GOVERNMENT BUDGET & THE

ECONOMY
MEANING OF BUDGET

Government budget is an annual statement, showing item wise estimates of receipts and
expenditures during a fiscal year.
In other words, a government budget is a statement showing estimated receipts and estimated
expenditure for a financial year i.e. 1 April to 31 March. In the beginning of every year,
government presents before the Lok Sabha an estimate of its receipts and expenditure for the
coming financial year. The government plans expenditure according to its objectives and then
tries to raise resources to meet the proposed expenditure.
OBJECTIVES OF THE BUDGET

1. Redistribution of Income and Wealth / Reduction of inequalities: Government through

fiscal tools of taxation, subsidies and transfer payments makes an effort to make income
distribution equitable in the economy. Equitable distribution of income and wealth is a way
to bring social justice. Government levies high rate of tax on rich people reducing their
disposable income and lowers the rate on lower income group. Government also provides
subsidies and amenities to people whose income level is low.
2. Reallocation of resources: The government through budgetary policy reallocates
resources so as to achieve social and economic objectives. Government produces those
goods which may not be economically beneficial but are extremely useful in terms of social
benefits like public sanitation, rural electrification, education, health etc. It also levies high
taxes on commodities that are undesirable socially or ethically. It provides essential goods
to the poor at subsidized rates. Government draws away resources from some other areas
to promote balanced economic growth of regions by allocating more funds to production
of socially useful goods.
3. Economic Stability / Price Stability: The government tries to prevent business
fluctuations and to maintain price and employment stability through taxes, subsidies and
expenditure. Economic stability increases the inducement to invest and increase the rate of
growth and development.
4. Managing Public Enterprise: The budgetary policy of the government shows interest of
the government to increase the rate of growth through public enterprises. Often,
government undertakes such activities which are of utmost importance or which have
monopoly advantage. Budget is prepared with the objective of making various provisions
for managing such enterprises and providing them financial help.
5. Economic growth: Economic growth implies a sustained increase in real GDP of the
economy, i.e., a sustained increase in volume of goods & services. For this purpose,
budgetary policy aims to mobilize sufficient resources for investment in the public sector.

PUBLIC GOODS
Public goods are those goods which are provided by the government and are non excludable
and non rivalry.
two features of public goods are
Once public goods are provided, no person can be stopped from using it.
It is called non excludable
Non rivalry means if one person uses a public good it does not its availability for other
people.
Therefore, the price of public goods cannot be determined by demand and supply forces.
COMPONENTS OF GOVERNMENT BUDGET

Two components of government budget are:

Revenue Budget: It consists of revenue receipts and revenue expenditure of the government.
Capital Budget: It consists of capital receipts and capital expenditure

REVENUE BUDGET

1. Revenue Receipts: Revenue receipts are those receipts which does not create a liability
or lead to reduction in asset. Revenue receipts are of recurring nature. Revenue receipts
can be further classified into tax revenue and non tax revenue.
a. Tax Revenue: Tax revenue refers to sum total of receipts from taxes and other duties
imposed by the government. A tax is a legally compulsory payment imposed by the
government in lieu of no direct benefit is given to the payer. Government imposes tax
on income, manufacturing, services, wealth etc. Tax revenue is the main source of
regular receipts of the government. Taxes are of two types:
I. Direct Tax: These refer to taxes that are imposed by the government on property
& income of individuals & companies and are paid directly to the government.
The liability to pay a tax and the burden of that tax cannot be shifted and the
burden of the tax is borne by the same person on whom the tax is levied.
Examples are Income tax, Wealth tax, Gift tax, corporation tax, Death duty etc.
II. Indirect tax: When the burden of a tax can be shifted on other persons, it is
called an indirect tax. They are imposed on goods & services. Examples are Sales
Tax, Service Tax, Entertainment tax, Excise duty etc.
Basis of classification:
  A tax is a direct tax, if its burden can’t be shifted. Its liability to pay and burden falls
on the same person. For example: income tax, corporate tax, wealth tax, gift tax, estate
duty etc.
 A tax is an indirect tax, if its burden can be shifted. Its liability to pay and burden falls
on different persons. For example: sales tax (paid by the shopkeeper but recovered from
the customer), excise duty (paid by the producer but recovered from wholesalers &
retailers), custom duty (paid by the importer but recovered from retailers & customers),
entertainment tax (paid by cinema owners but recovered from customers) etc.
b. Non Tax Revenue: Non Tax revenue refers to receipts of the government from sources
other than tax. Its main sources are:
I. Fees: It refers to the charges imposed by the government to cover the cost of
recurring services provided by it. It gives a special advantage to the fee payer.
Example college fee, license fee, registration fee.
II. Fines and penalties: A payment for the violation of law. It is levied to
maintain law and order. For example: fine for jumping red light etc.
III. Forfeitures: A penalty imposed by the court for non compliance with orders
or non-fulfillment of contracts.
IV. Escheat: A claim of the government on the property of a person who dies
without having a legal heir or without leaving a will.
V. Interest: Government receives interest on the funds advanced to states,
union territories, railways, post & telegraph etc.
VI. Profits & dividends: The government earns profits through public sector
undertakings like Indian Railways, LIC, and BHEL etc. It also gets dividend
from its investment in other companies.
VII. License Fee: It is a payment charged by the government to grant permission
for something. For example: license fee paid for permission of keeping gun
or to obtain permission for driving.
VIII. Gifts & Grants: Government received gifts and grants from foreign
governments and international organizations like World Bank. These are
generally received during national crisis such as war, flood etc.
2. Revenue Expenditure: Revenue expenditure is an expenditure which does not result in
creation of an asset or reduction in a liability. Such expenses are incurred on running of
government departments and maintenance of public services. These are financed out of
revenue receipts. It is recurring in nature which is incurred every year. For example,
salaries, pensions, interest payments, subsidies, grants, education & health services etc.

CAPITAL BUDGET

1. Capital Receipts: Those receipts which either create a liability or reduce an asset are
called capital receipts. Capital receipts are receipts under capital account. When
government raises funds either by incurring a liability or by disposing off its assets, it is
called a capital receipt. These include market borrowings, external loans and advances
made by the government and provident fund. The main sources of capital receipts are:
a. Recoveries of loans: Loans offered by government to others are government assets
because it owns money that it lends. Recovery of such loan is capital receipt as it
reduces the assets of the government.
b. Borrowings and other liabilities: These are the funds raised by government to meet
excess expenditure. These are treated as capital receipts because they create a liability
 of returning loans. These funds are borrowed from (i) open market, (ii) RBI, (iii) foreign
governments and (iv) international organizations like World Bank, IMF etc.
c. Disinvestment: It is withdrawal of government investment. It refers to selling whole
or a part of the shares of selected PSUs held by the government to private sector. As a
result of this, government assets are reduced. Disinvestment is also termed as
privatization because it involves transfer of ownership from public sector to private
sector.
d. Small Savings: It refers to the funds raised from the public in the form of post office
deposits, NSC, Kisan Vikas Patras etc.

2. Capital expenditure: An expenditure which leads to either creation of assets or

reduction in liability is a part of capital expenditure. These expenditures are met out of
capital receipts. Its main sources are:
a. Expenditure on purchase of assets like land, buildings, machinery etc.
b. Investment in shares
c. Repayment of loan

Difference between Capital receipts and revenue receipts:

Basis Revenue Receipts Capital Receipts

Meaning It does not create a liability or lead to It either creates a liability or reduces an
reduction in asset. asset.
Nature It is regular and recurring in nature. It is irregular & non-recurring.
Future There is no future obligation to return the In case of borrowings, there is an
obligation amount. obligation of returning the amount.
Example Tax Revenues like income tax, sales tax Recoveries of loans, Borrowings and other
etc. and non-tax revenue like interest, liabilities etc.
fees, penalties etc.

Difference between Capital expenditure and revenue expenditure:

Basis Revenue Expenditure Capital Expenditure
Meaning It does not result in creation of an It leads to either creation of assets or
asset or reduction in a liability reduction in liability.
Purpose It is incurred for normal running & It is incurred for acquisition of assets
maintenance of government or granting of loans.
departments.
Nature It is recurring in nature. It is of non-recurring nature.
Example Salaries, pensions, interest payments, Loans granted to states or other
subsidies, grants etc. countries, repayment of loan,
expenditure on purchasing capital
assets

TYPES OF BUDGET
 Balanced Budget Surplus Budget Deficit Budget

• A budget is said to be a • A budget is said to be a • A budget is said to be a

balanced budget if surplus budget if deficit budget if estimated
estimated government estimated government government receipts are
receipts are equal to the receipts are more than less than estimated
estimated government estimated government government expenditure.
expenditure. expenditure. • It is a good policy to
• It ensures financial • It is a good strategy to control recession /
stability in the country. control inflation/excess deficient demand.
demand.

Estimated Receipts = Estimated Receipts > Estimated Receipts <

Estimated Expenditure Estimated Expenditure Estimated Expenditure

BUDGETARY DEFICIT

Budgetary Deficit is a situation, wherein the estimated expenditure of the government exceeds
its estimated revenue. When the government spends more than it collects, then it incurs a
budgetary deficit. This excess expenditure is financed by either borrowing from the market or
from RBI. Budgetary deficit can be of three types:
1. Revenue deficit
2. Fiscal deficit
3. Primary deficit
Revenue Deficit Meaning It is the excess of revenue expenditure over revenue
receipts. It signifies that governments’ own earning is
insufficient to meet normal functioning of government
departments and provisions of services.
Revenue deficit = Revenue Expenditure – Revenue
Receipts
Implications  It indicates the inability of government to meet its
regular & recurring expenditure.
 It indicates dissavings because the government has
to make up the uncovered gap by drawing upon
capital receipts either through borrowings or sale of
its assets.
 Use of capital receipts for meeting the extra
consumption expenditure leads to inflationary
situation.
 Higher borrowings increase the future burden of
loan and interest payments.
  It is a warning signal to the government to either
curtail its expenditure or increase its revenue.
Remedial  Government should take steps to reduce its
measures expenditure & avoid unproductive & unnecessary
expenditure.
 Government should increase its receipts from its
various sources.
Fiscal Deficit Meaning It is defined as the excess of total budget expenditure
over total budget receipts excluding borrowings during
a fiscal year. In other words, it is equal to the amount of
borrowings during a year. It is a measure of how much
the government needs to borrow from the market to
meet its expenditure when its resources are inadequate.
Greater fiscal deficit implies greater borrowings.
Fiscal deficit = Total Expenditure – Total receipts
excluding
borrowings
Implications  Debt trap: Fiscal deficit is financed by borrowings
and borrowings not only involve repayment of
principal amount but also the 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 earlier loans.
As a result, the country is caught in a debt trap.
 Inflation: Government generally borrows from
RBI. This means there is printing of more currency
notes to meet deficit requirements. It raises the
circulation of money and causes inflation.
 Foreign dependence: Government also borrows
from foreign countries which raises its dependence
on them.
 Reduces future growth: Borrowings increases the
financial burden of future generations. It adversely
affects the future growth and development prospects
of the country.
Remedial  Reduction in expenditure on major subsidies.
measures  To curtail non-planned expenditure.
 Tax base should be broadened & reductions in taxes
should be curtailed.
 Tax evasion should be effectively checked.
 More emphasis on direct taxes to increase revenue.
Primary deficit Meaning It is defined as the difference between fiscal deficit of
the current year and interest payments on previous
borrowings. Primary deficit reflects the extent to which
interest commitments on earlier loans have compelled
the government to borrow in the current period.
Fiscal deficit reflects borrowing requirements of the
government for financing the expenditure inclusive of
 interest payment whereas primary deficit shows the
borrowing requirements exclusive of interest payments.
Primary deficit = Fiscal deficit – Interest payments
Implications  It shows how much government borrowing is going
to meet expenses other than interest payments.
 Zero primary deficits means that government has to
borrow only to make interest payments.
 The difference between fiscal deficit & primary
deficit reflects the amount of interest payments.
Remedial Interest payments should be reduced through early
measures repayment of loans.