Gevernment Budget and the economy

U N I T - V G B OVERNMENT UDGET E AND THE CONOMY 8 C HAPTER (cid:1) (cid:9)(cid:10) (cid:9) (cid:9) (cid:2)(cid:3)(cid:4)(cid:5)(cid:6)(cid:7)(cid:4)(cid:6)(cid:8) (cid:11)(cid:12)(cid:1)(cid:4)(cid:8) (cid:13)(cid:6)(cid:12) (cid:8)(cid:14)(cid:4) (cid:4) (cid:15)(cid:2)(cid:6)(cid:2)(cid:7)(cid:16) The purpose of this chapter is to Implementation of these policies understand what a government budget requires expenditure by the is and how the government budget government, and some source of interacts with and affects the economy. funding for that expenditure. The The budget is the most important budget, is thereby a fiscal tool for the information document of the government to implement its various government. One part of the budget is policies. similar to a company’s annual report. The objectives that are pursued by This part presents the overall picture the government through the budget are of the financial performance of the as follows: government during the period since its 1. Activities to secure a reallocation of last budget. The second part of the resources: The government has to budget presents the government’s reallocate resources in line with financial plans for the period up to its social and economic considerations next budget, in order to inform the in case the market fails to do so, or country, and seek legislative approval. does so inefficiently. As a consequence of Keynesian 2. Redistributive Activities: The economics, budgetary policies are government redistributes income considered significant in the and wealth to reduce inequalities, stabilisation of the economy. by expenditures on social security, subsidies, public works etc. Budget and its Objectives 3. Stabilising Activities: The The budget is an annual statement of government tries to prevent the estimated receipts and expenditures business fluctuations and maintain of the government over the fiscal year, economic stability through which runs from April 1 to March 31. expanding public expenditure The government has several policies it during recession and contracting wishes to implement in the overall the former during inflation. task of performing its functions. (Keynesian economics). 122 INTRODUCTORY MACROECONOMICS 4. Management of Public Enterprises: present and execute their budgets. We Government undertakes commercial shall however, focus only on the budget activities that are of the nature of the Central Government.1 The budget of natural monopolies, heavy is divided into the revenue budget and manufacturing, etc. through its the capital budget. The Revenue Budget public enterprises. A natural consists of the revenue receipts of the monopoly is a situation where there government and the expenditure met are economies of scale over a large from such revenues. The Capital Budget range of output; then one firm can consists of capital receipts and produce at a lower average cost payments. We will now undertake a than could more than one firm. classification of receipts and Industries which are potential expenditure in order to understand how natural monopolies are railways, they are reflected in the Revenue and electricity etc. These usually come the Capital Budgets. under state regulation because if left Budget Receipts unregulated, there will be a tendency of the monopolist to Receipts may be classified as revenue curtail output in pursuit of profit receipts and capital receipts. maximising behaviour, thereby Revenue Receipts lowering social welfare. Revenue receipts may be divided into There are three levels at which the tax revenue and non-tax revenue. Tax budget impacts the economy. First, is revenues consist of the proceeds of taxes aggregate fiscal discipline. This means and other duties levied by the Union having control over expenditures, given Government (Central Government). The the quantum of revenues. This is proposals of government for levy of new necessary for proper macroeconomic taxes, modification of the existing tax performance. The second is the allocation rates or continuance of the existing tax of resources based on social priorities and rates are contained the budget. Taxes the third is the effective and efficient are of two types – direct taxes and provision of programmes and delivery of indirect taxes. Direct taxes are those services. Effectiveness measures the taxes levied immediately on the extent to which goods and services the property and income of persons, and government provides achieves its goals, those that are paid directly by the or attains its targets or achieves its persons to the state. Income tax, interest mission. Efficiency refers to the cost per tax, wealth tax, corporation tax are all unit of goods or services provided. examples of direct taxes. Indirect taxes are those that affect the income and Components of the Budget property of persons through their Governments at every level have their consumption expenditures. Customs own constitutional processes to prepare, duties, excise duties, sales tax, service 1 Similar to Central Government, states also prepare budgets. GOVERNMENT BUDGENT AND THE ECONOMY 123 tax are all examples of indirect taxes. service of a more tangible and definite Indirect taxes are levied on the goods sort, e.g. registration fee for an and services which people consume, automobile, firearm, etc. Fines and and are hence indirectly taxing income, penalties are levied for an infringement at the time when the income is spent. of a law. Forfeitures of basic surety or While direct taxes are compulsory bonds are penalties imposed by courts and cannot be escaped, a person can for non-compliance with orders or non- avoid paying indirect tax by refraining fulfilment of contract etc. Escheat refers from entering into the particular to the claim of the government on the transaction that leads to the tax being property of a person who dies without levied e.g. a person can avoid excise having any legal heirs or without duty on biscuits by merely avoiding the leaving a will. purchase of biscuits. Table 8.1 shows the revenue Non-tax revenue consists of all receipts of the Government of India as other revenue receipts. They may be of per budget estimates for 2002-03. the following types. Commercial revenue is revenue received by the government Table 8.1: Revenue receipts of the Union Government as per 2002-03 in the form of prices paid for budget estimates government-supplied commodities and services. This includes payments for Item Amount postage, tolls, interest on funds (Rs. in crores) borrowed from government credit Tax revenue 172965 corporations, electricity, railway Non-tax revenue 72140 services etc. Another source of revenue is interest and dividends on Total revenue receipts 245105 investments made by the government. Source : Economic Survey, 2002-03, Administrative revenue is revenue that Government of India. arises on account of the administrative Capital Receipts function of the government. The following are some examples of different The main items of capital receipts are sources of administrative revenue. loans raised by the government from the Fees are defined as ‘a payment to public (these are called Market Loans), defray the cost of each recurring service borrowings by the government from the undertaken by the government, Reserve Bank of India and other parties primarily in the public interest, but through the sale of treasury bills, loans conferring a measurable special received from foreign governments and advantage on the fee payer’, e.g. college bodies (e.g. World Bank, Asian fees in government colleges. License Development Bank, etc.), recoveries of fees are paid in those instances in loans granted to state and union which the government authority is territory governments and other parties, invoked simply to confer a permission small savings and deposits in the public or privilege rather than to perform a provident fund (PPF), etc. 124 INTRODUCTORY MACROECONOMICS Table 8.2 shows the capital receipts government to state and union territory of the Government of India as per governments, government companies, budget estimates for 2002-03. corporations and other parties. 2. Plan expenditure and Non-Plan Table 8.2: Capital receipts of the Union expenditure: Government as per 2002-03 Plan expenditure is that public budget estimates expenditure which represents current Item Amount development and investment outlays that (Rs. in crores) arise due to plan proposals. Non-plan Recovery of loans 17680 expenditure is all other expenditure, generally of recurring nature. Other receipts (mainly 12000 Table 8.3 shows the break up of PSU disinvestment) expenditure into revenue and capital, Borrowings and 135524 plan and non-plan, as per the budget other liabilities estimates for 2002-03. Total Capital receipts 165204 Table 8.3: Break ups of expenditure as Source : Economic Survey 2002-03, Government per budget estimates for of India. 2002-03 Sl. Item Amount Expenditure No (Rs. in crores) Expenditure may be classified in the 1 Interest payments 1,17,390 following three ways: 2 Major subsidies 38,923 1. Revenue expenditure and capital 3 Defence expenditure 43,589 expenditure 4 Revenue expenditure 3,40,482 Revenue expenditure is the 5 Capital expenditure 69,827 expenditure incurred for the normal 6 Plan expenditure 1,13,500 running of government departments and provision of various services, 7 Non-plan expenditure 2,96,809 interest charges on debt incurred by the 8 Total Expenditure 4,10,309 government, subsidies etc. In general, (6+7) or (4+5) any expenditure that does not result in Source : Economic Survey 2002-03, Government the creation of assets is treated as of India. revenue expenditure. However, all 3. Developmental and Non- grants given to state governments are developmental expenditure treated as revenue expenditure even though some of the grants may be for Developmental expenditure includes creation of assets. plan expenditure of Railways, Posts Capital expenditure consists mainly and Telecommunications and non- of expenditure on acquisition of assets like departmental commercial undertakings land, buildings, machinery, equipment; which are financed out of their internal and investments in shares, etc., and loans and extra budgetary resources, including advances granted by the central market borrowings and term loans from GOVERNMENT BUDGENT AND THE ECONOMY 125 Table 8.4 : Break-ups of expenditure plans) into developmental and non- of Central, State and developmental expenditure, as per Union Territory Governments, 2001-02 budget estimates. 2001-02. Balanced, Surplus and Deficit Sl. Item Amount Budgets No (Rs. in crores) 1 Developmental 369266 We have defined the budget as an expenditure annual statement of the estimated 2 Defence (net) 62000 receipts and expenditures of the 3 Interest payments 144588 government over the fiscal year. A 4 Tax collection charges 8533 budget may be in surplus, in deficit or 5 Police 24383 balanced, subject to the following 6 Others 121045 conditions: 7 Non-developmental 360549 expenditure Relative Sizes Type of (2+3+4+5+6) of estimates Budget 8 Total expenditure 729815 Revenue < Expenditure Deficit (1+7) Revenue = Expenditure Balanced Source :Economic Survey, 2002-03, Government Revenue > Expenditure Surplus of India. Let us first consider the case of a financial institutions to State Government surplus budget. A surplus budget is public enterprises. It also includes one where the estimated revenues are developmental loans given by the Central greater than the estimated and State Governments to non- expenditures. To simplify the analysis, departmental undertakings, local bodies let us assume a situation where the only and other parties. source of revenue is a lump sum tax. Non-developmental expenditures Now, as we saw from chapter VI, the include expenditures on defence, effect of a tax is to lower the interest payments, tax collection, police, consumption and therefore, aggregate and other expenditures. Other demand by an amount equal to the expenditures include that on general marginal propensity to consume (MPC) administration, pensions, ex-gratia times the amount of the tax. The effect payments to former rulers, famine relief, of government expenditure is to subsidies on food and controlled cloth, increase the aggregate demand by the grants and loans to foreign countries and loans for non-development purpose amount of the expenditure. Now, if tax to other parties etc. (and therefore revenue) is sufficiently Table 8.4 shows the break up of higher than the government expenditure of Central, State and Union expenditure, then we will have MPC Territory Governments (including times tax is greater than expenditure. internal and extra-budgetary resources Then, the reduction in aggregate of public sector undertakings for their demand (due to the tax) is greater than 126 INTRODUCTORY MACROECONOMICS the increase in aggregate demand (due A deficit budget is one where the to expenditure). The net effect of this is estimated revenue is less than the to lower aggregate demand. Thus, a estimated expenditure. This means that surplus budget will lower aggregate the tax is less than the expenditure. The demand. reduction in aggregate demand (due to Lowering aggregate demand is a the tax) is equal to MPC times the tax. good way to combat inflation that arises The increase in aggregate demand (due out of the presence of excess demand. to expenditure) is by an amount equal However, a surplus budget is a poor to the expenditure. Now, if tax is strategy in the case of a deflation and sufficiently less than the expenditure then the reduction in aggregate demand recession, as it will lower the already will be less than the increase in aggregate deficient demand, thus worsening the demand. The effect of this will be to situation. increase aggregate demand. The deficit A balanced budget is one where the budget is therefore a policy instrument estimated revenue equals the estimated to combat recession, where the economy expenditure. Again, suppose that the is in an under-employment equilibrium only source of revenue is a lump sum due to deficient demand. tax. A balanced budget will then mean that the amount of tax equals the Types of Deficit amount of expenditure. The decrease There are four different concepts of in aggregate demand (due to the tax) is budget deficit. They are budget deficit, equal to MPC times the tax. Since tax is fiscal deficit, primary deficit and the equal to expenditure, the decrease in revenue deficit. We shall analyse them aggregate demand is also equal to MPC individually. times the expenditure. Now, the Budget Deficit increase in aggregate demand due to The budget deficit is the difference the expenditure is equal to the amount between the total expenditure on one of the expenditure. Then, the increase hand, and current revenue and net in aggregate demand (due to internal and external capital receipts of expenditure) is greater than the the government on the other. It has to decrease in aggregate demand (due to be financed by net internal and external the tax). The net effect is to increase capital receipts. The calculation of the aggregate demand by an amount equal budget deficit is shown in Table 8.6. to the expenditure multiplied by 1– MPC. Thus, a balanced budget will Fiscal Deficit slightly increase the aggregate demand. The fiscal deficit is the difference A balanced budget is therefore a policy between the total expenditure of the instrument to bring the economy which government (by way of revenue is at near full-employment to a full- expenditure, capital expenditure and employment equilibrium. loans net of repayments) on one hand, GOVERNMENT BUDGENT AND THE ECONOMY 127 and on the other hand, the revenue household, the revenue deficit tells the receipts plus those capital receipts amount the householder is borrowing which are not in the nature of to pay the grocer, rather than add a roof borrowing, but which finally accrue to to the house. Given the same level of the government. fiscal deficit, a higher revenue deficit is The extent of the fiscal deficit is an worse than a lower one. The revenue indication of how far the exchequer is deficit implies a repayment burden in living beyond its means. The fiscal the future, not matched by any benefits deficit indicates the amount of via investment. Table 8.5 shows the various deficits borrowing the government has to do. A as per 2002-03 Indian budget large fiscal deficit implies a large estimates. amount of borrowings. This creates a Table 8.5: Types of deficits as per correspondingly large burden of 2002-03 budgetary estimates interest payments in the future. In the present, a large fiscal deficit may also No.Item Amount (Rs. in Crores) fuel inflationary pressures. 1. Revenue receipts 245105 Primary Deficit (i)Tax revenue 172965 The primary deficit is the fiscal deficit (ii)Non-tax revenue 72140 minus interest payments. It therefore 2. Capital receipts 165204 indicates, how much government (i)Recovery of loans 17680 borrowing is going to meet expenses (ii)Other receipts 12000 (mainly PSU other than interest payments. It reflects disinvestments) the extent to which current government (iii)Borrowings and 135564 policy is adding to future burdens other liabilities stemming from past policy. It is often 3. Revenue expenditure 340482 used as a basic measure of fiscal (i)Interest payments 117390 irresponsibility. In other words, it is a (ii)Major subsidies 38923 measure of how much the government (iii)Defence expenditure43589 is borrowing in continuance of its 4. Capital expenditure 69827 profligate ways. A low or zero primary 5. Total expenditure 410309 deficit means that while its interest (i)Plan expenditure 113500 commitments on earlier loans have (ii)Non-plan 296809 compelled the government to borrow, expenditure it is aware of the need to tighten its belt. 6. Fiscal deficit 135524 [5 – 1 – 2(i) – 2(ii)] Revenue Deficit 7. Revenue deficit 95377 The revenue deficit is the excess of [3 – 1] government’s revenue expenditures 8. Primary deficit 18134 over revenue receipts. It gives [6 – 3(i)] information on what the government is Source : Economic Survey, 2002-03, Government borrowing for. In the analogy of the of India. 128 INTRODUCTORY MACROECONOMICS The overall budgetary deficit of (i)Net market loans 84410 Central, State and Union Territory (ii)Net small savings 11938 Governments is estimated using the (iii)Net State and PPFs 31525 table of budgetary transactions (iv)Special deposits on 10500 non-government PFs (Table 8.6) (v)Net miscellaneous Table 8.6: Overall budgetary deficit of capital receipts 107188 Central, State and Union B. External 2563 Territory Governments as (i)Net loans 1165 per 2001-02 budgetary (a) Gross 10763 estimates. (b) Less repayments 9598 (ii)Grants 698 No. Item Amount (Rs. in Crores) (iii)Revolving fund 700 5. Overall Budgetary 1. Total Outlay 729815 Deficit (3 – 4) 5660 A.Development 369266 B. Non-Development 360549 Source:Economic Survey, 2002-03, Government (i)Defence (net) 62000 of India. (ii)Interest payments 144588 We have now seen the four concepts (iii)Tax collection of deficits. The deficit in a budget has charges 8533 (iv)Police 24383 to be financed in one of two ways – by (v)Others 121045 monetary expansion or by borrowing. 2. Current Revenue 476031 Monetary expansion amounts to A. Tax Revenue 371355 printing money to the extent of the (i)Income and deficit. The process of monetary corporation tax 84801 expansion involves the government (ii)Customs 54822 borrowing from the Central Bank (iii)Union excise duties 81720 (iv)Sales tax 81579 through the issue of treasury bills to (v)Others 68433 the Central Bank. The Central bank B.Non-Tax Revenue 104676 purchases the treasury bills in return for cash, which the government uses (Internal resources of public sector undertaking (45100) to fund the deficit. Alternatively, the for the plan) deficit may be funded by borrowing 3. Gap (1 – 2) 253784 from the public through market loans Financed by: etc. The safe level of fiscal deficit is 4. Net Capital Receipts (A+B) 248124 considered to be 5% of Gross A. Internal (net) 245561 Domestic Product. GOVERNMENT BUDGENT AND THE ECONOMY 129 SUMMARY (cid:1) The budget is an annual statement of the estimated receipts and expenditures of the government over the fiscal year, which runs from April 1 to March 31. (cid:1) The government implements its policies through the budget. (cid:1) The budget impacts the economy through aggregate fiscal discipline, resource allocation and provision of programmes and delivery of services. (cid:1) The budget is divided into revenue budget and capital budget. (cid:1) Revenue may be divided into revenue receipts and capital receipts. (cid:1) Expenditure may be classified in three ways – revenue vs. capital, plan vs. non-plan, and developmental vs. non-developmental. (cid:1) Budgets are of three types – surplus, balanced and deficit. (cid:1) The three concepts of deficit are – fiscal deficit, revenue deficit and primary deficit. EXERCISES 1. What is a budget? 2. What are the objectives of a budget? 3. What are the revenue items? 4. Define tax and non-tax revenue. 5. What is the difference between Revenue Budget and Capital Budget? 6. Classify public expenditure. 7. Differentiate between developmental and non-developmental expenditure. 8. What is non-plan expenditure? 9. Define: (a) Fiscal deficit (b) Budget deficit (c) Revenue deficit (d) Primary deficit 10. How may a deficit be financed?