Introductory Macroeconomics Chapter 5 The Government : Budget And The Economy

Objectives of a Government Budget. Briefly put, promoting rapid and balanced economic development with equality and social justice has been the general objective of all our policies and plans. General objectives of a government budget are as under:
(i)    Economic growth. To promote rapid and balanced economic growth so as to improve living standard of the people. Economic growth implies increasing capacity of the economy to produce more goods and services. Public welfare is the main guide.
(ii)    Reduction of Poverty and Unemployment. To eradicate mass poverty and unemployment by creating maximum employment opportunities and providing maximum social benefits to the poor. Social welfare is the single most objective of the government. Every Indian should be able to meet his basic needs like food, clothing, housing along with decent health care and educational facilities.
(iii)    Reallocation of Resources. (A 2010, D 2011) To reallocate resources in line with social and economic objectives, government has to allocate resources into areas where private sector is not coming, e.g., sanitation, water supply, rural development, education, health, etc. Moreover, government provides more funds to productive sectors and draws away resources from some other sectors to promote balanced economic growth of different regions.
(iv)    Reduction of inequalities/Redistribution of income. To reduce inequalities of income and wealth government can influence distribution of income through levying taxes on the rich and granting subsidies to poor. Government uses progressive taxation policy, i.e., high rate of tax on rich people and lower rate on lower income group. Government provides subsidies and amentities to people whose income level is low. More, emphasis is laid on equitable distribution of wealth and income. Economic progress in itself is not a sufficient goal but goal must be equitable progress.
(v)    Price Stability/Economic stability. Government can bring economic stability i.e. can control fluctuations in general price level through taxes, subsidies and expenditure. For instance when there is inflation (continuous rise in prices), govt. can reduce its expenditure and when there is depression characterised by following output and prices, govt. can reduce taxes and grant subsidies to encourage spending by people.
(vi)    Management of public enterprises. To manage, public enterprises which are of the nature of monopolies like railways, electricity, 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. In short, the budget impacts the economy through aggregate fiscal discipline, resource allocation and provision of programmes for delivery of services.

Components of the budget. The budget is divided into two parts — (i) Revenue Budget, and (ii) Capital Budget.
(i) The Revenue Budget comprises current revenue receipts and current expenditure met from such revenues. The revenue receipts include both tax revenue (like income tax, excise duty) and non-tax revenue (like interest receipts, profits). (ii) Capital Budget consists of capital receipts (like borrowing, disinvestment) and capital expenditure (creation of assests, investment) of the government. Capital receipts are receipts of the government which create liabilities or reduce assets. Capital expenditure is the expenditure of the government which either reduces liability or creates an asset. Thus, capital budget is an account of assets and liabilities of the government which takes into consideration changes in capital.
The structure (or components) of a government budget broadly consists of two parts — Budget Receipts and Budget Expenditure as shown in the following chart. Let us see their classification.

Difference between Revenue Receipts and Capital Receipts. Government receipts are divided into two groups — Revenue Receipts and Capital Receipts.
Basis of classification—All government receipts which either create liability or reduce assets of the government are treated as capital receipts whereas receipts which neither create liability nor reduce assets of the government are called revenue receipts.
(i)    Revenue Receipts. Government receipts which neither (a) create liabilities, nor
(b)    reduce assets are called revenue receipts. These are proceeds of taxes, interest and dividends on government investments, cess and other receipts for services rendered by government. Thus these are current income receipts of the government from all sources. Government revenue is the means for government expenditure in the same way as production is means for consumption. 
(ii)    Capital Receipts. Government receipts which either (i) create liabilities (of returning loans), or (ii) reduce assets (on disinvestment) are called capital receipts. Two main examples of capital receipts which create liability are (a) Borrowing, and (b) Raising of funds from PPF and Small Saving Deposits. Borrowing is treated capital receipts because it creates liability of returning loans. Similarly, funds raised from Post Office deposits, Public Provident Fund, NSS deposits, etc. are also treated as capital receipts because government has to repay these amounts.
Two main examples which reduce assets are (a) Recovery of loan, and (b) Disinvestment. How? Recovery of loan is treated as capital receipt because it causes reduction in assets. For example, a loan of र 100 crores given by Central government to State government (say UP govt.) is central govt. assets because it owns money that it lends. If UP government repays say र 20 crores to Central govt., it means reduction in assets of Central govt, to the time of र 20 crores. Thus recovery of loan by Central govt. is treated as capital receipt. Similarly, disinvestment by the govt. in the form of selling whole or part of its shares of public sector enterprises to private enterprises is treated capital receipt because it reduces govt. assets. In short, when government raises funds either by incrurring a liability or by disposing of assets,it is called a capital receipt. In government budget capital receipts are classified in three groups, namely, (i) Borrowings (ii) Recovery of loans, and (iii) Disinvestment and other receipts.
Difference. The main difference between revenue receipts and capital receipts is that in case of revenue receipts, government is under no future obligation to return the amount, i.e., they are non-redeemable. But in case of capital receipts which are borrowings, government is under obligation to return the amount alongwith interest.
Debt creating and non-debt creating capital receipts. Capital receipts may be debt creating or non-debt creating. Examples of debt creating receipts are: Net borrowing by government at home, loans received from foreign governments, borrowing from RBI. Examples of non-debt capital receipts are: Recovery of loans, proceeds from sale of public enterprises (i.e., disinvestment, etc.). These do not give rise to debt.

Components (Sources) of Revenue Receipts (Tax Revenue and Non-tax Revenue). Revenue receipts of the government are divided into two groups, namely, (i) tax revenue, and (ii) non-tax revenue. Tax revenue consists of proceeds of taxes and other duties levied by the Union Government such as income tax, corporate tax, excise duty, custom duty, etc. Non-tax revenue consists of all receipts from sources other than taxes. These are shown in the above chart. Components or sources of revenue receipts are explained below.
(A) Tax revenue. Tax revenues consist of proceeds of taxes and other duties levied by the Union Government. It is the main source of government revenue. A tax is a legally compulsory payment imposed by the government on income and profit of persons and companies without reference to any benefit. Similarly, government levies taxes on sale of goods (sale tax), manufacturing of goods (excise duty), an export and import of goods (custom duty), wealth, gifts, properties, etc. Government proposals for levy of new taxes, modification of existing tax rates are contained in the budget. The money received from taxes is used by the government to meet the expenditure incurred on providing common benefits to the people. No one can refuse to pay the tax otherwise the defaulter is prosecuted and penalised. The tax payer cannot demand in exchange for tax payment. For instance, a rich man cannot claim that he would not pay taxes to support schools because he has no children. The central government collects revenue in the form of various taxes such as income tax, corporate tax, custom duty, excise duty, expenditure tax, wealth tax, interest tax, etc. The main objectives of taxation are:
(i)    to increase government income,
(ii)    to achieve equitable distribution of income,
(iii)    to restrain use of harmful commodities,
(iv)    to regulate foreign trade, and
(v) to conserve country's resources.
(B) Non-tax revenue. Income from sources other than taxes is called non-tax revenue. It arises on account of administrative function of the government. These are incomes which the government gets in the form of interest, dividend, profit, fees, fines and external grants as explained below. It comprises the following items.
(i)    Interest. It is an important source of government non-tax revenue. Government receives interest on loans given by it to state governments, union territory governments, local governments, private enterprises and the people.
(ii)    Profits and dividends. Of late government has developed a new source of income by starting its own production units called public enterprises which like private enterprises produce and sell goods and services. For instance, Nationalised Banks, Industrial Finance Corporation of India, LIC, STC, HMT, MMTC, BHEL, etc. provide profits. Government also gets dividends on investments made by it.
(iii)    Fees and fines. Government gets income, though nominal, in the form of different types of fees charged by it, e.g., tuition fees in schools, OPD card fees in hospitals, land registration fees, passport fees, court fees, driving licence fees, import fees, etc. Similarly, government gets income by way of fines and penalties imposed by it on various types of offences committed by the law-breakers. These are called administrative revenue. Forfeitures of basic surety or bond (imposed by courts for non-compliance with orders) and escheat (lapsing of property to state for want of legal heir of the deceased) are other sources of non-tax revenue. Administration revenue is revenue that arises on account of administrative functions of the government.
(iv)    Special Assessment. When government undertakes development activities like construction of roads, provision of drainage, street lighting in a particular areas, the value of nearby property or rental value of houses goes up in the vicinity. Clearly, the additional income and profit which the owners of the landed property get is not the result of efforts on their part. Special assessment is, therefore, like a special tax that government levies in proportion to the benefit accruing to property owners to defray the cost of development. It is a payment made once-for-all by the owners of properties for increase in the value of their properties resulting from development activities of the government.
(v)    External grants-in-aid. Government receives financial help from foreign governments and international organisations in the form of grants, donations, gifts and contribution.

Components (Sources) of Capital Receipts. These are the following:
(i)    Recovery of loans and advances. Loans offered by government to others are govt. assets because it owns money that it lends. We know that Central Government grants loans to (i) states, union territories, (ii) public sector enterprises, other parties, and (iii) foreign governments. Recovery of all such loans is treated as capital receipts because it causes reduction in assets of the government.
(ii)    Disinvestment. Government raises funds from disinvestment also. Disinvestment means selling whole or a part of the shares (i.e., equity) of selected public sector enterprises held by government to private sector. As a result, government assets are reduced. Sometimes disinvestment is also termed as privatisation because it involves transfer of ownership of public sector enterprises to private entrepreneurs.
(iii)    Borrowing (domestic and external). Funds raised by government from borrowing are treated as capital receipts. These funds are borrowed from (i) open market (known as market borrowing), (ii) Reserve Bank of India, (iii) foreign governments and international organisations (like World Bank, Asian Development Bank, etc.). Government resorts to borrowing when its expenditure exceeds its revenue (i.e., when there is fiscal deficit).
(iv)    Small savings. Government receipts also include small savings like Post Office deposits, GPF deposits, NSS deposits, Kisan Vikas Patras, etc.

Distinction between Direct Tax and Indirect Tax:
Basis of Classification. The basis of classifying taxes into direct tax and indirect tax is 'whether the burden of the tax is shiftable to other or not.' If it is not shiftable, it is a direct tax. If burden is shiftable to others, it is an indirect tax.
(i) Direct tax. When (i) liability to pay a tax, and (ii) the burden of that tax falls on the same person, the tax is called a direct tax. Thus a direct tax is the tax which is paid by the same person on whom it has been levied, i.e., its burden cannot be shifted to others. For example (i) income tax is a direct tax because the person whose income is taxed is liable to pay the tax directly to the government and bear its burden himself. Other examples of direct tax are: (ii) Corporate tax — It is levied on the profit of corporations and companies.(iii) Wealth tax — It is imposed on property of individuals depending upon the value of property. (iv) Gift tax - It is paid to the government by the recipient of gift depending upon the value of gift. (v) Estate duty — It is charged from successor of inherited property. Similarly, (vi) Expenditure tax, (vii) Fringe benefit tax are other examples of direct taxes. In short, direct tax are levied on the income and the property of persons and are paid directly to the state.
Merits (i) Direct taxes help in reducing disparities in income and wealth of people. (ii) They are economical because cost of collection for government is relatively low. (iii) Social and economic justice is achieved to some extent because direct taxes are based on 'ability to pay'.
Direct taxes are generally considered progressive taxes because they are based on the ability to pay. A progressive tax is one the rate of which increases with rise in income and decreases with fall in income.
(ii) Indirect tax. When (i) liability to pay a tax is on one person, and (ii) the burden of that tax falls on some other person, the tax is called an indirect tax. Thus it is a tax whose burden can be shifted to others. For example, (i) Sales tax is an indirect tax because liability to pay tax is that of shopkeeper who, in turn, realises the tax amount from the customer by including it in price of the commodity. Other examples of indirect tax are (ii) Excise duty — It is paid by the producer (manufacturer) of goods who recovers it from wholesalers and retailers. (iii) Custom duty — It is charged from the importer of goods from a foreign country which is recovered from retailers and customers. (iv) Entertainment tax — It is charged from cinema-owners who recover it from cinema-viewers. (v) Service tax — It is imposed on selling services (e.g., serving meals in hotels) to customers. Similarly, (vi) Octroi (chungi), and (vii) Value added tax are other examples of indirect taxes. In short, all taxes levied on goods and services in different forms (like on production, sale, transport, etc.) are called indirect tax.
Merits — (i) Indirect taxes are convenient to realise because they are included in the price of the commodity. (ii) They have wide coverage since every member (consumer) of the society is taxed through price of the commodity. (iii) Consumption of harmful commodities like wine, cigarettes, etc. is curtailed thus serving social purpose.

(i) Wealth tax is a direct tax as liability of its payment and burden fall on the same person.
(ii)    Entertainment tax is an indirect tax because its burden can be shifted.
(iii)    Income tax is a direct tax because its liability to pay and its burden fall on the same person.

Meaning of Budget Expenditure.
Budget (or Government) Expenditure refers to the estimated expenditure to be incurred by the government under different heads in a year. It needs to be noted that public (govt) expenditure for a welfare state has great significance because it (i) accelerates economic growth (ii) reduces inequality (iii) checks employment and depression.
Like two types of budget receipts, i.e., Revenue Receipts and Capital Receipts, budget expenditure is also of two types, i.e., Revenue Expenditure and Capital Expenditure as explained below. Components of each are shown in the following chart.

Note: According to India's budget for 2010-11, Expenditure of 1 Rupee was made on : Central plans 21 paise, assistance to states and U.T. plans 7 paise, interest payment 19 paise, defence 11 paise, subsidies 9 paise, nonplan assistance to states and U.T. 4 paise, state's share of taxes and duties 16 paise, other non-plan expenditure 13 paise = 100 paise.

Difference between Revenue Expenditure and Capital Expenditure. An expenditure that neither creates assets nor reduces a liability is categorised as revenue expenditure. If it creates an asset or reduces a liability, it is categorised as capital expenditure. This is the basis of classification between the two.

(i) Revenue Expenditure. Simply put, an expenditure which neither creates assets nor reduces liability is called Revenue Expenditure, i.e., Salaries of employees, interest payment on post debt, subsidies, pension, etc. These are financed out of revenue receipts. Broadly, any expenditure that does not lead to any creation of assets or reduction in liability is treated as revenue expenditure. Generally, expenditure incurred on normal running of the government departments and maintenance of services is treated as revenue expenditure. Examples of revenue expenditure are salaries of government employees, interest payment on loans taken by the government, pensions, subsidies, grants, rural development, education and health services, etc. It is a short period expenditure and recurring in nature which is incurred every year (as against capital expenditure which is long period expenditure and non-recurring in nature). The purpose of such expenditure is not to build up any capital asset but to ensure normal functioning of government machinery. Traditionally, all grants given to state governments are treated as revenue expenditure even though some of the grants may be for creation of assets.

(ii) Capital Expenditure. An expenditure which either creates an asset (e.g., School building) or reduces a liability (e.g., repayment of loan) is called capital expenditure. (A) Capital expenditure which leads to creation of assets are (a) expenditure on purchase of assets like land, buildings, machinery and construction of roads, canals, etc. (b) investment in shares, loans by central government to state government, foreign governments and government companies, cash in hand, and (c) acquisition of valuables. Such expenditure is incurred on long period development programmes, real capital assets and financial assets. This type of expenditure adds to the capital stock of the economy and raises its capacity to produce more in future. (B) Repayment of loan to World Bank, foreign government, etc. is also capital expenditure because it reduces liability. Such expenditure is met out of capital receipts of the government including borrowing from public and foreign governments.

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We know that since First April 1951, India has adopted the path of planning (Five-Year Plans) to achieve its rapid economic development. So far ten Five-Year Plans have been implemented and presently Eleventh Plan (2012-2017) is in operation with effect from First April 2007. In the light of these Plans, government expenditure is classified into plan expenditure and non-plan expenditure on the basis of whether or not it arises due to plan proposals.
(i)    Plan Expenditure. Plan Expenditure refers to the estimated expenditure which is provided in the budget to be incurred during the year on implementing various projects and programmes included in the plan.
Provision of such expenditure in the budget is called Plan Expenditure. Expressed alternatively 'plan expenditure is that public expenditure which represents current development and investment outlays (expenditure) that arise due to proposals in the current plan'. Such expenditure is incurred on financing the central plan relating to expenditure on (i) construction of roads and bridges, (ii) generation of electricity, (iii) irrigation and rural development, and (iv) science, technology and environment, etc. It includes both revenue expenditure and capital expenditure. Again the assistance given by the Central Government for the plans of States and Union Territories (U.T.) is also a part of plan expenditure. Plan expenditure is further sub-classified into Revenue Expenditure and Capital Expenditure which along with their components are shown in the preceding chart.
(ii)    Non-plan Expenditure. This refers to the estimated expenditure provided in the budget for spending during the year on routine functioning of the government. Non-plan expenditure is all expenditure other than plan expenditure. Such an 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, government has to spend on police, judiciary, military, etc. Similarly, government has to incur expenditure on normal running of government departments and on providing economic and social services. In short, Expenditure other than plan expenditure related to current Five-Year Plan is treated as non-plan expenditure. Its components are shown in the preceding chart.

(i)    Developmental expenditure. It refers to expenditure on activities which are directly related to economic and social development of the country. For instance, expenditure incurred on education, health, housing, agricultural and industrial development, rural development, social welfare, scientific research, etc. are treated as development expenditure. It also includes plan expenditure of Railway, Post and Telecommunications, Non-departmental commercial undertakings.
(ii)    Non-developmental expenditure. It refers to government expenditure incurred on essential general services of routine nature like defence, administration, etc. Such expenditure is essential from administrative point of view. For instance, expenditure on police, judiciary, defence, general administration, interest payment, tax collection, subsidies on food, etc. are treated as non-developmental expenditure. Agreed non-developmental expenditure does not contribute directly to national product but it does help indirectly in economic development of a country. That way it is an essential part of the development process.
Main difference between development and non-development expenditures is that the development expenditure directly adds to the flow of goods and services whereas non-development expenditure does not. Again all the different types of expenditure, viz., plan or non-plan expenditure, revenue or capital expenditure can also be categorised into developmental expenditure and non-developmental expenditure.

Recall, a budget is defined as an annual statement of the estimated receipts and expenditure of the government over the fiscal year. Budgets are of three types —balanced, surplus and deficit depending upon whether the estimated expenditure is equal to, more than or less than estimated receipts respectively. It is explained below.
(i) Balanced Budget. A government budget is said to be a balanced budget in which government estimated receipts (revenue and capital) are shown equal to government estimated expenditure. Let us suppose for the sake of convenience that the only source of revenue is a lump sum tax. A balanced budget will then imply that the amount of tax is equal to the amount of expenditure. Symbolically:
Balanced Budget
Estimated Govt. Receipts = Estimated Govt. Expenditure
Two main merits of a balanced budget are: (i) It ensures financial stability, and (ii) It avoids wasteful expenditure. Two main demerits are: (i) Process of economic growth is hindered, and (ii) Scope of undertaking welfare activities is restricted.
According to Adam Smith, public expenditure should never exceed public revenues, i.e., he advocated a balanced budget. But Keynes and modern economists are not agreed with the policy of a balanced budget. They argue that in a balanced budget, total expenditure (public and private) falls short of the amount necessary to maintain full employment. Therefore, government should increase its expenditure to close the gap between the expenditure essential for full employment and expenditure that actually takes place. Ideally a balanced budget is a good policy to bring the near full employment economy to a full employment equilibrium.
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 either be surplus budget or deficit budget.
(ii) Surplus Budget. When government estimated receipts are more than government estimated expenditure in the budget, the budget is called a surplus budget. In other words, a surplus budget implies a situation wherein government revenue is in excess of government expenditure.
Symbolically:
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 price level. Therefore, in times of severe inflation which arises due to excess demand, a surplus budget is the appropriate budget. But in a situation of deflation and recession, surplus budget should be avoided.

Deficit Budget. When government estimated expenditure exceeds government estimated receipts in the budget, the budget is said to be a deficit budget In other words, in a deficit budget, government estimated revenue is less than estimated expenditure. Symbolically :
Deficit Budget
Estimated Govt. Receipts < Estimated Govt. Expenditure
Keynes recommended deficit budget to solve the problem of unemployment and underemployment. Today deficit budget has become very common. Government covers the gap either (i) through domestic borrowing or (ii) through sale of assets or (iii) through borrowing from external sources. Thus a deficit budget implies increase in government liability and fall in its reserves. When an economy is in an under-employment equilibrium due to deficient demand, a deficit budget is a good remedy to combat recession.
A deficit budget has its own merits especially for developing economy. For example:
(i) It accelerates economic growth, (ii) It enables to undertake welfare programmes of the people, and (iii) It is a cure for deflation as it checks downward movement of prices.
At the same time, it has demerits also such as: (i) It encourages unnecessary and wasteful expenditure by the government, (ii) It may lead to financial and political instability, and (iii) It shakes the confidence of foreign investors.
We have read in the preceding chapter 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 depression.

Budget deficit is the excess of total expenditure over total receipts. Following are the three types (measures) of deficit.
1.    Revenue deficit = Total revenue expenditure - Total revenue receipts
2.    Fiscal deficit = Total expenditure - Total receipts excluding borrowings
3.    Primary deficit = Fiscal deficit - Interest payments

Meaning. Revenue deficit refers to the excess of total revenue expenditure of the government over its total revenue receipts. It is related to only revenue expenditure and revenue receipts of the government. It signifies that government's own revenue is insufficient to meet the normal running of the government. Simply put, when government spends more than what it collects by way of revenue, it incurs revenue deficit. Mind, revenue deficit includes only such transactions that affect current income and expenditure of the government. Symbolically:
Revenue Deficit = Total Revenue Expenditure - Total Revenue Receipts
For instance, revenue deficit in government budget for the year 2008-09 is र 55,184 crores (= Revenue expenditure र 6,58,119 crores - Revenue receipts of र 6,02,935 crores). It reflects government failure to meet its revenue expenditure fully from its revenue receipts. This deficit is to be met from capital receipts, i.e., through borrowing or sale of its assets. Given the same level of fiscal deficit, a higher revenue deficit is worse than a lower one because it implies a higher repayment burden in future, not matched by any benefit via investment.
Remedial measures. A high revenue deficit warns the government either to cut its expenditure or increase its tax and non-tax receipts. Thus main remedies are: (i) Government should raise rate of taxes especially on rich people and levy new taxes where possible. (ii) Government should try to reduce its expenditure and avoid unnecessary expenditure.

Implications. It gives information on what the government is borrowing for, i.e., for financing its current expenditure or for capital formation. Main implications of deficit are:
(i)    Reduction of assets. Revenue deficit indicates dissavings on government account because government has to make up the uncovered gap by drawing upon capital receipts through sale of its assets (disinvestment). Thus it results in reduction of assets.
(ii)    Inflationary situation. Since borrowed funds from capital account are used to meet generally consumption expenditure of the government, it leads to inflationary situation in the economy with all its ills.
(iii)    More revenue deficit. Large borrowing to meet revenue deficit will increase debt burden due to repayment liability and interest payment. This may lead to larger and larger revenue deficit in future.

Meaning. Primary deficit is defined as fiscal deficit minus interest payments on previous borrowings. We have seen that borrowing includes not only accumulated debt but also interest payment on the debt. If we deduct 'interest payments on debt' from borrowing, the balance is called primary deficit. It shows how much government borrowing is going to meet expenses other than interest payments. Thus zero primary deficit means that government has to resort to borrowing only to make interest payments. To know the amount of borrowing on account of current expenditure over revenue, we need to calculate primary deficit. Thus primary deficit is equal to fiscal deficit less interest payments. Symbolically:
Primary deficit - Fiscal deficit - Interest payments

Importance. Whereas fiscal deficit reflects the borrowing requirements of the government for financing the expenditure inclusive of interest payment, primary deficit shows the borrowing requirements of the government for meeting its existing expenses other than interest payment. Thus if primary deficit is zero, then fiscal deficit is equal to interest payment. It is not adding to existing loans. Thus it indicates how much government borrowing is going to meet expenses other than interest payments. The difference between fiscal deficit and primary deficit reflects the amount of interest payments on public debt.
The following summary reflects factually India's position of revenue deficit, fiscal deficit and primary deficit.

(i) Revenue deficit =    (17 - 1) = 658,119 - 602,935 = 55,184 crores
(ii) Fiscal deficit =    [16 - (1 + 5 + 6)]
=    750,884 - (602,935 + 4,497 + 10,165)
=    133,287 crores
(iii) Primary deficit =    Fiscal deficit (b) - Interest payment (11)
      =    133,287 - 190,807 = - 570,520 crores

(i) Revenue deficit = 100 - 80 = 20 र Arab
(ii) Fiscal deficit = Total expenditure - Total receipts net of borrowings
                            = (100 + 110) - (80 + 95) = 210 - 175 = 35 Arabs
(iii) Primary deficit = Fiscal deficit - Interest payments
                             = 35 - 10 = 25 Arab.

(i) Revenue deficit = Total revenue receipts - total revenue expenditure = 80 - 47 - 10 = र 23 Arab.
(ii)    Fiscal deficit = Borrowings = र 32 Arab.
(iii)    Primary deficit = Fiscal deficit (borrowings) - interest payment = 32 - 20 = र 12 Arab.

(i) Fiscal deficit is defined as excess of total expenditure of government over sum of its revenue receipts and non-debt capital receipts during a fiscal year.
(ii)    Budget deficit refers to the excess of total budgetary expenditure over total budgetary receipts (both revenue receipts and capital receipts) of the government.
(iii)    Revenue deficit refers to the excess of governments revenue expenditure over its revenue receipt.
(iv) Primary deficit is defined as fiscal deficit minus interest payments on previous borrowings. It indicates how much of government borrowing is required to meet expenses other than interest payments.

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Tips: -

Hint. (a) (i) Borrowing at home, (ii) Borrowing from abroad, and (iii) Loan from RBI are debt creating capital receipts.
(b) (i) Recovery of loans, (ii) Proceeds from sale of Public sector units, and (iii) Partial sale of govt. shares in a company.

Meaning. Fiscal deficit is defined as excess of total expenditure over total receipts excluding borrowings during a fiscal year. In simple words, it is the amount of borrowing the government has to resort to meet its expenses. A large deficit means a large amount of borrowing. Fiscal deficit is a measure of how much the government needs to borrow from the market to meet its expenditure when its revenues are inadequate. In the form of an equation:
Fiscal Deficit = Total Expenditure - Total Receipts excluding Borrowings = Borrowing
If we add borrowing, fiscal deficit is zero. Clearly fiscal deficit gives borrowing requirement of the government. Let it be noted safe limit of fiscal deficit is considered to be 5% of GDP. Again borrowing includes not only accumulated debt but also interest on debt. If we deduct interest payment on debt from borrowing, the balance is called primary deficit.
Fiscal Deficit = Total Expenditure - Revenue Receipts - Capital Receipts excluding Borrowing
Fiscal deficit is the most important measure of deficit budget.
Can there be Fiscal deficit without Revenue deficit? Fiscal deficit without revenue deficit is possible (i) when revenue budget is balanced but capital budget shows a deficit or (ii) when there is surplus in revenue budget but deficit in capital budget is greater than surplus of revenue budget. The following equations further clarify the distinction between the two.
Revenue Deficit = Revenue expenditure - Revenue receipts
Fiscal Deficit = Total expenditure (Revenue exp. + Capital exp.) - Revenue receipts - Capital receipts excluding borrowing.

(i) Debt trap. Fiscal deficit, i.e., borrowing creates problems of not only
(a) repayment of loans but also of (b) payment of interest. As the government borrowing increases, its liability in future to repay loans along with interest thereon also increases. Payment of interest increases revenue expenditure leading to a higher revenue deficit. Increased revenue deficit may further lead to more borrowing and more interest payment. Ultimately government may be compelled to borrow to finance even interest payment leading to emergence of a vicious circle and debt trap.
(ii)    Wasteful expenditure. High fiscal deficit generally leads to wasteful and unnecessary expenditure by the government. Therefore, fiscal deficit should be kept as low as possible.
(iii)    Inflationary pressure. As government borrows mainly from RBI which meets this demand by printing of more currency-notes (called deficit financing), it results in circulation of more money. This may cause inflationary pressure in the economy.
(iv)    Retards future growth. The entire amount of fiscal deficit, i.e., whole borrowed amount is not available for growth and development of economy because a part of it is used for interest payment. Only primary deficit (fiscal deficit - interest payment) is available for financing expenditure. In fact, borrowing is financial burden on future generation to pay loan and interest amount which retards growth of economy.
(v)    Increases foreign dependence. Government also borrows from foreign countries. This increases dependence on foreign countries which often lead to economic and political interference.
Is fiscal deficit advantageous? It depends on its use. Fiscal deficit is advantageous to a country, if it creates new capital assets which increase productive capacity and generate future income stream. On the contrary it is deterimental for the economy if it is used merely to cover revenue deficit.

How is fiscal deficit met? When drastic cut in public expenditure and revenue expenditure fail to solve this problem, fiscal deficit is met by the following measures. Let it be noted that safe level of fiscal deficit is considered to be 5% of GDP.
(i)    Borrowing from domestic sources. Fiscal deficit can be met by borrowing from domestic sources. Borrowing from public is considered better than deficit financing because it does not increase money supply which is regarded as main cause of rising prices. It also includes tapping of money deposits in Provident Fund, Small Saving Schemes.
(ii)    Borrowing from external sources like world bank, foreign banks, IMF, etc.
(iii)    Deficit financing (printing of extra currency-notes). Another measure to meet fiscal deficit is by borrowing from Reserve Bank of India. Government issues treasury bills which RBI buys in return for cash to the government. This cash is created by printing new currency-notes against government securities. Thus it is an easy way to raise funds but it carries with it adverse effects also. Its implication is that money supply increases in the economy creating inflationary trends and other ills that result from deficit financing. Therefore, deficit financing, if at all unavoidable, should be kept within safe limits.
Measures to reduce fiscal deficit. (a) Measures to reduce public expenditure are: (i) A drastic reduction in expenditure on major subsidies, (ii) Reduction in expenditure on LTC, bonus, leave encashment, etc. (iii) Austerity measures to curtail non-plan expenditure.
(b)    Measures to increase revenue are: (i) Tax base should be broadened, (ii) Tax evasion should be effectively checked, (iii) More emphasis on direct tax to increase revenue, and
(iv) Sale of shares in public sector units.

1. Fiscal deficit = Primary deficit + Interest payment
   = 4,400 + 400 = 4,800 crores
2. Fiscal deficit = Borrowing = र 7,500 crores

B.

Fiscal deficit

Fiscal deficit: The fiscal deficit is defined as the excess of government revenue over government expenditure. Hence borrowing in government budget is a fiscal deficit.

C.

Dividends

Allocation of resources is one of the important objectives of government budget. In a mixed economy, the private producers aim towards profit maximisation, while, the government aims towards welfare maximisation. The private sector always tend to divert resources towards areas of high profit, while, ignoring areas of social welfare. In such a situation, the government through the budgetary policy, 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 ‘Khaki products’ by providing subsidies.
(ii) Directly producing goods and services:
If private sector does not take interest, government can directly undertake the production.

A government budget is a government document presenting the government's proposed revenues and spending for a financial year. It is a financial statement showing item-wise expected government receipts and government payments during a particular financial year. It also presents the government's report on the financial performance during the previous fiscal year.

An expenditure that neither creates an asset nor reduces a liability is categorised as revenue expenditure. If it creates an asset or reduces a liability, it is categorised as capital expenditure.

1. Expenditure on collection of taxes is a revenue expenditure. This type of expenditure includes the government expenditure which does not cause any reduction in government liabilities and also does not create assets for the government.

2. Expenditure on purchasing computers is a capital expenditure. This expenditure includes that government expenditure, which causes reduction in the government liabilities as well as creates assets for the government.

The economic value that is reflected in the rise in the production of public goods is the 'social welfare'. The major objective of the budgetary policy of the government is to enhance the welfare of the society at large. For this, it performs the allocative function. The allocative function is concerned with allocating the resources between the private and public sectors. As the public goods cannot be provided by the private sectors through market mechanism, hence the need for providing such goods is to be fulfilled by the government. In addition to this, private goods cannot be afforded by all, that is, only those who can pay for these goods can avail the benefits of such goods. But, as the public goods are required by all and are essential from welfare point of view, thus, government provide these goods.

Two examples of indirect taxes are
a) Sales tax and
b) Excise duty.

A government budget is a government document presenting the government's proposed revenues and spending for a financial year. 

Revenue Expenditure- Revenue expenditure refers to the expenditure which neither creates any asset nor causes reduction in any liability of the government.
1. It is recurring in nature.
2. It is incurred on normal functioning of the government and the provisions for various services.
3. Examples: Payment of salaries, pensions, interests, defence services, health services, grants to state, etc.
Capital Expenditure- Capital expenditure refers to the expenditure which either creates an asset or causes a reduction in the liabilities of the government.

1. It is non-recurring in nature.
2. It adds to capital stock of the economy and increases its productivity through expenditure on long period development programmers, like Metro or Flyover.
3. Examples: Loan to states and Union Territories, expenditure on building roads, flyovers. Factories, purchase of machinery etc., repayment of borrowings, etc.

One of the main objectives of government budget is 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.

A Tax is a fee levied by a government on a product, income, or activity. If tax is levied directly on personal or corporate income, then it is a direct tax. If tax is levied on the price of a good or service, then it is called an indirect tax. The purpose of taxation is to finance government expenditure.

Through the budgetary policy, Government aims to allocate 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 ‘Khaki products’ by providing subsidies.

(ii) Directly producing goods and services:
If private sector does not take interest, government can directly undertake the production.

Expenditure on fertilizers by a farmer should not be included in the estimation of National Income. This is because it is an intermediate consumption that a farmer purchases in order to enhance the crop productivity, so that he can sell more output.

Purchase of tractor by a farmer should be included in the estimation of National Income. This is because it is a part of Gross Domestic Capital Formation.

Revenue deficit is the gap between the consumption expenditure (revenue expenditure) of the Government and its current revenues (revenue receipts). It also indicates the extent to which the government has borrowed to finance the current expenditure. Revenue receipts consist of tax revenues and non-tax revenues. Tax revenues comprise proceeds of taxes and other duties levied. The expenditure incurred for normal running of government functionaries, which otherwise does not result in the creation of assets is called revenue expenditure.
Revenue Deficit = Revenue Expenditure - Revenue Receipts
Indications of Revenue Deficit:
The revenue deficit indicates the following points.
i. It reflects the government fiscal policy.
ii. It indicates the need for government’s borrowings to finance its consumption expenditures and revenue expenditures such as payments to government employees, etc.
iii. Revenue deficit implies unsoundness of the financial system of an economy.
An increase in revenue deficit implies a proportional increase in the fiscal deficit.

Allocation of resources is one of the important objectives of government budget. In a mixed economy, the private producers aim towards profit maximisation, while, the government aims towards welfare maximisation. The private sector always tend to divert resources towards areas of high profit, while, ignoring areas of social welfare. In such a situation, the government through the budgetary policy, 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 ‘Khaki products’ by providing subsidies.
(ii) Directly producing goods and services:
If private sector does not take interest, government can directly undertake the production.

Redistribution of income is one of the important objectives of government budget. The government through its budgetary policy attempts to promote fair and right distribution of income in an economy. This is done through taxation and expenditure policy. Through its taxation policy, government levies high rate of tax on rich people reducing their disposable income and lowers the rate on lower income group. Purchasing power extracted from the higher income groups in the form of taxes is then transferred to the poor sections of the society through the expenditure policy (subsidies, transfer payments, etc). Thus, with the help of taxation and expenditure policy in the budget, the government aims at redistribution of income such that a fair and just distribution of income is achieved in the society.

(a) Computation of Revenue Deficit:
Revenue deficit= Revenue expenditure –Revenue receipts
Revenue expenditure = 100
Revenue receipts = 80
Revenue Deficit = 100-80 = Rs 20 arab

(b) Computation of Fiscal deficit:
Fiscal deficit = Revenue Expenditure + Capital Expenditure - Revenue Receipts - Capital Receipts net of Borrowings
= 100+110 – 80-95 = Rs 35 arabs
(c) Computation of Primary Deficit:
Primary deficit = Fiscal deficit - Interest payment
= 35- 10= Rs 25 arab.

A revenue receipt does not reduce the liability of the government and it does not add to assets of the government. Revenue receipts are classified into tax receipts and non-tax receipts.

The correct option is (c). Primary deficit is the difference between the fiscal deficit and interest payment. It determines the amount of borrowing which is necessary for the government to pay for the expenses other than interest payments.
Primary deficit = Fiscal deficit − Interest payment.

Excess demand can be reduced by using the following instruments to control the money supply:
i. Cash Reserve Ratio (CRR) is the necessary minimum percentage of a bank’s total deposits which is to be kept with the Central Bank. Commercial banks need to maintain with the Central Bank a certain percentage of their deposits in the form of cash reserves. The Central Bank can vary CRR between 3% and 15%. When they hold a large portion of their deposits as CRR, it reduces the provision of credit to the public. This leads to a decline in the demand for loans and consumption expenditure. Thus, the aggregate demand comes down and the economy attains equilibrium.
ii. The Central Bank increases the bank rate and there is an increase in the cost of borrowing for commercial banks. This enables the decrease for the demand for loans and borrowings in the market. This in turn decreases the ability to purchase more. In this way, the aggregate demand decreases to the level of aggregate supply and the economy attains equilibrium.
iii. The repo rate will be increased by the Central Bank and it will increase the cost of borrowings for the commercial bank. This leads to a decline in the demand for loans and consumption expenditure. Thus, the aggregate demand comes down and the economy attains equilibrium. iv. Reduction of margin money requirements is a measure which induces borrowers to avail more loans from commercial banks. This in turn increases the ability to purchase more. In this way, the aggregate demand increases to the level of aggregate supply and the economy attains equilibrium.
iv. Reduction of margin money requirements is a measure which induces borrowers to avail more loans from commercial banks. This in turn increases the ability to purchase more. In this way, the aggregate demand increases to the level of aggregate supply and the economy attains equilibrium.

(d) none of the above

Involuntary unemployment means an unemployment situation where a person who is able to and willing to work at the existing wage rate but is not able to get work.

Primary deficit is the difference between fiscal deficit and interest payments. It indicates the borrowing requirements of the government excluding interest.
Primarydeficit = Fiscal deficit − Interest payments

Direct tax refers to those taxes which are directly imposed individuals and companies and are paid directly by them to the government. For example, income tax- the tax burden cannot be shifted to any other person, wealth tax, corporate tax etc.

Indirect tax refers to those taxes which are imposed on an individual but are paid by another person either partly or wholly. Hence, the impact and incidence of taxes are on different persons. Examples of indirect taxes are custom duties, excise dutiesetc. Indirect taxes are those taxes in which the tax burden can be shifted to another person. For example, the sales tax where the tax burden is shifted by the seller of the commodity to the buyer. Example: Direct tax- income tax and indirect tax- sales tax