The government budget is an annual statement of the estimated receipts and expenditure of the government for the coming financial year. It is the most important instrument of fiscal policy through which the government influences the level of aggregate demand, the allocation of resources, the distribution of income, and the stability of the economy. The budget, presented by the finance minister, gives a detailed account of how public money will be raised and how it will be spent.
The objectives of the government budget are the reallocation of resources, reduction of inequalities in the distribution of income and wealth, economic stabilisation, management of public enterprises, and promotion of economic growth. By imposing taxes and subsidies and by undertaking public expenditure, the government influences the pattern of production, the prices of goods, and the incomes of different sections of society.
A budget can be balanced, surplus, or deficit. A balanced budget is one where estimated receipts equal estimated expenditure, a surplus budget has receipts exceeding expenditure, and a deficit budget has expenditure exceeding receipts. In practice, most governments run deficit budgets to finance development and welfare expenditure, and the budget deficit is financed through borrowings.
Revenue receipts are those receipts that do not create a liability or reduce an asset of the government. They are of two types:
Capital receipts are those receipts that either create a liability or reduce an asset of the government, such as borrowings, disinvestment of public sector equity, and recovery of loans.
$$\text{Total Receipts} = \text{Revenue Receipts} + \text{Capital Receipts}$$
Revenue expenditure is expenditure that does not create assets or reduce liabilities, such as payment of salaries, interest on borrowings, subsidies, and pensions.
Capital expenditure is expenditure that creates assets or reduces liabilities, such as construction of roads, bridges, dams, schools, and repayment of loans.
The revenue deficit is the excess of revenue expenditure over revenue receipts:
$$\text{Revenue Deficit} = \text{Revenue Expenditure} - \text{Revenue Receipts}$$
It indicates that the government's current revenue is insufficient to cover its current (revenue) expenditure, and the shortfall is met by borrowing or disinvestment.
The fiscal deficit is the excess of total expenditure over total receipts excluding borrowings:
$$\text{Fiscal Deficit} = \text{Total Expenditure} - (\text{Revenue Receipts} + \text{Non-debt Capital Receipts})$$
$$\text{Fiscal Deficit} = \text{Borrowings} + \text{Other Liabilities}$$
The fiscal deficit is the most comprehensive measure of the government's borrowing requirement. A high fiscal deficit implies high borrowing, which can fuel inflation and burden future generations with debt.
The primary deficit is the fiscal deficit minus interest payments:
$$\text{Primary Deficit} = \text{Fiscal Deficit} - \text{Interest Payments}$$
It measures the fiscal deficit excluding the interest burden on past borrowings, showing how much of the deficit is due to current year's operations rather than past debt.
Deficit financing refers to the financing of the budget deficit through borrowing from the central bank, which amounts to printing new money. It is inflationary because it increases the money supply without a corresponding increase in output. The national debt is the total accumulated borrowings of the government. Governments borrow by issuing bonds, treasury bills, and through external loans.
Fiscal policy uses the budget to influence aggregate demand. During a recession, the government can increase expenditure and cut taxes (expansionary fiscal policy) to raise aggregate demand. During inflation, it can cut expenditure and raise taxes (contractionary fiscal policy) to reduce aggregate demand.
$$\text{Change in Aggregate Demand} = \text{Multiplier} \times \text{Change in Government Expenditure}$$
A balanced budget increase in government expenditure (financed entirely by taxes) still raises income by the full amount of the increase because the multiplier for government expenditure (1/(1-b)) is larger than the tax multiplier (b/(1-b)). The balanced budget multiplier is equal to one:
$$\Delta Y = \Delta G \times \frac{1}{1-b} - \Delta T \times \frac{b}{1-b} = \Delta G \text{ when } \Delta G = \Delta T$$
| Basis | Revenue Receipts | Capital Receipts |
|---|---|---|
| Nature | No liability created, no asset reduced | Liability created or asset reduced |
| Examples | Taxes, fees, dividends, interest | Borrowings, disinvestment, loan recovery |
| Basis | Revenue Expenditure | Capital Expenditure |
|---|---|---|
| Effect on assets | No asset created, no liability reduced | Asset created or liability reduced |
| Examples | Salaries, interest, subsidies, pensions | Roads, dams, repayment of loans |
| Deficit | Formula | Meaning |
|---|---|---|
| Revenue Deficit | Revenue Expenditure - Revenue Receipts | Gap in current income and current spending |
| Fiscal Deficit | Total Expenditure - (Revenue Receipts + Non-debt Capital Receipts) | Total borrowing requirement |
| Primary Deficit | Fiscal Deficit - Interest Payments | Fiscal deficit net of interest burden |
The government budget is the principal instrument through which the government allocates resources, redistributes income, stabilises the economy, and promotes growth. The classification of receipts and expenditure into revenue and capital categories, and the calculation of the revenue, fiscal, and primary deficits, provide the analytical framework for evaluating fiscal policy. The fiscal deficit measures the total borrowing requirement of the government and is the most widely watched indicator of the fiscal health of the economy. Understanding how taxes, subsidies, and government expenditure influence aggregate demand, and how deficits are financed, completes the macroeconomic picture and connects directly with the determination of income and the open economy.