DETAILED

TEST-8 EXPLANATION PDF

October 6th, 2019

Lesson 4
Government Budgeting
 Subscribe to our YouTube Channel – CivilsTap by EduTap for free, quality and regular content

Government Budgeting............................................ 2 Effective Revenue Deficit ................................ 11

Meaning of Government Budget ......................... 2 Gross Fiscal Deficit .......................................... 11
Union Budget of India – Key Points .................. 2 Net Fiscal Deficit.............................................. 12
Objectives of Government Budget ...................... 2 Gross Primary Deficit ...................................... 12
Allocation Function of Government Budget..... 2 Net Primary Deficit .......................................... 13
Redistribution Function of Government Budget Traditional Budget Deficit ............................... 13
.......................................................................... 4
Monetised Deficit ............................................ 13
Stabilisation Function of Government Budget . 4
Other Deficit Measures ................................... 14
Components of Budget ........................................ 5
Significance of Different Measures of Deficit . 14
Receipts ............................................................ 5
Fiscal Deficit ....................................................... 14
Revenue Receipts ................................................. 5
Budget Deficit .................................................... 14
Capital Receipts .................................................... 6
Monetized Deficits ............................................. 14
Distinction between Revenue Receipt and
Primary Deficits.................................................. 15
Capital Receipt .................................................. 7
Revenue Deficit.................................................. 15
Effect .................................................................... 7
Debt .................................................................... 15
Occurrence ........................................................... 7
Perspectives on the Appropriate Amount of
Generation of further receipts ............................. 7
Government Debt ........................................... 15
Effect on Assets/Liabilities ................................... 7
Public Debt in India ......................................... 17
Expense ................................................................ 7
Internal Debt ...................................................... 17
Expenditure ...................................................... 7
External Debt ..................................................... 18
Revenue Expenditure ........................................... 7
Deficit Reduction ............................................. 18
Capital Expenditure .............................................. 8
Fiscal Responsibility and Budget Management
Why is Capital Expenditure important? ............... 8 Act, 2003 ............................................................ 19
Distinction between Revenue Expenditure and FRBM Review Committee .................................. 20
Capital Expenditure .......................................... 8
GST: One Nation, One Tax, One Market (Linked to
Balanced, Surplus & Deficit Budget ..................... 9 Tax Revenue) ...................................................... 21
Balanced Budget ............................................... 9 MCQs for Practice................................................... 23
MERITS OF A BALANCED BUDGET ........................ 9 MCQs with Answer & Explanation ......................... 24
DEMERITS OF A BALANCED BUDGET ................... 9
Surplus Budget .................................................. 9
Deficit Budget ................................................... 9
MERITS OF A DEFICIT BUDGET ...........................10
DEMERITS OF A DEFICIT BUDGET.......................10
Measures of Government Deficit ...................... 10
Revenue Deficit............................................... 10

Visit: [Link]
For Any Query Mail us: hello@[Link] or call us at - (+91)-8146207241
1
 Subscribe to our YouTube Channel – CivilsTap by EduTap for free, quality and regular content

word budget is derived from the Old French

GOVERNMENT BUDGETING bougette (“little bag”).

MEANING OF GOVERNMENT
OBJECTIVES OF GOVERNMENT
BUDGET
BUDGET
Union Budget of India is the country’s As mentioned earlier, the Union Budget’s general
objective is to present the yearly financial record
comprehensive Annual Financial Statement. The
and plannings of the government and it helps the
Union Budget consists of a detailed account of the
government in bringing out fast and all-inclusive
government’s finances, its revenues from various economic growth of our country. It also empowers
sources and expenditures to be incurred on different the government to carry out its constitutional
activities that it will incur. duties such as providing social justice and equality
for all. It has the following key objectives which
highlight its importance of Union Budget in India:
UNION BUDGET OF INDIA – KEY
POINTS ▪ Resource allocation in the best interest of the
society and the country and allocating resources
▪ According to Article 112 of the Indian
optimally for public welfare.
Constitution, the Union Budget of a year,
▪ Uplift downtrodden sections of the society by
referred to as the annual financial statement reducing poverty levels and creating
(AFS), is a statement of the estimated receipts employment.
and expenditure of the government for that ▪ Creating programmes for citizens so that they
particular year. get basic needs such as food, shelter, education
▪ The Union Budget keeps the account of the and health care.
government's finances for the financial year ▪ Union Budget makes sure that there is fair
that runs from April 1 to March 31. distribution of income through taxes and
▪ The Annual Financial Statement distinguishes subsidies.
the expenditure on revenue account from the ▪ Union Budget takes steps to control inflation,
expenditure on other accounts, as mandated by deflation and economic fluctuations thus
ensuring economic stability in the country.
the Constitution of India.
▪ The Union Budget of any country is crucial as it
▪ In the Budget, the receipts and disbursements
has widespread implications on that country’s
are shown in three parts in which Government
economic stability and general life as such.
Accounts comprise (i) the Consolidated Fund, (ii)
the Contingency Fund and (iii) the Public Thus, government plays a very important role in
Account. increasing the welfare of the people. In order to do
that the government intervenes in the economy in
KEY DEFINITION
the following ways.
Government budget: It is a forecast by a
government of its expenditures and revenues for ALLOCATION FUNCTION OF
GOVERNMENT BUDGET
a specific period of time. In national finance, the
period covered by a budget is usually a year, Government provides certain goods and services
known as a financial or fiscal year, which may or which cannot be provided by the market
may not correspond with the calendar year. The mechanism i.e. by exchange between individual
Visit: [Link]
For Any Query Mail us: hello@[Link] or call us at - (+91)-8146207241
2
 Subscribe to our YouTube Channel – CivilsTap by EduTap for free, quality and regular content

consumers and producers. Examples of such goods

are national defence, roads, government There is, however, a difference between public
administration etc. which are referred to as public provision and public production. Public provision
goods. means that they are financed through the budget
and can be used without any direct payment. Public
To understand why public goods need to be provided goods may be produced by the government or the
by the government, we must understand the private sector. When goods are produced directly
difference between private goods such as clothes, by the government it is called public production.
cars, food items etc. and public goods. There are two
major differences. KEY DEFINITION

▪ Public Goods are non-rivalrous: One, the Public Goods: Goods that are difficult to keep
benefits of public goods are available to all and nonpayers from consuming (excludability), and
are not only restricted to one particular use of the goods by one person doesn't prevent
consumer. For example, if a person eats a use by others (rival consumption). Examples
chocolate or wears a shirt, these will not be include national defence and a clean environment.
available to others. It is said that this person’s Public goods are invariably provided by
consumption stands in rival relationship to the government because there's no way a private
consumption of others. However, if we consider business can profitably produce them. Private
a public park or measures to reduce air businesses can't sell public goods in markets,
pollution, the benefits will be available to all. because they can't charge a price and keep
One person’s consumption of a good does not nonpaying people away. For efficiency,
reduce the amount available for consumption government needs to pay for public goods through
for others and so several people can enjoy the taxes.
benefits, that is, the consumption of many
people is not ‘rivalrous’. Private Good: A good that's easy to keep
▪ Public Goods are non-excludable: Two, in case nonpayers from consuming (called excludability),
of private goods anyone who does not pay for and use of the good by one person prevents use
the goods can be excluded from enjoying its by others (termed rival consumption). Examples
benefits. If you do not buy a ticket, you will not include almost anything that you can buy at a
be allowed to watch a movie at a local cinema grocery store or shopping mall. The reason for this
hall. However, in case of public goods, there is is that private goods are privately owned and can
no feasible way of excluding anyone from be sold to others for a price. For efficiency, its best
enjoying the benefits of the good. That is why for these goods to be traded through markets
public goods are called non-excludable. Even if without any direct government involvement
some users do not pay, it is difficult and (unless they have a market failure).
sometimes impossible to collect fees for the
public good. These non-paying users are known Resource Allocation: The process of dividing up
as ‘free-riders’. Consumers will not voluntarily and distributing available, limited resources to
pay for what they can get for free and for which competing, alternative uses that satisfy unlimited
there is no exclusive title to the property being wants and needs. Given that world is rampant
enjoyed. with scarcity (unlimited wants and needs, but
limited resources), every want and need cannot be
The link between the producer and consumer which satisfied with available resources. Choices have to
occurs through the payment process is broken and be made. Some wants and needs are satisfied,
the government must step in to provide for such some are not. These choices, these decisions are
goods. the resource allocation process. An efficient

Visit: [Link]
For Any Query Mail us: hello@[Link] or call us at - (+91)-8146207241
3
 Subscribe to our YouTube Channel – CivilsTap by EduTap for free, quality and regular content

resource allocation exists if society has achieved everybody is provided with some minimum
the highest possible level of satisfaction of wants standard of living.
and needs from the available resources AND
resources can not be allocated differently to Progressive Tax System: A progressive tax is one
achieve any greater satisfaction. in which the proportion of income paid in taxes is
greater for higher income levels. A progressive
income tax exists, for example, if taxpayers with
REDISTRIBUTION FUNCTION OF more income pay a 25% of their income in taxes,
GOVERNMENT BUDGET while those with less income pay 20%.
Total national income of the country goes to either
the private sector, that is, firms and households QUESTION 1
(known as private income) or the government Q. A redistribution of income in a country can be
(known as public income). Out of private income, best brought about through: [1996]
what finally reaches the households is known as (a) progressive taxation combined with
personal income and the amount that can be spent progressive expenditure
is the personal disposable income. (b) progressive taxation combined with regressive
expenditure
The government sector affects the personal (c) regressive taxation combined with regressive,
disposable income of households by making expenditure
transfers and collecting taxes. (d) regressive taxation combined with progressive
expenditure
It is through this that the government can change Answer: B
the distribution of income and bring about a
distribution that is considered ‘fair’ by society. This
is the redistribution function. STABILISATION FUNCTION OF
GOVERNMENT BUDGET
The transfer of income from one section of the
The government may need to correct fluctuations in
society to another is achieved primarily by the use of
income and employment.
a progressive taxation system and a variety of
welfare provisions (subsidized housing, old age
The overall level of employment and prices in the
pensions, etc).
economy depends upon the level of aggregate
demand which depends on the spending decisions
If the government spending decreases with the
of millions of private economic agents apart from
increase in income of people then it is called as
the government.
regressive expenditure. On the other hand, if the
government spending increases with the increase in
These decisions, in turn, depend on many factors
income then it is called as progressive expenditure.
such as income and credit availability.
KEY DEFINITION
In any period, the level of demand may not be
sufficient for full utilisation of labour and other
Income redistribution: A policy concerned with
resources of the economy. Since wages and prices do
altering the pattern of the personal distribution of
not fall below a level, employment cannot be
income in an economy, mainly with social rather
brought back to the earlier level automatically. The
than economic objectives in mind. The general aim
government needs to intervene to raise the
of such a policy is to achieve a more equitable
aggregate demand.
distribution of income as between the various
sections of the community so as to ensure that
Visit: [Link]
For Any Query Mail us: hello@[Link] or call us at - (+91)-8146207241
4
 Subscribe to our YouTube Channel – CivilsTap by EduTap for free, quality and regular content

On the other hand, there may be times when RECEIPTS

demand exceeds available output under conditions
of high employment and thus may give rise to Government receipts are divided into two groups—
inflation. In such situations, restrictive conditions Revenue Receipts and Capital Receipts. All
may be needed to reduce demand. Government receipts which either create liability or
reduce assets are treated as capital receipts whereas
The intervention of the government whether to receipts which neither create liability nor reduce
expand demand or reduce it constitutes the assets of Government are called revenue receipts.
stabilisation function.
REVENUE RECEIPTS

KEY DEFINITION Revenue receipts are those receipts that do not lead
to a claim on the government. They are therefore
Stabilization Policies: Economic policies termed non-redeemable.
undertaken by government to counteract
business cycle fluctuations and prevent high rates They are divided into tax and non-tax revenues.
of unemployment and inflation. These are also
termed counter-cyclical policies. To counter a Tax revenues, an important component of revenue
business cycle contraction and high rates of receipts, have for long been divided into direct taxes
unemployment, expansionary policies that (personal income tax) and firms (corporation tax),
promote increasing economic activity are and indirect taxes like excise taxes (duties levied on
appropriate. To counter an inflationary expansion, goods produced within the country), customs duties
contractionary policies are recommended. (taxes imposed on goods imported into and
exported out of India) and service tax.
COMPONENTS OF BUDGET Other direct taxes like wealth tax, gift tax and estate
Government Budget in India is divided into two duty (now abolished) have never brought in large
parts – Revenue Budget and Capital Budget. amount of revenue and thus have been referred to
as ‘paper taxes’.
The Revenue Budget comprises revenue receipts
and expenditure met from these revenues. The The redistribution objective is sought to be achieved
revenue receipts include both tax revenue (like through progressive income taxation, in which
income tax, excise duty) and non-tax revenue (like higher the income, higher is the tax rate.
interest receipts, profits). Capital Budget consists of
capital receipts (like borrowing, disinvestment) and Firms are taxed on a proportional basis, where the
long period capital expenditure (creation of assets, tax rate is a particular proportion of profits.
investment).
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 organisations are also
included.

The estimates of revenue receipts take into account

the effects of tax proposals made in the Finance Bill.
Visit: [Link]
For Any Query Mail us: hello@[Link] or call us at - (+91)-8146207241
5
 Subscribe to our YouTube Channel – CivilsTap by EduTap for free, quality and regular content

known as "Revenue receipts", e.g. sale proceeds

KEY DEFINITION of goods, interest received, commission received,
rent received, dividend received etc. In case of
Direct Taxes: A direct tax is paid by an individual government, tax revenue is a major component of
or organization to the entity that levied the tax. revenue receipts.
Direct taxes include income tax, property tax,
corporate tax, estate tax, gift tax, value-added tax
QUESTION 2
(VAT), sin tax, and taxes on assets.
Q. Consider the following taxes: [2001]
1. Corporation tax
Indirect Taxes: An indirect tax is collected by one
2. Customs duty
entity in the supply chain (usually a producer or
3. Wealth tax
retailer) and paid to the government, but it is
4. Excise duty
passed on to the consumer as part of the purchase
Which of these is/are indirect taxes?
price of a good or service. The consumer is
(a) 1 only
ultimately paying the tax by paying more for the
(b) 2 and 4
product.
(c) 1 and 3
(d) 2 and 3
Progressive Tax: A tax in which people with more
Answer: B
income pay a larger percentage in taxes. A
progressive tax is given by this example -- You earn
Rs 10,000 a year and your boss gets Rs 20,000. You CAPITAL RECEIPTS
pay Rs 1,000 in taxes (10 percent) and your boss
pays Rs 4,000 in taxes (20 percent). Our income The government also receives money by way of
tax system is designed to be progressive, but loans or from the sale of its assets.
assorted loopholes and deductions keep it from
being as progressive in practice as it is on paper. Loans will have to be returned to the agencies from
which they have been borrowed. Thus they create
Proportional Tax: A tax in which people pay the liability.
same percentage of income in taxes regardless of
their incomes. Here's an example of a proportional Sale of government assets, like sale of shares in
tax -- You earn Rs 10,000 a year and your boss gets Public Sector Undertakings (PSUs) which is referred
Rs 20,000. You pay Rs 1,000 in taxes (10 percent) to as PSU disinvestment, reduce the total amount of
and your boss pays Rs 2,000 in taxes (10 percent). financial assets of the government.

Regressive Tax: A tax in which people with more All those receipts of the government which create
income pay a smaller percentage in taxes. A liability or reduce financial assets are termed as
regressive tax is given by this example--You earn capital receipts.
Rs 10,000 a year and your boss gets Rs 20,000. You
pay Rs 2,000 in taxes (20 percent) while your boss When government takes fresh loans it will mean
also pays Rs 2,000 in taxes (10 percent). Examples that in future these loans will have to be returned
of regressive taxes abound, including sales tax and and interest will have to be paid on these loans.
excise tax. Similarly, when government sells an asset, then it
means that in future its earnings from that asset, will
Revenue Receipt: Receipts which are recurring disappear. Thus, these receipts can be debt creating
(received again and again) by nature and which or non-debt creating.
are available for meeting all day to day expenses
(revenue expenditure) of a business concern are

Visit: [Link]
For Any Query Mail us: hello@[Link] or call us at - (+91)-8146207241
6
 Subscribe to our YouTube Channel – CivilsTap by EduTap for free, quality and regular content

KEY DEFINITON ▪ Revenue Receipt: This does not increase or

decrease the value of asset or liability.
Disinvestment: Disinvestment means sale or ▪ Capital Receipt: The capital receipt decreases
liquidation of assets by the government, usually the value of asset or increases the value of
Central and state public sector enterprises, liability e.g. sale of a fixed asset, loan from bank
projects, or other fixed assets. The government etc.
undertakes disinvestment to reduce the fiscal
burden on the exchequer, or to raise money for EXPENSE
▪ Revenue Receipt: Sometimes, expenses of
meeting specific needs, such as to bridge the
capital nature are to be incurred for revenue
revenue shortfall from other regular sources. In
receipt, e.g. purchase of shares of a company is
some cases, disinvestment may be done to
capital expenditure but dividend received on
privatise assets. However, not all disinvestment is
shares is a revenue receipt.
privatisation.
▪ Capital Receipt: Sometimes expenses of
revenue nature are to be incurred for capital
Capital Receipt: Receipts which are non-recurring
receipt e.g. on obtaining loan (a capital receipt)
(not received again and again) by nature and
interest is paid until its repayment.
whose benefit is enjoyed over a long period are
called "Capital Receipts", e.g. money brought into EXPENDITURE
the business by the owner (capital invested), loan
from bank, sale proceeds of fixed assets etc. Expenditure can be classified under two heads –
Capital receipt is shown on the liabilities side of revenue expenditure and capital expenditure. The
the Balance Sheet. differences between capital expenditures and
revenue expenditures include whether the
purchases will be used over the long-term or short-
DISTINCTION BETWEEN REVENUE term. Revenue expenditures are typically referred
RECEIPT AND CAPITAL RECEIPT to as ongoing operating expenses. Capital
EFFECT expenditures are typically one-time large purchases
▪ Revenue Receipt: It has short-term effect. The of fixed assets that will be used for revenue
benefit is enjoyed within one accounting period. generation over a longer period.
▪ Capital Receipt: It has long-term effect. The REVENUE EXPENDITURE
benefit is enjoyed for many years in future.

OCCURRENCE Revenue Expenditure is expenditure incurred for

▪ Revenue Receipt: It occurs repeatedly. It is purposes other than the creation of physical or
recurring and regular. financial assets of the central government.
▪ Capital Receipt: It does not occur again and
again. It is nonrecurring and irregular. It relates to those expenses incurred for the normal
functioning of the government departments and
GENERATION OF FURTHER RECEIPTS various services, interest payments on debt incurred
▪ Revenue Receipt: It does not produce capital by the government, and grants given to state
receipt. governments and other parties (even though some
▪ Capital Receipt: Capital receipt, when invested, of the grants may be meant for creation of assets).
produces revenue receipt e.g. when capital is
invested by the owner, business gets revenue The main items of revenue expenditure are interest
receipt (i.e. sale proceeds of goods etc.). payments, defence services, subsidies, salaries and
pensions.
EFFECT ON ASSETS/LIABILITIES

Visit: [Link]
For Any Query Mail us: hello@[Link] or call us at - (+91)-8146207241
7
 Subscribe to our YouTube Channel – CivilsTap by EduTap for free, quality and regular content

Interest payments on market loans, external loans

and from various reserve funds constitute one of the Capital expenditure is the part of the government
largest components of revenue expenditure. spending that goes into the creation of assets like
schools, colleges, hospitals, roads, bridges, dams,
Defence expenditure, is committed expenditure in railway lines, airports and seaports. Capital
the sense that given the national security concerns, expenditure also covers the acquisition of
there exists little scope for drastic reduction. equipment and machinery by the government,
including those for defence purposes. Capital
Subsidies are an important policy instrument which expenditure also includes investment by the
aim at increasing welfare. Apart from providing government that yields profits or dividend in future.
implicit subsidies through under-pricing of public
goods and services like education and health, the
government also extends subsidies explicitly on WHY IS CAPITAL EXPENDITURE
IMPORTANT?
items such as exports, interest on loans, food and
fertilisers.
▪ High capital expenditure usually means more
investment by the government towards the
KEY DEFINITION
creation of infrastructure and other assets that
are crucial for rapid economic growth.
Subsidy: A subsidy is a benefit given to an
▪ Capital expenditure means construction of
individual, business, or institution, usually by the
roads, highways, dams, bridges, ports, airports
government. It is usually in the form of a cash
and railway lines.
payment or a tax reduction. The subsidy is
▪ India experienced low growth rates for decades
typically given to remove some type of burden,
as it failed to develop physical and social
and it is often considered to be in the overall
infrastructure, the key to achieving high
interest of the public, given to promote a social
economic growth.
good or an economic policy.
KEY DEFINITION
Revenue Expenditure: All the expenditures which
are incurred in the day to day conduct and
Capital Expenditure: An expenditure which results
administration of a business and the effect-of
in the acquisition of permanent asset which is
which is completely exhausted within the current
intended lo be permanently used in the business
accounting year are known as "revenue
for the purpose of earning revenue, is known as
expenditures". These expenditures are recurring
capital expenditure. These expenditures are 'non-
by and the effect of these expenditures is always
recurring' by nature. Assets acquired by incurring
short-lived i.e. the benefit thereof is enjoyed by
these expenditures are utilized by the business for
the business within the current accounting year.
a long time and thereby they earn revenue.
CAPITAL EXPENDITURE
DISTINCTION BETWEEN REVENUE
There are expenditures of the government which EXPENDITURE AND CAPITAL
result in creation of physical or financial assets or EXPENDITURE
reduction in financial liabilities.
Revenue Expenditure Capital Expenditure
This includes expenditure on the acquisition of land, 1. Its effect is 1. Its effect is long-term,
building, machinery, equipment, investment in temporary, i.e. the i.e. it is not exhausted
shares, and loans and advances by the central benefit is received within the current
government to state and union territory within the accounting accounting year-its
governments, PSUs and other parties. year. benefit is received for
Visit: [Link]
For Any Query Mail us: hello@[Link] or call us at - (+91)-8146207241
8
 Subscribe to our YouTube Channel – CivilsTap by EduTap for free, quality and regular content

a number of years in to expected government receipts in a particular

future. financial year.
2. Neither an asset is 2. An asset is acquired or
This type of budget is based on the principle of
acquired nor the the value of an
“living within means.” They believed the
value of an asset is existing asset is
government’s expenditure should not exceed their
increased. increased.
revenue.
3. It has no physical 3. Generally it has
existence because it physical existence Though an ideal approach to achieve a balanced
is incurred on items except intangible economy and maintain fiscal discipline, a balanced
which are used by the assets. budget does not ensure financial stability at times
business. of economic depression or deflation. Theoretically,
4. It is recurring and 4. It does not occur it’s easy to balance the estimated expenditure and
regular and it occurs again and again. It is anticipated revenues but when it comes to practical
repeatedly. nonrecurring and implementation, such balance is hard to achieve.
irregular.
MERITS OF A BALANCED BUDGET
5. This expenditure 5. This expenditure ▪ Ensures economic stability, if implemented
helps to maintain the improves the position successfully.
business. of the business. ▪ Ensures that the government refrains from
6. It does not appear in 6. It appears in the imprudent expenditures.
the balance sheet. balance sheet until its
benefit is fully DEMERITS OF A BALANCED BUDGET
exhausted. ▪ Unviable at times of recession and does not
offer any solution to problems such as
7. It reduces profit of 7. It does not reduce the unemployment.
the business. profit of the concern. ▪ Inapplicable in less developed countries as it
Purchase of fixed limits the scope of economic growth.
asset does not affect ▪ Restricts the government from spending on
profit. public welfare.

SURPLUS BUDGET

BALANCED, SURPLUS & DEFICIT A government budget is said to be a surplus budget

if the expected government revenues exceed the
BUDGET
estimated government expenditure in a particular
A government budget is an annual financial financial year. A surplus budget denotes the
statement which outlines the estimated government financial affluence of a country. Such a budget can
expenditure and expected government receipts or be implemented at times of inflation to reduce
revenues for the forthcoming fiscal year. Depending aggregate demand.
on the feasibility of these estimates, budgets are of
three types -- balanced budget, surplus budget and DEFICIT BUDGET
deficit budget.
A government budget is said to be a deficit budget if
BALANCED BUDGET the estimated government expenditure exceeds
the expected government revenue in a particular
A government budget is said to be a balanced budget financial year. This type of budget is best suited for
if the estimated government expenditure is equal developing economies, such as India. Especially
helpful at times of recession, a deficit budget helps
Visit: [Link]
For Any Query Mail us: hello@[Link] or call us at - (+91)-8146207241
9
 Subscribe to our YouTube Channel – CivilsTap by EduTap for free, quality and regular content

generate additional demand and boost the rate of There are different measures of deficits in
economic growth. Here, the government incurs the macroeconomics and each type of deficit measure
excessive expenditure to improve the employment carries a different macroeconomic meaning. The
rate. This results in an increase in demand for goods broad measures of deficit (which have been and/or
and services which helps in reviving the economy. are being) reported by the government in India, may
The government covers this amount through public be classified, either in terms of the ‘nature of
borrowings (by issuing government bonds) or by transactions’ or on the basis of the ‘means of
withdrawing from its accumulated reserve surplus. financing’ them.

MERITS OF A DEFICIT BUDGET

▪ Helps in addressing public concerns such as
unemployment at times of economic recession.
▪ Enables the government to spend on public
welfare.

DEMERITS OF A DEFICIT BUDGET

▪ Can encourage imprudent expenditures by the
government.
▪ Increases burden on the government by
accumulating debts.

KEY DEFINITION

Balanced Budget: A balanced budget is a situation REVENUE DEFICIT

in financial planning or the budgeting process
The revenue deficit refers to the excess of
where total revenues are equal to or greater than
government’s revenue expenditure over revenue
total expenses.
receipts.
Budget Deficit: A budget deficit occurs when
The formula for Revenue deficit is:
expenses exceed revenue and indicate the
financial health of a country. The government
Revenue deficit = Revenue expenditure – Revenue
generally uses the term budget deficit when
receipts
referring to spending rather than businesses or
individuals. Accrued deficits form national debt.
The revenue deficit includes only such transactions
that affect the current income and expenditure of
Budget Surplus: A budget surplus is a period when
the government.
income or receipts exceed outlays or
expenditures. A budget surplus often refers to the
When the government incurs a revenue deficit, it
financial states of governments; individuals prefer
implies that the government is dissaving and is using
to use the term 'savings' instead of the term
up the savings of the other sectors of the economy
'budget surplus.' A surplus is an indication that the
to finance a part of its consumption expenditure.
government is being effectively managed.
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
MEASURES OF GOVERNMENT a build-up of stock of debt and interest liabilities
DEFICIT and force the government, eventually, to cut
expenditure.

Visit: [Link]
For Any Query Mail us: hello@[Link] or call us at - (+91)-8146207241
10
 Subscribe to our YouTube Channel – CivilsTap by EduTap for free, quality and regular content

Since a major part of revenue expenditure is Grants for creation of capital assets, as a concept,
committed expenditure, it cannot be reduced. Often was introduced in the FRBM Act through the
the government reduces productive capital amendment in 2012. The Act defines grants for
expenditure or welfare expenditure. This would creation of capital assets as grants-in-aid given by
mean lower growth and adverse welfare the Central Government to state governments,
implications. autonomous bodies, local bodies and other scheme
implementing agencies for creation of capital assets
KEY DEFINITION which are owned by these entities.

Revenue Deficit: Revenue deficit is the gap In short, Effective Revenue Deficit is the difference
between the consumption expenditure (revenue between revenue deficit and grants for creation of
expenditure) of the Government (Union or the capital assets.
State Governments) and its current revenues
(revenue receipts). It also indicates the extent to Effective Revenue Deficit signifies that amount of
which the government has borrowed to finance capital receipts that are being used for actual
the current expenditure. consumption expenditure of the Government.

KEY DEFINITION
EFFECTIVE REVENUE DEFICIT
Effective Revenue Deficit: It is defined as revenue
Effective Revenue deficit is a new term introduced in deficit minus that revenue expenditure (in the
the Union Budget 2011-12. form of grants), which goes into the creation of
Capital Assets.
While revenue deficit is the difference between
revenue receipts and revenue expenditure, the
present accounting system includes all grants from GROSS FISCAL DEFICIT
the Union Government to the state
governments/Union territories/other bodies as Gross Fiscal deficit is the difference between the
revenue expenditure, even if they are used to create government’s total expenditure and its total
assets. receipts excluding borrowing.

Such assets created by the sub-national The formula for Gross fiscal deficit is:
governments/bodies are owned by them and not by
the Union Government. Nevertheless, they do result Gross fiscal deficit = Total expenditure – (Revenue
in the creation of durable assets. receipts + Non-debt creating capital receipts)

According to the Finance Ministry, such revenue OR

expenditures contribute to the growth in the
economy and therefore, should not be treated as Gross fiscal deficit = Total expenditure of the
unproductive in nature. government (capital and revenue expenditure) –
Total income of the government (Revenue receipts
In the Union Budget (2011-12) a new methodology + recovery of loans + other receipts)
has been introduced to capture the ‘effective
revenue deficit’, which excludes those revenue Non-debt creating capital receipts are those
expenditures (or transfers) in the form of grants for receipts which are not borrowings and, therefore,
creation of capital assets. do not give rise to debt. Examples are recovery of
loans and the proceeds from the sale of PSUs.

Visit: [Link]
For Any Query Mail us: hello@[Link] or call us at - (+91)-8146207241
11
 Subscribe to our YouTube Channel – CivilsTap by EduTap for free, quality and regular content

The gross fiscal deficit will have to be financed

through borrowing. Thus, it indicates the total The Central government makes capital
borrowing requirements of the government from all disbursements as loans to the different segments of
sources. the economy. In the developing countries, a large
part goes as loans to other sectors – States and local
From the financing side, the formula for Gross fiscal Governments, public sector enterprises and the
deficit is: like.

Gross fiscal deficit = Net borrowing at home + Net fiscal deficit can be arrived at by deducting net
Borrowing from RBI + Borrowing from abroad domestic lending from gross fiscal deficit.

Net borrowing at home includes that directly GROSS PRIMARY DEFICIT

borrowed from the public through debt instruments
We must note that the borrowing requirement of
(for example, the various small savings schemes) and
the government includes interest obligations on
indirectly from commercial banks through Statutory
accumulated debt.
Liquidity Ratio (SLR).
The goal of measuring gross primary deficit is to
The gross fiscal deficit is a key variable in judging the
focus on present fiscal imbalances.
financial health of the public sector and the stability
of the economy.
To obtain an estimate of borrowing on account of
current expenditures exceeding revenues, we need
From the way gross fiscal deficit is measured as given
to calculate what has been called the primary deficit.
above, it can be seen that revenue deficit is a part of
It is simply the fiscal deficit minus the interest
fiscal deficit.
payments.
The formula showing relation between Gross Fiscal
The formula for Gross primary deficit is:
deficit and Revenue deficit is:
Gross primary deficit = Gross fiscal deficit – Net
Gross Fiscal Deficit = Revenue Deficit + Capital
interest liabilities
Expenditure – non-debt creating capital receipts
Net interest liabilities consist of interest payments
A large share of revenue deficit in fiscal deficit
minus interest receipts by the government on net
indicated that a large part of borrowing is being used
domestic lending.
to meet its consumption expenditure needs rather
than investment.
KEY DEFINITION
KEY DEFINITION
Primary Deficit: It indicates the borrowing
requirements of the government, excluding
Fiscal Deficit: It is the difference between the total
interest to be paid on the borrowings of the
income of the government (total revenue receipts
previous year. It is the amount by which the total
and non-debt capital receipts) and its total
expenditure of a government exceeds the total
expenditure. A fiscal deficit situation occurs when
income in the current accounting period.
the government’s expenditure exceeds its income.

NET FISCAL DEFICIT

Fiscal deficit can be either ‘gross’ or ‘net’.

Visit: [Link]
For Any Query Mail us: hello@[Link] or call us at - (+91)-8146207241
12
 Subscribe to our YouTube Channel – CivilsTap by EduTap for free, quality and regular content

NET PRIMARY DEFICIT

Note: Budgetary Deficit
Net primary deficit is gross primary deficit minus
net domestic lending. Budgetary deficit is the difference between all
receipts and expenses in both revenue and capital
RECAP account of the government.

Tax Revenue receipts of the government Budgetary deficit is the sum of revenue account
▪ Corporation Tax deficit and capital account deficit. If revenue
▪ Income Tax expenses of the government exceed revenue
▪ Custom Duties receipts, it results in revenue account deficit.
▪ Union Excise Duties Similarly, if the capital disbursements of the
▪ GST and taxes of Union territories. government exceed capital receipts, it leads to
capital account deficit. Budgetary deficit is usually
Non-Tax Revenue receipts of the government expressed as a percentage of GDP.
▪ Interest Receipts
▪ Dividends and Profits
▪ External Grants MONETISED DEFICIT
▪ Other non-tax revenues
▪ Receipts of union territories Monetized deficit, also known as the ‘net reserve
bank credit to the government’, is that part of the
Expenditures of the government government deficit which is financed solely by
▪ Revenue Expenditure borrowing from the RBI.
▪ Capital Expenditure
▪ Interest Payments Since borrowings from the RBI can be both short-
▪ Grants-in-aid for creation of capital assets term and long-term, therefore, monetized deficit is
the sum of the net issuance of short-term treasury
bills, dated securities (that is, long-term borrowing
from the RBI) and rupee coins held exclusively by the
RBI, net of Government’s deposits with the RBI.

This is different from the Traditional Budget deficit

in two ways:
1. Traditional Budget deficit includes 91-day
treasury bills held by both, the RBI and non-RBI
entities whereas Monetized deficit includes 91-
TRADITIONAL BUDGET DEFICIT day Treasury Bills held only by the RBI.
2. Traditional Budget deficit includes only short-
It is that part of the government’s deficit which is term sources of finance whereas Monetized
financed through short-term borrowings. These deficit includes long-term securities also.
short-term borrowings may be from the RBI or from
other sources.

Normally, short-term borrowings from the RBI are

through the net issuance of short-term treasury bills
(that is, ad-hoc and ordinary treasury bills) and by
running-down the central government’s cash
balances held by the RBI.
Visit: [Link]
For Any Query Mail us: hello@[Link] or call us at - (+91)-8146207241
13
 Subscribe to our YouTube Channel – CivilsTap by EduTap for free, quality and regular content

▪ This measure has been adopted by the

International Monetary Fund (IMF) as the
principal policy target in their programmes. In
India, the government began to report the fiscal
deficit only after 1991.
▪ Since the shortfall in receipts over expenditure
must be covered through borrowing, therefore,
Gross Fiscal Deficit, gives the overall borrowing
requirements of the government over a given
financial year.
KEY DEFINITION
▪ And it thus shows the net addition to the level of
public debt during a financial year.
Deficit financing through central bank borrowing:
Financing of budget deficit by the government BUDGET DEFICIT
through borrowing money from the central bank. ▪ In the presence of the system of automatic
Leads to increase in money supply in an economy monetization of deficits through issuance of ad-
and may result in inflation. Deficit financing is a hoc treasury bills, this measure of deficit,
necessary evil in a welfare state as the states often becomes an important target to keep in check.
fail to generate tax revenue which is sufficient ▪ However, in the year 1997, the government
enough to take care of the expenditure of the discontinued the issuance of ad-hoc and tap
state. The basic intention behind deficit financing treasury bills.
is to provide the necessary impetus to economic ▪ As a result of this, now, the concept of budget
growth by artificial means. deficit in the traditional sense has lost its
significance in public finance and is now not
reported in the Budget documents of the
OTHER DEFICIT MEASURES Government of India.
There are various other types of measures of deficit MONETIZED DEFICITS
that are widely used internationally. ▪ Monetization of deficits, which increases the
▪ Consolidated Public Sector Deficit, which is the money supply, is inflationary if the rate of
excess of expenditure over revenue for all the growth of money supply is greater than the rate
government entities. of increase of the demand for cash balances
▪ Operational Deficit, which is the ‘inflation- arising from the growth of the economy.
corrected’ deficit and is defined as Consolidated ▪ Thus, monetized deficits are an important
Public Sector Deficit minus inflation rate times indicator of the inflationary impact of the
the debt stock increase in government’s budgetary deficits.
▪ Structural deficit which removes the effects of
temporary movements in the variables from KEY DEFINITION
their long-run values, thereby providing an idea
of the long-run position of the country after Monetize the Debt: In government, to print
removing the impact of temporary shocks. money in order to repay the national debt. For
example, suppose a government is Rs 1 lakh crore
SIGNIFICANCE OF DIFFERENT in debt. Theoretically, the government can simply
MEASURES OF DEFICIT expand the money supply by Rs 1 lakh crore and
FISCAL DEFICIT reduce the national debt to zero. It is not
▪ Widely used as a summary indicator of the uncommon for governments monetize their
macroeconomic impact of the budget in several debts, but because it increases the amount of
industrialized countries.
Visit: [Link]
For Any Query Mail us: hello@[Link] or call us at - (+91)-8146207241
14
 Subscribe to our YouTube Channel – CivilsTap by EduTap for free, quality and regular content

money in circulation, it is considered highly (d) Reducing the foreign debt

inflationary. Answer: A

PRIMARY DEFICITS
▪ It excludes the burden of the past debt and DEBT
shows the net increase in the government’s
indebtedness due to the current year’s fiscal Budgetary deficits must be financed by either
operations. taxation, borrowing or printing money.
▪ A reduction in primary deficit is reflective of Governments have mostly relied on borrowing,
government’s efforts at bridging the fiscal gap giving rise to what is called government debt.
during a financial year.
The concepts of deficits and debt are closely related.
REVENUE DEFICIT Deficits can be thought of as a flow which add to the
▪ A positive revenue deficit implies that the stock of debt. If the government continues to
government is resorting to borrowing to finance borrow year after year, it leads to the accumulation
current consumption. of debt and the government has to pay more and
more by way of interest. These interest payments
QUESTION 3
themselves contribute to the debt.
Q. Match List I with List II and select the correct
answer using the codes given below the lists: PERSPECTIVES ON THE APPROPRIA TE
[2001] AMOUNT OF GOVERNMENT DEBT
List-I (Term) List-II (Explanation)
A. Fiscal deficit 1. Excess of Total There are two interlinked aspects of the issue. One is
Expenditure over Total whether government debt is a burden and two, the
Receipts issue of financing the debt. The burden of debt must
B. Budget deficit 2. Excess of Revenue be discussed keeping in mind that what is true of one
Expenditure over small trader’s debt may not be true for the
Revenue Receipts government’s debt, and one must deal with the
C. Revenue deficit 3. Excess of Total ‘whole’ differently from the ‘part’. Unlike any one
Expenditure over Total
trader, the government can raise resources through
Receipts less borrowings
taxation and printing money.
D. Primary deficit 4. Excess of Total
Expenditure over Total
Receipts less borrowings By borrowing, the government transfers the burden
and Interest Payments of reduced consumption on future generations. This
Codes: is because it borrows by issuing bonds to the people
(a) A-3; B-1; C-2; D-4 living at present but may decide to pay off the bonds
(b) A-4; B-3; C-2; D-1 some twenty years later by raising taxes. These may
(c) A-1; B-3; C-2; D-4 be levied on the young population that have just
(d) A-3; B-1; C-4; D-2 entered the work force, whose disposable income
Answer: A will go down and hence consumption. Thus, national
savings, it was argued, would fall.
QUESTION 4
Q. In India, deficit financing is used for raising Also, government borrowing from the people
resources for [2013 - I] reduces the savings available to the private sector.
(a) Economic development To the extent that this reduces capital formation
(b) Redemption of public debt and growth, debt acts as a ‘burden’ on future
(c) Adjusting the balance of payments generations.

Visit: [Link]
For Any Query Mail us: hello@[Link] or call us at - (+91)-8146207241
15
 Subscribe to our YouTube Channel – CivilsTap by EduTap for free, quality and regular content

Also, if the government invests in infrastructure,

It has often been argued that ‘debt does not matter future generations may be better off, provided the
because we owe it to ourselves’. This is because return on such investments is greater than the rate
although there is a transfer of resources between of interest. The actual debt could be paid off by the
generations, purchasing power remains within the growth in output. The debt should not then be
nation. However, any debt that is owed to foreigners considered burdensome. The growth in debt will
involves a burden since we have to send goods have to be judged by the growth of the economy as
abroad corresponding to the interest payments. a whole.

Other Perspectives on Deficits and Debt: One of the KEY DEFINITION

main criticisms of deficits is that they are
inflationary. This is because when government National Debt: The total of all bonds and other
increases spending or cuts taxes, aggregate debt owed by a government. Most of the time, the
demand increases. Firms may not be able to national debt comes from bonds and other debt
produce higher quantities that are being demanded securities, but some countries in the developing
at the ongoing prices. Prices will, therefore, have to world borrow directly from international
rise. institutions such as the World Bank. The national
debt may be internal, that is, owed to bondholders
However, if there are unutilised resources, output is and banks within the country, or external, that is,
held back by lack of demand. In such a scenario, owed to foreign governments, institutions, and/or
government may decide to give a fiscal stimulus by individuals.
running a high fiscal deficit. A high fiscal deficit is
accompanied by higher demand and greater output Capital Formation: The creation of productive
and, therefore, need not be inflationary. assets that expand an economy's capacity to
produce goods and services. Private savings
It has been argued that there is a decrease in facilitates capital formation by allowing resources
investment due to a reduction in the amount of to be diverted to corporate investment rather
savings available to the private sector. This is than individual consumption.
because if the government decides to borrow from
private citizens by issuing bonds to finance its Crowding Out: A situation in which a government
deficits, these bonds will compete with corporate borrows so much money that it discourages
bonds and other financial instruments for the lending to private businesses. Crowding out
available supply of funds. If some private savers generally occurs because lenders prefer the
decide to buy bonds, the funds remaining to be government as a borrower because it is much less
invested in private hands will be smaller. Thus, some risky and the government is able to pay any
private borrowers will get ‘crowded out’ of the interest rate. Thus, when the government is
financial markets as the government claims an borrowing heavily and lenders have only a finite
increasing share of the economy’s total savings. amount they can lend, it may crowd out private
borrowers.
However, one must note that the economy’s flow of
savings is not really fixed unless we assume that Stimulus: A ‘stimulus’ is an attempt by
income cannot be augmented. If government policymakers to kickstart a sluggish economy
deficits succeed in their goal of raising production, through a package of measures. A monetary
there will be more income and, therefore, more stimulus will see the central bank expanding
saving. In this case, both government and industry money supply or reducing the cost of money
can borrow more. (interest rates), to spur consumer spending. A
fiscal stimulus entails the Government spending

Visit: [Link]
For Any Query Mail us: hello@[Link] or call us at - (+91)-8146207241
16
 Subscribe to our YouTube Channel – CivilsTap by EduTap for free, quality and regular content

more from its own coffers or slashing tax rates to from internal sources. Thus, the Government of
put more money in the hands of consumers. India incurs both external and internal debt, while
State Governments incur only internal debt.

QUESTION 5
The Union government describes those of its
Q. Consider the following actions by the liabilities as public debt, which are contracted
Government: [2010] against the Consolidated Fund of India. This is as per
1. Cutting the tax rates Article 292 of the Constitution.
2. Increasing the government spending
3. Abolishing the subsidies The Union government includes all other funds
In the context of economic recession, which of received outside Consolidated Fund of India under
the above actions can be considered a part of the Article 266 (2) of the Constitution, where the
“fiscal stimulus” package? government merely acts as a banker or custodian.
(a) 1 and 2 only The second type of liabilities is called public account.
(b) 2 only
(c) 1 and 3 only Therefore, in India, total Central Government
(d) 1, 2 and 3 Liabilities constitutes the following three categories:
Answer: A ▪ Internal Debt
▪ External Debt
QUESTION 6 ▪ Public Account Liabilities
Q. Which one of the following statements
INTERNAL DEBT
appropriately describes the “fiscal stimulus”?
[2011 - I] The major instruments covered under Internal Debt
(a) It is a massive investment by the government are as follows:
in manufacturing sector to ensure the supply of ▪ Dated Securities: Primarily fixed coupon
goods to meet the demand surge caused by rapid securities of short, medium- and long-term
economic growth. maturity which have a specified redemption
(b) It is an intense affirmative action of the date. These are the single-most important
government to boost economic activity in the component of financing the fiscal deficit of the
country. Central Government (around 91 % in 2010-11)
(c) It is government’s intensive action on financial with average maturity of around 10 years.
institutions to ensure disbursement of loans to ▪ Treasury-Bills: Zero coupon securities that are
agriculture and allied sectors to promote greater issued at a discount and redeemed in face value
food production and contain food inflation. at maturity. These are issued to address short
(d) It is an extreme affirmative action by the term receipt-expenditure mismatches under
government to pursue its policy of financial the auction program of the Government. These
inclusion. are primarily issued in three tenors, 91,182 and
Answer: B 364 day.
▪ 14 Day Treasury Bills.
▪ Securities issued to International Financial
PUBLIC DEBT IN INDIA
Institutions: Securities issued to institutions viz.
Article 292 of the Indian Constitution states that the IMF, IBRD, IDA, ADB, IFAD etc. for India’s
Government of India can borrow amounts specified contributions to these institutions etc.
by the Parliament from time to time. ▪ Securities issued against ‘Small Savings’: All
deposits under small savings schemes are
Article 293 of the Indian Constitution mandates that credited to the National Small Savings Fund
the State Governments in India can borrow only (NSSF). The balance in the NSSF (net of
Visit: [Link]
For Any Query Mail us: hello@[Link] or call us at - (+91)-8146207241
17
 Subscribe to our YouTube Channel – CivilsTap by EduTap for free, quality and regular content

withdrawals) is invested in special Government

securities. Also, note that external loans are not market loans.
▪ Market Stabilization Scheme (MSS) Bonds: They have been raised from institutional creditors
Governed by a MoU between the GoI and the at concessional rates. Most of these external loans
RBI, MSS was created to assist the RBI in are fixed-rate loans, free from interest rate or
managing its sterilization operations. GoI currency volatility.
borrows under this scheme from the RBI, while
proceeds from such borrowings are maintained India’s external debt was $513.4 billion at the end of
in a separate cash account with the latter and is December 2017. Most of it was owed by private
used only for redemption of T-bills /dated businesses which borrowed at attractive rates from
securities raised under this scheme. foreign lenders. To be precise, 78.8% of the total
external debt ($404.5 billion) was owed by non-
Internal loans that make up for the bulk of public governmental entities like private companies.
debt are further divided into two broad categories
– marketable and non-marketable debt. While external debt may be denominated in either
▪ Marketable Debt: Dated government securities the rupee or a foreign currency like the U.S. dollar,
(G-Secs) and treasury bills (T-bills) are issued most of India’s external debt is linked to the dollar.
through auctions and fall in the category of This means Indian borrowers will have to pay back
marketable debt. their lenders by first converting their rupees into
▪ Non-marketable Debt: Intermediate treasury dollars. As of December 2017, about 48% of India’s
bills (with a maturity period of 14 days) issued to total external debt was denominated in dollars and
state governments and public sector banks, 37.3% in rupees.
special securities issued to National Small
Savings Fund (NSSF) are classified as non-
QUESTION 8
marketable debt.
Q. Consider the following statements: [2019]
1. Most of India’s external debt is owed by
QUESTION 7 government entities.
Q. Consider the following: [2001] 2. All of India’s external debt is denominated in US
1. Market borrowing dollars.
2. Treasury bills Which of the statements given above is/are
3. Special securities issued to RBI correct?
Which of these is/are components(s) of internal (a) 1 only
debt? (b) 2 only
(a) 1 only (c) Both 1 and 2
(b) 1 and 2 (d) Neither 1 nor 2
(c) 2 only Answer: D
(d) 1, 2 and 3
Answer: D
DEFICIT REDUCTION

EXTERNAL DEBT Government deficit can be reduced by an increase in

taxes or reduction in expenditure. In India, the
Over the years, the Union government has followed government has been trying to increase tax revenue
a considered strategy to reduce its dependence on with greater reliance on direct taxes (indirect taxes
foreign loans in its overall loan mix. Internal debt are regressive in nature – they impact all income
constitutes more than 93% of the overall public groups equally).
debt.

Visit: [Link]
For Any Query Mail us: hello@[Link] or call us at - (+91)-8146207241
18
 Subscribe to our YouTube Channel – CivilsTap by EduTap for free, quality and regular content

There has also been an attempt to raise receipts Select the correct answer using the code given
through the sale of shares in PSUs. However, the below:
major thrust has been towards reduction in (a) 1 and 3 only
government expenditure. This could be achieved (b) 2 and 3 only
through making government activities more (c) 1 only
efficient through better planning of programmes (d) 1, 2, 3 and 4
and better administration. Answer: A

The other way is to change the scope of the

government by withdrawing from some of the FISCAL RESPONSIBILITY AND BUDGET
areas where it operated before. Cutting back MANAGEMENT ACT, 2003
government programmes in vital areas like
In a multi-party parliamentary system, electoral
agriculture, education, health, poverty alleviation,
concerns play an important role in determining
etc. would adversely affect the economy.
expenditure policies. A legislative provision, it is
Governments in many countries run huge deficits argued, that is applicable to all governments –
present and future – is likely to be effective in
forcing them to eventually put in place self-imposed
keeping deficits under control.
constraints of not increasing expenditure over pre-
determined levels. These will have to be examined
The enactment of the FRBMA, in August 2003,
keeping in view the above factors.
marked a turning point in fiscal reforms, binding the
government through an institutional framework to
QUESTION 9 pursue a prudent fiscal policy.
Q. In the context of governance, consider the
following: [2010] The central government must ensure
1. Encouraging Foreign Direct Investment inflows intergenerational equity and long-term macro-
2. Privatization of higher educational Institutions economic stability by achieving sufficient revenue
3. Down-sizing of bureaucracy surplus, removing fiscal obstacles to monetary policy
4. Selling/offloading the shares of Public Sector and effective debt management by limiting deficits
Undertakings and borrowing. The rules under the Act were notified
Which of the above can be used as measures to with effect from July, 2004.
control the fiscal deficit in India?
(a) 1, 2 and 3 The FRBM Act made it mandatory for the
(b) 2, 3 and 4 government to place the following along with the
(c) 1, 2 and 4 Union Budget documents in Parliament annually:
(d) 3 and 4 only
Answer: B 1. Medium Term Fiscal Policy Statement: It is a
statement presented to the Parliament under
Section 3(2) of the Fiscal Responsibility and
QUESTION 10
Budget Management (FRBM) Act, 2003, which
Q. There has been a persistent deficit budget year
sets out three-year rolling targets for five
after year. Which of the following actions can be
specific fiscal indicators in relation to GDP at
taken by the government to reduce the deficit?
market prices, namely, (i) Revenue Deficit (ii)
[2015-I]
effective revenue deficit, (iii) Fiscal Deficit, (iv)
1. Reducing revenue expenditure
Tax to GDP ratio and (v) Total outstanding Debt
2. Introducing new welfare schemes
as percentage of GDP at the end of the year.
3. Rationalizing subsidies
2. Macroeconomic Framework Statement: It is a
4. Expanding industries
statement presented to the Parliament at the
Visit: [Link]
For Any Query Mail us: hello@[Link] or call us at - (+91)-8146207241
19
 Subscribe to our YouTube Channel – CivilsTap by EduTap for free, quality and regular content

time of Union Budget under Section 3(5) of the economic stability provided that they can be
Fiscal Responsibility and Budget Management financed in a sustainable manner.
Act, 2003 and the rules made thereunder and
contains an assessment of the growth prospects
Intergenerational Equity of Debt: The
of the economy with specific underlying
assumptions. It contains an assessment government borrowing represents an
regarding the expected GDP growth rate, fiscal alternative to increase current taxation.
balance of the Central Government and the Politicians and voters would rarely (perhaps
external sector balance of the economy. The never) accept higher taxation to cover their
statement is submitted annually. current spending. The intergenerational
3. Fiscal Policy Strategy Statement: It is a equity of public debt means that it is not the
statement presented to the Parliament at the future generations, but those who receive
time of Union Budget Presentation under
the public goods and services that should
Section 3(4) of the Fiscal Responsibility and
Budget Management Act, 2003, and it outlines pay for them.
the strategic priorities of Government in the
fiscal area for the ensuing financial year relating Fiscal policy: The policy of the government
to taxation, expenditure, lending and regarding the level of government spending and
investments, administered pricing, borrowings transfers and the tax structure.
and guarantees. The Statement explains how
the current policies are in conformity with FRBM REVIEW COMMITTEE
sound fiscal management principles and gives
the rationale for any major deviation in key The FRBM Review Committee (Chairperson: Mr.
fiscal measures. In essence, it presents the N.K. Singh) submitted its report in January 2017. The
strategy to be adopted by the Government in Committee proposed a draft Debt Management and
moving towards the FRBM targets. Fiscal Responsibility Bill, 2017 to replace the Fiscal
Responsibility and Budget Management Act, 2003
Several years have passed since the FRBM Act was (FRBM Act). Key recommendations of the
enacted, but the Government of India has not been Committee and features of the draft Bill are
able to achieve targets set under it. The Act has been summarised below.
amended several times. In May 2016, the
government set up a committee under NK Singh to ▪ Debt to GDP ratio: The Committee suggested
review the FRBM Act. using debt as the primary target for fiscal policy.
A debt to GDP ratio of 60% should be targeted
KEY DEFINITION with a 40% limit for the centre and 20% limit for
the states. The targeted debt to GDP ratio should
Macroeconomic Macroeconomic
Stability: be achieved by 2023. This ratio is expected to be
stability exists when key economic around 70% in 2017.
relationships are in balance—for example, ▪ To achieve the targeted debt to GDP ratio, it
between domestic demand and output, the proposed yearly targets to progressively reduce
balance of payments, fiscal revenues and the fiscal and revenue deficits till 2023.
expenditure, and savings and investment.
These relationships, however, need not
necessarily be in exact balance. Imbalances
such as fiscal and current account deficits or
surpluses are perfectly compatible with
Visit: [Link]
For Any Query Mail us: hello@[Link] or call us at - (+91)-8146207241
20
 Subscribe to our YouTube Channel – CivilsTap by EduTap for free, quality and regular content

fiscal implications, or (iii) decline in real output

growth of at least 3% below the average of the
previous four quarters. These deviations cannot
be more than 0.5% of GDP in a year.
QUESTION 11
Q. Fiscal Responsibility and Budget Management
Act (FRBMA) concerns: [2006]
▪ Debt indicates the total outstanding liabilities of (a) Fiscal Deficit only
the government, while the fiscal deficit indicates (b) Revenue deficit only
new borrowings made in the year, and the (c) Both fiscal deficit and revenue deficit
revenue deficit indicates what part of these new (d) Neither fiscal deficit nor revenue deficit
borrowings have been used to cover revenue Answer: C
expenses.
▪ Fiscal Council: The Committee proposed to
create an autonomous Fiscal Council with a GST: ONE NATION, ONE TAX, ONE
Chairperson and two members appointed by the
centre. To maintain its independence, it
MARKET (LINKED TO TAX
proposed a non-renewable four-year term for REVENUE)
the Chairperson and members. Further, these
people should not be employees in the central
Goods and Services Tax (GST) is the single
or state governments at the time of
comprehensive indirect tax, operational from 1 July
appointment.
2017, on supply of goods and services, right from the
▪ Role of the Council: The role of the Council
manufacturer/ service provider to the consumer.
would include: (i) preparing multi-year fiscal
forecasts, (ii) recommending changes to the
It is a destination-based consumption tax with
fiscal strategy, (iii) improving quality of fiscal
facility of Input Tax Credit in the supply chain. It is
data, (iv) advising the government if conditions
applicable throughout the country with one rate for
exist to deviate from the fiscal target, and (v)
one type of goods/service. It has amalgamated a
advising the government to take corrective
large number of Central and State taxes and cesses.
action for non-compliance with the Bill.
It has replaced large number of taxes on goods and
▪ Deviations: The Committee noted that under the
services levied on production/sale of goods or
FRBM Act, the government can deviate from the
provision of service.
targets in case of a national calamity, national
security or other exceptional circumstances
As there have been a number of intermediate
notified by it. Allowing the government to notify
goods/services, which were manufactured/provided
these grounds diluted the 2003 Act. The
in the economy, the pre-GST tax regime imposed
Committee suggested that grounds in which the
taxes not on the value added at each stage but on
government can deviate from the targets should
the total value of the commodity/service with
be clearly specified, and the government should
minimal facility of utilisation of Input Tax Credit
not be allowed to notify other circumstances.
(ITC). The total value included taxes paid on
▪ Further, the government may be allowed to
intermediate goods/services. This amounted to
deviate from the specified targets upon the
cascading of tax.
advice of the Fiscal Council in the following
circumstances: (i) considerations of national
Under GST, the tax is discharged at every stage of
security, war, national calamities and collapse
supply and the credit of tax paid at the previous
of agriculture affecting output and incomes, (ii)
stage is available for set off at the next stage of
structural reforms in the economy resulting in
supply of goods and/or services. It is thus effectively
Visit: [Link]
For Any Query Mail us: hello@[Link] or call us at - (+91)-8146207241
21
 Subscribe to our YouTube Channel – CivilsTap by EduTap for free, quality and regular content

a tax on value addition at each stage of supply.

In view of our large and fast growing economy, it

addresses to establish parity in taxation across the
country, and extend principles of ‘value- added
taxation’ to all goods and services.

It has replaced various types of taxes/cesses, levied

by the Central and State/UT Governments. Some of
the major taxes that were levied by Centre were
Central Excise Duty, Service Tax, Central Sales Tax,
and Cesses. The major State taxes were VAT/Sales
Tax, Entry Tax, Luxury Tax, Octroi, Entertainment
Tax, Taxes on Advertisements, Taxes on Lottery
/Betting/ Gambling, State Cesses on goods etc.
These have been subsumed in GST.

Five petroleum products have been kept out of GST

for the time being but with passage of time, they will
get subsumed in GST. State Governments will
continue to levy VAT on alcoholic liquor for human
consumption. Tobacco and tobacco products will
attract both GST and Central Excise Duty.

GST has simplified the multiplicity of taxes on goods

and services. The laws, procedures and rates of
taxes across the country are standardised. It has
facilitated the freedom of movement of goods and
services and created a common market in the
country. It is aimed at reducing the cost of business
operations and cascading effect of various taxes on
consumers. It has also reduced the overall cost of
production, which will make Indian
products/services more competitive in the domestic
and international markets. It will also result into
higher economic growth as GDP is expected to rise
by about 2%. Compliance will also be easier as all tax
payment related services like registration, returns,
payments are available online through a common
portal [Link]. It has expanded the tax base,
introduced higher transparency in the taxation
system, reduced human interface between
Taxpayer and Government and is furthering ease of
doing business.

Visit: [Link]
For Any Query Mail us: hello@[Link] or call us at - (+91)-8146207241
22
 Subscribe to our YouTube Channel – CivilsTap by EduTap for free, quality and regular content

(d) Neither 1 nor 2

MCQS FOR PRACTICE
Q5. If we deduct interest payments from the
Q1. Through which of the following sources can the Fiscal deficit we arrive at the concept of
government finance its fiscal deficit? (a) Revenue Deficit.
1. net borrowing at home (b) Primary Deficit.
2. borrowing from abroad (c) Effective Revenue Deficit.
3. borrowing from RBI (d) Budget Deficit.
Select the correct answer using the code given
below:
(a) 1 and 3 only
(b) 2 only
(c) 1 and 2 only
(d) 1, 2 and 3

Q2. With reference to Goods and Services Tax

(GST), consider the following statements:
1. It is a type of value added tax.
2. The tax under GST regime is imposed at the point
of consumption.
3. It is not applicable on imports of goods and
services.
Which of the statements given above is/are
correct?
(a) 1 and 2 only
(b) 1 only
(c) 2 and 3 only
(d) 1, 2 and 3

Q3. Effective Revenue Deficit is

(a) fiscal deficit minus net interest payments.
(b) total revenue expenditure minus total revenue
receipts.
(c) revenue deficit minus grants for creation of
capital assets.
(d) total government expenditure minus total
government receipts.

Q4. Fiscal Responsibility and Budget Management

(FRBM) Act, 2003 aims at:
1. Reducing revenue deficit every year.
2. Eliminating fiscal deficit completely.
Select the correct answer using the code given
below:
(a) 1 only
(b) 2 only
(c) Both 1 and 2

Visit: [Link]
For Any Query Mail us: hello@[Link] or call us at - (+91)-8146207241
23
 Subscribe to our YouTube Channel – CivilsTap by EduTap for free, quality and regular content

Explanation:
MCQS WITH ANSWER & Goods and Services Tax (GST) refers to the single
EXPLANATION unified tax created by amalgamating a large number
of Central and State taxes presently applicable in
India. The salient features of GST are as under:
Q1. Through which of the following sources can the 1. GST comes under the broad spectrum of what is
government finance its fiscal deficit? known as Value Added Tax which provides for
1. net borrowing at home input credits and taxes only the value addition
2. borrowing from abroad that happened in the process of production /
3. borrowing from RBI provision of service.
Select the correct answer using the code given 2. GST would be applicable on supply of goods or
below: services as against the present concept of tax on
(a) 1 and 3 only the manufacture or on sale of goods or on
(b) 2 only provision of services.
(c) 1 and 2 only 3. GST would be a destination based tax as against
(d) 1, 2 and 3 the present concept of origin based tax. i.e, tax is
Answer: D imposed at the point of consumption.
4. It would be a dual GST with the Centre and the
Explanation: States simultaneously levying it on a common
Fiscal deficit is the difference between the base.
government’s total expenditure and its total receipts 5. The Centre would levy and collect the
excluding borrowing. It indicates total borrowing Integrated Goods and Services Tax (IGST) on all
requirements of the government from all sources. inter-State supply of goods and services. There
will be seamless flow of input tax credit from one
Gross fiscal deficit= Net borrowing at home + State to another. Proceeds of IGST will be
Borrowing from RBI + Borrowing from abroad apportioned among the States.
6. Import of goods or services would be treated as
Net borrowing at home includes that directly inter-State supplies and therefore, would be
borrowed from the public through debt instruments subject to IGST in addition to the applicable
(for example, the various small savings schemes) and customs duties. In other words, all imported
indirectly from commercial banks through Statutory goods will be charged integrated tax (IGST) which
Liquidity Ratio (SLR). is equivalent to Central GST + State GST. This will
bring equality with taxation on local products.
Q2. With reference to Goods and Services Tax
(GST), consider the following statements: Q3. Effective Revenue Deficit is
1. It is a type of value added tax. (a) fiscal deficit minus net interest payments.
2. The tax under GST regime is imposed at the point (b) total revenue expenditure minus total revenue
of consumption. receipts.
3. It is not applicable on imports of goods and (c) revenue deficit minus grants for creation of
services. capital assets.
Which of the statements given above is/are (d) total government expenditure minus total
correct? government receipts.
(a) 1 and 2 only Answer: C
(b) 1 only
(c) 2 and 3 only Explanation:
(d) 1, 2 and 3 Effective Revenue Deficit is the difference between
Answer: A revenue deficit and grants for creation of capital

Visit: [Link]
For Any Query Mail us: hello@[Link] or call us at - (+91)-8146207241
24
 Subscribe to our YouTube Channel – CivilsTap by EduTap for free, quality and regular content

assets. The government introduced the Effective Q5. If we deduct interest payments from the
Revenue Deficit concept from Union Budget 2011- Fiscal deficit we arrive at the concept of
12. From 2012-13 onwards the Effective Revenue (a) Revenue Deficit.
Deficit is being brought in as a fiscal parameter. (b) Primary Deficit.
(c) Effective Revenue Deficit.
Effective Revenue Deficit is the difference between (d) Budget Deficit.
revenue deficit and grants for creation of capital Answer: B
assets. In other words, the Effective Revenue Deficit
excludes those revenue expenditures which were Explanation:
done in the form of grants for creation of capital Fiscal Deficit is the difference between government‘s
assets (GoCA). total expenditure and its total receipts excluding
borrowing whereas primary deficit is a difference
Such grants include the grants given under: Pradhan between fiscal deficit and interest payment.
Mantri Gram Sadak Yojana Accelerated Irrigation
Benefit Programme Jawaharlal Nehru National
Urban Renewal Mission MGNREGA etc. The logic is
clear; these expenses despite being shown in the
accounts as Revenue Expenditures, are involved with
asset creation and cannot be considered completely
'unproductive'.

Q4. Fiscal Responsibility and Budget Management

(FRBM) Act, 2003 aims at:
1. Reducing revenue deficit every year.
2. Eliminating fiscal deficit completely.
Select the correct answer using the code given
below:
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2
Answer: A

Explanation:
Fiscal Responsibility and Budget Management Act
(FRBMA), 2003 concerns with gradual reduction of
both fiscal and revenue deficit.

Targets under FRBMA:

Visit: [Link]
For Any Query Mail us: hello@[Link] or call us at - (+91)-8146207241
25