1. Meaning and components of a budget
A government budget is an annual statement of the estimated receipts and expenditure of the government for a financial year (in India, 1 April to 31 March). The Union budget is placed before Parliament (the Constitution calls it the "annual financial statement"); each state places its own budget before its assembly.
Components: (1) the receipts budget, showing where money comes from; (2) the expenditure budget, showing where it goes. Both are split into revenue and capital parts.
| Feature | What it means |
|---|---|
| A statement of estimates | Expected receipts and expenditure, not actual figures |
| For one financial year | In India, 1 April to 31 March |
| Placed before the legislature | Parliament for the Union budget (the "annual financial statement" of the Constitution); state assemblies for state budgets |
| A policy document | Shows how the government means to raise and use money to meet its aims |
Key terms
- Government budget
Annual statement of the estimated receipts and expenditure of the government for the coming financial year.
- Financial year
In India, the twelve months from 1 April to 31 March.
2. Objectives of a government budget
- Reallocation of resources: taxes on harmful goods and subsidies on useful ones shift production; public goods (non-excludable, non-rival, e.g. defence, street lights) are supplied by the government because free riders make private supply unprofitable.
- Redistribution of income: progressive taxes plus transfers and free services (food, schooling, health, pensions) narrow inequality.
- Economic stability: raise spending or cut taxes in a slump; cut spending or raise taxes in an inflationary boom.
- Managing public enterprises: public ownership of natural monopolies (railways, power lines) keeps essential services affordable and prevents concentration of economic power.
| Private good | Public good | |
|---|---|---|
| Example | A cricket bat, a plate of dosa | Street lights, national defence, a lighthouse |
| Can non-payers be kept out? | Yes (excludable) | No (non-excludable) |
| Does one person's use reduce another's? | Yes (rival) | No (non-rival) |
| Who supplies it? | The market | Mainly the government, paid for from taxes |
| Situation | Problem | Budget response | Effect on demand |
|---|---|---|---|
| Slump | Deficient demand, unemployment | Raise spending, cut taxes | Demand rises |
| Boom with inflation | Excess demand, rising prices | Cut spending, raise taxes | Demand falls |
Key terms
- Public good
A good from whose benefit no one can be excluded and whose use by one person does not reduce its availability to others.
- Free rider
A person who enjoys a good without paying for it.
- Progressive tax
A tax whose rate rises as income rises.
3. Budget receipts
Revenue receipts neither create a liability nor reduce assets.
- Tax revenue: direct taxes (personal income tax, corporation tax): impact and incidence on the same person, cannot be shifted. Indirect taxes (GST, introduced in 2017; customs duties): shifted to buyers through prices.
- Non-tax revenue: interest receipts, dividends and profits of public enterprises, fees, fines and penalties, grants received.
Capital receipts create a liability or reduce assets.
- Borrowings (debt-creating): from the public, banks, the central bank, abroad.
- Non-debt capital receipts: recovery of loans, disinvestment.
| Direct tax | Indirect tax | |
|---|---|---|
| Levied on | Income and property of persons and companies | Goods and services |
| Can the burden be shifted? | No: impact and incidence on the same person | Yes: passed on to buyers in the price |
| Examples | Personal income tax, corporation tax | GST (since 2017), customs duties |
| Non-tax revenue | Example (imagined) |
|---|---|
| Interest receipts | Interest on loans the Centre gave to states |
| Dividends and profits | Dividend from a public-sector bank |
| Fees | Passport fee, court fee, college fee |
| Fines and penalties | Fine on a factory for pollution |
| Grants and gifts received | A grant from an international agency for flood relief |
| Capital receipt | Why it is capital | Debt-creating? |
|---|---|---|
| Borrowings (bonds, loans from banks and abroad) | Creates a liability | Yes |
| Recovery of loans given earlier | Reduces an asset (a claim) | No |
| Disinvestment (sale of shares in public enterprises) | Reduces an asset (ownership) | No |
Key terms
- Revenue receipts
Receipts that neither create a liability nor reduce the assets of the government.
- Capital receipts
Receipts that create a liability or reduce the assets of the government.
- Direct tax
A tax whose burden falls on the person on whom it is levied and cannot be shifted.
- Indirect tax
A tax on goods and services whose burden can be shifted to buyers.
- Disinvestment
Sale of part or all of the government's shares in a public enterprise.
4. Budget expenditure
Revenue expenditure neither creates an asset nor reduces a liability: salaries, pensions, interest payments, subsidies, running costs, and grants to state governments (for the Centre, even if the states build assets with them).
Capital expenditure creates an asset or reduces a liability: roads, dams, buildings, machinery, purchase of shares, loans given to states and others, repayment of loans.
Revenue expenditure keeps the government running; capital expenditure adds to the productive capacity of the economy.
| Spending (imagined) | Test | Class |
|---|---|---|
| Salaries of police officers | No asset, no liability reduced | Revenue expenditure |
| Building a district hospital | Creates an asset | Capital expenditure |
| Interest on government bonds | Loan itself not reduced | Revenue expenditure |
| Repaying a loan to a foreign bank | Reduces a liability | Capital expenditure |
| Loan to a state for a metro | Creates an asset (a claim) | Capital expenditure |
| Grant to a state for school buildings | No asset for the Centre | Revenue expenditure |
Key terms
- Revenue expenditure
Expenditure that neither creates an asset nor reduces a liability of the government.
- Capital expenditure
Expenditure that creates an asset or reduces a liability of the government.
5. Balanced, surplus and deficit budgets
- Balanced: estimated receipts = estimated expenditure.
- Surplus: receipts > expenditure; reduces aggregate demand, suits inflation.
- Deficit: expenditure > receipts; raises aggregate demand, suits a slump, and is common in developing economies that spend on development.
| Type | Condition | Suits |
|---|---|---|
| Balanced | Estimated receipts = estimated expenditure | Rarely possible; does not fight a slump or inflation |
| Surplus | Receipts > expenditure | Inflation (excess demand) |
| Deficit | Expenditure > receipts | Slump and unemployment (deficient demand), development spending |
Key terms
- Balanced budget
A budget in which estimated receipts equal estimated expenditure.
- Deficit budget
A budget in which estimated expenditure exceeds estimated receipts.
6. Measures of deficit and their implications
- Revenue deficit = revenue expenditure − revenue receipts. Shows dissaving: borrowing or selling assets to meet current spending. Implications: debt without assets, rising interest, pressure to cut capital spending.
- Fiscal deficit = total expenditure − (revenue receipts + non-debt capital receipts) = borrowings. Implications: debt and interest burden, a possible debt trap, inflation if financed by new money from the central bank, less credit for private firms. It can help in a slump or when it finances assets.
- Primary deficit = fiscal deficit − interest payments. Shows borrowing for present needs; if it is zero, all borrowing goes to interest on past debt.
Deficits are compared across years as a per cent of GDP. Ways to reduce them: wider tax base and better collection, better-targeted subsidies and less waste, disinvestment (one-time), and legal targets (Fiscal Responsibility and Budget Management Act, 2003).
| Measure | Formula | Shows |
|---|---|---|
| Revenue deficit | Revenue expenditure − revenue receipts | Borrowing for current spending (dissaving) |
| Fiscal deficit | Total expenditure − total receipts excluding borrowings | Total borrowing needed |
| Primary deficit | Fiscal deficit − interest payments | Borrowing for present needs, excluding past debt |
Key terms
- Revenue deficit
Excess of revenue expenditure over revenue receipts.
- Fiscal deficit
Excess of total expenditure over total receipts excluding borrowings; equal to the borrowing requirement.
- Primary deficit
Fiscal deficit minus interest payments.
- Debt trap
A situation where a government borrows to pay interest on past loans, so its debt keeps growing.
Exam tips
Common mistakes
- Including borrowings among receipts for the fiscal deficit. Leave them out; then check fiscal deficit = borrowings.
- Calling interest received a capital receipt (it is revenue), or loan recovery a revenue receipt (it is capital).
- Calling grants to states capital expenditure in the central budget (they are revenue expenditure).
- Calling GST a direct tax: its burden is shifted, so it is indirect.
- Saying a zero primary deficit means no borrowing: it means all borrowing pays interest.
- Teaching plan and non-plan expenditure: this classification is no longer used.
How marks are usually awarded
- 1 mark: one correct option or value.
- 3-mark numericals: one mark per deficit, usually for formula plus correct value.
- Classification questions: the class alone gets little; the reason earns the mark.
- 5 marks: five distinct points; for "evaluate", give both sides and a conclusion.