NCERT Fundamentals - Class XII - Introductory Macroeconomics - Government Budget And The Economy

By BYJU'S IAS|Updated : September 3rd, 2022

Introduction

  • In a mixed economy, the government plays a crucial role along with the private sector.
    • A Mixed economy refers to a system that is a combination of both capitalism and socialism.
  • The government can influence the economy through various means and the government budget is one such mechanism.

Government Budget

  • According to Article 112 of the Constitution, the government is mandated to produce a statement of estimated receipts and expenditures of the government for every financial year or fiscal year (running between 1st of April of the current calendar year to 31st of March of the next calendar year).
  • This document is called the “Annual Financial Statement” (also called budget document) and is presented before the parliament every year.
  • Although this budget document relates to the receipts and expenditures of the government for a particular financial year, the budget will have a significant impact even in the coming years.
  • To differentiate between such impacts, there are two accounts in the budget:
    • Revenue account or budget - those that relate to the current financial year
    • Capital account or budget - those that relate to the assets and liabilities of the government

Objectives of Government Budget

 

  • Allocation Function of the Budget 
  • The government is entrusted to provide a few goods and services which cannot be procured from the market. For example, equipment for national defence. These are called public goods.
  • Public goods are the ones that are available to all the citizens of a country and are not limited to one consumer hence it is called “non rivalrous”.

 

        • Further, there are no mechanisms to exclude people from availing public goods, hence public goods are “non-excludable”.
      • The government through the budget can ensure that there is adequate allocation to public goods which are crucial for the welfare of society.

 

  • Redistribution Function of the Budget
  • The government through taxation and making benefits transfers can affect the personal disposable income of households.
  • The government through the budget can ensure that there is a fair distribution of income.
  • Stabilisation Function of the Budget

 

    • The government can address the fluctuations in income and employment through its annual budget.
    • The level of income and employment depend directly on the aggregate demand which ultimately depends on the spending by the government. However, it is to be noted that increased spending by the government may lead to inflation.
    • The government interventions to increase or reduce aggregate demand are regarded as the stabilisation function of the budget.

 

Classification of the Government Budget 

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Classification of Receipts

 

  • Revenue Receipts: Revenue receipts refer to those receipts which do not lead to a claim on the government i.e. these receipts neither create an asset nor reduce any liability to the government. These receipts are called “non-redeemable”. These are further classified into:

 

      • Tax revenues - Tax revenues encompass direct taxes (Example: income and corporation taxes) and indirect taxes (Example: excise tax, Goods and Service Tax, Value Added Tax, customs duties, etc.)
      • Non Tax revenues - Non-tax revenue mainly constitutes interest received on account of loans by the government, dividends and profits on investments made by the government, fees and other receipts for services provided by the government and grants-in-aid from other countries and organisations.

 

  • Capital Receipts: The revenue received by the government through loans or from the sale of its assets. These receipts either create liability or reduce the assets of the government.

 

Classification of Expenditure

 

  • Revenue Expenditure: Such expenditure incurred by the government which does not create any physical or financial asset to the government is called revenue expenditure. It includes expenses incurred for the day to day governance of various departments and services, interest payments on debt incurred by the government, and grants in aid to states
  • Plan Expenditure - expenditure incurred on account of implementing central plans and extending central aid for various State and Union Territory (UT) plans.

 

      • Non-plan Expenditure - expenditure incurred due to interest payments, defence services, subsidies, salaries and pensions.

 

  • Capital Expenditure: Such expenditures by the government which result in the creation of physical or financial assets or reduction in financial liabilities of the government are called capital expenditure. This includes expenditure on the purchase of land, building, machines, equipment, government’s investment in shares, etc.

 

      • Plan Expenditure - expenditure incurred on account of implementing central plans and extending central aid for various State and UTs.

 

  • Non-plan Expenditure - expenditure incurred on account of providing general, social and economic services by the government.

 

Balanced, Surplus AND Deficit Budget

  • Balanced Budget - A balanced budget is a situation in the budgeting process where total expected revenues are equal to total planned spending.
  • Surplus Budget - A surplus budget is a situation where the revenue collected is higher than the expenditure.
  • Deficit Budget -  A deficit budget is a situation wherein the expenses exceed the revenue collected.

Measures of Government Deficit

  • Revenue Deficit: The revenue deficit refers to the excess of government’s revenue expenditure over revenue receipts
    • Revenue deficit = Revenue expenditure – Revenue receipts
  • Fiscal Deficit: The fiscal deficit is the difference between total expenditure and revenue of the government excluding borrowing. It indicates the total borrowing that is needed by the government.
    • Gross fiscal deficit = Total expenditure – (Revenue receipts + Non Debt creating capital receipts)
    • Fiscal Deficit = Revenue Deficit + Capital Expenditure – non debt creating capital receipts
  • Primary Deficit: Primary Deficit refers to the difference between the current year's fiscal deficit and interest payment on previous borrowings.
    • Gross primary deficit = Gross fiscal deficit – Net interest liabilities

Fiscal Policy

  • According to Keynes’s principle in the “General Theory of Employment, Interest and Money” the fiscal policy of the government must be ultilised to stabilise the level of output and employment in the economy.
  • By making necessary changes in its expenditure and taxes, the government can increase output and income and seeks to stabilise the fluctuations in the economy. 
  • In this process, fiscal policy creates a surplus or a deficit budget rather than a balanced budget.
  • The government directly affects the level of equilibrium income in two specific ways:
    • The government purchases of goods and services - increase aggregate demand 
    • The government taxes and transfers - affect the relation between income and disposable income (which is the income available for consumption and saving with the households after paying taxes)

Debt

  • Budgetary deficits are to be financed by either taxation or through borrowing or by printing more money. 
  • Governments have generally relied on borrowing to finance deficits, giving rise to government debt or public debt.
  • If the government pursues its borrowing strategies year after year, it causes an accumulation of debt and the government will have to pay more interest.

Deficit Reduction

  • The government deficit could be lessened by either increasing taxes or by reducing expenditure. 
  • In the Indian context, the government has mainly been using the strategy of increasing tax revenue with more dependence on direct taxes as the indirect taxes are regressive in nature.
  • The government has also tried to increase its receipts by selling its shares in Public Sector Undertakings. 
  • However, the key focus has been on reducing government expenditure and this can be realised by ensuring more efficiency in government activities through better administration and planning.

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