Government Budget and the Economy

The One Thing

The government budget is an annual financial statement and a major instrument of fiscal policy. By managing receipts, expenditure, taxation and borrowing, it seeks to promote economic growth and stability while addressing inequality, employment, public services and the sustainability of public debt.

Who and What

• Government Budget: A statement of the estimated receipts and expenditure of the government during a financial year, usually from 1 April to 31 March. It supports resource allocation, redistribution of income and wealth, economic stability, management of public enterprises and economic growth.
• Budget Receipts: Money received by the government from taxes, fees, borrowings, disinvestment and other sources.
• Revenue Receipts: Receipts that neither create a liability nor reduce government assets. They comprise tax revenue and non-tax revenue.
• Tax Revenue: Compulsory payments collected by the government, including income tax, corporation tax, GST, customs duty and excise duty.
• Direct Tax: A tax whose burden generally cannot be shifted to another person, such as income tax and corporation tax.
• Indirect Tax: A tax whose burden can generally be shifted through prices, such as GST and customs duty.
• Non-Tax Revenue: Revenue from fees, fines, penalties, interest receipts, profits of public enterprises and dividends.
• Capital Receipts: Receipts that either create a government liability or reduce government assets. They include borrowings, recovery of loans and disinvestment.
• Borrowings: Funds raised from the public, financial institutions, foreign governments or international institutions. Borrowing creates a liability.
• Disinvestment: The sale of part or all of the government’s ownership in a public sector enterprise, reducing government assets.
• Budget Expenditure: Planned government spending during a financial year.
• Revenue Expenditure: Expenditure that neither creates assets nor reduces liabilities, including salaries, pensions, subsidies, interest payments and routine administration.
• Capital Expenditure: Expenditure that creates assets or reduces liabilities, including spending on roads, schools, hospitals and machinery, as well as repayment of loans.
• Developmental Expenditure: Expenditure directly supporting economic and social development, including education, health, agriculture, transport and industry.
• Non-Developmental Expenditure: Expenditure supporting essential government functions without directly promoting development, including interest payments, pensions, defence and general administration.
• Plan and Non-Plan Expenditure: An earlier classification used in Indian government budgets. It was discontinued from the financial year 2017–18; expenditure is now mainly classified as revenue or capital expenditure.
• Allocation of Resources: The direction of resources towards socially desirable activities and public goods such as education, health, infrastructure and defence. Public goods such as street lighting, national defence and law enforcement are generally provided or financed by the government because private markets may not supply them efficiently.
• Redistribution of Income and Wealth: The reduction of inequality through progressive taxation, subsidies, welfare programmes and public provision of essential services. A progressive tax system applies relatively higher tax rates to higher-income groups.
• Economic Stability: The use of taxation, public expenditure and borrowing to control inflation, reduce unemployment and manage fluctuations in economic activity.
• Economic Growth: The promotion of growth through investment in infrastructure, human capital, technology and productive activities.
• Public Debt Management: Planning borrowing and repayment so that public debt remains sustainable and does not impose an excessive burden on future generations.
• Balanced Budget: A budget in which estimated receipts equal estimated expenditure.
• Surplus Budget: A budget in which receipts exceed expenditure.
• Deficit Budget: A budget in which expenditure exceeds receipts.
• Revenue Deficit: The excess of revenue expenditure over revenue receipts. It indicates that routine expenditure cannot be met from regular revenue and may imply borrowing for consumption.
• Fiscal Deficit: The excess of total expenditure over total receipts excluding borrowings. It indicates the government’s total borrowing requirement.
• Primary Deficit: Fiscal deficit minus interest payments. It measures the current borrowing requirement excluding the burden of past debt.
• Effective Revenue Deficit: Revenue deficit minus grants for creation of capital assets. It measures the revenue deficit after excluding grants used to create capital assets.
• Monetised Deficit: The part of the fiscal deficit financed by borrowing from the central bank, which may increase the money supply.
• Fiscal Policy: Government policy concerning taxation, public expenditure and borrowing, used to influence economic activity, national income, employment, prices and economic growth.

Causes and Consequences

• Classification of government finances:

Total receipts are divided into revenue receipts and capital receipts, while total expenditure is divided into revenue expenditure and capital expenditure. - Total receipts = Revenue receipts + Capital receipts - Total expenditure = Revenue expenditure + Capital expenditure

• Composition of revenue receipts:

Revenue receipts consist of tax revenue and non-tax revenue. - Revenue receipts = Tax revenue + Non-tax revenue These receipts neither create liabilities nor reduce government assets.

• Role of capital receipts:

Capital receipts include borrowings, recovery of loans and disinvestment or other receipts that reduce government assets. Non-debt capital receipts mainly include recovery of loans and proceeds from disinvestment because they do not create debt. The distinction between revenue and capital items depends on their effect on government assets and liabilities, not simply on the size of the payment.

• Functions of government expenditure:

Revenue expenditure is necessary for government functioning, including salaries, pensions, subsidies, interest payments and routine administration. Capital expenditure creates assets or reduces liabilities, for example through spending on roads, schools, hospitals and machinery or through repayment of loans. Productive capital expenditure can increase future productive capacity.

• Budgetary allocation and development:

The government directs resources towards public goods and socially beneficial activities. Spending on education, health, agriculture, transport, industry, infrastructure, human capital and technology can support economic growth and social development.

• Redistribution and social justice:

Progressive taxation, subsidies, welfare programmes and public provision of essential services reduce inequality. Higher tax rates on higher-income groups are particularly significant for redistribution.

• Economic stabilisation:

Taxation, expenditure and borrowing influence aggregate demand and economic activity. A deficit budget may be used during a recession to increase aggregate demand, employment and output. Conversely, a surplus budget may help control inflation, although a substantial reduction in public expenditure may reduce aggregate demand.

• Revenue deficit and borrowing:

- Revenue deficit = Revenue expenditure − Revenue receipts A persistent revenue deficit represents government dissaving and may result in borrowing for routine consumption expenditure rather than investment. This is generally undesirable because it does not directly expand productive capacity. - Revenue deficit as a percentage of GDP = (Revenue deficit / GDP) × 100

• Fiscal deficit and financing:

- Fiscal deficit = Total expenditure − Total receipts excluding borrowings - Fiscal deficit = Total expenditure − (Revenue receipts + Non-debt capital receipts) A deficit may be financed through market borrowings, borrowing from financial institutions, external borrowing or borrowing from the central bank. - Fiscal deficit as a percentage of GDP = (Fiscal deficit / GDP) × 100

• Evaluation of fiscal deficit:

A fiscal deficit is not necessarily harmful. Borrowing for capital formation may support long-term growth by increasing productive capacity. However, excessive borrowing for non-productive expenditure can increase public debt and create inflationary pressures. A high fiscal deficit may also raise interest rates and reduce funds available for private investment. Its significance should therefore be assessed in relation to GDP, the purpose of borrowing, the rate of economic growth and the government’s capacity to repay debt.

• Primary deficit and past debt:

- Primary deficit = Fiscal deficit − Net interest liabilities or interest payments This measure separates the current borrowing requirement from the burden created by past debt. - Primary deficit as a percentage of GDP = (Primary deficit / GDP) × 100

• Effective revenue deficit:

- Effective revenue deficit = Revenue deficit − Grants for creation of capital assets This measure excludes grants used to create capital assets and therefore gives a more precise indication of revenue expenditure that does not contribute to asset creation.

• Monetised deficit:

When part of the fiscal deficit is financed by borrowing from the central bank, the resulting monetised deficit may increase the money supply. This can contribute to inflationary pressure if demand rises faster than productive capacity.

• Public debt and fiscal discipline:

Public debt management requires the government to balance borrowing with repayment capacity. Budgetary policy must reconcile economic growth, price stability, employment generation, social justice and financial sustainability. Borrowing for productive investment is more defensible than excessive borrowing for non-productive expenditure.

What Gets Asked

• Distinguish between revenue receipts and capital receipts, including tax revenue, non-tax revenue, borrowings, recovery of loans and disinvestment.
• Compare revenue expenditure with capital expenditure, and explain why the classification depends on effects on government assets and liabilities.
• Explain the differences between revenue deficit, fiscal deficit, primary deficit, effective revenue deficit and monetised deficit, including their equations.
• Assess whether a fiscal deficit is necessarily harmful by considering the purpose of borrowing, GDP, economic growth, debt repayment capacity, inflation and private investment.
• Explain how taxation, public expenditure and borrowing promote allocation of resources, redistribution of income and wealth, economic stability and economic growth.
• Evaluate the advantages and risks of surplus and deficit budgets, including their effects on inflation, aggregate demand, employment and output.