PUBLIC FINANCE MODULE 1 BUDGET

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1 PUBLIC FINANCE MODULE 1 BUDGET 22/01/2017 According to Article 112 of the Indian Constitution, the Union Budget of a year, also referred to as the annual financial statement, is a statement of the estimated receipts and expenditure of the government for that particular year. Union Budget keeps the account of the government's finances for the fiscal year that runs from 1st April to 31st March. Union Budget is classified into Revenue Budget and Capital Budget. Revenue budget includes the government's revenue receipts and expenditure. There are two kinds of revenue receipts - tax and non-tax revenue. Revenue expenditure is the expenditure incurred on day to day functioning of the government and on various services offered to citizens. If revenue expenditure exceeds revenue receipts, the government incurs a revenue deficit. Capital Budget includes capital receipts and payments of the government. Loans from public form a major part of the government's capital receipts. Capital expenditure is the expenditure on development of machinery, equipment, building, health facilities, education etc. The government plans expenditure according to its objectives and then tries to raise resources to meet the proposed expenditure. Government earns money broadly from taxes, fees and fines, interest on loans given to states and dividend by public sector enterprises. Government spends mainly on (i) securing and providing goods and services to citizens, (ii) on law and order and (iii) internal security, defence, staff salaries, etc. In India, there is constitutional requirement to present budget before Parliament for the ensuing financial year. The financial (fiscal) year starts on April 1 and ends on March 31 of next year. Obviously, the budget is the most important information document of the government because government implements its plans and programmes through the budget. MAIN ELEMENTS OF THE BUDGET ARE: 1. It is a statement of estimates of government receipts and expenditure. 2. Budget estimates pertain to a fixed period, generally a year. 3. Expenditure and sources of finance are planned in accordance with the objectives of the government. 4. It requires to be approved (passed) by Parliament or Assembly or some other authority before its implementation. OBJECTIVES OF A GOVERNMENT BUDGET: The rapid and balanced economic growth with equality and social justice has been the general objective of all the Government policies and plans. General objectives of a government budget are as under: 1. ECONOMIC GROWTH: To promote rapid and balanced economic growth so as to improve living standard of the people. Economic growth implies a sustained increase in real GDP of the economy, i.e., a sustained increase in volume of goods and services. Public welfare is the main guide. 2. REDUCTION OF POVERTY AND UNEMPLOYMENT: To eradicate mass poverty and unemployment by creating employment opportunities and providing maximum social benefits to the poor.in fact, social welfare is the single most important objective. Every Indian should be able to meet his basic needs like food, clothing, housing (roti, kapda, makaan) along with decent health care and educational facilities. 3. REDUCTION OF INEQUALITIES/REDISTRIBUTION OF INCOME: To reduce inequalities of income and wealth, government can influence distribution of income through levying taxes and granting subsidies. Government levies high rate of tax on rich people reducing their disposable income and lowers the rate on lower income group. NEO IAS , , Page 1

2 Again, government provides subsidies and amenities to people whose income level is low. Again public expenditure can be useful in reducing inequalities. More emphasis is laid on equitable distribution of wealth and income. Economic progress in itself is not a sufficient goal but the goal must be equitable progress. REDISTRIBUTION OF INCOME: Equalities in income distribution mean allocating the income distribution in such a way that reduces income inequalities and also there is no concentration of income among few rich. It primarily requires that rate of increase in real Income of poor sections of society should be faster than that of rich sections of society. Fiscal instruments like taxation, subsidies and public expenditure can be made use of to achieve the object. 4. REALLOCATION OF RESOURCES: To reallocate resources so as to achieve social and economic objectives. Again, government provides more resources into socially productive sectors where private sector initiative is not forthcoming, e.g., public sanitation, rural electrification, education, health, etc. Moreover Government allocates more funds to production of socially useful goods (like Khadi) and draws away resources from some other areas to promote balanced economic growth of regions. In addition government. undertakes production directly when required. 5. PRICE STABILITY/ECONOMIC STABILITY: Government can bring economic stability, i.e., control fluctuations in general price level through taxes, subsidies and expenditure. For instance, when there is inflation (continuous rise in prices), government can reduce its expenditure. When there is depression, government can reduce taxes and grant subsidies to encourage spending by the people. 6. FINANCING AND MANAGEMENT OF PUBLIC ENTERPRISES: To finance and manage public enterprises which are of the nature of national monopohes like railways, power generation and water lines etc. IMPACT OF THE BUDGET: A budget impacts the society at three levels, (i) It promotes aggregate fiscal discipline through controlled expenditure, given the quantum of revenues, (ii) Resources of the country are allocated on the basis of social priorities, (iii) It contains effective and efficient programmes for delivery of goods and services to achieve its targets and goals. TYPES OF BUDGET: Budgets are of three types: balanced, surplus and deficit budgets depending upon whether the estimated receipts are equal to, less than or more than estimated expenditure. (a) BALANCED BUDGET: A government budget is said to be a balanced budget in which government estimated receipts (revenue and capital) are equal to government estimated expenditure Estimated Govt. Receipts = Estimated Govt. Expenditure Two main merits of a balanced budget are: (a) It ensures financial stability and (b) It avoids wasteful expenditure. Two main demerits are: (i) Process of economic growth is hindered and (ii) Scope of undertaking welfare activities is restricted. UNBALANCED BUDGET: When government estimated expenditure is either more or less than government estimated receipts, the budget is said to be an unbalanced budget. It may be either surplus budget or deficit budget. NEO IAS , , Page 2

3 (b) SURPLUS BUDGET: When government receipts are more than government expenditure in the budget, the budget is called a surplus budget. Surplus Budget = Estimated Govt. Receipts > Estimated Govt. Expenditure A surplus budget shows that government is taking away more money than what it is pumping in the economic system. As a result, aggregate demand tends to fall which helps in reducing the price level. Therefore, in times of severe inflation, which arises due to excess demand, a surplus budget is the appropriate budget. But in situation of deflation and recession, surplus budget should be avoided. Balanced budget and surplus budget are rarely used by the government in modern-day world. (c) DEFICIT BUDGET: When government estimated, expenditure exceeds government receipts in the budget, the budget is said to be a deficit budget. Deficit Budget = Estimated Govt. Expenditure > Estimated Govt. Receipts Popular democratic governments adopt mostly deficit budget to meet the growing needs of the people. Keynes had advocated a deficit budget to remedy the situation of unemployment and underemployment. Government covers the gap either through borrowing or through withdrawals from its reserves. Thus, a deficit budget implies increase in government liability and fall in its reserves. MERITS AND DEMERITS OF DEFICIT BUDGET: A deficit budget has its own merits especially for developing economy. (i) It accelerates economic growth and (ii) It enables to undertake welfare programmes of the people, (iii) It is a cure for deflation as it checks downward movement of prices. DEMERITS (i) It encourages unnecessary and wasteful expenditure by the government, (ii) It may lead to financial and political instability, (iii) It shakes the confidence of foreign investors The situation of excess demand leading to inflation (continuous rise in prices) and the situation of deficient demand leading to depression (fall in prices, rise in unemployment, etc.). A surplus budget is recommended in the situation of inflationary trends in the economy whereas a deficit budget is suggested in the situation of recession. RECEIPTS As per Articles 112 and 202 of Indian Constitution it is necessary to distinguish revenue expenditure from other expenditure. In addition to this classification, Indian budget classifies receipts also alike. Receipts Revenue Receipts Capital Receipts REVENUE RECEIPTS The sources of funds which neither create liabilities nor reduce assets are called Revenue Receipts. Revenue receipts are two types. 1. Tax Revenues 2. Non-tax Revenues 1. TAX REVENUES (i) Union Excise Duties It is the tax on production of commodities NEO IAS , , Page 3

4 (ii) Customs Duties It is the tax on export and import of commodities from and to the country. (iii) Corporate Tax It is levied on the company s profit income. (iv) Income Tax (Personal income tax) It is a tax on the personal income of the individuals. (v) Service Tax It is a tax on the services consumed by consumers. (vi) Taxes of Union Territories In India, Union Territories (except Delhi and Puducherry) are under the direct administration of the Centre. So their tax income is lumped and taken into account in the Central budget. 2. NON TAX REVENUES (i) Interest Receipts It is the interest income from the loans given by the Central Government to State Governments and other Government bodies. (ii) Dividends & Profits Dividends are income from the shares held by Governments in private enterprises and semigovernment enterprises. Profits are dividend income from the fully Government owned enterprises. CAPITAL RECEIPTS Other sources of funds such as borrowings which create liabilities or those that reduce assets are called Capital Receipts. In short, they are: (a) Receipts due to disposal of permanent assets. (b) Recovery of loans given to others. (c) Fresh loans raised by the Government. EXPENDITURES Revenue expenditure Capital expenditure REVENUE EXPENDITURE Expenditure incurred to meet day to day expenditure of government and that will not yield any revenue in future are termed as revenue expenditure. These are: 1. Interest payments Interest paid on borrowing and other liabilities, discounts on treasury bills, constitute this category. 2. Subsidies Subsidies on public distribution, fertilizers etc. are included in this category. 3. Salaries and Pensions Pensions and salaries of Central Government departments, and those paid out of Consolidated Fund as charged expenditure come under this category. 4. Grants to States & Union Territories Grants given by Centre to States and Union Territories come under this head. CAPITAL EXPENDITURE In general, expenditures that create permanent assets and yield periodical income and loans given to State Governments and local bodies are called Capital Expenditure. NEO IAS , , Page 4

5 PLAN AND NON-PLAN EXPENDITURE As India is following planned development through five year planning, the expenditure came to be classified as plan and non plan expenditure also. Since 1st April 1951, India has adopted the path of planning (Five Year Plans) to achieve its rapid economic development. So far, eleven Five Year Plans have been implemented and presently the Twelfth Five Year Plan ( ) is in operation w.e.f. April 1, In the light of these plans, government expenditure is classified into plan expenditure and nonplan expenditure on the basis of whether or not it arises due to plan proposals. PLAN EXPENDITURE Any expenditure that is incurred on programmes which are detailed under the current (Five Year) Plan of the Centre or Centre s advances to State for their plans is called plan expenditure. Provision of such expenditure in the budget is called Plan Expenditure. It includes both revenue expenditure and capital expenditure. Again, the assistance given by the Central Government for the plans of States and Union Territories (UTs) is also a part of plan expenditure. NON-PLAN EXPENDITURE This refers to the estimated expenditure provided in the budget, for spending during the year on routine functions of the Government. Non-Plan expenditure is all expenditure other than plan expenditure of the Government. Such expenditure is a must for every country, planning or no planning. For instance, no Government can escape from its basic function of protecting the lives and properties of the people and protecting the country from foreign invasions. For this, the Government has to spend on police, Judiciary, military, etc. Similarly, the Government has to incur expenditure on normal running of government departments and on providing economic and social services. Non-plan revenue expenditure is accounted for by interest payments, subsidies (mainly on food and fertilisers), wage and salary payments to government employees, grants to States and Union Territories governments, pensions, police, economic services in various sectors, other general services such as tax collection, social services, and grants to foreign governments. Non-plan capital expenditure mainly includes loans to public enterprises, loans to States, Union Territories and foreign governments. Thus non-plan expenditure is not only expenditure on these items but also includes expenditure on the following items. 1. Maintenance expenditure Maintaining services and assets created in the past. 2. Services and activities left incomplete in the previous plans, which after the plan become non-plan. Union Budget will drop the distinction between plan and non-plan expenditure. DEFICIT Deficit means shortage. Here deficit means shortage of money for expenditure. The gap between the receipts and expenditure is called deficit. There are various types of deficits: 1. BUDGET DEFICIT It is the difference between Total Expenditure and Total Receipts. Budget deficit is always zero. It doesn t have any meaning in Central Government budget. So Budget Deficit = Total Expenditure Total Receipts 2. REVENUE DEFICIT Revenue Deficit = (Revenue Expenditure Revenue Receipt) Effective Revenue Deficit = Revenue Deficit Grants for Creation of Capital Assets. NEO IAS , , Page 5

6 3. FISCAL DEFICIT Fiscal Deficit is the difference between Total Expenditure and Total Receipts except Borrowing and Other liabilities. Fiscal Deficit = Total Expenditure Total Receipts except Borrowing and other liabilities. = Total Expenditure - [Non Debt Creating Capital Receipts + Revenue Receipts] To be precise fiscal deficit, is the amount of Borrowing and other Liabilities 4. PRIMARY DEFICIT Primary Deficit is measured by subtracting the interest payments from fiscal deficit. It is a measure of current year s fiscal operation after excluding the liability of interest payment created due to borrowings under taken in the past. Primary Deficit = Fiscal Deficit Interest Payment 5. MONETISED DEFICIT Monetised deficit goes beyond the Government budgetary operations. This represents increase in the net RBI credit to the Union Government which is the sum of increases in the RBI s holding of Government debt and any draw down by the Government of its cash balance with RBI. To say simply, the monetized deficit represents the expansion in money by the RBI. Monetised Deficit = Borrowing from RBI + Draw down balance of government from RBI DEFICIT FINANCING Deficit financing is a method of meeting government deficits through the creation of new money. The deficit is the gap caused by the excess of government expenditure over its receipts. Creation of new money to meet the deficit is in use for a long time. But it has now being given up. Instead a new scheme called Ways and Means Advances is being ushered in with effect from April Under this system the Government can get only temporary loans to overcome the mismatch between its receipts and expenditures. In India, the deficit financing is resorted mainly to enable the Government to obtain the necessary resources for economic development. The levels of outlay laid down are of an order which cannot be met only by taxation and borrowing from the public. The gap in resources is made up partly through external assistance, but when external assistance is not enough to fill the gap; deficit financing has to be resorted to. The targets of production and employment in the plans are fixed primarily with reference to what is considered as the desirable rate of growth for the economy. When these targets cannot be achieved by levels of expenditure possible with resources obtained from taxation and borrowing, additional resources have to be found. FISCAL SLIPPAGE If the actual fiscal deficit is more than what was expected it is called as fiscal slippage. For example in the budget, estimated fiscal deficit was 4.5% but the actual deficit at the end of the financial year is 7%, then it is called fiscal slippage. PREVIOUS YEARS QUESTIONS (PRELIMS) 1. There has been a persistent deficit budget year after year. Which action/actions of the following can be taken by the Government to reduce the deficit? (2016) 1. Reducing revenue expenditure 2. Introducing new welfare schemes 3. Rationalizing subsidies 4. Reducing import duty Select the correct answer using the code given below. (a) 1 only (b) 2 and 3 only (c) 1 and 3 only (d) 1, 2, 3 and 4 NEO IAS , , Page 6

7 2. Which of the following is/are included in the capital budget of the Government of India? (2016) 1. Expenditure on acquisition of assets like roads, buildings, machinery, etc. 2. Loans received from foreign governments 3. Loans and advances granted to the States and Union Territories Select the correct answer using the code given below. (a) 1 only (b) 2 and 3 only (c) 1 and 3 only (d) 1, 2 and 3 3. There has been a persistent deficit budget year after year. Which of the following actions can be taken by the government to reduce the deficit? (2015) 1. Reducing revenue expenditure 2. Introducing new welfare schemes 3. Rationalising subsidies 4. Expanding industries Select the correct answer using the code given below. (a) 1 and 3 only (b) 2 and 3 only (c) 1 only (d) 1, 2, 3 and 4 4. With reference to Union Budget which of the flowing is / are covered under Non-Plan expenditure? 1. Defence expenditure (2014) 2. Interest payments 3. Salaries and pensions 4. Subsidies Select the correct answer using the code given below. (a) 1 only (b) 2 and 3 only (c) 1, 2, 3 and 4 (d) None 5. In India, deficit financing is used for raising resources for (2013) (a) economic development (b) redemption of public debt (c) adjusting the balance of payments (d) reducing the foreign debt 6. In the context of governance, consider the following: (2010) 1. Encouraging Foreign Direct Investment inflows. 2. Privatization of higher educational Institutions. 3. Down-sizing of bureaucracy. 4. Selling/offloading the shares of Public Sector Undertakings. Which of the above can be used as measures to control the fiscal deficit in India? (a) 1, 2 and 3 (b) 2, 3 and 4 (c) 1, 2 and 4 (d) 3 and 4 only 7. With reference to the Indian Public Finance, consider the following statements: (2002) 1. External liabilities reported in the Union Budget are based on historical exchange rates. 2. The continued high borrowing has kept the real interest rates high in the economy. 3. The upward trend in the ratio of Fiscal Deficit to GDP in recent years has an adverse effect on private investments. 4. Interest payments are the single largest component of the non-plan revenue expenditure of the Union Government. Which of these statements are correct? (a) 1, 2 and 3 (b) 1 and 4 only (c) 2, 3 and 4 (d) 1, 2, 3 and 4 8. Match List I with List II and select the correct answer using the codes given below the lists: (2001) List I (Term) List-II (Explanation) A. Fiscal deficit 1. Excess of Total Expenditure over Total Receipts B. Budget deficit 2. Excess of Revenue Expenditure over Revenue Receipts C. Revenue deficit 3. Excess of Total Expenditure over Total Receipts less borrowings D. Primary deficit 4. Excess of Total Expenditure over Total Receipts less borrowings & Interest Payments NEO IAS , , Page 7

8 A B C D A B C D (a) (b) (c) (d) Assertion (A): Fiscal deficit is greater than budgetary deficit Reason (R): Fiscal deficit is the borrowing from the Reserve Bank of India plus other liabilities of government to meet its expenditure. (1999) 10. Which of the following come under Non-Plan expenditure? (1997) 1. Subsides 2. Interest payments 3. Defence expenditure 4. Maintenance expenditure for the infrastructure created in the previous plans. Choose the correct answer using the codes given below: (a) 1 and 2 only (b) 1 and 3 only (c) 2 and 4 only (d) 1, 2, 3 and The following Table shows the percentage distribution of revenue expenditure of Government of India in and : Expenditure Head (percent to total) (1996) Years Defence Interest Payments Subsides Grants to States/UT s Others Based on this table, it can be said that the Indian economy is in poor shape because the Central Government continues to be under pressure to: (a) reduce expenditure on defence (b) spend more and more on interest payments (c) reduce expenditure on subsides (d) spend more and more as grants-in-aid to State Government/Union Territories. 12. Which of the following are among the non-plan expenditure of the Government of India? (1995) 1. Defence expenditure 2. Subsidies 3. All expenditures linked with the previous plan periods 4. Interest payments Choose the correct answer using the codes given below: (a) 1 and 2 only (b) 1 and 3 only (c) 2 and 4 only (d) 1, 2, 3 and 4 PREVIOUS YEARS QUESTIONS (MAINS) 1. What is deficit financing? (2004) 2. Which are the three major items of expenditure of the Government of India on revenue account? (2003) 3. What are the hurdles faced by the Finance Ministers of India in keeping the fiscal deficit below 3-4 percent of the GDP? Suggest steps to lower the fiscal deficit. (2001) NEO IAS , , Page 8

UNIT IX: GOVERNMENT BUDGET AND THE ECONOMY GOVERNMENT BUDGET A FLOW CHART

UNIT IX: GOVERNMENT BUDGET AND THE ECONOMY KEY CONCEPTS: Meaning of the Budget Objectives of the Budget Components of the Budget Budget Receipts Budget Expenditure Balanced, Surplus and Deficit Budgets