8. Government Budget and the Economy
Government budget is annual statement of the estimated receipts and proposed expenditure of the govt. over the fiscal year.
Objectives
1. Activities to secure a reallocation of resources: The govt. has to reallocate resources in line with the social and economic policies of the country.
2. Redistributive activities: The govt. redistributes income and wealth in order to reduce inequalities, by expenditures on social security, subsidies, public works, etc.
3. Stabilizing activities: The govt. tries to prevent business fluctuations and maintain economic stability, i.e., high level of employment and price stability (Keynesian economics).
4. Management of Public Enterprises: Govt. undertakes commercial activities such as railways and electricity, which are of the nature of natural monopolies and heavy manufacturing. The management of such enterprises comes under state regulation because if left unregulated, there is a tendency of the monopolist to curtail output in pursuit of maximizing profit. This will lower social welfare.
Impact of govt. budget on the economy
1) Aggregate fiscal discipline: The govt. ought to have a control over its expenditure, given the quantum of its revenue. This is to ensure proper macro economic performance.
2) Allocation of resources based on social priorities: Govt. budget allocates the resources on the basis of its social and economic priorities in order to maximize social welfare.
3) Delivery of services: It measures the effectiveness of its programs and the extent to which the govt. provides achieves its goals.
Components of a govt. budget
A govt. budget is divided into revenue budget and capital budget.
Revenue receipts: They are those which do not create a liability or they do not lead to reduction of assets.
For example, receipts from taxes do not create a liability or it does not reduce assets.
It may be divided into tax revenue and non-tax revenue. .
Tax revenue includes revenue from direct and indirect taxes imposed by the govt., while non-tax revenue includes revenue from profits earned by govt. enterprises, prices paid for govt. supplied commodities and services. This includes payments for postage, tolls, interest on funds received from govt. corporations such as railways, etc. and interest and dividends on investments made by govt.
Administrative revenue is revenue that arises on account of the administrative function of the govt. Some of the administrative revenue are
1) Fees which are payment to defray the cost of each recurring service undertaken by the govt. primarily in the public interest, but conferring a measurable special advantage on the fee payer. E.g., license fees
2) Fines and penalties which are levied on the violation of a law.
3) Forfeitures of basic surety or bonds are penalties imposed by courts for no-compliance with orders or non-fulfillment of contracts
4) Escheat refers to the govt. claims on the property of a person who dies without having any legal heirs or without leaving a will.
| Direct tax | Indirect tax |
| 1. Tax in which the liability and the burden to pay the tax lie on the person. 2. The burden of paying the tax cannot be shifted to others. 3. It is imposed on the property and income of persons. 4. E.g., are income tax, wealth tax and interest tax. | 1. Tax in which the liability to pay the tax and the burden of paying the tax can be on different persons. 2. The burden of paying the tax can be shifted to others. 3. It is imposed on production and consumption of commodities. 4. E.g., are sales tax, excise duty and import duty. |
| Tax revenue | Non-tax revenue |
| 1. It is the revenue receipts that the govt. receives by imposing direct and indirect taxes. 2. E.g., are revenue from income tax, excise duty wealth tax and import duty. | 1. It is the revenue receipts that the govt. receives from sources other than tax. 2. E.g., are revenue from interest on govt. loans, dividends and profits of govt. enterprises and external grants from foreign govts. |
Capital receipts: While one part of govt. receipts is revenue receipts, the other part is capital receipts. When govt. receives funds either by incurring a liability or by disposing its assets, it is called a capital receipts.
For example, when the govt. raises funds by borrowing, it increases the liability of the govt. Such funds are called capital receipts.
Capital receipts of the Govt. of India can be classified into three. They are
1) recoveries of loans
2) borrowings and other liabilities and
3) other receipts
| Revenue receipts | Capital receipts |
| 1. Receipt of govt. which does not increase its liability or it does not reduce the assets of the govt. 2. Sources of revenue receipts are tax and non-tax revenues such as interest , profit and external grants | Govt. receipt which either increases the govt.’s liability or decreases its assets. 2. Sources of capital receipts are recoveries of loans, borrowing and other liabilities and other receipts such as disinvestment. |
Budget expenditure: While one part of the govt. budget is receipts, the other part is expenditure. Similar to budget receipts, budget expenditure also can be divided into revenue expenditure and capital expenditure.
Revenue expenditure: An expenditure which does not result in creation of assets nor reduction of liability is called revenue expenditure. Such expenses are incurred for the normal running of the govt. departments. Main examples are salaries and pensions of govt. employees, interest paid by the govt. on the loans raised by it, subsidies and financial grants given by the govt.
Capital expenditure: It is an expenditure which leads to creation of assets or reduction of liabilities,. Some of the examples are the expenditure on purchasing land, buildings, shares as well as loans granted to the State govts., foreign govts., public enterprises and others.
Plan expenditure and Non-Plan expenditure
Plan expenditure: In every five-year and annual plans, the govt. makes several programmes for the development of the economy such as Integrated Rural Development Programme and Jawahar Rozgar Yojna. For the implementation of such programmes, the govt. incurs expenditure. This is known as plan expenditure.
Non-Plan expenditure: When the govt. spends on anything other than the expenditure related to the current five-year plan or annual plan, it is known as non-plan expenditure.
Developmental and Non-Developmental Expenditure
Budget expenditure of a govt., whether Plan or Non-Plan, Revenue or Capital, can also be classified into developmental and non-developmental expenditure.
Developmental expenditure: It is the expenditure on activities which are directly related to economic and social development of the country. Examples of developmental expenditure are expenditure on agricultural and industrial development, education, health, social welfare and scientific research.
Non-developmental expenditure: Govt. expenditure on essential general services such as defence and administration is known as non-developmental expenditure. This expenditure is an essential part of the development process. This expenditure does not directly contribute to the national product but it lubricates the wheels of economic development.
| Developmental expenditure | Non-developmental expenditure |
| 1. Expenditure on activities which are directly related to economic and social development of the country. 2. E.g. are expenditure on agriculture, health and education. | 1. Expenditure on essential general services of the govt. 2. E.g. are expenditure on defence and administration. |
Types of budget
Budget can be classified into balanced, surplus or deficit budget.
Balanced budget: A balanced budget is one in which the estimated revenue equals the estimated expenditure. Supposing that the only source of revenue for the govt. is a lump sum tax. It means that the tax amount is equal to the govt. expenditure.
The decrease in aggregate demand (due to the tax) is equal to MPC times the tax. Now, the aggregate demand will increase because of the expenditure. Increase in aggregate demand will be equal to 1 – MPC multiplied by expenditure. Thus, the increase in aggregate demand due to expenditure will be more than the fall in aggregate demand due to tax. Thus, a balanced expenditure will slightly increase the aggregate demand. A balanced budget is a good policy to bring the economy which is at near-full employment to full employment.
Surplus budget: It is a budget in which the estimated revenue is more than the estimated expenditure. Supposing that the only source of revenue is a lump sum tax, its effect on the economy will be to decrease aggregate demand. Due to tax, aggregate demand will fall by MPC times of tax. The effect of govt. expenditure is to increase aggregate demand.
If tax is sufficiently higher than expenditure, the net effect of the budget will be to decrease aggregate demand. This is done at times of inflation that arises out of excess demand.
Deficit budget: A deficit budget is one in which the estimated revenue is less than estimated expenditure. This means that tax is less than expenditure. Again supposing that the only source of revenue is a lump sum tax, The reduction in aggregate demand (due to tax) is equal to MPC times the tax. The increase in aggregate demand (due to expenditure) is by an amount equal expenditure. Now, if tax is sufficiently les than the expenditure, then the reduction in aggregate demand will be less than the increase in aggregate demand. The net effect of this is to increase aggregate demand.
This is done when the economy is facing recession due to deficient demand.
Types of deficit
There are four different concepts of deficit. They are budget deficit, revenue deficit, primary deficit and fiscal deficit.
1. Revenue deficit: When revenue expenditure is more than revenue receipts, the shortfall is known as revenue deficit.
Revenue deficit = Total revenue expenditure – total revenue receipts
Though revenue expenditure and revenue receipts do not affect either liabilities or assets, revenue deficit affects them. When revenue expenditure is more than revenue receipts, this deficit is met either by borrowing or by selling the assets. Thus revenue deficit either increases the govt. liabilities or reduces its assets.
2) Fiscal deficit: When the total govt. expenditure is more than the total govt. receipts, the shortfall is known as fiscal deficit.
Fiscal deficit = Total govt. expenditure - Total govt. receipts.
Importance of fiscal deficit: Fiscal deficit is an overall measure of the total borrowing requirements of the govt. It shows how much the govt. needs to borrow, in order to meet its budget expenditure.
For example, in the Indian govt. budget of 2000 – 2001, fiscal deficit is about 33% of the total budget expenditure. It means that the govt. has to borrow 33 paise in order to finance 1 rupee.
Fiscal deficit creates many problems for the economy. With borrowing, the govt.’s liability in future increases because it has to pay the interest and repay the loans. Payment of interest increases revenue expenditure Increased revenue expenditure may lead to higher revenue deficit. In order to finance the higher revenue deficit, the govt. borrows more and more which again increases its fiscal deficit. This creates a vicious circle.
Every year, the govt. has to borrow, just to finance interest payments. Repayment of loans is another problem. That is why the Indian govt. is trying to reduce fiscal deficit as much as possible.
iii) Primary deficit: It is equal to the fiscal deficit less interest payments.
Thus, primary deficits = Fiscal deficit – Interest payments
It shows the borrowing requirements of the govt. net of interest payment.
