Chapter 5. Government Budget and Economy

Overview
An economy in which there is both private sector and Government, is called a mixed economy. Government Budget — Meaning and its Components
• Article 112 of Indian Constitution states that annual statement of estimated receipts and expenditures of government is to be presented before Parliament.
• A budget shows financial accounts of previous year, budget & revised estimates for current year and budget estimates for coming year.
• The budget document relates to receipts and expenditure of government for a particular financial year, impact of which will be felt in subsequent years.
• Union Annual Financial Statement have two accounts- those that relate to current financial year only, are included in revenue account (also known as revenue budget) and those that concern assets and liabilities of government, into capital account (also known as capital budget).

Objectives of Government Budget
The government plays a very important role in increasing welfare of people.
• Allocation of Resources
• Redistribution of Income and Wealth
• Economic Stability
• Managing Public Enterprises

Redistribution Function of Government Budget
• The government sector affects personal disposable income of households by making transfers and collecting taxes. It is through this that government can change distribution of income and bring about a distribution that is considered ‘fair’ by society. This is redistribution function.

Stabilization Function of Government Budget
The government tries to prevent business fluctuations and maintain price and employment stability. Economic stability stimulates inducement to invest and increases rate of growth and development.

Public Goods
• The government provides certain goods and services which cannot be provided by market mechanism, i.e., by exchange between individual consumers and producers, which are referred to as public goods. They are known as non-excludable.

Difference between Private Goods and Public Goods
• The benefits of public goods are available to all and are not only restricted to one particular consumer.
• In case of private goods, anyone who does not pay for goods, can be excluded from enjoying its benefits.

Public Production
• Public provision means that they are financed through budget and can be used without any direct payment. Public goods may be produced by government or private sector. When goods are produced directly by government, it is known as public production.

Classification of Receipts
• Revenue receipts are those receipts that do not lead to a claim on government. They are therefore termed non-redeemable.
• This receipt does not either create a liability or lead to reduction in assets.
• They are divided into tax and non-tax revenues.

Tax revenues
• It is an important component of revenue receipts, which have for long been divided into direct taxes i.e., personal income tax and corporation tax, and indirect taxes like excise taxes (duties levied on goods produced within country), customs duties (taxes imposed on goods imported into and exported out of India) and service tax.
• Other direct taxes like wealth tax, gift tax & estate duty (now abolished), have never brought in a large amount of revenue and thus have been referred to as ‘paper taxes’.

Non-tax revenue
• It mainly consists of interest receipts on account of loans by central government, dividends & profits on investments made by government, fees & other receipts for services rendered by government, and Cash grants-in-aid from foreign countries and international organisations.

MACRO-ECONOMICS
• Forfeitures and Escheat are a types of non-tax revenue of government.
• The estimates of revenue receipts take into account effects of tax proposals made in Finance Bill.

Capital Receipts
• All those receipts of government which create liability or reduce financial assets are termed as capital receipts. The government receives money by way of loans or from sale of its assets. Loans will have to be returned to agencies from which they have been borrowed. Thus, they create liability.

Classification of Expenditure Revenue Expenditure
• It is expenditure incurred for purposes other than creation of physical or financial assets of central government.
• Subsidies are an important policy instrument which aim at increasing welfare.

Capital Expenditure
• There are expenditures of government which result in creation of physical or financial assets or a reduction in financial liabilities.
• This includes expenditure on acquisition of land, building, machinery, equipment, investment in shares, & loans & advances by Central Government to state and union territory governments, PSUs & other parties.

Balanced, Surplus & Deficit Budget
• The government may spend an amount equal to revenue. This is called a balanced budget.
• When estimated revenue are more than estimated expenditure, budget is said to be a Surplus Budget.
• When expenditure exceeds revenue, this is when government runs a budget deficit.

Different Types of Deficits
Revenue Deficit:
• It refers to excess of government’s revenue expenditure over revenue receipts. Revenue deficit = Revenue expenditure – Revenue receipts
• It includes only those transactions that affect current income and expenditure of government. Fiscal Deficit:
• Fiscal deficit is a wider concept. It is sum of borrowing and other liabilities of government.
• It is difference between government’s total expenditure and its total receipts, excluding borrowing. Gross fiscal deficit = Total expenditure – (Revenue receipts + Non-debt creating capital receipts)
• Non-debt creating capital receipts are those receipts which are not borrowings and, therefore, do not give rise to debt. Examples are, recovery of loans and proceeds from sale of PSUs. Gross fiscal deficit = Net borrowing at home + Borrowing from RBI + Borrowing from abroad

Primary Deficit:
• It is simply fiscal deficit minus interest payments. Gross primary deficit = Gross fiscal deficit – Net interest liabilities
• Net interest liabilities consist of interest payments minus interest receipts by government on net domestic lending.

Fiscal Policy
• One of Keynes’s main ideas in ‘The General Theory of Employment, Interest & Money’ was that government’s fiscal policy should be used to stabilise level of output and employment.
• The government directly affects level of equilibrium income in two specific ways – government purchases of goods and services increases aggregate demand and taxes, and transfers affect relation between income and disposable income.
Disposable Income: The income available for consumption and saving with households.
1. When GDP rises, disposable income rises but by less than rise in GDP, because a part of it is siphoned-off as taxes.
2. This helps limit upward fluctuation in consumption spending.
3. During a recession when GDP falls, disposable income falls less sharply, and consumption does not drop as much as it otherwise would have fallen had tax liability been fixed. This reduces fall in aggregate demand and stabilises economy.

Changes in Taxes
• A cut in taxes increases disposable income at each level of income. This shifts aggregate expenditure schedule upwards by a fraction c of decrease in taxes.
• A tax cut (increase) will cause an increase (reduction) in consumption and output, tax multiplier is a negative multiplier. The tax multiplier is smaller in absolute value compared to government’s spending multiplier. This is because an increase in government spending directly affects total spending whereas taxes enter multiplier process through their impact on disposable income, which influences household consumption.
• Proportional taxes not only lower consumption at each level of income but lower slope of consumption function.

Discretionary Fiscal Policy
• If investment falls, government spending can be raised so that autonomous expenditure and equilibrium income remains same. This deliberate action to stabilise economy is often referred to as discretionary fiscal policy.

Debt
• Budgetary deficits must be financed by either taxation, borrowing or printing money. Governments have mostly relied on borrowing, giving rise to what is known as government debt.

Perspectives on Appropriate Amount of Government Debt
• One is whether government debt is a burden and two, issue of financing debt.
• Government borrowing from people reduces savings available to private sector.
• They will understand that borrowing today means higher taxes in future.
• They would increase savings now, which will fully offset increased government dissaving so that national savings do not change. This view is known as Ricardian equivalence after one of greatest nineteenth century economists, David Ricardo, who first argued that in face of high deficits, people save more. It is known as ‘equivalence’ because it argues that taxation and borrowing are equivalent means of financing expenditure.

Other Perspectives on Deficits and Debt
• One of main criticisms of deficits is that they are inflationary. This is because when government increases spending or cuts taxes, aggregate demand increases.
• Firms may not be able to produce higher quantities that are being demanded at ongoing prices.

Deficit Reduction
Government deficit can be reduced by an increase in taxes or reduction in expenditure
• Cutting back government programmes in vital areas like agriculture, education, health, poverty alleviation, etc., would adversely affect economy.
• If an economy experiences a recession and GDP falls, tax revenues fall because firms and households pay lower taxes when they earn less.
• This means that deficit increases in a recession and falls in a boom, even with no change in fiscal policy.

Fiscal Responsibility and Budget Management Act, 2003 (FRBMA)
• It was enacted in August 2003, which marked a turning point in fiscal reforms, binding government through an institutional framework to pursue a prudent fiscal policy.
• The Central Government must ensure intergenerational equity and long-term macroeconomic stability by achieving a sufficient revenue surplus, removing fiscal obstacles to monetary policy, and effective debt management by limiting deficits and borrowing.

Main Features of Act
• It mandates central government to take appropriate measures to reduce fiscal deficit to not more than 3% of GDP and to eliminate revenue deficit by March 31, 2009 & thereafter build up an adequate revenue surplus.
• It requires a reduction in fiscal deficit by 0.3% of GDP each year and revenue deficit by 0.5%. If this is not achieved through tax revenues, necessary adjustment has to come from a reduction in expenditure.
• The actual deficits may exceed targets specified only on grounds of national security, natural calamity, or such other exceptional grounds as Central Government may specify.
• The Central Government shall not borrow from Reserve Bank of India except by way of advances to meet temporary excess of cash disbursements over cash receipts.
• RBI must not subscribe to primary issues of Central Government securities from year 2006-07.
• Measures to be taken to ensure greater transparency in fiscal operations.
• The Central Government to lay before both Houses of Parliament, three statements – Medium-term Fiscal Policy Statement, Fiscal Policy Strategy Statement, and Macroeconomic Framework Statement-along with Annual Financial Statement.
1. The Medium-term Fiscal Policy Statement sets a three-year rolling target for specific fiscal indicators and examines whether revenue expenditure can be financed through revenue receipts on a sustainable basis and how productively capital receipts, including market borrowings, are being utilised.
2. The Fiscal Policy Strategy Statement sets priorities of government in fiscal area, examining current policies and justifying any deviation in important fiscal measures.
3. The Macroeconomic Framework Statement assesses prospects of economy with respect to GDP growth rate, fiscal balance of central government and external balance.
• A quarterly review of trends in receipts and expenditure in relation to budget will be placed before both Houses of Parliament.
1. The act applies to central government. However, 26 states have already enacted fiscal responsibility legislation, which has made rule-based fiscal reform programme of government broader-based.
2. Although, government has emphasised that FRBMA is an important institutional mechanism to ensure fiscal prudence and support macroeconomic balance, there have been fears that welfare expenditure may be reduced to meet targets mandated by Act.

Goods and Service Tax (GST): One Nation, One Tax, One Market
• It is single comprehensive indirect tax, operational from 1 July 2017, on supply of goods and services, right from manufacturer/ service provider to consumer.
• Under GST, there are 6 standard rates applied, i.e., 0%, 3%, 5%, 12%, 18%, & 28%, on supply of all goods and/or services across country.
• GST is biggest tax reform in country since independence and was rolled out on mid-night of 30 June/1 July, 2017 during a special midnight session of Parliament.
• It is a destination-based consumption tax with facility of Input Tax Credit in supply chain.
• It is applicable throughout country with one rate for one type of goods/service.
• It has amalgamated a large number of Central and State taxes and cesses.
• It has replaced a large number of taxes on goods and services levied on production/ sale of goods or provision of services.
• Under GST, tax is discharged at every stage of supply and credit of tax paid at previous stage is available for set-off at next stage of supply of goods and/or services.
• It is thus effectively a tax on value addition at each stage of supply.
• Goods and Service Tax (GST) has abolished following taxes: Central Excise duty, Duties of Excise, Additional Duties of Excise, Additional Duties of Customs, Special Additional Duty of Customs, Service Tax, and Central Surcharges

Constitutional Provision for GST
• The 101st Constitutional Amendment Act received assent of President of India on 8 September, 2016.
• The amendment introduced Article 246A in Constitution cross empowering Parliament and Legislatures of States to make laws with reference to Goods and Service Tax imposed by Union and States. Thereafter CGST Act, UTGST Act & SGST Acts were enacted for GST.

Product kept outside purview of GST
• Five petroleum products have been kept out of GST for time being but with passage of time, they will get subsumed in GST.
• State Governments will continue to levy VAT on alcoholic liquor for human consumption.
• Tobacco and tobacco products will attract both GST and Central Excise Duty.

Benefits of GST
• It has facilitated freedom of movement of goods and services and created a common market in country.
• It is aimed at reducing cost of business operations and cascading effect of various taxes on consumers.
• It has reduced overall cost of production, which will make Indian products/services more competitive in domestic and international markets.
• It will result into higher economic growth as GDP is expected to rise by about 2%.
• Compliance will be easier, as all tax payment related services like registration, returns, & payments are available online through a common portal.
• It has expanded tax base, introduced higher transparency in taxation system, reduced human interface between taxpayer and government, and is furthering ease of doing business.

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