Manoj Jha in CBSE 2 years ago

GOVERNMENT BUDGET AND THE ECONOMY

Dear readers , this post specifically targets CBSE Class 12 students . This article would deal with Government Budget and the Economy – Class 12 CBSE Notes Macro Economics . However , this article also incorporates EXPLANATIONS of every topic . For the sole purpose of notes of Government Budget , no need to consider / write explanations . However , explanations would help digesting the concepts . One may read explanations for better understanding of the topics .

DEFINITION OF GOVERNMENT BUDGET

Government budget is an annual statement , representing estimated receipts and estimated expenditure for the upcoming Fiscal year .
Fiscal year starts from 1st April and ends at 31st March .
Estimated expenditure and receipts refers to the planned level I.e. government is planning to receive and spend for the upcoming year .

GOVERNMENT BUDGET AND THE ECONOMY – COMPONENTS OF GOVERNMENT BUDGET

There are 2 main components of government budget – Revenue Budget and Capital Budget

Revenue Budget – It deals with the revenue aspect of government budget . Revenue budget has 2 parts – Revenue Receipts and Revenue expenditures.
Capital Budget – It deals with the capital aspect of government budget . Capital Budget has 2 parts – Capital receipts and Capital expenditure .
However , Budget can also be classified into Budget Receipts and Budget expenditure .

BUDGET RECEIPTS

It refers to estimated money receipts , which government expects to receive from various sources during a given fiscal year .
Budget receipts is further classified into 2 parts – Revenue Receipts and Capital Receipts .

REVENUE RECEIPTS ( RR )

RR are those receipts which neither create any liability nor causes any reduction in the assets of the government . Revenue receipts are regular and recurring in nature ( meaning government receives RR on regular basis ) .
There are two sources of Revenue Receipts – Tax revenue and Non – tax revenue

TAX REVENUE – Tax revenue refers to those receipts which government receives by levying taxes and imposing duties.

WHAT IS TAX ? – Tax is a compulsory payment made by the citizens and companies to the government and in return they do not claim any direct benefit .

Tax Revenue can be further classified into –
1. Direct Taxes
2. Indirect Taxes

DIRECT TAX – It refers to those taxes in which the liability to pay tax ( tax impact ) and actual burden of tax ( Tax incidence ) lies on the same person . In case of direct tax , tax burden cannot be shifted . Direct tax directly affects the income level and purchase h power of people and company . Eg – Income tax , Corporate tax , wealth tax ( does not exist now ) , Death duty , Capital gains tax etc.

NOTE- Direct taxes can be levied by the government by using various systems . Three primary systems are Progressive , Regressive and Proportional tax systems . In India , we follow Progressive system , primarily .

INDIRECT TAXES – It refers to those taxes where liability to pay ( impact ) and actual burden ( incidence ) lie on different persons . In case of indirect taxes , tax burden can be shifted to others . Indirect taxes affect the price of goods and services . Eg – GST( Goods and services tax ) ,Sales tax , service tax , VAT ( Value added tax ) , Entertainment tax etc..

NON TAX REVENUE

Non – Tax revenue refers to receipts of government from all sources other than that of tax receipts . Various items under non – tax revenue are Interest , Profits and Dividends , Fees , Fines and Penalties , Escheat , Gifts and grants , Forfeiture , Special assessment .
INTEREST – Suppose government of India ( Central government ) gave loan of ₹100 cr. To any state government / union territory / private entity . So , that entity will pay interest to government of India . This interest income is Revenue Receipt for government of India . Why ? – Because this receipt ( interest income ) is neither increasing any liability nor decreasing any asset to the government of India .
PROFITS AND DIVIDENDS – There are various PSUs ( Public sector undertakings ) in India like BHEL , NTPC ,LIC etc . These PSUs perform business activities and earn profits and dividends by selling goods and services . This profit or dividend , which is earned by PSUs are transferred to government of India every year . So , government receives profits and dividends from PSUs and this money is Revenue Receipt to government of India .
Q – Why PSUs transfer hard earned profit or dividend to government ?
Ans – Because it is government only who has created PSUs and who owns PSUs .
Fees – It refers to the charges imposed by the government to cover the cost of services it provides . Eg – Court fees , licence fees etc..

EXPLANATION = As we have understood what is Fees , so now let us see how this fees is revenue receipt . Fees is revenue receipt for the government because when government receives fees , against it neither any liability increase nor any asset decreases . Suppose Ram went to RTO office in order to get Driving license . So , he will pay certain amount , so as to get the license . Suppose he paid ₹ 1500 for license . When government will receive this amount , against it governments liability is not going to increase , also any asset of government will not decrease . Hence , fees is Revenue receipt .

FINES AND PENALTIES – It refers to such payments which is generally imposed on law breakers . Eg – Fine imposed for red light jump , without helmet / seat belt driving etc..
NOTE – Fines and penalties are never imposed by government to earn revenue . It is always imposed to make people follow law .

EXPLANATION – Fines and penalties are also Revenue Receipts because against it , neither any liability increases nor any asset decreases vis-a-vis government .

ESCHEATS – Escheats refers to claim of the government on the property of a person who dies without leaving behind any legal heir or will .

EXPLANATION – Suppose Ram was travelling with his family by car and unfortunately entire family along with Ram died in a major car accident . So , there would be no person left on earth , who can claim over Ram’s property . So , this property would now automatically be owned by the government . This property , which government has gained is nothing but Escheat . Also , escheat is Revenue Receipt for government . Why ? – Because governments by receiving this , neither liability would increase nor any asset of government would decrease .

GIFTS AND GRANTS – Government receives gifts and grants from various foreign governments / international organizations / private companies etc.. . These gifts and grants are Revenue Receipts for the government .
NOTE – Gifts and grants are occasionally received by government . It is not regular source of income for the government .

EXPLANATION – Suppose Mr. Barrack obama ( previous US president ) visited India . During his visit , he came to know that there are lots of people who die because of Malaria in India . So , he gave 500 million USD ( US dollar ) to Indian government so as to help India fight against Malaria . Now , this money for Indian government is Revenue Receipt . Why ?? – Neither liability increased nor the asset decreased .

FORFEITURES – Forfeitures refers to penalties imposed , generally by courts , for non-compliance of orders or non – fulfillment of the contracts . It is Revenue Receipt to the government .

EXPLANATION Suppose XYZ ltd. took money from various people and promised to build an apartment in near future . People paid money because they trusted the company . Now suppose that company got indulged into fraudulent activities and is not providing houses to people . People went to court and court said , all the assets and money which company owns would be seized and forfeited ( जब्त कर लेना ) . So , this money or property would also go in the hands of government of India , and for government it would be Revenue receipt .

SPECIAL ASSESSMENT – It refers to the payment , which is made by those people to the government , whose property value has increased because of the developmental activities done by government in their locality . It is Revenue Receipt to the government .

EXPLANATION – In Delhi , the property rates are very high . It is so because government has performed high quality developmental activities in Delhi or at the outskirts of Delhi . For eg . Delhi has got Metro facility , lots of hospitals has been constructed in Delhi , better roads are there , DTC buses are there , good water facility and better policing is also there . So , due to these developmental activities the value of the properties in Delhi has increased . So , government may ask for some fee or amount from the property owners , who own property in Delhi . Hence , this fees would be paid under the name called SPECIAL ASSESSMET FEE and it would be Revenue Receipt for government .

CAPITAL RECEIPTS

Capital receipts refer to those receipts which results either into increase of liability or decrease of asset . Capital receipts are non – recurring in nature .

EXPLANATION – Any receipt to the government which satisfies any of the 2 conditions , it would be considered as Capital Receipt . Those 2 conditions are – Either liability should increase OR asset should decrease .

SOURCES OF CAPITAL RECEIPTS

Primarily , there are 3 categories of Capital Receipts –

Borrowings.
Recovery of loans.
Other receipts – Disinvestment , Small savings .

BORROWINGS- Borrowings refers to the funds raised by the government to meet excess expenditure .
Government borrows funds from sources such as – Reserve Bank of India ( RBI ) , Open market ( i.e. from public ) , Foreign governments , International institutions ( like world Bank and IMF ) .
Q – Why borrowings are considered capital receipts ?
ANS – Because borrowings create obligation on government I.e. liability gets increased .

EXPLANATION – Borrowings are generally raised by governments . Governments borrow because , it has to perform lots of work and as we know that government also has limited funds . So , in order to perform developmental works , generally governments raise borrowings .
Borrowings are capital receipts because they increase liability of the government . Here one may wonder that how borrowing increases liability of the government ? Because government has borrowed , so it would have to repay the loan amount in future . So , in this sense liability has increased for the government .

RECOVERY OF LOANS – Various state governments or union territories are granted loans by central government . When the state governments / union territories repay the loan amount to central government , at that time it becomes capital receipt for the central government . Why ? – Because Recovery of such loans reduces the assets of the government .

EXPLANATION – Suppose that government of Bihar , wants to perform some developmental work in Bihar ( Say it wants to construct Roads or build schools or hospitals etc. ) . Definitely for this purpose , Bihar government would require lots of funds . What if , Bihar government lacks funds . In that case Bihar government may ask Central government to help , by providing or granting loan .

Now suppose the central government provided loan worth Rs. 5000 crore to Bihar government in the year 2022 . So, after this transaction Bihar government would become debtor or asset to the central government because in future Bihar government will have to REPAY the loan amount to central government . So , in the year 2022 Rs.5000 crore is EXPENDITURE to the central government but in the same year ( i.e. 2022 ) Rs. 5000 crore is INCOME / RECEIPT for the Bihar government . To be specific , in the year 2022 , Rs. 5000 crore is CAPITAL EXPENDITURE for Central government ( because it is increasing ASSET to the Central government ) , Where as same 5000 crore is CAPITAL RECEIPT to the Bihar government ( because it is increasing future LIABILITY of the Bihar government ) .

Now , suppose in the year 2030 , Bihar government wants to return the money / repay the loan to central government . So , in the year 2030 , Rs. 5000 crore would be received by Central government and Bihar government would repay the amount . So , in the year 2030 , for Bihar government the same amount would become CAPITAL EXPENDITURE ( because the Repayment of loan will reduce the liability of Bihar government ) , Where as for Central government , the same amount ( 5000 cr. ) would become CAPITAL RECEIPTS ( because it would reduce ASSET of the central government . How ? – Read above , it has been explained that Bihar government was Asset for Central government ) . This complete explanation , would help understanding how loans are received and granted and how when we should consider them as capital receipt and when capital expenditure . This explanation would help solving various questions also .

OTHER RECEIPTS – It includes Disinvestment and Small Savings .

DISINVESTMENT – It refers to the process of selling of part or whole of shares of a PSU ( Public Sector undertakings is nothing but a government company , like NTPC , CIL , BHEL etc. ) owned by the government. Disinvestments are CAPITAL RECEIPTS as they reduce the ASSETS of the government .
SMALL SAVINGS – It refers to the funds received by government from general public in the form of Kisan Vikas Patras , Post office deposits , National Savings Certificates etc. . Small Savings are CAPITAL RECEIPTS as they increase liability of the government .

EXPLANATION OF DISINVESTMENT – As we know that Mr. Mukesh Ambani is the owner of JIO , which is a private company . Similarly , government also owns various companies . Such companies are called as PSUs or in layman language they are also called as government company . Now , suppose NTPC is a government company but government wants to sell the company ( reason for sale may be like company is loss making OR government no more wants to remain in that business or any other reason ) . Now , Suppose government decided to sell the company to Mr. Donald Trump . So practically , what would happen is government in order to sell the company , will have to transfer the shares to Mr. Trump and in return Mr. Trump will pay the amount to the government . ( Shares refers to the ownership ) .

When government will sell the company i.e. shares to Mr. Trump , then it would be called that government is DISINVESTING . So , it becomes clear that disinvestment simply means the sale of the Shares of the government company . Obviously , when the government will disinvest then government will receive money . This money ( money from disinvestment ) will be CAPITAL RECEIPTS for the government because , against it the ASSET of the company will reduce . HOW ? – Because the sold company , earlier was an asset to the government and after Disinvestment Asset of the government got reduced , hence capital receipts .

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EXPLANATION FOR SMALL SAVINGS – Governments has to perform various activities and in that sense government always needs or requires funds ( money ) . One of the source from where government may get funds is Small savings , which is done by general public . Suppose , government wants to do some expenditure for farmers of India , like it wants to construct canals for farmers or provide HYV seeds to the farmers or it may want to any other thing towards the welfare and development of the farmers . But to do that , government will require funds . So , what government occasionally does is government issues KISAN VIKAS PATRAS ( KVP ) .

Let us discuss in bit more detail . Suppose , Ram wants to do some savings . So , one of the option available to him is , he may purchase KVP . Suppose he purchased KVP worth Rs. 2 lakh . So , this 2 lakh will be received by government and in return government will promise to repay the same amount PLUS interest to Ram , say after 5 years . So , Ram has done savings for 5 years and on the other hand government has received the same amount for 5 years . Similarly , there would be many people like Ram and they would also invest or save in the form of KVP . So, in this way government will receive lots of funds and it can now perform or do whatever it was thinking to do for farmers . After 5 years , government will repay the amount to general public along with interest . Now , we can clearly understand that the amount received by government by selling KVP to public is CAPITAL RECEIPTS to the government because it increases liability over the government as government will have to repay after 5 years or so .

CAPITAL EXPENDITURE

Capital expenditures refers to those expenditures which either results into increase of asset OR decrease of liability to the government . Capital expenditures are non – recurring in nature . Eg – Loans to state and union territories , expenditures on building roads , flyovers , factories , purchase of machinery , repayment of borrowings etc..

EXPLANATION – Government does lots of expenditure every year . But , Only those expenditures which can increase asset to the government OR which can decrease liability to the government are considered as Capital expenditures . Government spends huge amount every year in order to provide SUBSIDISED FOOD or CROPS to the poor . Under it , government purchases rice or wheat from farmers at MSP ( Minimum Support Price ) and sells to poor at very low price say @ 1 or 2 Rs. per kg . Suppose government purchased at Rs. 10 per kg and is selling at Rs, 1 per kg . So , we can say that the difference of Rs. 9 is being spent by government . But , logically against this expenditure , government’s asset is not being increased OR nor any liability of government is getting reduced . So , this type of expenditures are NOT Capital expenditure . In fact , they are Revenue Expenditure ( Read above the definition of RE).

On the other hand , suppose government spent Rs. 2000 crore and built schools and hospitals . So , here this expenditure has increased asset to the government and hence would be considered as CAPITAL EXPENDITURE . It is important to note here that schools , hospitals , flyovers , roads , machinery etc. are considered asset because they fall under the category of Infrastructure . Also , suppose government , in past , had borrowed Rs. 5000 crore from World bank and now in the year 2022 , government repaid the borrowed amount to world bank . So , here this repayment of borrowing is also CAPITAL EXPENDITURE to the government because when government repaid the amount , the liability of the government got reduced .

GOVERNMENT BUDGET AND THE ECONOMY – TYPES OF BUDGET

Government budget can primarily be classified into 3 types , namely Surplus Budget , Balanced Budget and Deficit Budget .
SURPLUS BUDGET – It refers to those kinds of budget wherein government’s estimated Receipts are more than estimated expenditure ( Receipts > Expenditure ) .
BALANCED BUDGET – It refers to those kinds of budget wherein government’s Receipts are equal to estimated expenditure ( Receipts = Expenditure ) .
DEFICIT BUDGET – It refers to those kinds of budget wherein government’s estimated Expenditure is more that estimated Receipts ( Expenditure > Receipts ) .

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BUDGET DEFICIT

Budget deficit OR Deficit budget is defined as the excess of government’s total estimated expenditure over total estimated revenue .
Budget Deficit can be of 3 types –

Revenue Deficit .
Fiscal Deficit .
Primary Deficit .

REVENUE DEFICIT

RD refers to the excess of Revenue Expenditure ( RE ) over Revenue Receipts ( RR ) during the given fiscal year.
RD = RE – RR .
Revenue Deficit signifies that government’s own revenue is insufficient to meet the expenditures required for normal functioning of the government .

IMPLICATIONS OF REVENUE DEFICIT

Revenue deficit indicates that government is finding it difficult to meet it’s regular and recurring expenditure .
It indicates that government is dissaving ( i.e. using up it’s savings ) to meet it’s regular expenses .
Revenue deficit also implies that government has to use Capital Receipts to meet up the deficit . Further , using of Capital Receipts means government is either Borrowing OR Disinvesting .
Use of Capital Receipts to meet Revenue Deficit leads to inflationary pressure on the economy .
Also , higher borrowings increases the future burden vis-a-vis loan amount and interest payments .
Higher Revenue Deficit is like a warning signal to the government to either reduce regular and recurring expenditure OR increase regular and recurring revenue .

MEASURES TO CONTROL REVENUE DEFICIT

REDUCE REVENUE EXPENDITURE – To combat Revenue Deficit , Government must take strong and serious steps in order to reduce or avoid unnecessary / unproductive expenditures .
INCREASE REVENUE RECEIPTS – To combat Revenue Deficit , government should increase it’s Revenue Receipts from sources such as Tax and Non – Tax sources .

FISCAL DEFICIT

Fiscal deficit (FD) refers to the excess of total expenditure (TE) over total receipts ( excluding borrowings ) during the given fiscal year .
FD = TE – TR excluding borrowings.

IMPLICATIONS OF FISCAL DEFICIT

DEBT TRAP – Fiscal deficit indicates the total borrowing requirements of the government . When borrowings are done , it not only creates the obligation to repay the principal amount , but also creates interest payment obligation . Interest payment obligations increases revenue expenditure , which further increases Revenue deficit . Revenue deficit further increases fiscal deficit and hence government gets trapped into vicious cycle of Revenue deficit and fiscal deficit ,where the government takes more loans to repay the earlier loans . Hence , country gets trapped into Debt trap .
INFLATION – To finance its’ fiscal deficit , government mainly borrows from RBI . For this , RBI prints new currency and transfers to the government . This increases the money supply in the economy and hence inflation also increases in the economy .
FOREIGN DEPENDENCE – Government , to finance fiscal deficit , sometimes borrows from rest of the world . This increases it’s dependence on other countries .
HAMPERS FUTURE GROWTH – Borrowings increases burden on future generations and hence it negatively affects growth and development of the country .

SOURCES OF FINANCING FISCAL DEFICIT

BORROWINGS – Fiscal deficit can be financed from internal borrowings ( Public , Commercial banks etc..) OR from external borrowings ( Foreign governments , international organizations like World Bank , IMF etc..) .
DEFICIT FINANCING ( PRINTING OF NEW CURRENCY ) – Government may borrow from RBI by mortgaging securities and hence can meet fiscal deficit . RBI issues or prints new currency and for this purpose . This process is known as Deficit Financing .

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PRIMARY DEFICIT ( PD )

Primary deficit refers to difference between fiscal deficit ( FD ) of the current year and interest payments on the previous borrowings .
PD = FD – Interest payments .

IMPLICATIONS OF PRIMARY DEFICIT

Primary deficit indicates that out of the total borrowings of the government , how much borrowings are going to meet expenses other than interest payments .
The difference between FD and PD shows the amount of interest payments on the borrowings made in the past.
So , a low or Zero PD shows that interest obligations ( on earlier loans ) have forced the government to borrow .
Q – How PD is the root cause of FD in India ?
ANS – Indian government because of the past borrowings , every year faces huge burden of Interest obligations . High interest payments on past borrowings have greatly increased the FD . That is why it is said that PD is the root cause of FD .
To reduce FD , Interest obligations should be reduced by repaying previous borrowings as soon as possible .

OBJECTIVES OF GOVERNMENT BUDGET

Government prepares budget for fulfilling certain objectives and they are as follows –

REALLOCATION OF RESOURCES – Government aims to reallocate resources w.r.t Economic ( profit maximization) and Social ( public welfare ) priorities of the country . The reallocation of resources is done by government through –
TAX CONSESSIONS OR SUBSIDIES – To promote investment in the economy , government gives tax concession , subsidies etc. to the Producers . Eg – Production of Liquor , cigarettes etc. are discouraged by levying hefty taxes , Whereas production of goods like Khadi products are encouraged by providing subsidies .
DIRECTLY PRODUCING GOODS AND SERVICES- If private sector does not takes keen interest in investment then government government can directly undertake the production .
REDUCING INCOME INEQUALITIES AND WEALTH – Government , through its’ budgetary policy aims to reduce economic inequalities of income and wealth . To reduce economic inequality , government influences distribution of income by taxing the rich and spending more on welfare of poor . This will result into less income left with rich and the standard of living of the poor would increase . Hence , economic inequality will reduce and redistribution of income will take place .
ECONOMIC STABILITY – Business fluctuations of inflation or deflation hampers economic growth . So , government with the help of budgetary policy tries to stabilize the economy and hence control business fluctuations . Policy of surplus budget during inflation and deficit budget during deflation helps in stabilizing the economy .
MANAGEMENT OF PUBLIC ENTERPRISES – Government manages large number of public sector enterprises in order to perform its’ objective of social welfare .
ECONOMIC GROWTH – GDP growth rate also depends upon the rate of savings and investment in the economy . Government through its’ budgetary policy tries to mobilize sufficient resources for investment in the economy .
REDUCING REGIONAL DISPARITIES – Government through its’ budgetary policy tries to setup production units in economically backward regions . This helps in reducing regional disparities.

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