ECO WITH ATM

MACRO ECONOMICS

MODULE – 4

GOVERNMENT BUDGET AND THE

ECONOMY

BY: ARCHANA TRIVEDI

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Government Budget and the Economy
Meaning
 A government budget is the annual financial statement showing item wise the estimated receipts
and estimated expenditure of the government under various heads during a fiscal year.
 The receipts and expenditures shown in the government are not the actual figures, but the
estimated values that government plans for the coming fiscal year.
 It also gives the actual financial accounts for the previous year and the revised estimates of the
current year.
 Indian financial year runs from 1st April to 31st March.

COMPONENTS OF GOVERNMENT BUDGET

The Budget is presented in two parts:

1. Revenue Budget: It shows current revenue receipts of the government and the expenditures met
from these revenues. It consists of revenue receipts and revenue expenditure. These are in the
form of routine/regular/recurring income and expenditure of the government.
2. Capital Budget: It shows capital requirements of the government and their financing patterns. It
consists of capital receipts and capital expenditure. These income and expenditure are generally
not in normal routine (non recurring) for the government.

The sum total of the revenue budget and the capital budget constitutes the overall budget of the government.

Structure of government budget

The government’s budget can be categorized according to receipts and expenditures.

 Budgeted Receipts: These refer to the estimated money receipts of the government from all
sources during a given fiscal year. These are of two types:
i. Revenue receipts:
 Those receipts which neither create any liability nor reduce the value of assets held
by the government.
 These are regular and recurring in nature and are received in the normal course of
activities.
 These are not subject to repayment by the government.
 These are subdivided into two categories:
 Tax receipts: Both direct and indirect taxes, which are compulsory payments made by
the individuals or firms to the government with no quid pro quo. Government does
not guarantee any good or service in return of a tax. Since receipt of tax does not
create any liability of the government, it is revenue receipt.
Taxes are of two types:
 Direct taxes are those taxes where the payment of the tax and its burden are on the
same person.
 Indirect taxes are those where the burden of the tax can be shifted by the payer to
someone else.

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 Basis Direct Tax Indirect Tax
Meaning A Tax where the burden of A Tax where the burden of paying
paying the tax and the liability to the tax and the liability to pay the tax
pay the tax falls on the same falls on different person.
person.
Shifting the These taxes cannot be shifted on These taxes have the potential to be
burden others. shifted on others.
Levied on These taxes are imposed/ levied These taxes are imposed on goods
on income and properties of and services.
individuals/ firms
Effect on Do not have any effect on the An increase in tax leads to increase in
market market price of goods and market price and a decrease in tax
price services. rate decreases the market price of
the goods and services.
Examples Income tax, property tax, Goods and services tax (GST)
corporate tax (Sales tax, service tax, excise duties,
value added tax)

 Non-tax receipts: Those receipts other than taxes. These include revenue from
commercial activities of the government, administrative functions and interest,
dividends and profits accruing to government.
a. Profits and Dividends: Government being shareholder of public sector
undertakings like SAIL, BHEL, Indian Oil Corporation etc. earns profit and receives
dividends by investing in other companies.
b. Interest: Interest received by the government on loans granted to state
governments, union territories, foreign governments etc.
c. Commercial revenue: Money received by the government by selling its goods and
services to the people e.g. Railway fare, tolls on roads, post etc.
d. Grants and aids: Financial help received from foreign governments and other
agencies at the time of crisis, natural calamities. There is no liability to repay this
amount.
e. Administrative revenue: The revenue that government earns while performing its
duties. These include;
 Fees: Money earned by the government for granting permission for certain
activity e.g. License fees.
 Fines and penalties: Amount collected when the public breaks the laws.
 Forfeitures: Amount to be paid by a person or a firm in the court for not
discharging the duties as per the contract.
 Escheat: Abandonment of property, bank balance and other assets in absence
of a legal heir.
 Special Assessment: Payment made by owners of properties for increase in the
value of their properties due to development activities by the government.
ii. Capital receipts:
 Those receipts of the government which either create a liability or leads to reduction
in the value of assets held by the government.
 These are non-recurring and non-routine in nature.

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  These receipts are in the form of borrowings, receipts from sale of assets, recovery of
loans given by the central government to state governments and other organizations.
 These include:
a. Borrowings: Since borrowings create liability these are capital receipts. Government can
raise loans from;
i. Market loans i.e. from public through the capital and money market.
ii. From Reserve Bank of India in the form of Treasury Bills.
iii. From foreign governments
iv. From international organizations like World Bank, IMF
b. Recovery of loans: Government grants loans to state governments, union territories,
departmental and non-departmental enterprises. When it recovers these loans the value
of financial assets of the government reduces thus it’s a capital receipt.
c. Other receipts:
i. Disinvestment: government holds the ownership in various public sector
undertakings in the form of equity shares. When government sells a part or whole
of its shares, it leads to transfer of ownership of PSUs to private entrepreneurs.
This reduces the value of assets held by the government thus is a capital receipt.
ii. Small savings: These include the deposits of the public in Public Provident Fund,
National Saving Certificates, Kisan Vikas Patra etc. Government utilizes these
amounts and is liable to repay to the de posit holders. These create liability and
thus are capital receipts.
Difference between Revenue and Capital Receipts
Basis Revenue Receipts Capital Receipts
Meaning The receipts which neither create any The receipts which either create any
liability nor reduce any asset of the liability or reduce any asset of the
government. government.
Nature They are regular and recurring in They are irregular and non-recurring in
nature. nature.
Future obligation There is no future obligation to return In case of certain capital receipts like
the amount. borrowings there is future obligation to
return the amount along with interest.
Example Tax revenue like income tax, sales tax Borrowings, disinvestment, etc.
etc. and Non-tax revenue like interest,
dividends, fines and penalties etc.

Budgeted Expenditure : It refers to the estimated expenditure of the government during a given
fiscal year.
Expenditure of government can be classified as:
i. Revenue and capital expenditure:
a. Revenue expenditure:
 The expenditure which neither increases the value of assets held by the government
nor leads to the reduction in the liabilities of the government.
 It is incurred on the day-to-day operations of the government.
 These are regular and recurring in nature.

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  Example: payment of salaries, pensions, interests, grants, expenditure on
administrative services etc.
b. Capital expenditure:
 The expenditure which either increases the value of assets held by the government or
reduces the value of liabilities of the government.
 These are irregular and non-recurring in nature.
 Example: Loans to state governments and union territories, expenditure on
construction of roads, buildings etc, purchase of machinery, land etc.
ii. Developmental and non-developmental expenditures: (non-evaluative topic)
a. Developmental expenditure: The expenditure which is directly related to economic and
social development of the economy. It adds to the flow of goods and services in the
economy. Example: Expenditure on agricultural and industrial development, education,
health, infrastructure etc.
b. Non-Developmental expenditure: The expenditure which is incurred on the essential
general services of the government. It is a part of normal functioning of the government
and is essential from administrative point of view. Example; expenditure on defence,
police, law and order, justice etc.
iii. Plan and non-plan expenditure (non-evaluative topic):
Plan expenditure is the expenditure undertaken on projects that are listed in the
current five-year plan of the government. Any other expenditure other than this (that
is not listed in current five year plan) is termed as non-plan expenditure.

Difference between Revenue and Capital Expenditure

Basis Revenue Expenditure Capital Expenditure
Meaning The expenditures which neither create The expenditures which either create any
any assets nor reduce any liability of the assets or reduce any liability of the
government. government.
Nature They are regular and recurring in They are irregular and non-recurring in
nature. nature.
Purpose It is incurred for normal running of It is incurred mainly for acquisition of
government departments and provision assets and granting of loans and advances.
of various services.
Example Payment of salaries, pension, interest, Repayment and granting of loan, Purchase
unemployment allowance of land, machinery, Expenditure on
construction of roads, dams etc.

Types of Budget
The government can prepare three types of budget:
1. Balanced Budget: when estimated government receipts are equal to estimated government
expenditure for the fiscal year, the government’s budget is said to be balanced.
Merits:
 It ensures financial stability
 It avoids wasteful expenditures
Demerit:

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  It does not solve the problem of inflation or deflation.
2. Surplus Budget: when estimated government receipts are more than the estimated government
expenditure for the fiscal year, the government’s budget is said to be surplus.
Merits:
 It helps in correcting inflationary gap by lowering the level of aggregate demand in the
economy.
Demerits:
 It is not desired during the period of deflation.
3. Deficit Budget: when estimated government receipts are less than the estimated government
expenditure for the fiscal year, the government’s budget is said to be deficit.
Merits:
 It accelerates economic growth
 It enables to undertake welfare programmes.
 Helps in solving the problem of deflation by increasing the level of aggregate demand in
the economy.
Demerits:
 It encourages wasteful and unnecessary expenditure by the governmen t.
 It may lead to financial instability.

Measures of deficit
Budgetary deficit is defined as the excess of total estimated expenditure over total estimated
receipts. It is a situation when budget expenditure of the government is greater than the budget
receipts.
Budgetary Deficit = Budgetary Expenditure (Revenue + Capital Expenditure) – Budgetary Receipts
(Revenue+ Capital Receipts)
Three types of deficit are present in government of India’s budget:

Revenue Deficit
It is the excess of total revenue expenditure over total revenue receipts of the government for a
fiscal year.
Revenue Deficit = Total Revenue Expenditure – Total Revenue Receipts
Significance/ implication:
1. Revenue deficit includes only those transactions which affect the current income and expenditure
of the Government.
2. It indicates that Government’s own revenue is insufficient to meet the normal running of
government departments and provision of services
3. It implies that Government is dissaving, i.e. government is using up savings of other sectors of the
economy to finance its consumption expenditure.
4. Government needs to make up the short fall of revenue receipts from capital receipts i.e. through
borrowing or through sale of its assets.Revenue deficit thus either increases the liabilities of
government or decreases the value of assets of government.
5. Borrowings increases interest payments in future which in turn increases revenue expenditure
and generate inflationary pressures in the economy.

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 6. Larger the deficit, large will be the borrowings to meet the regular expenditures, which will result
in increase in the revenue expenditure (interest payments) of the government and thus more
revenue deficit.
7. A high revenue deficit implies that the government is not borrowing to finance any capital
formation in the economy.

Measures to reduce revenue deficit

1. Curtail expenditure: Government should its expenditure and avoid unnecessary and
wasteful expenditure.
2. Raise more tax: government should increase its tax revenue.
Fiscal Deficit
It is the excess of Total expenditure (capital and revenue) over the sum of revenue and capital
receipts excluding borrowings.
Fiscal Deficit =Total Budget Expenditure – (Revenue receipts + Capital receipts excluding borrowing)
Fiscal Deficit = Total Expenditure – Revenue Receipts – Capital Receipts + Borrowings
or
Fiscal Deficit = Budgeted Expenditure > Budgeted Receipts (other than borrowings)
Therefore
Fiscal Deficit = Borrowings
The fiscal deficit will have to be financed through borrowings. Thus it indicates the total borrowing
requirements of the government from all sources.
How to calculate Fiscal Deficit?
1. Fiscal Deficit = Total Expenditure – Total Receipts excluding borrowings.
= (Revenue Expenditure + Capital Expenditure) – (Revenue Receipts + Capital Receipts
– Borrowings)

Can there be fiscal deficit in a government budget without a revenue budget?

Yes, it is possible in following situations:
i. When revenue budget is balanced (i.e. Revenue Expenditure is equal to Revenue Receipts) and
capital budget shows a deficit (i.e. Capital expenditure exceeds Capital Receipts other than
borrowings).
ii. When there is surplus in the revenue budget (i.e. Revenue Expenditure is less than Revenue
Receipts) but the deficit in capital budget is greater than this surplus generated in the revenue
budget.
Significance/ implications
1. Indicates total borrowing requirements of the government from all sources
2. Measures the extent to which government needs to borrow to finance its expenditure
3. Fiscal deficit creates many problems for the economy:
a. Increase in government’s liability in future as it has to pay interest in addition to the repayment
of the loans.
b. Debt Trap: Payment of interest increases revenue expenditure which may lead to a higher
revenue deficit. Higher revenue deficit further lead to more borrowings and more interest
payments creating a vicious circle of debt trap (that is why government tries to reduce and keep
it as low as possible).
c. Inflation: If fiscal deficit is financed by deficit financing (borrowing from RBI), money supply in the
economy increases leading to inflationary pressures.

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 d. Increase in foreign dependence: Government can also borrow from rest of the world to finance
its deficit. It increases the dependence of the government on the other countries.
e. Hampers future growth and development: Borrowings increase the financial burden of
repayment of loans and interest on future generations. It hampers the future growth and
development prospects of the economy.

 borrowing
Vicious circle of interest burden
Debt

 revenue deficit
(receipts constant)

Whether fiscal deficit is advantageous or disadvantageous?

 It depends upon what the deficit or expenditure is being used for.
 If it is being used to cover revenue deficit then it is detrimental for the economy as it does not
lead to any investment which enhances the productive capacity of the nation.
 If the deficit or borrowing is being used to fund capital formation (create new assets) then it will
positively impact the economy. This is so because it will increase assets, which shall generate
more income and can repay the additional borrowings.
Difference between Revenue and Fiscal deficit
Basis Fiscal Deficit Revenue Deficit
Meaning It is the excess of total expenditure It is the excess of revenue expenditure
over total receipts excluding over revenue receipts.
borrowings
Indicator It measures the total borrowing It indicates the inability of the government
requirements of the government to meet its regular and recurring
expenditure.

Primary Deficit
It is the difference between fiscal deficit and interest payments
Primary deficit = Fiscal deficit – interest payments
Significance:
1. It indicates the extent to which government is borrowing to meet its existing expenses
other than interest payments on public debts.
2. A zero primary deficit means that the government is borrowing just to meet its interest
payments on public debts. It is not adding to the existing loans. It is a sign of fiscal
discipline.
3. Low primary deficit indicate that government is largely borrowing to meet previous years’
debt obligations. A low primary deficit indicates that interest commitments (on earlier
loans) have forced the government to borrow.
4. High primary deficit indicate that government is using a larger component of its fiscal
deficit to finance the current year’s expenditure rather than previous year’s interest
burden. It also reflects fiscal irresponsibility of the government.

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Difference between Primary and Fiscal Deficit
Basis Primary Deficit Fiscal Deficit
Meaning It is the difference between fiscal It is the excess of total expenditure over
deficit and interest payments total receipts excluding borrowings
Indicator It indicates the total borrowing It measures the total borrowing
requirement of the government requirements of the government including
excluding interest interest.
Formula Primary deficit = Fiscal deficit – Fiscal Deficit = Total Budget
interest payments Expenditure – (Revenue receipts +
Capital receipts excluding borrowing)

Objectives of government Budget:

1. Economic growth:
 Economics growth refers to a sustained increase in the production of goods and services over
a period of time. Every government aims at achieving a higher growth rate.
 The Government aims at generation of savings, Investments (capital formation) and
consumption expenditure to assess the trend of growth in the economy and improve the
standard of living of the people. Budget is an effective tool to ensure the economic growth.
 Government through its budgetary policy creates the conditions for increase in savings and
investment by offering a higher rate of interest.
 Provision of tax rebates and other incentives on productive ventures can stimulate savings
and investments in the economy.
 An increase in savings leads to increase in investment, which increases the production
capacity in the economy, which in turn increases the flow of goods and services leading to a
higher growth rate.
 Spending on infrastructure of an economy enhances the production activity in different
sectors of an economy which contributes to the growth.
 Government’s expenditures on various activities generate demand for different types of
goods and services which induces growth in private sector too.
2. Reallocation of resources:
 Government through its budgetary policy reallocates resources so that social and economic
objectives are met i.e. there is a balance between the goals of profit maximization and social
welfare.
 Government uses its budgetary policy to allocate resources by influencing market mechanism
through taxes, subsidies and direct participation in production process.
 Private sector does not involve in production of goods which are not profitable and require
huge investment like sanitation, roads parks etc., thus govt. produces these goods to
maximize social benefits.
 It discourages the production of harmful goods by imposing heavy taxes and encourages the
production of socially wanted goods by providing tax concessions and subsidies.
3. Economic stability:
 Through its budgetary policy government prevents inflationary and deflationary pressures
in the economy.
 To prevent inflationary pressures it prepares surplus budget i.e. it plans its expenditures
less than the receipts.
 To prevent deflationary pressures it prepares a deficit budget i.e. it plans to keep its
expenditures more than its receipts to bring stability in the economy.

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 4. Economic equality (Redistribution of income and wealth);
 Government through fiscal tools of taxation, subsidies and transfer payments brings about
fair distribution of income.
 To reduce the gap between rich and poor it adopts progressive taxation system. Higher the
income, higher taxes to be paid. By collecting high taxes from rich class it spends the money
collected on the poor mass in the form of free education, free medical facilities etc. This
reduces disparities in income and wealth and reduces the gap between rich and poor.
 Also it grants subsidies to the entrepreneurs to sell the essential goods at lower price in the
market to ensure availability of these goods to poor masses.
5. Achievement of full employment: To achieve the objective of full employment government
through its policy promotes labour-absorbing technology and undertakes public works
programmes like construction of roads, dams, irrigation canals etc.
6. Management of Public enterprises: Government establishes public enterprises keeping in view
the social interest especially in the form of natural monopolies, where economies of scale over a
large range of output can be received.
7. Transparency in government working: Planned appraisal of governments’ earnings and spending
is necessary to avoid corruption, inefficiencies and bankruptcy of the government. Moreover
budgeting is desirable to answer its critics and prove its honesty in financial matters.

Exercise
Answer the following questions:
1. Define government budget.
2. Why is repayment of loan a capital expenditure/
3. In a government budget primary deficit is Ra 10,000 crores and interest payment is Rs 8,000
crores. How much is the fiscal deficit?
4. If the borrowings of the government are Rs 1,500 crores and interest payment is Rs 300 crores,
then what is the fiscal deficit?
5. Why are borrowings treated as capital receipts?
6. Give the meanings of capital receipts and revenue receipts with an example of each.
7. What is the basis of classifying government expenditure into revenue and capital expenditure?
Give an example of each.
8. What is meant by revenue deficit? What are its implications?
9. What is fiscal deficit? Why should government try to reduce it?
10. What is fiscal deficit? Does it necessarily generate inflationary pressures in the economy?
11. Can there be a fiscal deficit in government’s budget without a revenue deficit?
12. What is primary deficit? What is its significance in the economy?
13. What is a tax? Distinguish between direct and indirect tax. Give example of each.
14. How does government use its budget to:
a. Reduce income inequalities
b. Achieve economic stability
c. Achieve higher growth rate.
15. Classify the following into revenue and capital expenditure. Give reasons in support of your
answer.
a. Repayment of loan to the World Bank.
b. Payment of salaries under the Sarva Siksha Abhiyan Programme.
c. Construction of roads under the Pradhan Mantri’s Gramin Sadak Yojana.
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 d. Salary paid to army officers.
e. Purchase of a Jet plane from Korea.
f. Grants given by central government to state government.
g. Loan given to union territories.
h. Interest paid on national debt.
i. 12% shares purchased in a company.
j. Expenditure on construction of Metro.
k. Pension paid to retired government employees.
16. Classify the following into revenue and capital receipts. Give reasons in support of your answer.
a. Dividends earned from Indian Oil Corporation.
b. Repayment of loan from Government to Sikkim to the centre.
c. Receipt of grant from Government of United States of America for Bihar flood victims.
d. Loans from the World Bank.
e. Corporation tax.
f. Profits of public sector undertaking.
g. Sale of shares held by government in a PSU.
h. Borrowings from public.
i. Fees of Government College.
j. Foreign aid against earthquake victims.
17. From the following data about a government budget, find out (a) Revenue Deficit (b) Fiscal Deficit
(c) Primary Deficit.
S.No. Particulars ` Arab
i. Capital receipts net of borrowings 95
ii. Revenue Expenditure 100
iii. Interest Payments 10
iv. Revenue Receipts 80
v. Capital Expenditure 110
18. . From the following data about a government budget, find out (a) Revenue Deficit (b) Fiscal Deficit
(c) Primary Deficit.
S.No. Particulars ` Arab
i. Tax Revenue 47
ii. Capital Receipts 34
iii. Non-Tax Revenue 10
iv. Borrowings 32
v. Revenue Expenditure 80
vi. Interest Payments 20

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