Economics Notes on Budget

By Ajeet Kumar, MA Economics

This is a concise notes on Budget useful for Economics students.

Budget: A budget is an estimate of income and expenditure from a future point of view as opposed to an account which records financial transactions of the past. A budget is also referred to as annual financial statement.

Budget is an essential element of planning and control of financial affairs.

Parts of a Budget: Every budget has two parts-receipts and expenditure. The budget of the State has two sections: First is revenue budget and second is capital budget.

Government Budget: A government budget is an annual financial statement showing expected receipts from various sources and expected expenditures on various items in a given financial year. The government budget requires to be approved by the Parliament or Assembly or some legitimate public authority before its implementation.

Objectives of A Government Budget: The government prepares its budget with view to achieve a number of socio-economic objectives such as reduction of inequality of income and wealth among individuals and different states, development of infrastructure of economy, promotion of exports, stabilization of prices of goods and services in the economy, rapid growth of the economy without loss of ecological balance etc. The allocation of fund in the government budget is on the basis of social priorities.

Impact of Government Budget: Impact of government budget can be far-reaching in time and space. The budget helps the government to maintain financial discipline and helps in reallocation of resources among members of society in desired manner.

Federalism in India and Its Role in Budget: In India, federal democracy has been accepted in the Constitution. It means that there are different layers (three layers) of governance in the country. These are -1) Central or Union government 2) State government and 3) Local government. These governments prepare their separate budgets.

Central Government Budget (also called union budget): The central government budget is presented every year by the Union finance minister in the Lok Saba normally on the last working day of the month of February. The central government budget presents the estimated receipts and expenditure for the current and ensuing/coming year along with the actual of the preceding year.

Structure of A Government Budget: A budget has two components: - receipts and expenditure. Accordingly, the receipt portion of the budget is termed as budget receipt and its expenditure portion is called budget expenditure. Again, each of these is further subdivided as revenue and capital parts. So, the budget receipts is subdivided as revenue receipts and capital receipts and the budget expenditure is similarly subdivided as revenue expenditure and capital expenditure Alternatively, the government budget can be firstly  divided as revenue budget and capital budget; and then can be  further subdivided receipts and expenditures wise. The public receipts can be classified into two parts: public revenue and public debt. Public revenue includes only those Incomes which do not carry with them the obligation of repayment for the state. The income from borrowing is included in public debt.

Budget Receipts: Budget receipts refer to the estimated receipts of the government from various sources during a fiscal year. Budget receipts have two components: revenue receipts and capital receipts.

Revenue Receipts: Revenue receipts refer to that receipts which neither create liabilities nor cause reduction in the assets of the government. These are current income receipts of the government from all sources. These are of repetitive nature.

Examples of Tax Revenue Receipts: Different types of direct and indirect taxes like income tax, sales tax, excise duty, wealth tax, interest tax, estate duty, custom duty etc.

Examples of Non-Tax Revenue Receipts:

(1)Interest: Interest receipts on the loans granted to state governments, union territory governments, local governments, private enterprises, and the people of the country.

(2)Profits and dividends: Profits and dividends received by the public enterprises like BHEL, HMT, STC, LIC etc.

(3)Fees: Various kinds of fees such as tuition fees of schools, driving license fee, passport fee, court fee, import fee, land registration fees etc.

(4)Fines: Various kinds of fines are imposed on the law breakers. For example, forfeiture of basic surety or bond imposed by courts for non-compliance with orders.

(5)Escheat: It refers to the lapse of property to state for want of its heir.

(6)Special assessment: When the government carries out developmental activities like construction of road, street lighting, parking facility, recreation centers etc in a particular area, the market value of the land increases in the locality. As a result, the government levies a special tax on those who are benefited from such activities. The tax is special in the sense that it is a payment once for all i.e. it is not of repetitive nature. Such levy is known as special assessment or betterment levy. Although a special assessment is a compulsory payment, it contains the element of quid pro quo; so it can not be considered as a tax but approximately as a price.

(7)Gifts: Gifts, grants-in-aids, donations, etc received from various international organizations and foreign governments.

Capital Receipts: Capital receipts refer to the receipts which either create liabilities or cause reduction in the assets of the government. Since these receipts create liabilities so the government is bound to pay back these receiving. Money borrowed from people appears in the capital receipts.

Examples of Capital Receipts:

(1)  external and internal borrowings

(2)  recovery of loans and advances

(3)  disinvestment

(4)  small savings

External and internal borrowings: The central government borrows from international organizations like IMF, World Bank, etc and from foreign governments to fill the gap of its financial deficit (when estimated expenditure is more than estimated receipts). It borrows also from domestic sources. These borrowings are the liabilities of the government since the government has to pay back these borrowings. So, external and internal borrowings are included in capital receipts.

Recovery of loans and advances: Central government grants loans and advances to state governments, union territories, private and public sector enterprises and foreign governments etc. The recovery of these loans is included in capital receipts.

Disinvestment:  Disinvestment refers to the process of sales of the equity of a public sector enterprise in part or whole to public. Disinvestment leads to decrease in assets of the government so it is included in capital receipts.

Small savings: Small savings like post office deposits, NSS deposits, Kishan Vikas Patra etc. are the liabilities of the government to pay these savings back to the depositors in future, so they are included in capital receipts.

Budget Expenditure: Budget expenditure refers to the estimated expenditure on various items to be incurred by the government in a financial year.

Nature of Capital Receipts: The items included in capital receipts are not of routine nature.

Examples Of Capital Receipts: Receiving from disinvestment, internal and external borrowings (e.g. from open market, foreign governments, international financial institutions  like IMF, Asian Development Bank, World Bank), recovery of loans and advances from different state and union territory governments, public sector enterprises and foreign governments which had been granted in past, etc. are included in capital receipts.

Revenue Expenditure: Revenue expenditure can be defined as the expenditure which neither creates assets nor causes reduction in the liabilities of the government. These are current expenditure of the government on various items which are of repetitive nature.

Examples of Revenue expenditure: The expenditure on running different administrative department e.g. Salaries paid to government employees, expenses on stationery, expenditure on health and education services like medicine, books, pen , pencil,  etc. (Note: only those which are of repetitive nature).

Capital Expenditure: Capital expenditure can be defined as the expenditure which either creates assets or causes reduction in the liabilities of the government. It leads to creation or acquisition of assets.

Examples of Capital expenditure: Loans and advances to state governments and union territory governments, loans to foreign governments, expenses on construction of school and hospital buildings, dam, canals, bridge, power house, road, etc. (Note: These expenditures are not of repetitive nature.)

Think over it: The government expenditure incurred on purchase of medical vans or school vans will be included in capital expenditure but the salaries paid to the drivers will be included in revenue expenditure.

Government expenditure is conventionally divided into two parts: Plan expenditure and Non-plan expenditure. Both are, thereafter, classified into revenue expenditure and capital expenditure.

Plan Expenditure: Plan expenditure refers to the estimated public/government expenditure on various projects and programs which are usually of long run nature. Thus, plan expenditure arises out of the plan proposals/needs of the government. Note that the financial assistance to state governments for their plans by the central government is included in the plan expenditure of the union government.

Non-Plan Expenditure: Non-plan expenditure refers to the estimated public/government expenditure on those items which are of recurring/routine nature.

Examples of Non-Plan Expenditure: The expenditure on maintaining law and order and defence ( e.g. spending on police, judiciary, military etc.), expenditure on normal running of government departments, expenditure on tax collection,  expenditure on provision of social and economic services etc.

Analogy: We never plan for our routine needs like roti, clothes etc. Rather we make plan when we buy bung law, kothi, car, etc which are not of recurring nature.

Developmental Expenditure: Developmental Expenditures refers to those expenditures which are incurred on various items that are directly related to social and economic development of the country.

Examples of Developmental Expenditure: The expenditure incurred on education, health, scientific research, electrification, rural development, poor relief, sickness insurance for laborers, housing for wage earners, improvement of agriculture, free hospitals for the poor, subsidies granted to poor farmers, construction of railway tracks etc.

Non-Developmental Expenditure: Non-Developmental Expenditure refers to the estimated public/government expenditure on those items which are not meant for socio-economic plans and projects but on regular /recurring/routine activities of state.

Examples of Non-Developmental Expenditure: Expenditure incurred on defence, police, administrative staffs, judges, etc.

Balanced budget: A budget in which estimated receipts is equal estimated expenditures is termed as balanced budget. In the strictest sense, a balanced budget is one in which there is no provision for borrowings, for borrowing is meant to fill the gap between revenue and expenditure.

Merits of Balanced Budget: It helps the government to avoid wasteful expenditure. In other words, it helps the government to maintain fiscal discipline. Also, it leads to financial stability.

Demerits of Balanced Budget: A number of useful/important plans may not be implemented if the estimated receipts fall short of estimated expenditure, since the government can not surpass its estimated receipts it follows balanced budget. As a result, the country will lag behind in its socio-economic development.

Unbalanced Budget: A budget in which estimated receipts is not equal to estimated expenditures is termed as unbalanced budget. Unbalanced budget is of two types: surplus budget and deficit budget.

Surplus Budget: A budget in which estimated receipts is more than estimated expenditures are termed as surplus budget.

Surplus budget is useful when the economy is reeling through severe inflation.

Deficit Budget: A budget in which estimated receipts is less than estimated expenditures are termed as deficit budget.

Deficit budget is useful when the economy is reeling through deflation/recession.

How does government cover the deficit/gap (of deficit budget): the government can fill the gap of receipts and expenditures in either of the following two ways: (1) it can borrow from internal and external sources and/or (2) it can withdraw from its reserves or print currency notes.

Budgetary Deficit:  Budgetary deficit refers to a situation in which the total receipts of the government i.e. sum of revenue receipts and capital receipts is less than the total expenditures of the government i.e. sum of revenue expenditures and capital expenditures. Budget deficit = total public expenditure – (tax revenue + non tax revenue + loans from public + external loans).

Sources to fill Up the Budgetary Deficit: The deficit/gap between the expenditure and income is met by the following sources:

(1)Withdrawal of cash balances from the RBI by the government,

(2) Borrowing from the RBI,

(3)  Borrowing from the commercial banks,

(4) Issue of new currency by the central government.

Deficit Financing: Deficit financing refers to the technique of financing the plan outlay/expenditure in which the government tries to cover its gap between fiscal outlay and total receipts, which includes domestic savings, market borrowings, external loans and surplus of the public enterprises by help of new currency notes issued by the RBI .The central government borrows from the RBI by issuing the treasury bills to it and the RBI in turn issues new currency notes to the government. Thus, deficit financing is the financing of the deficit of budget by help of new currency notes. In short, deficit financing means borrowing from the Reserve Bank of India by the government.

Role of deficit financing:  Deficit financing helps in mobilizing the resources of the economy but it is, in general, inflationary in economy. (Note that the government can fill the deficit of budget also by the help of internal and external borrowings.)

Revenue Deficit: Revenue deficit refers to the situation in which the total revenue expenditure exceeds total revenue receipts. In other words, revenue expenditure minus revenue receipts is revenue deficit. This deficit is covered by the help of capital receipts i.e. borrowings. It, therefore, increases the burden of repayment in future.

Implications of revenue deficits: It shows the dissavings of government because the government covers this deficit either by disinvestment of its assets or borrowing. Revenue deficit thus implies either decrease in the assets of the government or increase in its liabilities in future.

Illustration: suppose that revenue receipts and revenue expenditures are 8000 crores and 9000 crores respectively. Thus, revenue deficit will be 9000 – 8000 = 1000 crores.  Since revenue expenditures neither creates assets nor reduces liabilities and is expenditure on consumption, it is usually inflationary in nature. Revenue deficit leads to repayment burden in future.

Fiscal Deficit: Fiscal deficit is the excess of public expenditure over public revenue excluding borrowing of all kinds. In other words, fiscal deficit is total budget expenditure minus total budget receipts excluding borrowings.

Implications of fiscal deficits: Fiscal deficit indicates the amount of borrowing required by the government to meet its budget expenditure. It includes also the amount of interest which will be paid in future. Thus it indicates the future liability of government to repay loan with interest.

Note that borrowing is a part of capital receipts; so fiscal deficit can be redefined as total budget expenditure minus non-debt capital receipts. Non-debt capital receipts mean recovery of loans plus disinvestment proceedings plus small savings like NSS, Post Office deposits, GPF deposits, Kisan Vikas Patra etc.

Primary Deficit: Primary deficit is defined as fiscal deficit minus interest payments on the borrowings.

Implications of Primary deficits: The primary deficit shows that part of the amount of fiscal deficit which is going to meet the expenses other than the interest payment on borrowing. The decrease in the primary deficit implies that a larger part of the borrowing is going to cover the interest payment. This is a very dangerous situation for an economy. It means that the government is taking loans to repay the interest of the previous borrowing (debt trap situation). It indicates fiscal irresponsibility. Interest paid on public debt is a transfer payment.

Fees: A fee is a levy that is meant to regulate and control the consumption of goods and services in desired manner produced/ rendered by the state. For example, school fee is levied by the government not for the purpose of collecting revenue but to discourage the wasteful expenses which might occur if the school service is not used in proper manner. Also, the fee is collected not to cover the expenses.

Duty: A duty is a levy that is meant to discourage and control the consumption and production of commodities produced and rendered by private agencies. Duty is levied by government not for the purpose of collecting income/revenue, although it is incidentally received.

Price: Price is a voluntary payment made by the payer for the use of the goods and services. Price paid for a commodity is of contractual nature. It carries no element of compulsion on the part of payer.

Think over it:   In case of fees and prices the objective is not entirely that of getting money. Revenue raised by the government can be classified into taxes, fees, and duties. Of these it is only the taxes that are meant to produce income. Fees and duties are levied not for the sake of money but for other socially desirable purposes. They do produce revenue; but that is only incidental to the main object of fees and duty.

Fines are not considered as taxes since they are not levied for the purpose of collecting revenue, although they are compulsory in nature and the element of quid pro quo is absent in them.  Fines are imposed to curb offences.

Tax: Tax is a compulsory payment made by a tax payer to government without any direct and definite quid pro quo from the government and it is levied by the government with view to raise revenue. (Quid pro quo means something given or taken as equivalent to another). In other words, a tax is a compulsory contribution from a person or institution to the government to defray the expenses incurred in the common interest of all without reference to special benefit conferred to the tax-payer. A tax is a compulsory levy and those who are taxed have to pay the sum irrespective of any corresponding returns of goods and services to them.

Elements of a Tax: Basic elements of a tax are as follows: (1) it is compulsory in nature. (2) It is levied by government (3) with sole purpose of raising revenue. (4) There is no definite and direct return of any good and service to tax payer (i.e. absence of quid pro quo)

Base of a Tax: The base of a tax is the legal description of the object with reference to which the tax is levied.  For example, the base of income tax, excise duty, and wealth are income, volume of output/production, and wealth respectively. The base of each taxis legally defined.

Direct Tax: Direct tax is defined as a tax in which the incidence of and impact of the tax are at the same point. In other words, the body upon which the tax is levied and the body which bears the burden of tax is the same. Alternatively, direct tax can be defined as a tax which burden is not shiftable from the body upon which its impact is felt.

Examples of Direct Tax:  income tax, wealth tax, inheritance tax, profit tax etc.

Indirect Tax: Indirect tax can be defined as a tax in which the impact and incidence of the tax are on two different bodies. An indirect tax is shift able. Thus the burden of indirect tax is not borne by the body on which the tax is levied.

Examples of Indirect Tax: sales tax, custom duty, entertainment tax, excises duty etc.

Impact of a Tax: Impact of a tax refers to the starting point of contact with the tax payers.

Incidence of a Tax:  Incidence of a tax refers to the final point of the chain of tax collection. Thus incidence of tax is defined as the effect of the tax on the persons/tax-payers that are ultimately affected by the tax. When a tax is levied on a body, it wishes to shift it to somebody else. For example, when a sales tax is levied on a commodity, the sales person shifts it upon consumers. So, the incidence and impact of sales tax are upon consumers and seller respectively. It is not necessary that the whole burden of a tax can be shifted from the seller to the consumers. The amount of burden shifted from e party to another depends upon the elasticity of demand for and supply of the commodity.