Functions of Government Budget
Primarily, there are three functions or requirement of Government budget such as: Allocation, Distribution and Stabilization of resources of government. Let’s discuss them one by one:
- Allocation Function: Certain goods, referred to as Public goods, such as roads, national defense, government administration, are cannot be provided through the market mechanisms. These must be provided by the government. This is the allocation function.
- Distributive Function: Through its tax and expenditure policy, the government attempts to bring about a distribution of income that is considered fair by society. The government affects the personal disposable income of households by making transfer payments and collecting taxes and, therefore, can alter the income distribution.
- Stabilization Function: The economy tends to be subject to substantial fluctuations and may suffer from prolonged periods or unemployment or inflation. In such situation, there need to frame proper policy to reduce the same. This function of budget is called stabilization function.
Difference between Public Goods and Private Goods
- The benefits of public goods are not limited to a particular consumer, as in case of Private Goods but become available to all.
- In case of Private Goods anyone who does not pay for the Goods can be excluded from enjoying its benefits. However, in case of public goods, there is no feasible way of excluding anyone from enjoying the benefits of the goods.
Public Provisions: Public provisions means that they are financed through the budget and made available free of any direct payment. These goods may be produced directly under government management or by the Private sector
Under Article-112 of the Indian Constitution, there is a constitutional requirement to present before Parliament a statement of estimated receipts and expenditures of the government in respect of every financial year which runs from 1st April to 31st March.
This Annual Financial Statements constitutes the main budget document. Further the budget must distinguish expenditure on the Revenue Account from other Expenditures. Therefore, the Budget comprises of the:
- Revenue Budget; and
- Capital Budget.
Now let’s discuss the different components of Government Budget in brief:
The Revenue Account (Revenue Budget)
The Revenue Budget shows the Current receipts of the Government and the Expenditure that can be met from these receipts.
The Revenue Receipts:
Revenue receipts are receipts of the government which are non-redeemable, i.e. they cannot be reclaimed from the Government. They are divided into Tax Revenue and Non-tax revenue.
Tax Revenue consists of the proceeds of the taxes and other duties levied by the Central Government. Tax revenues comprises of direct taxes– which fall directly on individuals (personal income tax) and firms (corporation tax) and indirect taxes like- excise duties (duties levied on Goods produced within the country), custom duties (taxes imposed on goods imported into and exported out of India), Service Tax, VAT and GST etc.
Non- tax revenues of the Central Government include-
- Interest receipts on accounts of loans by the Central government
- Dividends and Profits on investments made by the government
- Fees and other receipts for services rendered by the government
- Cash-grant-in-aid from foreign countries and international organizations also included
Note: The estimates of revenue receipts take into account the effects of tax proposals made in the finance Bill.
Finance Bill presented along with the Annual Financial Statement, provides deficits of the imposition, abolition, remission, alteration or regulation of taxes proposed in the Budget.
Revenue Expenditure is expenditure incurred for purposed other than the creation of physical or financial assets of the Central Government. It includes-
- Expenses incurred for the normal functioning of the government department and various services
- Interest payments on debt incurred by the government
- Grants given to state governments and other parties (even though some of the grant may be meant for creation of assets)
Budget document classify total revenue expenditure into plan and non-plan revenue expenditure
Plan Revenue Expenditure: These relate to the Central Plans (the five-year plans) and the Central assistance for state and Union Territory Plans.
Non-plan Expenditure: (most important component of Revenue expenditure) covers a vast range of general, economic and social services of the government. The main items of the non-plan revenue expenditure are-
- Interest payments
- Defense services
- Salaries and Pensions
Let’s discuss them-
- Interest Payments on market loans, external loans and from various reserve funds constitute the single largest component of non-plan revenue expenditure.
- Defense Expenditure is committed expenditure in the sense that given the national security concerns, there exists little scope for drastic reduction.
- Subsidies are an important policy instrument which aim at increasing welfare. Apart from providing implicit subsidies through underpricing public goods and services like education and health, the government also extends subsidies explicitly on items such as exports, interest on loans, food and fertilizers.
The Capital Account (Capital Budget)
The Capital Budget is an account of the assets as well as liabilities of the Central Government, which takes into considerations changes in Capital. It consists of capital receipts and capital expenditure of the government.
This shows the capital requirements of the government and the pattern of their financing.
All those receipts of the government which create liability or reduce financial assets are termed as Capital Receipts are-
- Loans raised by the government from the public which are called market borrowings.
- Borrowing by the government from RBI and commercial banks and other financial institutions through the sale of treasury bills.
- Loans received from foreign governments and international organizations- foreign loans
- Recoveries of loans granted by the Central Government
- Others include-
- Small savings (post-office savings account, National Savings Certificates, etc)
- Provident funds
- Net receipts obtained from the sale of shares in Public Sectors Undertakings called PSUs Disinvestment
These are expenditures of the government which result in creation of physical or financial assets or reduction in financial liabilities. Main components of the capital expenditures are-
- Expenditures on the acquisition of land, building, machinery and equipment etc.
- Investment in shares
- Loans and advances by the Central Government to state and Union territory governments, PSUs and other parties
Again, Capital Expenditures are classified in to Plan Capital Expenditure and Non-plan Expenditure.
- Plan Capital Expenditure relates to Central Plan and Central assistance for state and Union Territories Plans.
- Non-plan Capital Expenditures covers various general, social and economics services provided by the Government.
Few More Things about Budget of India
The Budget is not merely a statement of receipts and expenditure, since independence, with the launching five-year plans. It has also become a significant national policy statement.
Along with Budget, three policy statements are mandated by the Fiscal Responsibility and Budget Management Act 2003 (FRBMA)
- The Medium-term Fiscal Policy Statements sets a three-year rolling target for specific fiscal indicators and examines whether revenue expenditure can be financed through revenue receipts on a substantial basis and how productivity Capital receipts including market borrowing are being utilized.
- Fiscal Policy Strategy Statement sets the priorities of the Government in Fiscal area, examining current policies and justifying any deviations in important fiscal measures
- Macroeconomics Framework Statement assesses the prospects of the economy with respect to the GDP growth rate, fiscal balance of the Central Government and External Balance.
Measures of Government Deficit
When a government spends more than it collects by way of revenue, it incurs a budget deficit.
Note: Budget deficit refers to the excess of the total expenditure (both revenue and capital) over total receipts (both revenue and capital) from 1997-98 budget, the practice of showing budget deficit has been discontinued in India.
There are various other measures that capture government deficit and they have their own implications for the economy such as-
- Revenue Deficit
- Fiscal Deficit
- Primary Deficit
The Revenue Deficits refers to the excess of government’s revenue expenditure over revenue receipts.
Revenue Deficit = Revenue Expenditure – Revenue receipts
The Revenue Deficit includes only such transactions that affect the current income and expenditure of the government.
When a government incurs a revenue deficit, it implies that the government is dissaving’s and is using up the savings of the other sectors of the economy to finance a part of its consumption expenditure.
This situation means that the government will have to borrow not only to finance its investment but also its consumption requirements. This will lead to a buildup of stock of debt and interest liabilities and force the government, eventually to cut expenditure.
Since a major part of the revenue expenditure is committed expenditure, it cannot be reduced often the government reduces productive capital expenditure or welfare expenditure. This would mean lower growth and advance welfare implications.
Fiscal deficit is the difference between the 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: Recovering of loans and the proceeds from the sale of PSUs, etc.
The Fiscal Deficit will have to be financed through borrowing. Thus, it indicates the total borrowing requirements of the government from all sources. From the finance side-
Gross Fiscal Deficit = Net borrowing at Home + Borrowing from RBI + Borrowing from abroad
Net Borrowings at Home includes-
- That directly borrowed from the public through debt instruments (e.g. the various small savings scheme) and
- Indirectly from commercial banks through (Statutory Liquidity Ratio) SLR
The gross fiscal deficit is a key variable in judging the financial health of the Public sector and the stability of the economy.
From the above it is clear that revenue deficit is a part of fiscal deficit.
Fiscal Deficit = Revenue deficit + (Capital expenditure – non-debt creating capital receipts)
A large share of revenue deficit is fiscal deficit indicated that a large part of borrowing is being used to meet its consumption expenditure needs rather than investment.
It is to be noted that the borrowing requirement of the government includes interest obligations on accumulated debt.
The goal measuring Primary Deficit to focus on present fiscal imbalances
To obtain an estimate of borrowing on account of current expenditures exceeding revenues we need to calculate what has been called the primary deficit. It is simply the fiscal deficit minus the interest payments.
Gross Primary Deficit = Gross Fiscal Deficit – Net Interest Liabilities
Net Interest Liabilities = Interest Payments – Interest receipts by the Government on net domestic lending
Government Deficit and Government Debt
- Budgetary deficit must be financed by taxation, borrowing or printing money. Generally, government mostly relied on borrowings, giving rise to what is called government debt.
- The concepts of deficits and debt are closely related. Deficits can be thought of as a flow which adds to the stock of debt.
- If the government continues to borrow year after year, it leads to the accumulation of debt and the government has to pay more and more by way of interest. These interest payments themselves contribute to the debt.
Does Public Debt Impose a Burden?
- “By borrowing, the government transfers the burden of reduced consumption of future generation.”
- Because, it borrows by issuing bonds to the people living at present but may decide to pay off the bonds some twenty years later by raising taxes. These may be levied on the young populations that have just entered the work force, whose disposable income will go down and hence consumption. Thus, national savings would fall. Also, government borrowing from people reduces the savings available to the private sector to the extent that this reduces capital formation and growth. Hence, debt acts as a burden on future generation.
- But according to Ricardian Equivalence – when the government increases spending by borrowing today, which will be repaid by taxes in the future, it will have the same impact on the economy as an increase in government expenditure that is financed by a tax increase today.
- It has often been argued that “debt does not matter because we owe it to ourselves”. This is because although there is a transfer of resources between generations, purchasing power remains within the nation. However, any debt that is owed to foreigners involves a burden since- we have to send goods abroad corresponding to the interest payments.
Are Fiscal Deficits Inflationary?
- “One of the main criticisms of the deficits is that they are inflationary.” Because- when government increases spending or cut taxes, aggregate demand increases. Firms may not be able to produce higher quantities that are being demanded at the ongoing princes. Prices will, therefore, have to rise.
- However, if there are unutilized resources, output is held back by lack of demand.
- A high fiscal deficit is accompanied by higher demand and greater output, and therefore, need not be inflationary.
Issue of Fiscal Deficit Reduction
- Government deficit can be reduced by an increase in taxes or reduction in expenditure. In India, the government has been trying to increase tax revenue with greater reliance on direct taxes. Because Indirect taxes are regressive in nature, they impact all income groups equally.
- There has also been an attempt to raise receipts through the sale of shares in PSUs. However, the major thrust has been towards reduction in government expenditure, this could be achieved through making government activities more efficient through better planning of programmes and better administration.
Few more terms related to Taxation
- This system of taxation generally benefits the higher sections of the society having higher incomes as they need to pay tax at lesser rates.
- Under this system of taxation, the tax rate diminishes as the taxable amount increases. In other words, there is an inverse relationship between the tax rate and taxable income. The rate of taxation decreases as the income of tax payers increases.
- This system of taxation generally benefits the higher sections of the society having higher incomes as they need to pay tax at lesser rates. On the other hand, people with lesser incomes are burdened with higher rate of taxation.
- A person earning Rs 100000 PA might be required to pay taxes at 15%, whereas a person earning Rs 500000 PA might be required to pay taxes at 10%.
- Progressive tax is taxing mechanism in which the taxing authority charges more taxes as the income of the tax-payer increases.
- Progressive tax is the taxing mechanism in which the taxing authority charges more tax as the income of the taxpayer increases. A higher tax is collected from the tax-payers who earn more and lower taxes from tax-payers who earn more and lower taxes from tax-payers earning less. Always the government uses a progressive tax mechanism.
- Under progressive taxes it is believed that people who earn more should pay more. The income tax is divided into slabs. As the income of the tax-payer crosses a benchmark income, a new rate of tax (higher than before) is charged to him.