Government Budgeting

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Relevance: GS III

Recent Budget analysis- Union-budget-2020-21

• According to Article 112 of the Indian Constitution, the Union Budget of a year is referred to as the Annual Financial Statement (AFS).
• It is a statement of the estimated receipts and expenditure of the Government in a financial year (which begins on 01 April of the current year and ends on 31 March of the following year).

In addition to it, the Budget contains:

• Estimates of revenue and capital receipts,
• Ways and means to raise the revenue,
• Estimates of expenditure,
• Details of the actual receipts and expenditure of the closing financial year and the reasons for any deficit or surplus in that year, and
• The economic and financial policy of the coming year, i.e., taxation proposals, prospects of revenue, spending program, and introduction of new schemes/projects.

In Parliament, the Budget goes through six stages:

1. Presentation of Budget
2. General discussion
3. Scrutiny by Departmental Committees
4. Voting on Demands for Grants
5. Passing of Appropriation Bill
6. Passing of Finance Bill.

The Budget Division of the Department of Economic Affairs in the Finance Ministry is the nodal body responsible for preparing the Budget.

Changes Introduced in 2017

• Advancement of Budget presentation to February 1 (earlier presented on the last working day of February)
• Merger of Railway Budget with the General Budget
• Doing away with plan and non-plan expenditure.
  • Plan Expenditure: All expenditures done in the name of planning (i.e. Five Year Plans) were called plan expenditures. For example expenditure on electricity generation, irrigation, and rural developments, construction of roads, bridges, canals, etc.
  • Non-plan Expenditure: All expenditures other than plan expenditure were known as non-plan expenditure. For example interest payments, pensions, statutory transfers to States and Union Territories governments, etc.

Reallocating the resources across the nation

• Through its budgetary policy, every government endeavors to reallocate the resources in line with the economic and social goals of the country namely maximizing profits and public welfare.
• It does so through subsidies or tax concessions and by producing goods and services directly.
• The government also implements heavy taxes in some cases toge the production of goods that will prove harmful when consumed like cigarettes and alcohol.
• In cases where the private sector does not take interest in producing some goods and services, the government can directly jump into production

Bringing down inequalities

• Every economic system is characterized by some kind of inequality.
• This is one of the important challenges a government to tackle.
• The budgetary policy of the government aims to tackle the inequalities in terms of earning and wealth accumulation.
• It aims to distribute the wealth by levying more taxes on the rich and allotting more funds towards welfare projects targeting poor people.

Paving way for economic stability

• One of the main issues addressed by a government budget is preventing the fluctuations in businesses like inflation and deflation and thereby paving the road for economic stability.
• The government does this by presenting a surplus budget at times of inflation and deficit budget at times of deflation to maintain the prices of goods and services in a stable condition in the country’s economy

Managing public enterprises

• In every country, we find a large number of public sector industries that are created and managed for the welfare of the public.
• One of the objectives of the budget is to bring in different provisions to increase the overall rate of savings and investments in the nation’s economy.

Contributing to economic growth

• A country’s growth ultimately depends on the extent of saving and investment.
• To augment these aspects, budgetary policies of a government endeavor to mobilize enough resources for investments in the public sector.
• Hence the government brings in several provisions in the budget to increase the overall rate of savings and investments in the economy.

Addressing the regional disproportion

• Reducing the regional disproportion is one of the chief aims of a government budget.
• This is done through an efficient system of taxation and expenditure policy.
• The government also archives this by setting up manufacturing facilities in the economically unprogressive regions

The significant components of the Budget are the Revenue Budget and Capital Budget

Revenue Budget

Revenue Receipts and Revenue Expenditure together constitute the Revenue Budget. If the revenue expenses are more than the revenue receipts, it indicates a Revenue Deficit.

• Revenue Receipts are receipts that do not have a direct impact on the assets and liabilities of the government. It consists of the money earned by the government through
  • Tax
    • Direct- Income tax, corporation tax
    • Indirect- GST, Excise duty on petroleum products
  • Non-tax sources (such as dividend income, profits, interest receipts)
• Revenue Expenditure includes expenditure for interest payment on the debt, government departments’ operational expenses, granting subsidies, etc.
  • Grants (revenue or capital) given to state governments/Union Territories and other parties are also treated as revenue expenses

Capital Budget 

Capital Budget is a combination of Capital Receipts and Capital Expenditure

• Capital Receipts include funds raised from the public, a loan taken from RBI or foreign government and bodies, sale of treasury bills, disinvestment receipt, and recoveries of loans from the state, Union Territory government, and other parties. 
• Capital Expenditure is the amount spent on assets like building, machinery, etc., investment in shares or other instruments, and granting loans by the central government to the state or Union Territory government.

Zero Based Budgeting:

• It is a method of budgeting in which all expenses are evaluated each time a Budget is made and expenses must be justified for each new period.
• Zero budgeting starts from the zero base and every function of the government is analyzed for its needs and cost. Budget is then made based on the needs

Outcome Budget: 

• It analyses the progress of each ministry and department and what the respected ministry has done with its Budget outlay.
• It measures the development outcomes of all government programs.
• It was first introduced in the year 2005

Gender Budgeting:

• It is defined as a “gender-based assessment of Budgets, incorporating a gender perspective at all levels of the budgetary process and restructuring revenues and expenditures to promote gender equality”.
• It is budgeting for gender equity.
• Through Gender Budget, the Government declares an amount to be spent over the development, Welfare, Empowerment schemes and programs for Females

Balanced, Surplus and Deficit Budget

• Balanced Budget – A government Budget is assumed to be balanced if the expected expenditure is equal to the anticipated receipts for a fiscal year.
• Surplus Budget – A Budget is said to be surplus when the expected revenues surpass the estimated expenditure for a particular business year. Here, the Budget becomes surplus, when taxes imposed, are higher than the expenses.
• Deficit Budget- A Budget is in deficit if the expenditure surpasses the revenue for a designated year.

Revenue Deficit

Meaning

• It is excess of the total revenue expenditure of the government over its total revenue receipts. 
• Alternatively, it is the shortfall of total revenue receipts compared to total revenue expenditure
• Revenue deficit = Total Revenue expenditure – Total Revenue receipts
• It signifies that government’s own earning is insufficient to meet normal functioning of government departments and provision of services.
• The deficit is to be met from capital receipts, i.e., through borrowing and sale of its assets.

Implications

• Reduction of assets:
• Revenue deficit indicates dissaving on government account because the government has to make up the uncovered gap by drawing upon capital receipts either through borrowing or through the sale of its assets (disinvestment).
• Inflationary situation:
• Since borrowed funds from a capital account are used to meet the general consumption expenditure of the government, it leads to an inflationary situation in the economy with all its ills. 
• More revenue deficit:
  • Large borrowings to meet revenue deficit will increase the debt burden due to repayment liability and interest payments.
  • This may lead to larger and larger revenue deficits in the future.
  • Given the same level of fiscal deficit, a higher revenue deficit is worse than a lower one because it implies a higher repayment burden in the future not matched by benefits via investment.

Measures to reduce revenue deficit

• A high revenue deficit warns the government either to curtail its expenditure or increase its tax and non-tax receipts.
• Thus, main remedies are:
  • Government should raise rate of taxes especially on rich people and any new taxes where possible,
  • Government should try to reduce its expenditure and avoid unnecessary expenditure.

Effective revenue deficit

Meaning

• It is the difference between revenue deficit and grants for the creation of capital assets.
• The concept of effective revenue deficit has been suggested by the Rengarajan Committee on Public Expenditure.
• It is aimed to deduct the money used out of borrowing to finance capital expenditure.
• The concept has been introduced to ascertain the actual deficit in the revenue account after adjusting for the expenditure of capital nature.
• Focusing on this will help in reducing the consumptive component of revenue deficit and create space for increased capital spending.

Fiscal Deficit

Meaning

• It is defined as the excess of total budget expenditure over total budget receipts excluding borrowings during a fiscal year. 
• It is the amount of borrowing the government has to resort to, to meet its expenses.
• A large deficit means a large amount of borrowing.
• Fiscal Deficit = Total expenditure – (Revenue receipts + Non-debt creating capital receipts)
• It is a measure of how much the government needs to borrow from the market to meet its expenditure when its resources are inadequate.

How is fiscal deficit met?

• Borrowing from domestic sources
  • The fiscal deficit can be met by borrowing from domestic sources, e.g., public and commercial banks.
  • It also includes tapping of money deposits in provident funds and small saving schemes.
  • Borrowing from public to deal with deficit is considered better than deficit financing because it does not increase the money supply which is regarded as the main cause of rising prices
• Borrowing from external sources
  • For instance, borrowing from World Bank, IMF and Foreign Banks
• Deficit financing (printing of new currency notes)
  • Another measure to meet fiscal deficit is by borrowing from Reserve Bank of India (RBI)
  • Government issues government securities that RBI buys in return for cash from the government.
  • This cash is created by RBI by printing new currency notes against government securities.
  • Thus, it is an easy way to raise funds but it carries with it adverse effects also.
  • Its implication is that money supply increases in the economy creating inflationary trends and other ills that result from deficit financing.
  • Therefore, deficit financing, if at all it is unavoidable, should be kept within safe limits.

Is fiscal deficit advantageous?

• It depends upon its use.
• A fiscal deficit is advantageous to an economy if it creates new capital assets which increase productive capacity and generate a future income stream.
• On the contrary, it is detrimental for the economy if it is used just to cover the revenue deficit.

Implications

• Debt traps
  • The fiscal deficit is financed by borrowing.
  • And borrowing creates the problem of not only (a) payment of interest but also of (b) repayment of loans.
  • As the government borrowing increases, its liability in the future to repay the loan amount along with interest thereon also increases.
  • Payment of interest increases revenue expenditure leading to a higher revenue deficit.
  • Ultimately, the government may be compelled to borrow to finance even interest payments leading to the emergence of a vicious circle and debt trap.
• Inflationary pressure
  • As the government borrows from RBI which meets this demand by printing more currency notes (called deficit financing), it results in the circulation of more money.
  • This may cause inflationary pressure in the economy
• Partial use
  • The entire amount of fiscal deficit, i.e., borrowing is not available for growth and development of the economy because a part of it is used for interest payment.
  • Only primary deficit (fiscal deficit-interest payment) is available for financing expenditure
• Retards future growth
  • Borrowing is financial burden on future generations to pay loan and interest amount which retards the growth of economy

Measures to reduce the fiscal deficit

• Reducing public expenditure
  • Rationalizing subsidies
  • Avoid leakages by increasing vigilance and using new technologies
  • Austerity steps to curtail non-plan expenditure
• Increasing revenue
• Tax base should be broadened
• Tax evasion should be effectively checked
• More emphasis on direct taxes to increase revenue
• Restructuring and sale of shares in public sector units
• Focus on disinvestment

Primary Deficit

Meaning

• It is defined as the fiscal deficit of the current year minus interest payments on previous borrowings.
• Primary deficit = Fiscal deficit – Interest payments
• The borrowing requirement of the government includes not only accumulated debt, but also interest payment on the debt.
• If we deduct ‘interest payment on debt’ from borrowing, the balance is called a primary deficit.

Importance

• It shows how much government borrowing is going to meet expenses other than interest payments.
• It is generally used as a basic measure of fiscal irresponsibility
• Zero primary deficits mean that government has to resort to borrowing only to make interest payments.
• To know the amount of borrowing on account of current expenditure over revenue, we need to calculate primary deficit
• Thus, a lower or zero primary deficits means that while its interest commitments on earlier loans have forced the government to borrow, it has realized the need to tighten its belt

• Fiscal policy is the use of government revenue collection (mainly taxes but also non-tax revenues such as divestment, loans) and expenditure (spending) to influence the economy.
• Through fiscal policy, the government of a country controls the flow of tax revenues and public expenditure to navigate the economy.
• If the government receives more revenue than it spends, it runs a surplus, while if it spends more than the tax and non-tax receipts, it runs a deficit.
• To meet additional expenditures, the government needs to borrow domestically or from overseas.
• Alternatively, the government may also choose to draw upon its foreign exchange reserves or print additional money
• Fiscal policy in India is the guiding force that helps the government decide how much money it should spend to support the economic activity, and how much revenue it must earn from the system, to keep the wheels of the economy running smoothly.
• Attaining rapid economic growth is one of the key goals of fiscal policy formulated by the Government of India.
• Fiscal policy, along with monetary policy, plays a crucial role in managing a country’s economy

Objectives of Fiscal Policy:

• To maintain and achieve full employment
• To stabilize the price level
• To stabilize the growth rate of the economy
• To maintain equilibrium in the Balance of Payments
• To promote the economic development of underdeveloped regions

Thus, fiscal policy of India always has two objectives, namely improving the growth performance of the economy and ensuring social justice to the people

The Fiscal Responsibility and Budget Management (FRBM) Act, 2003 sets a target for the government to establish financial discipline in the economy, improve the management of public funds and reduce fiscal deficit

The main objectives of the act were:

• To introduce transparent fiscal management systems in the country
• To introduce a more equitable and manageable distribution of the country's debts over the years
• To aim for financial stability for India in the long run
• Additionally, the act was expected to give necessary flexibility to the Reserve Bank of India for managing inflation in India

The act provided for certain documents to be tabled in the parliament annually with regards to the country's fiscal policy. This included the following along with the Annual Financial Statement and demands for grants:

• Medium-term Fiscal Policy Statement – This report was to present a three-year rolling target for the fiscal indicators with any assumptions, if applicable.
  • This statement was to further include an assessment of sustainability with regards to revenue deficit and the use of capital receipts of the Government (including market borrowings) for generating productive assets
• Fiscal Policy Strategy Statement – This was a tactical report enumerating strategies and policies for the upcoming Financial Year including strategic fiscal priorities, taxation policies, key fiscal measures and an evaluation of how the proposed policies of the Central Government conform to the 'Fiscal Management Principles' of this act
• Macro-economic Framework Statement – This report was to contain forecasts enumerating the growth prospects of the country. GDP growth, revenue balance, gross fiscal balance, and external account balance of the balance of payments were some of the key indicators to be included in this report.
• Medium-term Expenditure Framework Statement – This is to set forth a three-year rolling target for prescribed expenditure indicators with specification of underlying assumptions and risk involved (vide Section 6 A of the Act amended in 2012)

The Act further required the government to develop measures to promote fiscal transparency and reduce secrecy in the preparation of the Government financial documents including the Union Budget.

Initial targets

• The FRBM rule set a target reduction of fiscal deficit to 3% of the GDP by 2008-09.
• This will be realized with an annual reduction target of 0.3% of GDP per year by the Central government.
• Revenue deficit has to be reduced by 0.5% of the GDP per year with complete elimination by 2008-09
• However, due to the 2007 international financial crisis, the deadlines for the implementation of the targets in the act were initially postponed and subsequently suspended in 2009.
• In 2011, given the process of ongoing recovery, Economic Advisory Council publicly advised the Government of India to reconsider reinstating the provisions of the FRBMA

FRBM Review Committee of 2016

• The Government of India had set up a review committee to evaluate the FRBM Act, 2003 to assess its functionality in the last 12 years.
• The five-member panel announced by the finance minister includes Former Revenue Secretary and Secretary to the Prime Minister of India N. K. Singh as its chairman
• It recommended that the government should target a
  • fiscal deficit of 3% of the GDP in years up to March 31, 2020
  • cut it to 2.8% in 2020-21 and
  • to 2.5% by 2023

Relaxation under the FRBM Act

Under Section 4(2) of the Act, the Centre can exceed the annual fiscal deficit target citing certain grounds. (Escape clause)

The grounds include

• National security, war
• National calamity
• Collapse of agriculture
• Structural reforms
• A decline in real output growth of a quarter by at least three percentage points below the average of the previous four quarters.

The lockdown could cause severe contraction in economic output and the COVID-19 pandemic could be considered a national calamity. Thus, the government has made use of an escape clause.

Instances of the FRBM Norms been Relaxed in the Past

• During the global financial crisis in 2008-09:
• The Centre resorted to a focused fiscal stimulus: tax relief to boost demand and increased expenditure on public projects to create employment and public assets, to counter the fallout of the global slowdown.
• This led to the fiscal deficit climbing to 6.2%, from a budgeted goal of 2.7%.
• Simultaneously, the deficit goals for the States too were relaxed to 3.5% of Gross State Domestic Product(GSDP) for 2008-09 and 4% of GSDP for fiscal 2009-10.
• Budget 2020-21:
  • The reductions in corporate tax were cited as structural reforms that triggered the escape clause.
  • This enabled the government to adjust the fiscal deficit target for 2019-20 to 3.8%, from the budgeted 3.3%.
  • It was also cited that the impact of the reforms would also necessitate a reset for 2020-21: from the earlier deficit target of 3% to 3.5%.

The 15th Finance Commission led by NK Singh has recommended setting up a high-powered intergovernmental group to restructure the Fiscal Responsibility and Budget Management Act and oversee its implementation.