10

GOVERNMENT BUDGET AND THE ECONOMY

LEARNING OBJECTIVES
10.1 INTRODUCTION
10.2 MEANING OF GOVERNMENT BUDGET
10.3 OBJECTIVES OF GOVERNMENT BUDGET
10.4 COMPONENTS OF BUDGET
10.5 BUDGET RECEIPTS
10.6 REVENUE RECEIPTS
10 7 CAPITAL RECEIPTS
10.8 BUDGET EXPENDITURE
10.9 MEASURES OF GOVERNMENT DEFICIT
10.1 INTRODUCTION
In the modern world, every government aims at maximising the welfare of its
country. It requires a number of infrastructural, economic and welfare activities. All
these activities require huge expenditure to be incurred. This requires appropriate
planning and policy of the government. The solution to all these problems is
'Budget'. A budget is a document containing detailed programmes and policies of
action for the given fiscal year.
10.2 MEANING OF GOVERNMENT BUDGET
Government budget is an annual statement, showing item wise estimates of receipts
and expenditures during a Fiscal year. The receipts and expenditures, shown in the
budget, are not the actual figures, but the estimated values for the coming fiscal
year. Fiscal year is taken from 1st April to 31st March.
Important Points of Government Budget
• Budget is prepared by Government at all levels, i.e. Central Government, State
Government and Local Government, prepares its respective annual budget.
However, we will restrict our studies to Budget of Central Government, known as
'Union Budget'.
• Estimated expenditures and receipts are planned as per the objectives of the
government.
• In India, Budget is presented in the parliament on such a day, as the President
may direct. By convention, it is presented on the First working day of February each
year.
• It is required to be approved by the parliament, before it can be implemented.
10.3 OBJECTIVES OF GOVERNMENT BUDGET
Government prepares the budget for fulfilling certain objectives. These objectives
are the direct outcome of government's economic, social and political policies. The
various objectives of government budget are:
1. Reallocation of Resources: Through the budgetary policy, Government aims to
reallocate resources in accordance with the economic (profit maximisation) and
social (public welfare) priorities of the country. Government can influence allocation
of resources through:
(i) Tax concessions 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. (ii) Directly producing goods and services: If private sector does not take
interest, government can directly undertake the production.
2. 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. It will reduce income of the rich and raise standard of living of
the poor, thus reducing inequalities in the distribution of income.
3. Economic Stability: Government budget is used to prevent business fluctuations
of inflation or deflation to achieve the objective of economic stability. Government
expenditure and taxes can help in fighting price fluctuations.
• Inflationary tendencies emerge when aggregate demand is higher than the
aggregate supply. Government can bring down aggregate demand by reducing its
own expenditure.
• During deflation, government can increase its expenditure and give tax
concessions and subsidies.
In short, policies of surplus budget during inflation and deficit budget during deflation
helps to maintain stability of prices in the economy.
4. 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 objective of making various
provisions for managing such enterprises and providing them financial help.
Natural Monopoly
Natural monopoly exists when a single firm can produce goods and services at a
cost which is lower than that of many competing firms. Government operates,
manages and controls natural monopolies like railways, post offices, electricity, etc.
to promote public welfare.
5. 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 investments in the
economy.
6. Reducing regional disparities: The government budget aims to reduce regional
disparities through its taxation and expenditure policy for encouraging setting up of
production units in economically backward regions.
10.4 COMPONENTS OF BUDGET
Components of budget refer to structure of the budget. Two main components of
budget are:
1. Revenue Budget: It deals with the revenue aspect of the government budget. It
explains how revenue is generated or collected by the government and how it is
allocated among various expenditure heads. Revenue budget has two parts: (i)
Revenue Receipts; (ii) Revenue Expenditures.
2. Capital Budget: It deals with the capital aspect of the government budget and it
consists of: (i) Capital Receipts; (ii) Capital Expenditures.

The Components of budget can also be categorised according to receipts and

expenditures.
On this basis, two broad components are: (1) Budget Receipts; (2) Budget
Expenditures.
10.5 BUDGET RECEIPTS
Budget receipts refer to the estimated money receipts of the government from all
sources during a given fiscal year. Budget receipts may be further classified as: (i)
Revenue receipts; (ii) Capital receipts.

10.6 REVENUE RECEIPTS

Revenue receipts refer to those receipts which neither create any liability nor cause
any reduction in the assets of the government. They are regular and recurring in
nature and government receives them in its normal course of activities.
A receipt is a revenue receipt, if it satisfies the following two essential conditions:
The receipt must not create a liability for the government. For example, taxes levied
by the government are revenue receipts as they do not create any liability. However,
any amount, borrowed by the government, is not a revenue receipt as it causes an
increase in the liability in terms of repayment of borrowings.

(ii) The receipt must not cause decrease in the assets. For example receipts from
sale of shares of a public enterprise is not a revenue receipt as it leads to a
reduction in assets of the government.
jkTwo Sources of Revenue Receipts
Revenue receipts of the government are generally classified under two heads:
(i) Tax Revenue
(ii) Non-Tax Revenue
Tax Revenue
Tax revenue refers to sum total of receipts from taxes and other duties imposed by
the government. Tax is a compulsory payment made by people and companies to
the government without reference to any direct benefit in return. It means, there are
two aspects of taxes:
(i) Tax is a compulsory payment, i.e., no one can refuse to pay it;
(ii) Tax receipts are spent by the government for common benefit of people in the
country. A tax payer cannot expect that the tax amount will be used for his direct
benefit.
Tax revenue is the main source of regular receipts of the government Government
collects various kinds of taxes from public to meet its day-to-day expenditures and
there is a strict action against anyone who fails to pay the taxes.
Tax Revenue can be further classified as:
(i) Direct Taxes
(ii) Indirect Taxes
Direct Taxes
Direct taxes refer to taxes that are imposed on property and income of individuals
and companies and are paid directly by them to the government.
• They are imposed on individuals and companies.
• The 'liability to pay' the tax (i.e. impact) and 'actual burden' of the tax (i.e.
incidence) lie on the same person, i.e. its burden cannot be shifted to others.
For example, in case of income tax, the liability to pay tax (i.e. impact) and 'actual
burden' is on the same person on whom it is levied.
• They directly affect the income level and purchasing power of people and help to
change the level of aggregate demand in the economy.
• Examples: Income tax, Corporate tax, Interest tax, Death duty, Capital gains tax,
etc.
Direct Tax Systems can be Progressive, Regressive or Proportional. For their
detailed study please refer Power Booster.
Indirect Taxes
Indirect taxes refer to those taxes which affect the income and property of
individuals and companies through their consumption expenditure.
• They are imposed on goods and services.
• The 'liability to pay' the tax (i.e. impact) and 'actual burden' of the tax (i.e.
incidence) lie on different persons, i.e. its burden can be shifted to others.
For example, in case of sales tax, the liability to pay tax to the government (i.e.
impact) is on sellers. But, 'actual burden' (i.e. incidence) is on consumers because
sellers collect the sales tax from them. So, burden of indirect taxes can be shifted.
• Examples: Sales tax, Service tax, VAT, Entertainment tax, Excise duty,
Custom duty, etc. (GST)
• Indirect Taxes can be avoided: Indirect taxes are compulsory payments. But, they
can be avoided by not entering into those transactions, which call for such taxes.
For example, consumers may save taxes by purchasing Khadi Gram Udyog items
as there is no indirect tax on khadi items.
How to classify a Tax as Direct Tax or Indirect Tax?
• A tax is a direct tax, if its burden cannot be shifted. For example, income tax is a
direct tax as its impact and incidence is on the same person.
• A tax is an indirect tax, if its burden can be shifted. For example, sales tax is an
indirect tax as its impact and incidence is on different persons.
Comparison Between Direct Taxes and Indirect Taxes
Basis Direct Taxes Indirect Taxes
Impact Direct taxes are levied on Indirect taxes are levied on
individuals and companies. goods and services.
Shift of The burden of a direct tax The burden of an indirect tax
burden cannot be shifted, i.e. impact can be shifted, i.e. impact and
and incidence is on the same incidence is on different
person. persons.
Nature They are generally They are generally
progressive in nature. proportional in nature.
Coverage They have limited reach as They have a wide coverage
they do not reach all the as they reach all the sections
sections of the economy. of the society.

Non-Tax Revenue
Non-Tax revenue refers to receipts of the government from all sources other than
those of tax receipts. The main sources of non-tax revenue are:
1. Interest: Government receives interest on loans given by it to state governments,
union territories, private enterprises and general public. Interest receipts from these
loans is an important source of non-tax revenue.
2. Profits and Dividends: Government earns profit through public sector
undertakings like Indian railways, LIC, BHEL, etc. It earns profit from the sale
proceeds of the products of such public enterprises. Government also gets dividend
from its investments in other companies.
3. Fees: Fees refer to charges imposed by the government to cover the cost of
recurring services provided by it. Such services are generally in public interest and
fees is paid by those, who receive such services. It is also a compulsory contribution
like tax. Court fees, registration fees, import fees, etc. are some examples of fees.
4. License Fee: It is a payment charged by the government to grant permission for
something. For example, license fee paid for permission of keeping a gun or to
obtain National Permit for commercial vehicles.
5. Fines and Penalties: They refer to those payments which are imposed on law
breakers. For example, fine for jumping red light or penalty for non-payment of tax.
Fines are different from taxes as the former is levied to maintain law and order,
whereas, the latter is imposed to generate revenue.
6. Escheats: It refers to claim of the government on the property of a person who
dies without leaving behind any legal heir or a will.
7. Gifts and Grants: Government receives gifts and grants from foreign governments
and international organisations. Sometimes, individuals and companies also
voluntarily gift money to the government. Such gifts are not a fixed source of
revenue and are generally received during national crisis such as war, flood, etc.
8. Forfeitures: These are in the form of penalties which are imposed by the courts
for noncompliance of orders or non-fulfilment of contracts etc.
9. Special Assessment: It refers to the payment made by owners of those properties
whose value has appreciated due to developmental activities of the government. For
example, if value of a property near a Metro Station has increased, then a part of
developmental expenditure is recovered from owners of such property in the form of
special assessment.
10.7 CAPITAL RECEIPTS
Capital receipts refer to those receipts which either create a liability or cause a
reduction in the assets of the government. They are non-recurring and non-routine
in nature.
A receipt is a capital receipt if it satisfies any one of the two conditions:
(i) The receipts must create a liability for the government.
For example, Borrowings are capital receipts as they lead to an increase in the
liability of the government.
However, tax received is not a capital receipt as it does not result in creation of any
liability.
(ii) The receipts must cause a decrease in the assets. For example, receipts from
sale of shares of public enterprise is a capital receipt as it leads to reduction in
assets of the government.

Sources of Capital Receipts

Capital receipts are broadly classified into three groups:
1. Borrowings: Borrowings are the funds raised by government to meet excess
expenditure. Government borrow funds from: (i) Open Market (Public); (ii) Reserve
Bank of India (RBI); (iii) Foreign governments (like loans from USA, England etc.);
(iv) International institutions (like World Bank, International Monetary Fund).
Borrowings are capital receipts as they create a liability for the government.
2. Recovery of Loans: Government grants various loans to state governments or
union territories. Recovery of such loans is a capital receipt as it reduces the assets
of the government.
3. Other Receipts: These include:
(a) Disinvestment Disinvestment refers to the act of selling a part or the whole of
shares of selected public sector undertakings (PSU) held by the government. They
are termed as capital receipts as they reduce the assets of the government.
Government holds ownership in various PSU's in the form of equity shares. When
the government sells a part or whole of its shares, it leads to transfer of ownership of
PSU's to the private enterprises.
(b) Small Savings: Small savings refer to funds raised from the public in the form of
Post Office deposits, National Saving Certificates, Kisan Vikas Patras etc. They are
treated as capital receipts as they lead to an increase in liability.
Comparison Between Revenue Receipts and Capital Receipts
Basis Revenue Receipts Capital Receipts
Meanin They neither create any liability They either create any liability
g nor reduce any asset of the or reduce any asset of the
government. government.
Nature They are regular and recurring They are irregular and non-
in nature. recurring in nature.
Future There is no future obligation to In case of certain capital
obligati return the amount. receipts (like borrowings),
on there is future obligation to
return the amount along with
interest.
Exampl Tax Revenue (like Income tax, Borrowings, Disinvestment,
es Sales tax, etc.) and Non-tax etc.
revenue (like interest, fees, etc.)
How to classify a receipt as Revenue Receipt or Capital Receipt?
• A receipt is a capital receipt, if it either creates a liability or reduces an asset.
• A receipt is a revenue receipt, if it neither creates a liability nor reduces any asset.
Items categorised as Revenue and Capital Receipts
1. Loan from the World Bank
It is a capital receipt as it creates liability for the government.
2. Corporation tax {CBSE, Delhi 2006}
OR
Income tax received by government {CBSE, Sample Paper2012}
It is revenue receipt as it neither creates any liability nor reduces any asset of the
government.
3. Grants received from World Bank
It is a revenue receipt as it neither creates any liability nor reduces any asset of the
government.
4. Profits of public sector undertakings {CBSE, Sample Paper2012}
It is revenue receipt as it neither creates any liability nor reduces any asset of the
government.
5. Sale of a public sector undertaking {CBSE, Delhi 2006}
OR
Receipts from sale of shares of a public sector undertaking.
{CBSE, Sample Paper 2012}
OR
Disinvestment. {CBSE, All India 2014}
It is a capital receipt as it reduces assets of the government.
6. Foreign aid against earthquake victims
It is revenue receipt as it neither creates any liability nor reduces any asset of the
government.
7. Dividends on investments made by government {CBSE, Delhi 2006}
It is revenue receipt as it neither creates any liability nor reduces any asset of the
government.
8. Borrowings from public {CBSE, Sample Paper 2012}
It is a capital receipt as it creates liability for the government.
9. Fees of Government College
It is revenue receipt as it neither creates any liability nor reduces any asset of the
government.
10. Recovery of loans {CBSE, Delhi 2006}
It is a capital receipt as it reduces assets of the government.
11. Interest received on loans {CBSE, Delhi Comptt. 2012}
It is revenue receipt as it neither creates any liability nor reduces any asset of the
government.
12. Tax receipts {CBSE, All India 2014}
It is revenue receipt as it neither creates any liability nor reduces any asset of the
government.
For “Classifying the following as revenue receipts and capital receipts", refer HOTS.
10.8 BUDGET EXPENDITURE
Budget Expenditure refers to the estimated expenditure of the government during a
given fiscal year. The budget expenditure can be broadly categorised as:
(i) Revenue Expenditure
(ii) Capital Expenditure.
Revenue and Capital Expenditure
Revenue Expenditure
Revenue expenditure refers to the expenditure which neither creates any asset nor
causes reduction in any liability of the government.
• It is recurring in nature
• It is incurred on normal functioning of the government and the provisions for
various services.
• Examples: Payment of salaries, pensions, interests, expenditure on administrative
services, defence services, health services, grants to state, etc.
An expenditure is a revenue expenditure, if it satisfies the following two essential
conditions:
(i) The expenditure must not create an asset of the government. For example,
payment of salaries or pension is revenue expenditure as it does not create any
asset. However, the amount spent on construction of Metro is not a revenue
expenditure as it leads to creation of an asset.

(ii) The expenditure must not cause decrease in any liability. For example,
repayment of borrowings is not revenue expenditure as it leads to reduction in
liability of the government.
It must be noted that Union Grants to states are treated as revenue expenditure,
even though some of the grants may be used for creation of assets.
Capital Expenditure
Capital expenditure refers to the expenditure which either creates an asset or
causes a reduction in the liabilities of the government.
• It is non-recurring in nature
• It adds to capital stock of the economy and increases its productivity through
expenditure on long period development programmes, like Metro or Flyover.
• Examples: Loan to states and Union Territories, expenditure on building roads,
flyovers, factories, purchase of machinery, repayment of borrowings, etc.
An expenditure is a capital expenditure, if it satisfies any one of the following two
conditions:
(i) The expenditure must create an asset for the government. For example.
Construction of Metro is a capital expenditure as it leads to creation of an asset.
However, any amount paid as salaries is not a capital expenditure as there is no
increase in the assets.
(ii) The expenditure must cause a decrease in the liabilities. For example,
repayment of borrowings is a capital expenditure as it leads to a reduction in the
liabilities of the government.
Payment of salary, interest or pension is not a capital expenditure as it neither
creates an asset nor reduces any liability.
Comparison Between Revenue Expenditure and Capital Expenditure
Basis Revenue Expenditure Capital Expenditure
Meaning Revenue expenditure neither Capital expenditure either
creates any asset nor reduces creates an asset or reduces a
any liability of the government liability of the government.
Purpose It is incurred for normal It is incurred mainly for
running of government acquisition of assets and
departments and provision of granting of loans and
various services. advances.
Nature It is recurring in nature as It is non-recurring in nature.
such expenditure is spent by
government on day-to-day
activities.
Example Salary, pension, Interest, etc. Repayment of borrowings;
s Expenditure on acquisition of
capital asset, etc.
How to classify Expenditure as Revenue or Capital Expenditure?
• An expenditure is a capital expenditure, if it either creates an asset or reduces a
liability.
• An expenditure is revenue expenditure, if it neither creates any asset nor reduces
any liability.
Items categorised as Revenue and Capital Expenditure
1. Subsidies {CBSE, All India 2006}
It is a revenue expenditure as it neither creates any asset nor reduces any liability of
the government.
2. Defence capital equipments purchased from Germany
It is a capital expenditure as it increases asset of the government.
3. Grants given to State Governments {CBSE, All India 2006}
It is a revenue expenditure as it neither creates any asset nor reduces any liability of
the government.
4. Construction of school buildings {CBSE, All India 2006}
It is a capital expenditure as it increases asset of the government.
5. Expenditure incurred on administrative and defence services
It is a revenue expenditure as it neither creates any asset nor reduces any liability of
the government.
6. Repayment of loans {CBSE, All India 2006}
It is a capital expenditure as it reduces the liability of the government.
7. Expenditure on building a bridge {CBSE, Foreign 2014}
It is a capital expenditure as it increases asset of the government.
8. Payment of salaries to staff of government hospitals
It is a revenue expenditure as it neither creates any asset nor reduces any liability of
the government.
9. Purchase of 20 cranes for the construction of flyovers
It is a capital expenditure as it increases asset of the government.
10. Amount borrowed from USA repaid
It is a capital expenditure as it reduces the liability of the government.
11. Expenditure on collection of taxes {CBSE, Delhi 2014}
It is a revenue expenditure as it neither creates any asset nor reduces any liability of
the government.
12. Expenditure on purchasing computers {CBSE, Delhi 2014}
It is a capital expenditure as it increases asset of the government.
13. Expenditure on scholarships {CBSE, Foreign 2014}
It is a revenue expenditure as it neither creates any asset nor reduces any liability of
the government.

Plan and Non-Plan Expenditure

Budget Expenditure can also be classified as Plan and Non-Plan Expenditure.
1. Plan Expenditure: Plan Expenditure refers to the expenditure that is incurred on
the programmes detailed in the current five year plan. For example, expenditure on
agriculture and allied activities, irrigation, energy, transport, communication, general
economic and social services etc. Plan expenditure shows the expenditure to be
incurred on: (i) Projects covered under the Central Plans, and (ii) Central Assistance
for State and Union Territory.
2. Non-Plan Expenditure: Non-Plan Expenditure refers to the expenditure other than
the expenditure related to the current five-year plan. For example, payment of
interest, expenditure on defence services, subsidies, expenditure to be incurred on
administrative services, etc. It is incurred on routine functioning of the government.
Therefore, it is a must for every country.
Plan Expenditure Vs Non-Plan Expenditure
(i) Plan expenditure is spent on current development and investment outlays, where
as, non-plan expenditure is spent on the routine functioning of the government.
(ii) Plan expenditure arises only when the plans provide for such expenditure, but
non-plan expenditure is a must for every economy and the government cannot
escape from it.
How to classify an expenditure as Plan or Non-Plan Expenditure?
• An expenditure is a plan expenditure, if it arises due to planned proposals.
• An expenditure is a non-plan expenditure, if it is out of the scope of government
plans.
Developmental and Non-Developmental Expenditure
Budget Expenditure can also be classified as Developmental and Non-
Developmental Expenditure.
1. Developmental Expenditure: Developmental expenditure refers to the expenditure
which is directly related to economic and social development of the country. For
example, expenditure on agricultural and industrial development, education, health,
social welfare, scientific research, etc. Expenditure on such services is not a part of
the essential functioning of the government. Developmental expenditure adds to the
flow of goods and services in the economy.
2. Non-Developmental Expenditure: Non-Developmental Expenditure refers to the
expenditure which is incurred on the essential general services of the government.
For example, expenditures on defence, administrative services, police, justice, etc. It
does not directly contribute to economic development, but it indirectly helps in the
development of the economy. Such expenditure is essential from the administrative
point of view.
Developmental Expenditure Vs Non-Developmental Expenditure
(i) Developmental expenditure directly contributes to development of the economy,
whereas, non-developmental expenditure does not contribute directly to the
development, but it lubricates the wheels of economic development;
(ii) Developmental expenditure is productive in nature as it adds to the flow of goods
and services, whereas, non developmental expenditure is not concerned with the
productivity of working class.
How to classify an expenditure as Developmental and Non-Developmental
Expenditure
• An expenditure is a developmental expenditure, if it directly adds to the flow of
goods and services
• An expenditure is a non-developmental expenditure, if it indirectly contributes to
economic development.
Types of Budgets]
The difference between government receipts and government expenditures may be
surplus or deficit, as the case may be. In this sense, there can be three types of
budgets:
Balanced Budget: Government budget is said to be a balanced budget if estimated
government receipts are equal to the estimated government expenditure.
Surplus Budget: If estimated government receipts are more than the estimated
government expenditure, then the budget is termed as 'Surplus Budget'.
Deficit Budget: If estimated government receipts are less than the estimated
government expenditure, then the budget is termed as 'Deficit Budget'.
10.9 MEASURES OF GOVERNMENT DEFICIT
Budgetary deficit is defined as the excess of total estimated expenditure over total
estimated revenue. When the government spends more than it collects, then it
incurs a budgetary deficit. With reference to budget of Indian government, budgetary
deficit can be of 3 types:
(i) Revenue Deficit
(ii) Fiscal Deficit
(iii) Primary Deficit

Revenue Deficit
Revenue deficit is concerned with the revenue expenditures and revenue receipts of
the government. It refers to excess of revenue expenditure over revenue receipts
during the given fiscal year.
Revenue Deficit = Revenue Expenditure - Revenue Receipts
Revenue deficit signifies that government's own revenue is insufficient to meet the
expenditures on normal functioning of government departments and provisions for
various services.
Implications of Revenue Deficit
• It indicates the inability of the government to meet its regular and recurring
expenditure in the proposed budget.
• It implies that government is dissaving, i.e. government is using up savings of other
sectors of the economy to finance its consumption expenditure.
• It also implies that the government has to make up this deficit from capital receipts,
i.e. through borrowings or disinvestments. It means, revenue deficit either leads to
an increase in liability in the form of borrowings or reduces the assets through
disinvestment.
• Use of capital receipts for meeting the extra consumption expenditure leads to an
inflationary situation in the economy. Higher borrowings increase the future burden
in terms of loan amount and interest payments.
• A high revenue deficit gives a warning signal to the government to either curtail its
expenditure or increase its revenue.
According to far-sighted approach, revenue receipts should always be more than
revenue expenditures so that surplus can be used for development projects.
However, Indian Budget is facing revenue deficit for the past several years.
Measure to Reduce Revenue Deficit
(i) Reduce Expenditure: Government should take serious steps to reduce its
expenditure and avoid unproductive or unnecessary expenditure. (ii) Increase
Revenue: Government should increase its receipts from various sources of tax and
non-tax revenue.
Fiscal Deficit
Fiscal deficit presents a more comprehensive view of budgetary imbalances. It is
widely used as a budgetary tool for explaining and understanding the budgetary
developments in India. Fiscal deficit refers to the excess of total expenditure over
total receipts (excluding borrowings) during the given fiscal year.
Fiscal Deficit = Total Expenditure - Total Receipts excluding borrowings**
The extent of fiscal deficit is an indication of how far the government is spending
beyond its means.
**Total Receipts excluding borrowings include:
(i) Revenue Receipts
(ii) Capital Receipts excluding borrowings (or Non-debt creating capital receipts).
Non-debt creating capital receipts include all the capital receipts except the
borrowings. So, such receipts do not give rise to debt. For example, recovery of
loans or proceeds from disinvestment.
Implications of Fiscal Deficit
The implications of fiscal deficit are as follows:
1. Debt Trap: Fiscal deficit indicates the total borrowing requirements of the
government. Borrowings not only involve repayment of principal amount, but also
require 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 the earlier loans. As a result,
country is caught in a debt trap.
2. Inflation: Government mainly borrows from Reserve Bank of India (RBI) to meet
its fiscal deficit. RBI prints new currency to meet the deficit requirements. It
increases the money supply in the economy and creates inflationary pressure.
3. Foreign Dependence: Government also borrows from rest of the world, which
raises its dependence on other countries.
4. Hampers the future growth: Borrowings increase the financial burden for future
generations. It adversely affects the future growth and development prospects of the
country.
Ways to Calculate Fiscal Deficit
Fiscal deficit can be calculated by any of the following methods:
(i) Fiscal Deficit = Total Expenditure - Total Receipts excluding borrowings
(ii) Fiscal Deficit = (Revenue Expenditure + Capital Expenditure) - (Revenue
Receipts + Capital Receipts excluding Borrowings)
OR
Fiscal Deficit = (Revenue Expenditure - Revenue Receipts) + (Capital Expenditure -
Capital Receipts excluding Borrowings)
OR
Fiscal Deficit = Revenue Deficit + (Capital Expenditure - Capital Receipts excluding
Borrowings) At times, only the total borrowings are given. In such a case, Fiscal
Deficit = Total Borrowings.
Comparison Between Fiscal Deficit and Revenue Deficit
Basis Fiscal Deficit Revenue Deficit
Meaning It shows the excess of total It shows the excess of
expenditure over total revenue expenditure over
receipts excluding the revenue receipts.
borrowings.
Indicator It measures the total It indicates inability of the
borrowing requirements of government to meet its
the government. regular and recurring
expenditure.
Sources of Financing Fiscal Deficit
Government has to look out for different options to finance the fiscal deficit. The
main two sources are:
1. Borrowings Fiscal deficit can be met by borrowings from the internal sources
(public, commercial banks etc.) or the external sources (foreign governments,
international organisations etc.).
2. Deficit Financing (Printing of new currency): Government may borrow from RBI
against its securities to meet the fiscal deficit. RBI issues new currency for this
purpose. This process is known as deficit financing.
Borrowings are considered a better source as they do not increase the money
supply, which is regarded as the main cause of inflation. On the other hand, deficit
financing may lead to inflationary trends in the economy due to more money supply.
Primary Deficit
Primary deficit refers to difference between fiscal deficit of the current year and
interest payments on the previous borrowings.
Primary Deficit = Fiscal Deficit - Interest Payments
The total borrowing requirement of the government includes the interest
commitments on accumulated debts. Primary deficit reflects the extent to which
such interest commitments have compelled the government to borrow in the current
period.
Implications of Primary Deficit
It indicates, how much of the government borrowings are going to meet expenses
other than the interest payments. The difference between fiscal deficit and primary
deficit shows the amount of interest payments on the borrowings made in past. So,
a low or zero primary deficit indicates that interest commitments (on earlier loans)
have forced the government to borrow.
Primary Deficit is the root Cause of Fiscal Deficit
In India, interest payments have considerably increased in the recent years. High
interest payments on past borrowings have greatly increased the fiscal deficit. To
reduce the fiscal deficit, interest payments should be reduced through repayment of
loans as early as possible.
Comparison Between Primary Deficit and Fiscal Deficit
Basis Primary Deficit Fiscal Deficit
Meaning It shows the difference It shows the excess of total
between fiscal deficit and expenditure over total
interest payment. receipts excluding
borrowings.
Indicator It indicates the total borrowing It indicates the total borrowing
requirements of the requirements of the
government, excluding government, including
interest. interest.
Formula Primary deficit = Fiscal deficit - Fiscal Deficit = Total
Interest payment Expenditure -Total Receipts
excluding borrowings
Union Budget Estimates for 2015-2016
Amount in ` Crores
1. Revenue Receipts 11,41,575
2. Capital Receipts (2a + 2b + 2c)
2a. Recoveries of loans 10,753
2b. Other receipts 69,500
2c. Borrowing and other liabilities 5,55,649 6,35,902
3. Total Receipts (1 + 2) 17,77,477
4. Plan Expenditure (4a + 4b)
4a. On revenue account 3,30,020
4b. On capital account 1,35,257 4,65,277
5. Non-Plan Expenditure (5a + 5b)
5a. On Revenue Account 12,06,027
(It includes interest payment of `
4,56,145 crores)
5b. On Capital Account 1,06,173 13,12,200
6. Total Expenditure (4 + 5) 17,77,477
Source: Union Budget 2015-16
Calculation of Various Deficits
Revenue Deficit
= Revenue Expenditure - Revenue Receipts
= (4a + 5a)-(1)
= 15,36,047 - 11,41,575 = ` 3,94,472 Crores
Fiscal Deficit
= Total Expenditure-Total Receipts excluding borrowings
= (4 + 5) - (1 + 2a + 2b)
= 17,77,477 - (11,41,575 + 10,753 + 69,500) = ` 5,55,649 Crores
Primary Deficit
= Fiscal Deficit - Interest Payments
= 5,55,649-4,56,145 = ` 99,504 Crores
REVISION OF KEY POINTS
• Government Budget is an annual statement, showing item wise estimates of
receipts and expenditures during a fiscal year, which usually runs from April 1 to
March 31.
• Objectives of Government Budget: (i) Reallocation of resources; (ii) Reducing
inequalities in income and wealth; (iii) Economic Stability; (iv) Management of public
enterprises; (v) Economic growth; (vi) Reducing regional disparities.
• Revenue Receipts are those receipts that neither create any liability nor reduce
any asset of the government. Main sources of revenue receipts are: (i) Tax
Revenue; and (ii) Non-tax Revenue.
• Tax Revenue refers to sum total of receipts from taxes and other duties imposed
by the government. Tax Revenue can be further classified as:
(i) Direct Taxes: Direct taxes refer to taxes that are imposed on property and income
of individuals and companies and are paid directly by them to the government.
(ii) Indirect Taxes: Indirect Taxes refer to those taxes which affect the income and
property of persons through their consumption expenditure.
• Non-Tax Revenue refers to the receipts of the government from all sources other
than those of tax receipts. Main sources of non-tax revenue are interest, profits and
dividends, fees, fines and penalties, etc.
• Capital Receipts are those receipts that either create a liability (like Borrowings)
or reduce an asset (like Disinvestment of a PSU) of the government. Main sources
of capital receipts are borrowings, recovery of loans and other receipts like
disinvestment and small savings.
• Revenue Expenditure refers to the expenditure that neither creates any asset nor
reduces any liability of the government.
• Capital Expenditure refers to the expenditure that either creates an asset (like
construction of a school building) or reduces a liability (like repayment of loan) of the
government.
• Revenue Deficit refers to the excess of revenue expenditure over revenue
receipts.
• Fiscal Deficit refers to the excess of total expenditure over total receipts
(excluding borrowings) during the given fiscal year.
• Primary Deficit refers to the difference between fiscal deficit of the current year
and interest payments on the previous borrowings.