PUBLIC FINANCE

MODULE 1
BUDGET
According to Article 112 of the Indian Constitution, the Union Budget of a year, also
referred to as the annual financial statement, is a statement of the estimated
receipts and expenditure of the government for that particular year. Union Budget
keeps the account of the government's finances for the fiscal year that runs from
1st April to 31st March. Union Budget is classified into Revenue Budget and
Capital Budget.
Revenue budget includes the government's revenue receipts and expenditure.
There are two kinds of revenue receipts - tax and non-tax revenue. Revenue
expenditure is the expenditure incurred on day to day functioning of the
government and on various services offered to citizens. If revenue expenditure
exceeds revenue receipts, the government incurs a revenue deficit.
Capital Budget includes capital receipts and payments of the government. Loans
from public form a major part of the government's capital receipts. Capital
expenditure is the expenditure on development of machinery, equipment,
building, health facilities, education etc.
The government plans expenditure according to its objectives and then tries to
raise resources to meet the proposed expenditure. Government earns money
broadly from taxes, fees and fines, interest on loans given to states and dividend
by public sector enterprises. Government spends mainly on
(i) securing and providing goods and services to citizens,
(ii) on law and order and
(iii) internal security, defence, staff salaries, etc. In India, there is constitutional
requirement to present budget before Parliament for the ensuing financial
year.
The financial (fiscal) year starts on April 1 and ends on March 31 of next year.
Obviously, the budget is the most important information document of the
government because government implements its plans and programmes through
the budget.
MAIN ELEMENTS OF THE BUDGET ARE:
1. It is a statement of estimates of government receipts and expenditure.
2. Budget estimates pertain to a fixed period, generally a year.
3. Expenditure and sources of finance are planned in accordance with the
objectives of the government.
4. It requires to be approved (passed) by Parliament or Assembly or some other
authority before its implementation.
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 OBJECTIVES OF A GOVERNMENT BUDGET:
The rapid and balanced economic growth with equality and social justice has
been the general objective of all the Government policies and plans. General
objectives of a government budget are as under:
1. ECONOMIC GROWTH:
To promote rapid and balanced economic growth so as to improve living
standard of the people. Economic growth implies a sustained increase in real
GDP of the economy, i.e., a sustained increase in volume of goods and services.
Public welfare is the main guide.
2. REDUCTION OF POVERTY AND UNEMPLOYMENT:
To eradicate mass poverty and unemployment by creating employment
opportunities and providing maximum social benefits to the poor .In fact, social
welfare is the single most important objective. Every Indian should be able to meet
his basic needs like food, clothing, housing (roti, kapda, makaan) along with
decent health care and educational facilities.
3. REDUCTION OF INEQUALITIES/REDISTRIBUTION OF INCOME:
To reduce inequalities of income and wealth, government can influence
distribution of income through levying taxes and granting subsidies.
Government levies high rate of tax on rich people reducing their disposable
income and lowers the rate on lower income group.
Again, government provides subsidies and amenities to people whose income
level is low. Again public expenditure can be useful in reducing inequalities.
More emphasis is laid on equitable distribution of wealth and income. Economic
progress in itself is not a sufficient goal but the goal must be equitable progress.
REDISTRIBUTION OF INCOME:
Equalities in income distribution mean allocating the income distribution in such a
way that reduces income inequalities and also there is no concentration of
income among few rich. It primarily requires that rate of increase in real Income
of poor sections of society should be faster than that of rich sections of society.
Fiscal instruments like taxation, subsidies and public expenditure can be made
use of to achieve the object.
4. REALLOCATION OF RESOURCES:
To reallocate resources so as to achieve social and economic objectives. Again,
government provides more resources into socially productive sectors where
private sector initiative is not forthcoming, e.g., public sanitation, rural
electrification, education, health, etc. Moreover Government allocates more funds
to production of socially useful goods (like Khadi) and draws away resources from
some other areas to promote balanced economic growth of regions. In addition
government. undertakes production directly when required.

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5. PRICE STABILITY/ECONOMIC STABILITY:
Government can bring economic stability, i.e., control fluctuations in general price
level through taxes, subsidies and expenditure. For instance, when there is
inflation (continuous rise in prices), government can reduce its expenditure.
When there is depression, government can reduce taxes and grant subsidies to
encourage spending by the people.
6. FINANCING AND MANAGEMENT OF PUBLIC ENTERPRISES:
To finance and manage public enterprises which are of the nature of national
monopohes like railways, power generation and water lines etc.

IMPACT OF THE BUDGET:

A budget impacts the society at three levels,
(i) It promotes aggregate fiscal discipline through controlled expenditure, given
the quantum of revenues,
(ii) Resources of the country are allocated on the basis of social priorities,
(iii) It contains effective and efficient programmes for delivery of goods and
services to achieve its targets and goals.

TYPES OF BUDGET:
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
expenditure.
(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
Estimated Govt. Receipts = Estimated Govt. Expenditure
Two main merits of a balanced budget are:
(a) It ensures financial stability and
(b) It avoids wasteful expenditure.

Two main demerits are:

(i) Process of economic growth is hindered and
(ii) Scope of undertaking welfare activities is restricted.

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.

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(b) SURPLUS BUDGET:
When government receipts are more than government expenditure in the budget,
the budget is called a surplus budget.
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.
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.
Deficit Budget = Estimated Govt. Expenditure > Estimated Govt. Receipts
Popular democratic governments adopt mostly deficit budget to meet the growing
needs of the people. Keynes had advocated a deficit budget to remedy the
situation of unemployment 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.

MERITS AND DEMERITS OF DEFICIT BUDGET:

A deficit budget has its own merits especially for developing economy.
(i) It accelerates economic growth and
(ii) It enables to undertake welfare programmes of the people,
(iii) It is a cure for deflation as it checks downward movement of prices.

DEMERITS
(i) It encourages unnecessary and wasteful expenditure by the government,
(ii) It may lead to financial and political instability,
(iii) It shakes the confidence of foreign investors
The situation of excess demand leading to inflation (continuous rise in prices) and
the situation of deficient demand leading to depression (fall in prices, rise in
unemployment, etc.). A surplus budget is recommended in the situation of
inflationary trends in the economy whereas a deficit budget is suggested in the
situation of recession.

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 RECEIPTS
As per Articles 112 and 202 of Indian Constitution it is necessary to distinguish
revenue expenditure from other expenditure. In addition to this classification,
Indian budget classifies receipts also alike.

Receipts

Revenue Receipts Capital Receipts

REVENUE RECEIPTS
The sources of funds which neither create liabilities nor reduce assets
are called Revenue Receipts. Revenue receipts are two types.
1. Tax Revenues
2. Non-tax Revenues
1. TAX REVENUES
1. Corporate Tax
It is levied on the company’s profit income.
2. Income Tax (Personal income tax)
It is a tax on the personal income of the individuals.
3. Goods & Services Tax
It is a tax on goods and services.
4. Customs Duties
It is the tax on export and import of commodities from and to the country.
5. Taxes of Union Territories
In India, Union Territories (except Delhi and Puducherry) are under the direct
administration of the Centre. So their tax income is lumped and taken into
account in the Central budget.
2. NON TAX REVENUES
(i) Interest Receipts
It is the interest income from the loans given by the Central Government to
State Governments and other Government bodies.
(ii) Dividends & Profits
Dividends are income from the shares held by Governments in private
enterprises and semi-government enterprises. Profits are dividend
income from the fully Government owned enterprises.

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 CAPITAL RECEIPTS
Other sources of funds such as borrowings which create liabilities or those that
reduce assets are called Capital Receipts. In short, they are:
(a) Receipts due to disposal of permanent assets.
(b) Recovery of loans given to others.
(c) Fresh loans raised by the Government.

EXPENDITURES

Revenue expenditure Capital expenditure

REVENUE EXPENDITURE
An expenditure that neither creates assets nor reduces a liability is categorised
as revenue expenditure. It is incurred to meet day to day expenditure of
government and that will not yield any revenue in future. These are:
1. Interest payments
Interest paid on borrowing and other liabilities, discounts on treasury bills,
constitute this category.
2. Subsidies
Subsidies on public distribution, fertilizers etc. are included in this category.
3. Salaries and Pensions
Pensions and salaries of Central Government departments, and those paid out
of Consolidated Fund as charged expenditure come under this category.
4. Grants to States & Union Territories
Grants given by Centre to States and Union Territories come under this head.

CAPITAL EXPENDITURE
An expenditure which either creates an asset (e.g., school building) or reduces
liability (e.g., repayment of loan) is called capital expenditure. In general,
expenditures that create permanent assets and yield periodical income and the
loans given to State Governments and local bodies are part of Capital
Expenditure.

PLAN AND NON-PLAN EXPENDITURE

As India was following planned development through five year planning, the
expenditure came to be classified as plan and non–plan expenditure also. Since
1st April 1951, India has adopted the path of planning (Five Year Plans) to achieve
its rapid economic development. So far, Twelve Five Year Plans have been
implemented. In the light of these plans, government expenditure is classified into
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plan expenditure and non- plan expenditure on the basis of whether or not it
arises due to plan proposals.

PLAN EXPENDITURE
Any expenditure that is incurred on programmes which are detailed under the
current (Five Year) Plan of the Centre or Centre’s advances to State for their
plans is called plan expenditure. Provision of such expenditure in the budget is
called Plan Expenditure.

It includes both revenue expenditure and capital expenditure. Again, the

assistance given by the Central Government for the plans of States and Union
Territories (UTs) is also a part of plan expenditure.

NON-PLAN EXPENDITURE
This refers to the estimated expenditure provided in the budget, for spending
during the year on routine functions of the Government. Non-Plan expenditure is
all expenditure other than plan expenditure of the Government. Such expenditure is
a must for every country, planning or no planning.

For instance, no Government can escape from its basic function of protecting the
lives and properties of the people and protecting the country from foreign invasions.
For this, the Government has to spend on police, Judiciary, military, etc.
Similarly, the Government has to incur expenditure on normal running of
government departments and on providing economic and social services.

Non-plan revenue expenditure is accounted for by interest payments, subsidies

(mainly on food and fertilisers), wage and salary payments to government
employees, grants to States and Union Territories governments, pensions,
police, economic services in various sectors, other general services such as
tax collection, social services, and grants to foreign governments.

Non-plan capital expenditure mainly includes loans to public enterprises, loans

to States, Union Territories and foreign governments. Thus non-plan
expenditure is not only expenditure on these items but also includes expenditure on
the following items.

1. Maintenance expenditure
Maintaining services and assets created in the past.
2. Services and activities left incomplete in the previous plans, which after
the plan become non-plan.

Union Budget 2017-18 had dropped the distinction between plan and non-plan
expenditure.
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 DEFICIT
Deficit means shortage. Here deficit means shortage of money for expenditure.
The gap between the receipts and expenditure is called deficit. There are various
types of deficits:

1. BUDGET DEFICIT
It is the difference between Total Expenditure and Total Receipts. Budget
deficit is always zero. It doesn’t have any meaning in Central Government
budget. So
Budget Deficit = Total Expenditure – Total Receipts
2. REVENUE DEFICIT
Revenue Deficit = (Revenue Expenditure – Revenue Receipt)
Effective Revenue Deficit = Revenue Deficit – Grants for Creation of Capital
Assets.
3. FISCAL DEFICIT
Fiscal Deficit is the difference between Total Expenditure and Total Receipts
except Borrowing and Other liabilities.
Fiscal Deficit = Total Expenditure – Total Receipts except Borrowing and other
liabilities.
= Total Expenditure - [Non Debt Creating Capital Receipts + Revenue Receipts]
To be precise fiscal deficit, is the amount of Borrowing and other Liabilities
4. PRIMARY DEFICIT
Primary Deficit is measured by subtracting the interest payments from fiscal
deficit. It is a measure of current year’s fiscal operation after excluding the
liability of interest payment created due to borrowings under taken in the past.
Primary Deficit = Fiscal Deficit – Interest Payment
5. MONETISED DEFICIT
Monetised deficit goes beyond the Government budgetary operations. This
represents increase in the net RBI credit to the Union Government which is the
sum of increases in the RBI’s holding of Government debt and any draw
down by the Government of its cash balance with RBI. To say simply, the
monetized deficit represents the expansion in money by the RBI.
Monetised Deficit = Borrowing from RBI + Draw down balance of government
from RBI

DEFICIT FINANCING
Deficit financing is a method of meeting government deficits through the creation
of new money. The deficit is the gap caused by the excess of government
expenditure over its receipts. Creation of new money to meet the deficit is in use for
a long time. But it has now being given up. Instead a new scheme called Ways and
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Means Advances is being ushered in with effect from April 1997. Under this
system the Government can get only temporary loans to overcome the mismatch
between its receipts and expenditures.

In India, the deficit financing is resorted mainly to enable the Government to

obtain the necessary resources for economic development. The levels of outlay
laid down are of an order which cannot be met only by taxation and borrowing
from the public. The gap in resources is made up partly through external
assistance, but when external assistance is not enough to fill the gap; deficit
financing has to be resorted to. The targets of production and employment in the
plans are fixed primarily with reference to what is considered as the desirable rate
of growth for the economy. When these targets cannot be achieved by levels of
expenditure possible with resources obtained from taxation and borrowing,
additional resources have to be found.

FISCAL SLIPPAGE
If the actual fiscal deficit is more than what was expected it is called as fiscal
slippage. For example in the budget, estimated fiscal deficit was 4.5% but the
actual deficit at the end of the financial year is 7%, then it is called fiscal slippage.

PREVIOUS YEARS’ QUESTIONS (PRELIMS)

1. Consider the following statements: (2017)
1. Tax revenue as percent of GDP of India has steadily increased in the last
decade.
2. Fiscal deficit as the percent of GDP of India has steadily increased in the last
decade.
Which of the statements given above is/are correct?
(a) 1 only (b) 2 only (c) Both 1 and 2 (d) Neither 1 nor 2
2. There has been a persistent deficit budget year after year. Which action/actions
of the following can be taken by the Government to reduce the deficit? (2016)
1. Reducing revenue expenditure
2. Introducing new welfare schemes
3. Rationalizing subsidies
4. Reducing import duty
Select the correct answer using the code given below.
(a) 1 only (b) 2 and 3 only (c) 1 and 3 only (d) 1, 2, 3 and 4
3. Which of the following is/are included in the capital budget of the Government of
India? (2016)
1. Expenditure on acquisition of assets like roads, buildings, machinery, etc.
2. Loans received from foreign governments
3. Loans and advances granted to the States and Union Territories
Select the correct answer using the code given below.
(a) 1 only (b) 2 and 3 only (c) 1 and 3 only (d) 1, 2 and 3

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4. There has been a persistent deficit budget year after year. Which of the following
actions can be taken by the government to reduce the deficit? (2015)
1. Reducing revenue expenditure
2. Introducing new welfare schemes
3. Rationalising subsidies
4. Expanding industries
Select the correct answer using the code given below.
(a) 1 and 3 only (b) 2 and 3 only (c) 1 only (d) 1, 2, 3 and 4
5. With reference to Union Budget which of the flowing is / are covered under Non-
Plan expenditure? (2014)
1. Defence expenditure
2. Interest payments
3. Salaries and pensions
4. Subsidies
Select the correct answer using the code given below.
(a) 1 only (b) 2 and 3 only (c) 1, 2, 3 and 4 (d) None
6. In India, deficit financing is used for raising resources for (2013)
(a) economic development
(b) redemption of public debt
(c) adjusting the balance of payments
(d) reducing the foreign debt
7. In the context of governance, consider the following: (2010)
1. Encouraging Foreign Direct Investment inflows.
2. Privatization of higher educational Institutions.
3. Down-sizing of bureaucracy.
4. Selling/offloading the shares of Public Sector Undertakings.
Which of the above can be used as measures to control the fiscal deficit in India?
(a) 1, 2 and 3 (b) 2, 3 and 4 (c) 1, 2 and 4 (d) 3 and 4 only
8. With reference to the Indian Public Finance, consider the following statements:
(2002)
1. External liabilities reported in the Union Budget are based on historical
exchange rates.
2. The continued high borrowing has kept the real interest rates high in the
economy.
3. The upward trend in the ratio of Fiscal Deficit to GDP in recent years has an
adverse effect on private investments.
4. Interest payments are the single largest component of the non-plan revenue
expenditure of the Union Government.
Which of these statements are correct?
(a) 1, 2 and 3 (b) 1 and 4 only (c) 2, 3 and 4 (d) 1, 2, 3 and 4
9. Match List I with List II and select the correct answer using the codes given below
the lists: (2001)
List I (Term) List-II (Explanation)
A. Fiscal deficit 1. Excess of Total Expenditure over Total Receipts
B. Budget deficit 2. Excess of Revenue Expenditure over Revenue
Receipts

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 C. Revenue deficit 3. Excess of Total Expenditure over Total Receipts
less borrowings
D. Primary deficit 4. Excess of Total Expenditure over Total Receipts
less borrowings & Interest Payments
A B C D A B C D
(a) 3 1 2 4 (b) 4 3 2 1
(c) 1 3 2 4 (d) 3 1 4 2
10. Which of the following come under Non-Plan expenditure? (1997)
1. Subsides
2. Interest payments
3. Defence expenditure
4. Maintenance expenditure for the infrastructure created in the previous plans.
Choose the correct answer using the codes given below:
(a) 1 and 2 only (b) 1 and 3 only (c) 2 and 4 only (d) 1, 2, 3 and 4
11. The following Table shows the percentage distribution of revenue expenditure of
Government of India in 1989-90 and 1994-95: Expenditure Head (percent to
total) (1996)
Years 1989-90 1994-95
Defence 15.1 13.6
Interest Payments 27.7 38.7
Subsides 16.3 8.0
Grants to States/UT’s 13.6 16.7
Others 27.4 23.0.
Based on this table, it can be said that the Indian economy is in poor shape
because the Central Government continues to be under pressure to:
(a) reduce expenditure on defence
(b) spend more and more on interest payments
(c) reduce expenditure on subsides
(d) spend more and more as grants-in-aid to State Government/Union Territories.
12. Which of the following are among the non-plan expenditure of the Government of
India? (1995)
1. Defence expenditure
2. Subsidies
3. All expenditures linked with the previous plan periods
4. Interest payments
Choose the correct answer using the codes given below:
(a) 1 and 2 only (b) 1 and 3 only (c) 2 and 4 only (d) 1, 2, 3 and 4