Context: The Union Budget will be tabled in Parliament by the Finance Minister on 1st February, 2025. It is likely to address concerns around growth, inflation and spending.
Relevance of the Topic:Prelims: Key concepts related to Union Budget- Components; Deficits- Fiscal, Revenue, Primary deficit.
Union Budget in India
- The budget is the government’s blueprint on expenditure, taxes it plans to levy, and other transactions which affect the economy and lives of citizens.
- Constitutional framework: According to Article 112 of the Indian Constitution, the Union Budget of a year is referred to as the Annual Financial Statement (AFS).
- Formulation: The Budget Division of the Department of Economic Affairs in the Finance Ministry is the nodal body responsible for preparing the Budget.
Components of Budget
- There are three major components— expenditure, receipts and deficit indicators. Depending on the manner in which they are defined, there can be many classifications and indicators of expenditure, receipts and deficits.
Expenditure | 1. Based on Asset Creation and Liability Reduction: Capital Expenditure: Incurred with the purpose of increasing assets of a durable nature or of reducing recurring liabilities. Example: Expenditure incurred for constructing new schools or new hospitals. Revenue Expenditure: involves any expenditure that does not add to assets or reduce liabilities. Example: Expenditure on the payment of wages and salaries, subsidies or interest payments. 2. Based on Sectoral Impact:Expenditure is also classified into: General services: Includes administrative expenses, defence, interest payments etc. Economic services: Includes expenditure on transport, communication, rural development, agricultural and allied sectors.Social services: Includes expenditure on the social sector including education or health. Grants-in-aid and contribution.The sum of expenditure on economic and social services together form the development expenditure. |
Receipts | Receipts of the Government have three components: -Revenue receipts -Non-debt capital receipts - Debt-creating capital receipts. Revenue receipts involve receipts that are not associated with increase in liabilities and comprise revenue from taxes and non-tax sources. Non-debt receipts are part of capital receipts that do not generate additional liabilities. Example: Recovery of loans and proceeds from disinvestment. Debt-creating capital receipts involve higher liabilities and future payment commitments of the Government. |
Fiscal Deficit | Fiscal deficit is the difference between total expenditure and the sum of revenue receipts and non-debt receipts. It indicates how much the Government is spending in net terms. Positive fiscal deficits indicate the amount of expenditure over and above revenue and non-debt receipts. It needs to be financed by a debt-creating capital receipt. Primary deficit is the difference between fiscal deficit and interest payments. Revenue deficit is derived by deducting capital expenditure from fiscal deficits. |
Implications of Budget on Economy
- Impact on Aggregate Demand:
- Expenditure: All Government expenditure generates aggregate demand in the economy, since it involves purchase of private goods and services by the Government sector.
- Receipts: All tax and non-tax revenue reduces net income of the private sector, and thereby leads to reduction in private and aggregate demand.
- Reducing aggregate demand: Following cases indicates the Government’s policy to reduce aggregate demand:
- Reduction in expenditure-GDP ratio
- Increase in revenue receipt-GDP ratio
- Reduction in fiscal deficit-GDP and primary deficit-GDP ratios.
- Increasing aggregate demand: Following cases indicates the Government’s policy to increase aggregate demand:
- Increase in expenditure-GDP ratio
- Decrease in revenue receipt-GDP ratio
- Increase in fiscal deficit-GDP and primary deficit-GDP ratios
- Impact on Income Distribution:
- Revenue expenditure such as employment guarantee schemes or food subsidies can directly boost the income of the poor.
- Concession in corporate tax may directly and positively affect corporate incomes.
What are Fiscal rules?
- Fiscal rules provide specific policy targets on the basis of which fiscal policy is formed.
- Fiscal policy refers to the use of government spending and tax policies to influence economic conditions, especially macroeconomic conditions, including aggregate demand for goods and services, employment, inflation, and economic growth.
- Policy targets can be met by using different policy instruments.
- There exists no unique fiscal rule that is applied to all countries.
- Rather, policy targets are sensitive to the nature of economic theory and depend on the specificity of an economy.
Fiscal Rules in India
- India’s present fiscal rule is guided by the recommendations of the N.K. Singh Committee Report.
- Allowing for some deviations under exceptional times, it has three policy targets:
- Stock Target: maintaining a specific level of debt-GDP ratio
- The total amount of debt a country has compared to its GDP.
- This shows how much a country owes to what it produces.
- If debt is too high, it can lead to financial instability.
- Flow Target: Fiscal deficit-GDP ratio
- The gap between how much the government spends and how much it earns in a year, compared to its GDP.
- A high fiscal deficit means the government is borrowing more to cover its expenses.
- Composition Target: Revenue deficit-GDP ratio
- The part of the fiscal deficit that comes from borrowing for regular expenses instead of investments.
- Stock Target: maintaining a specific level of debt-GDP ratio
- Governments can manage their finances in 2 ways:
- Changing tax rates
- Adjusting spending
- However, in India, tax-rates within the existing policy framework are determined independent of the expenditure requirement of the economy. So, when the government needs to meet fiscal targets, it mainly adjusts its spending instead of changing taxes.
How India’s fiscal rules affect fiscal policy?
- Spending limits: Independent of the extent of expenditure needed to stimulate the economy or boost labour income, existing fiscal rules provide a cap on expenditure by imposing the three policy targets.
- Rigid Targets: Under any situation when the debt-ratio or deficit ratio is greater than the targeted level, expenditure is adjusted in order to meet the policy targets. Thus, independent of the state of the economy and the need for expansionary fiscal policy, existing policy targets may lead the Government to reduce expenditure.
In the midst of the inadequacies of fiscal policy to address the contemporary challenges of unemployment and low output growth rate, the nature and objective of fiscal rules in India would have to be re-examined.