Module 5

Fiscal policy and deficit finance

Public budget
Government budget refers to an annual financial statement that denotes its anticipated
expenditure and expected revenue generation in a fiscal year. It is presented by the
government in Lok Sabha at the beginning of every fiscal year, to give an estimate of its
expenditure and receipts for the upcoming year.
The term “Annual Financial Statement” of a nation is often used to define government
budget. 

Components of a Government Budget

Government budget and its components can be divided into two parts – 
 Capital budget
 Revenue budget

Capital Budget – These refer to receipts that reduce assets for a government
and create financial liabilities. Conversely, capital expenditure on a government’s part
helps to create assets and reduce liabilities. The capital budget, thus, is an account of
these liabilities and assets under the government, which denote a change in total
capital.
Revenue Budget – As its name suggests, the revenue budget refers to
revenue receipts generated and expenses met through this revenue. These receipts
include both tax and non-tax revenue earned by a government. 

Objectives of Government Budget

While rapid economic growth and social justice are primary goals of any policy undertaken
by any government, a budget’s general objectives are given below – 

i. Promoting Economic Growth

Economic growth of a country refers to sustained growth in its GDP. The primary objective
of the government budget is, thus, to boost GDP growth by promoting balanced economic
development and improving people’s standard of living.  That is done by considering general
public welfare.

ii. Poverty Alleviation and Employment Generation

Social welfare is the most crucial objective of setting a country’s budget. This budget is set in
a way to ensure that every Indian can meet basic requirements like housing, clothing, food,
alongside basic education and healthcare. Further, a budget is also set by keeping in
consideration goals like eradication of poverty by generating employment.

iii. Resource Reallocation

Each year, the government allocates more resources to the socially productive sector where
there is a shortage of private initiatives, like – providing electricity to rural areas, health,
education, public sanitation, etc. Further, the government also undertakes initiatives for
promotion of India’s indigenous industry, like Khadi, while drawing away from a few other
sectors to ensure balanced growth in every sector.

iv. Reducing Inequality and Income Redistribution

To reduce inequality in the country, the government can undertake measures like imposing
taxes or granting subsidies. The government usually imposes taxes on the country’s affluent
to reduce their disposable income and undertakes schemes to aid the country’s poor. The
government also provides amenities and subsidies to those in need. Redistribution of income
is another measure undertaken by the government to promote economic welfare.

Types of Budget:
Recall, a budget is defined as an annual statement of the estimated receipts and
expenditure of the government over the fiscal year. Budgets are of three types: balanced,
surplus and deficit budgets—depending upon whether the estimated receipts are equal to,
less than or more than estimated receipts, respectively its three types are explained
hereunder.

(a) Balanced Budget:

A government budget is said to be a balanced budget in which government estimated
receipts (revenue and capital) are equal to government estimated expenditure. Let us
suppose for the sake of convenience that the only source of revenue is a lump sum tax. A
balanced budget will then imply that the amount of tax is equal to the amount of
expenditure.

Put in symbols:

Balanced Budget=Estimated Govt. Receipts = Estimated Govt. Expenditure

Unbalanced Budget:

When government estimated expenditure is either more or less than government

estimated receipts, the budget is said to be an unbalanced budget. It may be either
surplus budget or deficit budget.

(b) Surplus Budget:

When government receipts are more than government expenditure in the budget, the
budget is called a surplus budget. In other words, a surplus budget implies a situation
where in government revenue is in excess of government expenditure.

Symbolically:

Surplus Budget =Estimated Govt. Receipts > Estimated Govt. Expenditure

A surplus budget shows that government is taking away more money than what it is
pumping in the economic system. As a result, aggregate demand tends to fall which
helps in reducing the price level. Therefore, in times of severe inflation, which arises due
to excess demand, a surplus budget is the appropriate budget. But in situation of
deflation and recession, surplus budget should be avoided. Mind, balanced budget and
surplus budget are rarely used by the government in modern-day world.

(c) Deficit Budget:

When government estimated expenditure exceeds government receipts in the budget, the
budget is said to be a deficit budget. In other words, in a deficit budget, government
estimated revenue is less than estimated expenditure.

Symbolically:

Deficit Budget = Estimated Govt. Expenditure > Estimated Govt. Receipts

These days’ popular democratic governments adopt mostly deficit budget to meet the
growing needs of the people. It may be mentioned that Keynes had advocated a deficit
budget to remedy the situation of unemplo3mient and under-employment.

Government covers the gap either through borrowing or through withdrawals from its
reserves. Thus, a deficit budget implies increase in government liability and fall in its
reserves. When an economy is in under-employment equilibrium due to deficient
demand, a deficit budget is a good remedy to combat recession.
Fiscal policy
fiscal policy, measures employed by governments to stabilize the economy,
specifically by manipulating the levels and allocations of taxes and government
expenditures. Fiscal measures are frequently used in tandem with monetary
policy to achieve certain goals.

Components of Fiscal Policy

The components of the Fiscal Policy can be categorized as

 Government Receipts
 Government Expenditures
 Public Accounts of India

1.Government Receipts
 The government's income in the form of Taxes, interests, and earnings on investments, cess,
and other receipts for services rendered are altogether known as government receipts. This is
the total amount of money received by the government from all sources. The government's
revenue is what enables it to spend money.
 Government receipts are divided into two groups—Revenue Receipts and Capital Receipts.
 All Government receipts that either create liability or reduce assets are treated as capital
receipts whereas receipts that neither create liability nor reduce assets of the Government are
called revenue receipts.
 Revenue Receipts
o Receipts that neither create liabilities nor reduce assets are called revenue receipts.
o Revenue Receipts can be subdivided into two: Tax and non-tax revenues.
o Tax revenues are of two types: direct and indirect taxes
o Nontax revenue sources are interest and dividend on government investment, cess
and other receipts for services rendered by the government, income through
licenses, permits, fines, penalties, etc.
 Capital Receipts
o The government raises funds for its functioning in different ways which are known as
capital receipts. These ways could either incur liabilities to the government or
could be by disposing of its assets. Incoming cash flows is another term used for
capital receipts.
o All kinds of borrowings, loans, etc. are treated as debt receipts as the government has
to repay this money and, with its interests in some cases.
o There are non-debt receipts as well for the government which do not incur any
future repayment burden for the government.
o Almost 75 percent of the total budget receipts are non-debt receipts.
o Loans from the general public, foreign governments, and the Reserve Bank of India
(RBI) form a crucial part of capital receipts.

2.Government Expenditure
The government’s expenditure can be classified into two:

Revenue expenditures
  They are short-term expenses used in the current period or typically within one year.
 Revenue expenditures include the expenses required to meet the ongoing operational
costs of the government, and thus are essentially the same as operating expenses (OPEX).
 Revenue expenditures also include the ordinary repair and maintenance costs that are
necessary to keep an asset in working order without substantially improving or extending the
useful life of the asset.
 Revenue expenditures can be considered to be recurring expenses in contrast to the one-off
nature of most capital expenditures.
 Example: Salaries and employee wages, utilities, rents, property taxes on government-
owned properties, etc.

Capital Expenditure
 Capital expenditures constitute investments made by the government in the capital, and more
often, to maintain or to expand its business and generate additional revenue.
 Capital expenditures consist of the purchase of long-term assets, which are assets that last
for more than one year but typically have a useful life of many years.
 Capital expenditures are often used for buying fixed assets, which are physical assets such
as equipment. As a result, capital expenditures are typically for larger amounts than revenue
expenditures. However, there are exceptions when large asset purchases are consumed in the
short term or the current accounting period.
 Example: purchase of factory equipment, purchases for business, other government
purchases like furniture, spending on infrastructure, etc.

3.Public Accounts of India (Public Debt)

 The Public Account of India accounts for flows for those transactions where the government
is merely acting as a banker.
 This fund was constituted under Article 266 (2) of the Constitution. It accounts for flows for
those transactions where the government is merely acting as a banker.
 Examples: provident funds, small savings, etc. These funds do not belong to the
government, but rather have to be paid back at some time to their rightful owners. Therefore
expenditures from the public account are not required to be approved by the Parliament.

Fiscal Policy Objectives

1. Price Stability

This policy primarily controls the absolute regulation of prices for all goods or things. It
regulates prices while the nation is through an economic crisis and keeps them steady during
an inflationary time; as a result, it regulates prices throughout the nation.
By regulating the supply of essential goods and services, the government supports price
stability. As a result, it invests money in rationing and stores with reasonable prices and a
sufficient supply of food grains. Additionally, it provides subsidies for utilities like
transportation, water, and cooking gas, keeping their prices low enough for regular people to
afford.

2. Complete Employment

Employment should be the top priority in every nation that needs to better its economic
situation. India has the highest number of young people, which increases the likelihood of
development. The younger generation is more capable than the older generation in several
areas. Therefore, if our nation could offer full or almost full employment, it would elevate our
economic statistics to the next level. The Fiscal policy guides all choices pertaining to
employment. The government creates more job opportunities in a number of different ways.

One, it produces jobs when it builds public sector businesses. Two, it provides the private
sector with incentives and other benefits, such as tax breaks, lower tax rates, and so on, to
increase output and employment. Additionally, it promotes people to launch small, cottage,
and rural businesses in order to provide employment. Giving them tax benefits, incentives,
subsidies, and low-interest loans are a few ways to do this.

3. Economic Growth

Specific fiscal policy initiatives can boost the nation’s growth rate and aid in meeting its
needs. The establishment of heavy industries like steel, chemicals, fertilisers, and industrial
machinery is one way the government promotes economic growth. It also builds
infrastructures that support economic development, including roads, bridges, railways,
schools, hospitals, water and electricity supplies, telecommunications, and so forth.

Role of fiscal policy in developing country

1. Resource Mobilization:
Owing to acute poverty, the marginal propensity to consume is very high in developing
economies. As a result the level of saving is very low in these economies. Therefore
fiscal policy has an important role to play in mobilizing saving for capital formation
through taxation and public borrowing.

2. Development of Private Sector:

In a developing economy private sector forms an important constituent of the economy.

The production and productivity of private sector can be influenced by fiscal policy.

Tax relief, rebates, subsides may be granted to boost up the productive activity in the
private sector. Fiscal tools and measures can be used to activate capital market to ensure
availability of adequate resources for the private sector.

3. Optimization of Resources Allocation:

In developing economies, fiscal tools can be utilized to effect optimum allocation of

resources. Very often resources in private sector are directed towards the production of
goods which cater to the requirement of richer section of society.

Fiscal tools can be employed to allocate the mobilized resources in desirable channels of
investment. That is to divert resources from less useful production to socially necessary
lines of production. Reallocation of resources can be determined according to well
defined priorities of plan. Thus process of reallocation can be done by various tax
incentive measures and subsidy programmes.

4. Creation of Social and Economic Overheads:

In developing economics there is the lack of the proper development of basic

infrastructure which are vital requirements for economic development. Provision of
social overheads like education and health service will directly enhance the productive
capacity of the people.

These are expenditure incurred for the provision of economic overheads like transport
facilities, power generation and telecommunication facilities which will speed up the
process of industrialization.

5. Balanced Regional Development:

Developing economies face the problem of regional imbalance in the matter of economic
development. Private investments usually concentrate in urban area where critical
infrastructures are easily accessible and better marketing facilities are available.

Moreover production in concentrated on those luxury goods, which are mostly consumed
by the richer income group. Backward areas and regions are neglected in the process of
investment and production process.

6. Economic Stability:
Fiscal tools such as taxation and expenditure programmes can be utilized as an effective
tool to control cyclical fluctuations arising during the process of economic development.
Taxation is an effective instrument to deal with inflationary and deflationary situations.

7. Reduction of Inequality:

Provision of equality in income wealth and opportunities form an integral part of

economic development in developing economics. Fiscal policy has an important role to
play in reducing inequality.

Deficit finance
Deficit financing, practice in which a government spends more money than it receives as
revenue, the difference being made up by borrowing or minting new funds. Although budget
deficits may occur for numerous reasons, the term usually refers to a conscious attempt to
stimulate the economy by lowering tax rates or increasing government expenditures. The
influence of government deficits upon a national economy may be very great. It is widely
believed that a budget balanced over the span of a business cycle should replace the old ideal
of an annually balanced budget. Some economists have abandoned the balanced budget
concept entirely, considering it inadequate as a criterion of public policy.

Types of Government Deficits

The two primary types of deficits a nation can incur are budget deficits and trade deficits.

Budget deficit
A budget deficit occurs when a government spends more in a given year than it collects in
revenues, such as taxes. As a simple example, if a government takes in $10 billion in
revenue in a particular year, and its expenditures for the same year are $12 billion, it is
running a deficit of $2 billion. That deficit, added to those from previous years, constitutes
the country's national debt.

Trade deficit
A trade deficit exists when the value of a nation’s imports exceed the value of its exports.
For example, if a country imports $3 billion in goods but only exports $2 billion worth, then
it has a trade deficit of $1 billion for that year. In effect, more money is leaving the country
than is coming in, which can cause a drop in the value of its currency as well as a reduction
in jobs.

Other Deficit Terms

Along with trade and budget deficits, these are some other deficit-related terms you may
encounter:

 Current account deficit is when a country is importing more goods and services
than it exports.
 Cyclical deficits occur  when an economy is not performing well because of a down
business cycle.
 Deficit financing refers to the methods governments use to finance their budget
deficits—such as issuing bonds or printing more money.
 Deficit spending is when a government spends more than the revenue it collects
during a certain period.
 Fiscal deficits occur when a government's total expenditures exceed the revenue that
it generates, excluding money from borrowing.
 Income deficit is a measurement used by the U.S. Census Bureau to reflect the
dollar amount by which a family’s income falls short of the poverty line.
 Primary deficit is the fiscal deficit for the current year minus interest payments on
previous borrowings.
 Revenue deficit describes the shortfall of total revenue receipts compared with total
revenue expenditures for a government.
 Structural deficits are said to occur when a country posts a deficit even though its
economy is operating at full potential.
 Twin deficits occur when an economy has both a fiscal deficit and a current account
deficit.