Class 12 Economics - Chapter 5: Government Budget and the Economy
5.1 Government Budget — Meaning and its Components
The government budget is an annual financial statement of estimated receipts and expenditures presented before Parliament (Article 112 of Indian Constitution).
5.1.1 Objectives of Government Budget
- Allocation Function: Provision of public goods (non-rivalrous and non-excludable) like defense, roads, administration.
- Public goods vs private goods
- Public provision vs public production
- Redistribution Function: Changing income distribution through taxes and transfers to achieve 'fair' distribution.
- Stabilisation Function: Correcting fluctuations in income and employment through fiscal policy.
5.1.2 Classification of Receipts
Revenue Receipts: Do not create liability or reduce assets
- Tax Revenue:
- Direct taxes (income tax, corporation tax)
- Indirect taxes (GST, customs duties)
- Non-tax Revenue: Interest receipts, dividends, fees, grants
Capital Receipts: Create liability or reduce assets
- Borrowings (create liability)
- Recovery of loans
- PSU disinvestment (reduce assets)
Chart: Components of Government Budget
Revenue Budget (Revenue Receipts + Revenue Expenditure)
Capital Budget (Capital Receipts + Capital Expenditure)
5.1.3 Classification of Expenditure
Revenue Expenditure: Does not create assets
- Interest payments
- Defense services
- Subsidies
- Salaries and pensions
Capital Expenditure: Creates assets or reduces liabilities
- Acquisition of land, buildings, machinery
- Investments in shares
- Loans to states/UTs
Fiscal Responsibility and Budget Management Act (FRBMA), 2003
- Mandates reducing fiscal deficit to ≤3% of GDP
- Eliminate revenue deficit
- Annual reduction targets: fiscal deficit by 0.3%, revenue deficit by 0.5%
- Restrictions on borrowing from RBI
- Requires three policy statements with budget
5.2 Balanced, Surplus and Deficit Budget
- Balanced Budget: Revenue = Expenditure
- Surplus Budget: Revenue > Expenditure
- Deficit Budget: Expenditure > Revenue (most common)
5.2.1 Measures of Government Deficit
- Revenue Deficit:
Revenue Deficit = Revenue Expenditure - Revenue Receipts
Indicates dissaving by government
- Fiscal Deficit:
Fiscal Deficit = Total Expenditure - (Revenue Receipts + Non-debt creating Capital Receipts)
Shows total borrowing requirements
- Primary Deficit:
Primary Deficit = Fiscal Deficit - Interest Payments
Focuses on current fiscal imbalance
Table 5.1: Receipts and Expenditures of Central Government, 2023-24 (P.A.)
| Item |
% of GDP |
| Revenue Receipts |
9.2 |
| Revenue Expenditure |
11.8 |
| Revenue Deficit |
2.6 |
| Fiscal Deficit |
5.6 |
| Primary Deficit |
2.0 |
Fiscal Policy and Multipliers
Keynesian fiscal policy uses government spending and taxes to stabilize output and employment.
Government Expenditure Multiplier
ΔY/ΔG = 1/(1 - c)
Where c = MPC
Tax Multiplier
ΔY/ΔT = -c/(1 - c)
Balanced Budget Multiplier
When ΔG = ΔT, ΔY = ΔG (multiplier = 1)
Example:
If MPC = 0.8:
- Government expenditure multiplier = 1/(1-0.8) = 5
- Tax multiplier = -0.8/(1-0.8) = -4
- If G increases by 100 and T increases by 100, Y increases by 100
Proportional Taxes
With tax rate t, the multiplier becomes:
ΔY/ΔG = 1/(1 - c(1 - t))
Proportional taxes act as automatic stabilizers by reducing the sensitivity of consumption to GDP fluctuations.
Government Debt
Persistent deficits lead to accumulation of government debt.
Perspectives on Government Debt
- Traditional View: Debt burdens future generations through higher taxes
- Ricardian Equivalence: Taxes and borrowing are equivalent as forward-looking consumers increase savings
Other Considerations
- Debt may be inflationary if economy is at full employment
- May crowd out private investment by competing for savings
- If used for productive investment, can enhance future growth
Goods and Services Tax (GST)
Implemented in India from 1 July 2017:
- Comprehensive indirect tax on supply of goods and services
- Destination-based consumption tax with input tax credit
- Standardized rates across country (0%, 5%, 12%, 18%, 28%)
- Replaced multiple central and state taxes
- Aims to create common national market
Key Concepts
- Public goods
- Revenue budget
- Capital budget
- Revenue deficit
- Fiscal deficit
- Primary deficit
- Automatic stabiliser
- Discretionary fiscal policy
- Government expenditure multiplier
- Tax multiplier
- Balanced budget multiplier
- Ricardian equivalence
- Crowding out
- GST (Goods and Services Tax)
- FRBMA (Fiscal Responsibility and Budget Management Act)
Review Questions
- Explain why public goods must be provided by the government.
- Distinguish between revenue expenditure and capital expenditure.
- 'The fiscal deficit gives the borrowing requirement of the government'. Elucidate.
- Give the relationship between the revenue deficit and the fiscal deficit.
- Suppose that for a particular economy, investment is equal to 200, government purchases are 150, net taxes is 100 and consumption is given by C = 100 + 0.75Y (a) What is the level of equilibrium income? (b) Calculate the value of the government expenditure multiplier and the tax multiplier. (c) If government expenditure increases by 200, find the change in equilibrium income.
- Consider an economy described by: C = 20 + 0.80Y, I = 30, G = 50, TR = 100 (a) Find equilibrium income and multiplier. (b) If G increases by 30, what's the impact? (c) If lump-sum tax of 30 is added to pay for G increase, how does equilibrium income change?
- In the above question, calculate the effect of 10% increase in transfers vs 10% increase in lump-sum taxes.
- With C = 70 + 0.70YD, I = 90, G = 100, T = 0.10Y (a) Find equilibrium income. (b) What are tax revenues? Does government have balanced budget?
- If MPC = 0.75 and 20% proportional income tax, find change in equilibrium income when: (a) G increases by 20 (b) Transfers decrease by 20.
- Explain why tax multiplier is smaller than government expenditure multiplier.
- Explain relation between government deficit and government debt.
- Does public debt impose a burden? Explain.
- Are fiscal deficits inflationary?
- Discuss deficit reduction.
- What is GST? How does it compare to old tax system? State its categories.
Suggested Readings
- Dornbusch, R. and S. Fischer. 1994. Macroeconomics, sixth edition. McGraw-Hill, Paris.
- Mankiw, N.G., 2000. Macroeconomics, fourth edition. Macmillan Worth publishers, New York.
- Economic Survey, Government of India, various issues.