Government Budget is a financial estimate of government expenditure and revenue for the coming year. Government Budget is a hotly debated topic because of its importance and significance of fund allocation. It is also debated because of Deficit Budget Indian government usually follow in any fiscal year. In this article we will understand basics of Government Budget and deficit budgeting and why it is bad for economy.
Meaning of Government Budget:
The government prepares a budget outlining the expected revenues and expenditures for a fiscal year. Fiscal year spans two calendar years in India, starting from April 1 and concluding on March 31.
Budget is crafted by government entities at various levels, including central, state, and local administrations, with a focus on policies aimed at promoting the welfare of the populace.
Constitutional Provision for Government Budget
Article 112 of the Indian Constitution labels each year’s Union Budget as the Annual Financial Statement (AFS). It outlines the projected government expenditures and revenues for a fiscal year, commencing on April 1 and ending on March 31 of the subsequent year.
Additionally, the Budget incorporates the following elements: formulation of economic and financial policies for the upcoming year, including proposals for taxation, revenue forecasts, spending plans, and the introduction of new initiatives or projects; projections of revenue and capital receipts; strategies for revenue generation; estimates of expenditure; breakdown of actual receipts and expenditures from the previous fiscal year, along with explanations for any deficits or surpluses incurred during that period.
Component of Government Budget:
There are two major components of a budget.
Revenue Budget
Revenue Receipts:
It consist of income received by the government that does not directly impact its assets or liabilities. These receipts include taxes such as excise duty and income tax, as well as non-tax revenue like dividends, profits, and interest.
Revenue Expenditure:
It refers to government spending that does not affect its assets or liabilities. Examples of such expenditure include salaries, interest payments, pensions, and administrative costs.
Capital Budget
Capital Receipts:
It encompass receipts that either reduce the government’s assets or increase its liabilities. These receipts include proceeds from asset sales (disinvestment) such as shares in public companies, and funds obtained through borrowing or repayment of loans by states.
Capital Expenditure:
It involves the creation of assets or reduction of liabilities by the government. This includes long-term investments in infrastructure such as roads and hospitals, as well as financial assistance provided to states in the form of loans or repayments for their borrowings.
What is the process of passing government budget, learn from here.
Issues with Budgeting Process in India
Transparency Concerns:
Critics have pointed out a lack of transparency in India’s budgeting process, highlighting limited opportunities for public participation and scrutiny. To ensure efficient allocation of public funds, there is a pressing need for greater openness and accountability.
Data and Analysis Shortcomings:
India’s budgeting process often suffers from insufficient data and analysis, resulting in poorly informed decision-making. Improving data collection and analysis is essential to support evidence-based budgeting and enhance policy-making quality.
Centralization Challenges:
The budgeting process in India exhibits heavy centralization, leading to limited integration of state and local governments. This situation can cause discrepancies between local needs and central priorities, as well as redundant efforts and resource inefficiencies.
Long-Term Planning Neglect:
India’s budgeting process often concentrates on short-term objectives, neglecting long-term planning and strategic thinking. This approach results in a lack of coherence and continuity in government policies and programs, hindering opportunities for sustainable and inclusive economic growth.
Outcome Emphasis Deficiency:
India’s budgeting process tends to prioritize inputs and outputs over outcomes, obscuring the actual impact of government programs and policies. There’s a crucial need to emphasize measuring and evaluating outcomes to ensure the effectiveness of government spending in achieving its objectives.
2nd ARC Suggestion on Budgeting:
- Ensure budget estimates are factually grounded and address any discrepancies between estimates and actuals annually, striving to minimize them. Implement thorough audits of these assumptions.
- Replace the traditional approach of combining information from various sources to formulate budget estimates with a “top-down” method, setting specific spending limits for each organization or agency instead of relying solely on trend analysis.
- Exercise caution in including schemes or projects in the budget, only incorporating those deemed absolutely necessary. Avoid token provisions and spreading resources thinly across numerous projects, emphasizing strict adherence to budget guidelines.
- Cease the practice of spontaneously announcing projects or plans during budget presentations, significant national events, or visits by dignitaries. Reserve such announcements for inclusion in annual plans or mid-term evaluations as deemed essential.
Budget Deficit:
When expenditures exceed revenue, causing a country’s financial health to suffer, it results in a budget deficit. The term “budget deficit” typically refers to overall economic spending rather than the budgets of businesses or individuals. The national debt accumulates from these budget deficits.
Types of Budget Deficit:
There are three types of budget deficit. They are
- Fiscal Deficit
- Revenue Deficit
- Primary Deficit
Fiscal Deficit: The fiscal deficit occurs when total expenditures exceed total receipts, excluding borrowings, within a year. It represents the amount the government must borrow to cover all expenses. Higher fiscal deficits result in increased borrowing. Fiscal deficit aids in recognizing the shortfall encountered by the government in meeting expenditures due to insufficient funds.
Fiscal deficit = Total expenditures – Total receipts excluding borrowings
Revenue Deficit: Revenue expenditure represents the surplus of total revenue expenditure over total revenue receipts. Put differently, the deficit between revenue receipts and revenue expenditure is termed as revenue deficit. Revenue deficit indicates to economists that the government’s revenue falls short of covering the expenses necessary for essential government functions.
Revenue deficit = Total revenue expenditure – Total revenue receipts
Primary Deficit: The primary deficit is calculated by subtracting the interest payments on previous borrowings from the fiscal deficit of the current year. In essence, it represents the borrowing requirement excluding interest payments. Consequently, the primary deficit indicates the expenses covered by government borrowings without accounting for interest payments. A zero deficit implies the need to borrow solely to settle pending interest payments.
Primary deficit = Fiscal deficit – Interest payments
Issues with Budget Deficit:
Crowding Out:
Crowding out can arise due to a budget deficit. When the government seeks to boost spending, it must borrow funds from the loanable funds market to finance its initiatives. However, this market is utilized by private businesses for their investments as well. Consequently, the government and private businesses compete for loans within the same market. Inevitably, the government tends to secure the majority of loans, leaving fewer resources for private businesses. This leads to a rise in interest rates for the limited available loans, a phenomenon referred to as crowding out.
Debt Default:
Budget deficits can also lead to debt defaults. When the government consistently runs substantial deficits over an extended period, it can eventually result in catastrophic economic consequences. For instance, if the United States persists in running budget deficits, it can address them through either raising taxes or continuing to borrow funds. However, raising taxes is often unpopular and may discourage the government from pursuing this course of action, leaving borrowing as the alternative option.
Increased Public Debt:
Continual budget deficits may cause an increase in public debt, imposing higher taxes and reduced public services on future generations.
Higher Interest Rates:
Elevated government borrowing can lead to higher interest rates, increasing the cost of borrowing for businesses and consumers, which could potentially dampen economic growth.
Inflation:
Printing more money to finance budget deficits can cause inflation, which diminishes consumers’ purchasing power and has adverse effects on the overall economy.
In summary, budget deficits have benefits such as providing economic stimulus, investing in infrastructure, and implementing countercyclical fiscal policy. However, they also bring drawbacks like rising public debt, increased interest rates, and inflation. Policymakers can achieve sustainable economic growth and fiscal stability by thoughtfully weighing these factors and striking the appropriate balance between the advantages and disadvantages of budget deficits.