Government Budget and the Economy Class 12 Notes

The government budget is an annual statement of the estimated receipts and expenditure of the government. It is not a mere account but the fiscal instrument through which the state reallocates the economy's resources, redistributes income, stabilises the economy and promotes growth — the four objectives the syllabus names, plus the management of public enterprises.

• Reallocation of resources: the government steers resources toward socially desirable goods — public goods, merit goods — that the market under-provides.
• Redistribution of income: progressive taxes and transfers, subsidies and welfare spending, narrow the gap between the rich and the poor.
• Stabilisation: the budget is counter-cyclical — demand is stimulated in a depression and cooled in an inflation.
• Promotion of economic growth: spending on infrastructure, education and health raises the productive capacity of the economy.
• Management of public enterprises: the budget accounts for the revenue and capital transactions of the undertakings the state owns.
• Reduction of regional disparities: the budget channels central resources to the backward regions.

Every flow into the budget is classified as a revenue receipt or a capital receipt by one test: whether it creates a liability or reduces an asset. A receipt that neither creates a liability nor reduces an asset is revenue; a receipt that does either is capital. The test decides the classification in every example.

• Revenue receipts: those that neither create a liability nor reduce an asset — the tax revenue and the non-tax revenue such as fees, fines and interest receipts.
• Tax revenue: direct taxes on income and wealth — corporation tax, income tax — and indirect taxes on goods and services — GST.
• Non-tax revenue: interest and dividends the government receives, fees, fines and forfeitures.
• Capital receipts: those that create a liability or reduce an asset — borrowings, loan repayments to the government and receipts from disinvestment.
• Borrowings are capital receipts and are excluded from the count in the fiscal deficit, because they finance rather than fund the deficit itself.
• Recovery of loans: repayments by borrowers reduce the receivable asset, so they are capital receipts.

The same single test classifies expenditure. A payment that creates an asset or reduces a liability is capital expenditure; a payment that does neither, the day-to-day running cost, is revenue expenditure. Revenue expenditure does not build an asset; capital expenditure creates, acquires or extends one, or repays a loan.

• Revenue expenditure: the running costs of the government — salaries, pensions, interest payments, subsidies, defence wages and maintenance — that neither create assets nor reduce liabilities.
• Capital expenditure: spending that creates the assets of the nation — roads, dams, plants, machinery — and the loans and grants given to others for capital purposes.
• Planned and unplanned, developmental and non-developmental: secondary classifications of the same two accounts.
• The test in one line: an asset is created or extended, capital; otherwise, revenue.
• Interest payments are revenue expenditure because they are the running cost of debt, and they reappear as the difference between the fiscal and the primary deficit.

A budget is balanced when the receipts equal the expenditure, surplus when the receipts exceed the expenditure, and deficit when the expenditure exceeds the receipts. Note the accounting convention: 'deficit budget' refers to total receipts excepting borrowings falling short of total expenditure, which is the fiscal deficit.

• Balanced budget: total receipts equal total expenditure; revenue equals expenditure and the deficit is zero.
• Surplus budget: total receipts exceed total expenditure; the surplus is used to reduce debt or build reserves.
• Deficit budget: expenditure exceeds the receipts other than borrowing; the gap is covered by borrowing and drawings on reserves.
• The deficit budget is the normal state of a developing economy, because its borrowing finances the infrastructure of growth.
• The terms are statements of the difference, not of approval — a deficit in a depression is stabilising, and a surplus in an inflation is stabilising.

The budget closes on three deficits, each answering a different question. The revenue deficit asks whether the day-to-day running of the government is funded from its current income. The fiscal deficit asks how much the government must borrow in all to run the year. The primary deficit strips the interest burden out of the fiscal deficit so the non-interest borrowing is visible.

A large fiscal deficit crowds out private investment, fuels inflation and raises the interest burden. Its reduction runs on two tracks, spending less and earning more, and the examiner asks for the measures rather than for the arithmetic alone.

• Reduce expenditure: prune subsidies, target them to the genuinely poor, freeze creation and trim administrative costs.
• Raise revenue: widen the tax base, improve collection efficiency, and review exemptions and rates.
• Raise non-tax income: dividends of public enterprises, user charges and the charges on capital assets.
• Improve the management of public enterprises: the losses and subsidies of the state undertakings are themselves a burden on the budget.
• Disinvestment: the partial sale of equity reduces the need for further budgetary support.
• The correct sequence in an answer: the size of the gap, then the two tracks of reduction, then one measure on each track.

The unit is examined through the classification questions, the deficit definitions and the numerical computation of the deficits. The classification questions are pure applications of the single asset-and-liability test.

• State the objectives of the budget with one example each.
• Classify any given receipt or payment as revenue or capital, with the reason on the test.
• Define revenue, fiscal and primary deficits, and compute them from a budget table.
• Distinguish direct from indirect taxes, and revenue expenditure from capital expenditure.
• Explain the measures to reduce the fiscal deficit.
• Explain the harmful effects of a large fiscal deficit and the meaning of crowding out.