example, loans by the government are a liability. These are to be paid back.

These are, therefore, the capital receipts of the government.

(ii) These receipts cause reduction in assets of the government. As stated earlier, money received by the government by selling its shares (say of Air India) would cause reduction in assets of the government. These are, therefore, to be treated as capital receipts.

In short, capital receipts are those money receipts of the government which either create a liability for the government or cause a reduction in its assets.

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In India, capital receipts of the government budget are often classified as under:

Recovery of Loans: The central government offers loans to the state governments to cope with financial crises. When these loans are recovered, assets of the government are reduced. Accordingly, these are classified as capital receipts.

Borrowings and Other Liabilities: While lending creates assets, borrowing creates liability. Accordingly, borrowings are to be treated as capital receipts. It may be noted that the government borrows money from:

(a) the general public. [ Borrowings from the general public are called market borrowings. ]

(b) the Reserve Bank of India.

(c) the rest of the world.

Other Receipts: These include items like 'disinvestment'. It is the opposite of investment. Disinvestment occurs when the government sells off its shares of public sector enterprises to private sector. It involves transfer of ownership of public sector enterprises to the private entrepreneurs, leading to privatisation. Money received through disinvestment is treated as capital receipt because it causes reduction in assets of the government.

Budget Expenditure

Budget expenditure refers to estimated expenditure of the government during the fiscal year.

Like budget receipts, budget expenditure of the government is broadly classified as:

• Revenue Expenditure, and
• Capital Expenditure.

Revenue Expenditure

Revenue expenditure of the government is that expenditure which shows the following two characteristics:

(i) It does not create any asset for the government. For example, expenditure by the government on old-age pensions, salaries and scholarships are to be treated as revenue expenditure. Because this does not lead to any type of asset formation.

(ii) It does not cause any reduction in liability of the government.

Expenditure by way of grants to the state government to cope with natural calamities (like floods and earthquakes) does not reduce financial liability of the central government in any manner.

Accordingly, this is to be treated as revenue expenditure.

In short , revenue expenditure refers to estimated expenditure of the government in a fiscal year which does not create assets or causes a reduction in liabilities.

Important Items of Revenue Expenditure in the�Indian Government Budget

These are:

(i) Wage bill of the government.

(ii) Interest payments.

(iii) Expenditure on subsidies.

(iv) Defence purchases.

Capital Expenditure

Capital expenditure of the government is that expenditure which shows the following two characteristics:

(i) It creates assets for the government. Equity (or shares) of the domestic or multinational corporations purchased by the government may be cited as an example.

(ii) It causes reduction in liabilities of the government. Repayment of loans certainly reduces liability of the government. Accordingly, this is to be treated as capital expenditure.

In short, capital expenditure refers to the estimated expenditure of the

government in a fiscal year which creates assets or causes a reduction in liabilities.

Important Items of Capital Expenditure in the Indian Government Budget

These are:

(i) Expenditure on land and building.

(ii) Expenditure on machinery and equipment.

(iii) Purchase of shares.

(iv) Loans by the central government to the state governments or state corporations.

Plan and Non-plan Expenditure

Budget expenditure (revenue expenditure + capital expenditure) is also classified as plan and non-plan expenditure. Following is the difference:

• Plan Expenditure: Plan expenditure refers to that expenditure which relates to (i) specified plans and programs of development, and (ii) assistance of the central government to the state governments. It includes both revenue expenditure (like assistance to the states) and capital expenditure (like expenditure on the construction of roads, bridges and hospitals).
• Non-plan Expenditure: Broadly, all expenditure other than plan expenditure is classified as non-plan expenditure. Specifically, nonplan expenditure relates to expenditure on routine functioning of the government. Or, it includes expenditure on such services as of law and order, defence and subsidies.

Thus, we can write that:

Budget Expenditure = Revenue expenditure + Capital expenditure

OR

Budget Expenditure = Plan expenditure + Non-plan expenditure

Structure of Government Budget at a Glance

Difference Between Revenue Receipts and Capital Receipts

Revenue Receipts

Capital Receipts

Difference Between Revenue Expenditure and Capital Expenditure

Revenue Expenditure

Capital Expenditure

How are revenue budget different from capita l budget?

Revenue Budget

Capital Budget

Budget Deficit

Budget deficit (also called government deficit) refers to a situation when budget expenditures of the government are greater than the budget receipts.

OR,

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.

Budget Deficit = Total expenditure (Revenue expenditure + Capital expenditure - Total receipts (Revenue receipts + Capital receipts)

BD = BE - BR, when BE > BR

Revenue Deficit

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

Revenue Deficit = Revenue expenditure - Revenue receipts

RD = RE - RR

when RE > RR

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Implications of Revenue Deficit

• Because of revenue deficit, the government may have to cut its expenditure on several welfare programs in the country. This leads to loss of social welfare.
• The government may have to raise funds through borrowing. This raises liabilities of the government and lowers its credit-worthiness.
• The government may be compelled for disinvestment-selling its ownership of public enterprises. The ownership of public enterprises may be lost to foreign companies. Consequently, economic control of the foreigners may increase in the domestic economy.

Fiscal Deficit

Fiscal deficit is the excess of total expenditure over total receipts (other than borrowings).

Fiscal Deficit = Total expenditure (Revenue expenditure + Capital expenditure) - Total receipts other than borrowings (Revenue receipts + Capital receipts other than borrowings)

FD = BE - BR other than borrowings, when BE > BR other than borrowings

In fact, fiscal deficit is the estimation of total borrowings by the government. It is often called ' Gross Fiscal Deficit'. Gross Fiscal Deficit = (i) Borrowing from RBI + (ii) Borrowing from abroad + (iii) Net borrowing at home

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Implications of Fiscal Deficit

Fiscal deficit is an estimate of borrowings by the government. Greater fiscal deficit implies greater borrowings by the government. It has following implications:

• Inflationary Spiral: Borrowing from RBI is often linked to inflationary spiral in the economy. This is how it happens: Borrowing from RBI increases money supply in the economy. Increase in money supply leads to increase in the general price level. A persistent increase in the general price level (over a period of time) leads to inflationary spiral. [Borrowing from RBI Increase in money supply Increase in prices Inflationary spiral.]
• National Debt: Fiscal deficit leads to national debt. It hinders GDP growth. Because, a significant percentage of national income is used up to pay the past debts
• Vicious Circle of High Fiscal Deficit and Low GDP Growth: Constantly high fiscal deficit leads to a situation where: (a) GDP growth remains low because of high fiscal deficit, and (b) fiscal deficit remains high because of low GDP growth. [ High fiscal deficit Low GDP growth High fiscal deficit.]
• Crowding-out: High fiscal deficit leads to 'Crowding-out Effect'. This is a situation when high borrowings by the government (owing to high fiscal deficit) reduces the availability of funds (in the money market) for the private investors. Accordingly, overall investment in the economy is reduced.
• Erosion of Government Credibility: High fiscal deficit (and consequently, the mounting national debt) erodes credibility of the government in the domestic as well as international money market. 'Credit rating' of the government (and the economy) is lowered. Owing to lower credit rating, global investors start withdrawing their investment from the domestic economy. Consequently, GDP growth is reduced.

Primary Deficit

Primary deficit is the difference between fiscal deficit and interest payment.

Primary Deficit = Fiscal deficit - Interest payment PD = FD-IP

While fiscal deficit shows borrowing requirement of the government inclusive of interest payment on the past loans, primary deficit shows borrowing requirement of the government exclusive of interest payment. In other words, primary deficit indicates government borrowings on account of current year expenditures and current year receipts of the government.

Implications Primary Deficit

Implications of primary deficit are similar to those of fiscal deficit.

The only difference is that primary deficit does not carry the load of interest payments on account of the past loans. Primary deficit just indicates borrowings when:

Current year expenditure > Current year revenue.

Balanced Budget

A balanced budget is that budget in which government receipts are equal to government expenditure.

Balanced Budget:

Government Receipts = Government Expenditure.

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Merits and Demerits of Balanced Budget

Merits:

• The government does not indulge in wasteful expenditure.
• A balanced budget ensures financial stability. It signals fiscal discipline in the economy.

However, during the general depression of 1930's, the policy of balanced

budget was severely criticised. It was then that the following shortcomings

of a balanced budget were highlighted.

Shortcomings or Demerits:

• Balanced budget does not offer any solution to the problem of unemployment. Particularly, when unemployment is linked with the lack of AD. It happened in most European Countries during 1930's.
• Balanced budget is not conducive to growth in less developed countries. Kick-start of growth in these economies depends on a big-push of investment expenditure by the government. This often leads to deficit budget.

Unbalanced Budget

An unbalanced budget is that budget in which receipts and expenditures of the government are not equal. This may be a situation of:

• Surplus Budget,

OR

• Deficit Budget.

Surplus Budget

Surplus Budget

This is a budget in which government receipts are greater than government expenditures.

Surplus Budget:

Estimated Government Receipts > Estimated Government Expenditures

Merits and Demerits of Surplus Budget

Merits:

Surplus budget (when, receipts > expenditures) is desired when the

economy is battling inflation due to excess AD. Surplus budget plugs the inflationary gap by lowering the level of AD. AD is lowered on account of (i) rise in revenue collection by the government, and (ii) fall in government expenditure.

Demerits:

As surplus budget tends to lower the level of AD in the economy, it

is not desired during periods of depression. If surplus budget policy is

constantly pursued by the government, AD may reduce to a level that

causes unemployment in the economy. The economy may be driven

into a low level equilibrium trap.

Deficit Budget

This is a budget in which government expenditures are greater than government receipts.

Deficit Budget:

Estimated Government Expenditures > Estimated Government Receipts

Keynes and other modern economists stress significance of deficit budget, highlighting its merits.

Merits and Demerits of Deficit Budget

Merits:

Keynes recommends deficit budget as a key instrument to correct the state of depression. According to him, depression is that phase of economic activity when the level of investment is low owing to the low level of AD. Consequently, planned output is much lower than the full employment level of output. Unemployment becomes a national problem. Deficit budget raises the level of AD in two ways :

• Directly by way of high government expenditure , and
• Indirectly by inducing greater (investment and consumption) expenditure by the people.

Demerits:

Deficit budget is not desired during periods of inflation . It is a period when the AD exceeds AS at full employment. Deficit budget in such situations (when AS can not increase) would further in crease the gulf between AD and AS. Consequently, inflationary gap would rise and wage-price spiral (when wages i n crease with prices and prices in crease with wages) may set in.

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