(Introductory Macro Economics) Chapter 5-Government Budget and the Economy (NCERT Class-XII)


  • There is a constitutional requirement in India (Article 112) to present before the Parliament a statement of estimated receipts and expenditures of the government in respect of every financial year which runs from 1 April to 31 March.
  • This „Annual Financial Statement‟ constitutes the main budget document.
  • Further, the budget must distinguish expenditure on the revenue account from other expenditures. Therefore, the budget comprises of the (a) Revenue Budget and the (b) Capital Budget (Refer Chart 1).

The Revenue Account

  •  The Revenue Budget shows the current receipts of the government and the expenditure that can be met from these receipts.
  • Revenue Receipts: Revenue receipts are receipts of the government which are non-redeemable, that is, they cannot be reclaimed from the government. They are divided into tax and non-tax revenues. 
  • Tax revenues consist of the proceeds of taxes and other duties levied by the central government. 
  • Tax revenues, an important component of revenue receipts, comprise of direct taxes – which fall directly on individuals (personal income tax) and firms (corporation tax), and indirect taxes like excise taxes (duties levied on goods produced within the country), customs duties (taxes imposed on goods imported into and exported out of India) and service tax.
  • Other direct taxes like wealth tax, gift tax and estate duty (now abolished) have never been of much significance in terms of revenue yield and have thus been referred to as „paper taxes‟.
  • Non-tax revenue of the central government mainly consists of interest receipts on account 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 grants-in-aid from foreign countries and international organizations are also included.
  • The estimates of revenue receipts take into account the effects of tax proposals made in the Finance Bill.

Revenue Expenditure: 

  • expenditure incurred for purposes other than the creation of physical or financial assets of the central government. 
  • relates to those expenses incurred for the normal functioning of the government departments and various services, interest payments on debt incurred by the government, and grants given to state governments and other parties (even though some of the grants may be meant for creation of assets).
  • Budget documents classify total expenditure into plan and non-plan expenditure.
  • Plan revenue expenditure relates to central Plans (the Five-Year Plans) and central assistance for State and Union Territory plans.
  • Non-plan expenditure, the more important component of revenue expenditure, covers a vast range of general, economic and social services of the government.
  • The main items of non-plan expenditure are interest payments, defence services, subsidies, salaries and pensions.
  • Interest payments on market loans, external loans and from various reserve funds constitute the single largest component of non-plan revenue expenditure. 
  • Defence 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

The Capital Account

  • The Capital Budget is an account of the assets as well as liabilities of the central government, which takes into consideration changes in capital. 
  • It consists of capital receipts and capital expenditure of the government.

Capital Receipts:

  • All those receipts of the government which create liability or reduce financial assets are termed as capital receipts.
  • The main items of capital receipts are loans raised by the government from the public which are called market borrowings, borrowing by the government from the Reserve Bank and commercial banks and other financial institutions through the sale of treasury bills, loans received from foreign governments and international organisations, and recoveries of loans granted by the central government.

Capital Expenditure:

  • There are expenditures of the government which result in creation of physical or financial assets or reduction in financial liabilities. 
  • This includes expenditure on the acquisition of land, building, machinery, equipment, investment in shares, and loans and advances by the central government to state and union territory governments, PSUs and other parties.
  • Capital expenditure is also categorised as plan and non-plan in the budget documents.
  • Plan capital expenditure, like its revenue counterpart, relates to central plan and central assistance for state and union territory plans. 
  • Non-plan capital expenditure covers various general, social and economic services provided by the government.

Measures of Government Deficit

  • When a government spends more than it collects by way of revenue, it incurs a budget deficit.
  • There are various measures that capture government deficit and they have their own implications for the economy.

Revenue Deficit:

  • The revenue deficit refers to the excess of government’s revenue expenditure over revenue receipts
  • Revenue deficit = Revenue expenditure – Revenue receipts

Fiscal Deficit:

  • 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)
  • Gross fiscal deficit = Net borrowing at home + Borrowing from RBI + Borrowing from abroad
  • Revenue deficit is a part of fiscal deficit (Fiscal Deficit = Revenue Deficit + Capital Expenditure – nondebt creating capital receipts).
  • A large share of revenue deficit in fiscal deficit indicated that a large part of borrowing is being used to meet its consumption expenditure needs rather than investment.

Primary Deficit:

  • borrowing requirement of the government includes interest obligations on accumulated debt.
  • The goal of measuring primary deficit is 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 consist of interest payments minus interest receipts by the government on net domestic lending.


  • One of Keynes‟s main ideas in The General Theory of Employment, Interest and Money was that government fiscal policy should be used to stabilize the level of output and employment. 
  • Through changes in its expenditure and taxes, the government attempts to increase output and income and seeks to stabilize the ups and downs in the economy. 
  • In the process, fiscal policy creates a surplus (when total receipts exceed expenditure) or a deficit budget (when total expenditure exceed receipts) rather than a balanced budget (when expenditure equals receipts).
  • In what follows, we study the effects of introducing the government sector in our earlier analysis of the determination of income.
  • The government directly affects the level of equilibrium income in two specific ways – government purchases of goods and services (G ) increase aggregate demand and taxes, and transfers affect the relation between income (Y) and disposable income (YD) – the income available for consumption and saving with the households. 
  • We take taxes first. 
  • We assume that the government imposes taxes that do not depend on income, called lump-sum taxes equal to T. We assume throughout the analysis that government makes a constant amount of transfers,


  • Budgetary deficits must be financed by either taxation, borrowing or printing money. 
  • Governments have mostly relied on borrowing, 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 add 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.

Deficits of debt:

  • Whether government debt is a burden and two, the issue of financing the debt. 
  • The burden of debt must be discussed keeping in mind that what is true of one small trader’s debt may not be true for the government’s debt, and one must deal with the „whole‟ differently from the „part‟. Unlike any one trader, the government can raise resources through taxation and printing money.
  • By borrowing, the government transfers the burden of reduced consumption on future generations.
  • This is 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 population that have just entered the work force, whose disposable income will go down and hence consumption. Thus, national savings, it was argued, would fall
  • Traditionally, it has been argued that when a government cuts taxes and runs a budget deficit, consumers respond to their after -tax income by spending more.
  • It is possible that these people are short-sighted and do not understand the implications of budget deficits.
  • They may not realize that at some point in the future, the government will have to raise taxes to pay off the debt and accumulated interest. Even if they comprehend this, they may expect the future taxes to fall not on them but on future generations.
  • One of the main criticisms of deficits is that they are inflationary.
  • This is because when government increases spending or cuts taxes, aggregate demand increases. Firms may not be able to produce higher quantities that are being demanded at the ongoing prices. 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.
  • there is a decrease in investment due to a reduction in the amount of savings available to the private sector.
  • This is because if the government decides to borrow from private citizens by issuing bonds to finance its deficits, these bonds will compete with corporate bonds and other financial instruments for the available supply of funds.
  • If some private savers decide to buy bonds, the funds remaining to be invested in private hands will be smaller. 
  • Thus, some private borrowers will get „crowded out‟ of the financial markets as the government claims an increasing share of the economy’s total savings.
  • Also, if the government invests in infrastructure, future generations may be better off, provided the return on such investments is greater than the rate of interest. The actual debt could be paid off by the growth in output. The debt should not then be considered burdensome. The growth in debt will have to be judged by the growth of the economy as a whole.

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 (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 programmed and better administration.

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