Budget Fundamentals

Module 3
 What is a budget
• Almost all organizations—governmental,
commercial, or not-for-profit—operate using
some form of budgeting
• Budget is to ensure that resources are used in
accordance with management's intentions
• Facilitate obtaining results of operations
consistent with management's plans.
• In the governmental environment, budgets
take on greater importance, because they
provide the framework in which public
resources are spent.
• Budget is prepared by governments at all levels, i.e.
central government, state government and local
government, prepares its respective annual budget.
• Estimated expenditures and receipts are planned as per
the objectives of the government.
• In India, Budget is presented in the parliament on such a
day, as the President may direct.
• By convention, it is prepared on the last working day of
February each year. (now it is FEB First)
• Our Fiscal year is from April to March
• It is required to be approved by the parliament, before
it can be implemented.
 Government budgets

• Government budgets are of the following

types
 Union Budget : The union budget is the
budget prepared by the central
government for the country as a whole.
• State Budget : In countries like India, there
is a federal system of government thus
every state prepares its own budget
• Central Government is constitutionally required to
lay an “annual financial statement” before both the
houses of Parliament.
• This statement is conventionally called
Government Budget.
• In India, every year Central (or Union) Budget for
the coming financial year is presented by the
Union Finance Minister in the Lok Sabha normally
on the last working day of the month of February.
• It gives item wise details of government
receipts and expenditure for three
consecutive years, i.e., Actuals for the
preceding year. Budget estimates for the
current year. Revised estimates for the current
year and Budget estimates for the ensuing
(coming) year .
 2016-17 2017-18 2017-18 2018-19
Actuals Budget Revised Budget
Rs crore Estimate estimate estimate
Rs crore Rs crore Rs crore
1. Revenue Receipts 1374203 1515771 1505428 1725738
2. Tax Revenue 1101372 1227014 1269454 1480649
3. Non-Tax Revenue
272831 288757 235974 245089

4. Capital Receipts 600991 630964 712322 716475

5. Recovery of Loans 17630 11933 17473 12199
6. Other Receipts 72500
7. Borrowings and Other 47743 100000 80000
Liabilities 535618 546531 594849 624276

8. Total Receipts (1+4) 1975194 2146735 2217750 2442213

9. Total Expenditure (10+13) 1975194 2146735 221775 2442213

10.On Revenue Account of 1690584 1836934 1944305 2141772
which
11. Interest Payments 480714 523078 530843 575795
12.Grants in Aid for creation 165733 195350 189245 195345
of capital assets
13.On Capital Account 284610 309801 273445 300441

14. Revenue Deficit (10-1) 316381 321163 438877 416034

16. Fiscal Deficit [9-(1+5+6)] 535618 546531 594849 624276

17. Primary Deficit (16-11) 54904 23453 64006 48481

 Importance of Budget
• why the budget is the most important financial event of the
year and why it creates a hype?
• Expectations of cuts in income tax and corporate tax rates and
some sector-specific announcements
• The budget is an expression of the government’s public
policy
• It informs the public as to how the government plans to
earn and spend
• the budget reflects the government’s balance sheet.
• It tells you the current state of the country’s economy
 Objectives of Government
Budget
• Some of the important objectives of government
budget are
• 1. Reallocation of Resources
• 2. Reducing inequalities in income and wealth
• 3. Economic Stability
• 4. Management of Public Enterprises
• 5. Economic Growth
• 6. Reducing regional disparities
Objectives
 Reallocation of Resources

• Budgetary policy aims to reallocate resources in

accordance with the economic (profit maximisation)
and social (public welfare) priorities of the country.
• Government can influence allocation of resources
through
Tax concessions or subsidies
• To encourage investment, government can give tax
concession, subsidies etc. to the producers
• Government discourages the production of harmful
consumption good through heavy taxes
Directly producing goods and services:
• If private sector does not take interest, government
can directly undertake the production
 Reducing inequalities in
income and wealth

• Economic inequality is an inherent part of every economic

system
• Government aims to reduce inequalities of income and wealth,
through its budgetary policy.
• Government aims to influence distribution of income by imposing
taxes on the rich and spending more on the welfare of the poor.
• It will reduce income of the rich and raise standard of living of the
poor, thus reducing inequalities in the distribution of income
 Economic Stability

• Government budget is used to prevent business fluctuations

of inflation or deflation to achieve the objective of economic
stability
• The government aims to control the different phases of
business fluctuations through its budgetary policy
• Policies of surplus budget during inflation and deficit budget
during deflation helps to maintain stability of prices in the
economy
 Management of Public
Enterprises
• There are large numbers of public sector
industries, which are established and
managed for social welfare of the public
• Budget is prepared with the objective of
making various provisions for managing
such enterprises and providing those
financial help
 Economic Growth
• The growth rate of a country depends on
rate of saving and investment.
• For this purpose, budgetary policy aims to
mobilise sufficient resources for
investment in the public sector.
• The government makes various provisions
in the budget to raise overall rate of
savings and investments in the economy
 Reducing regional disparities:

• The government budget aims to reduce

regional disparities through its taxation
and expenditure policy
• Encouraging setting up of production
units in economically backward regions
 Budget Classification

• A budget can be of 3 types:

 Balanced Budget: When government receipts are
equal to the government expenditure, it is called a
balanced budget.
 Deficit Budget: When government expenditure
exceeds government receipts, the budget is said
to be deficit. A deficit can be of 3 types, Revenue,
Fiscal and primary deficit
• Surplus: When government receipts are more than
expenditure
Budget Component
Components of budget refers to structure of the budget.
• Two main components of Budget are:
Revenue Budget and Capital Budget

• Revenue budget deals with the revenue aspect of the

government budget- which consists of Revenue
Receipts and Revenue Expenditures
• It explains how revenue is generated or collected by the
government and how it is allocated among various
expenditure heads

• Capital Budget deals with the capital aspect of the

government budget and it consists of Capital receipts
and capital expenditure
 Revenue Receipt
• Revenue receipts refer to those receipts which
neither create any liability nor cause any reduction in the assets
of the government.
• They are regular and recurring in nature and
government receives them in its normal course of activities
• A receipts Is revenue receipt, if it satisfies the following two
essential conditions
• The receipts must not create a liability for the government.
• The receipts must not cause decrease in the assets
 Sources Of Revenue Receipts
• Tax Revenue
Tax Revenue refers to sum total of receipts from
taxes and other duties imposed by the
government
• Non-Tax Revenue
Non Tax revenue refers to receipts of the
government from all sources other than those of
tax receipts
 Tax Revenue
• Tax revenue consists of the income received from different taxes and other
duties levied by the government. It is a major source of public revenue.
Every citizen, by law is bound to pay them and non-payment is punishable.
• Taxes are of two types, viz., Direct Taxes and Indirect Taxes.
• Direct taxes are those taxes which have to be paid by the person on whom
they are levied. Its burden can not be shifted to some one else. E.g.
Income tax, property tax, corporation tax, estate duty, etc. are direct taxes.
There is no direct benefit to the tax payer.
• Indirect taxes are those taxes which are levied on commodities and
services and affect the income of a person through their consumption
expenditure. Here the burden can be shifted to some other person. E.g.
Custom duties, sales tax, services tax, excise duties, etc. are indirect taxes.
 Non-Tax Revenue
• Apart from taxes, governments also receive revenue from other non-tax
sources.
The non-tax sources of public revenue are as follows :-
• Fees : The government provides variety of services for which fees have to
be paid. E.g. fees paid for registration of property, births, deaths, etc.
• Fines and penalties : Fines and penalties are imposed by the government
for not following (violating) the rules and regulations.
• Profits from public sector enterprises : Many enterprises are owned and
managed by the government. The profits receives from them is an
important source of non-tax revenue. For example in India, the Indian
Railways, Oil and Natural Gas Commission, Air India, Indian Airlines, etc.
are owned by the Government of India. The profit generated by them is a
source of revenue to the government.
• Gifts and grants : Gifts and grants are received by the government when
there are natural calamities like earthquake, floods, famines, etc. Citizens
of the country, foreign governments and international organisations like
the UNICEF, UNESCO, etc. donate during times of natural calamities.
 Revenue expenditure
• Revenue expenditure is the expenditure incurred for the
routine, usual and normal day to day running of
government departments and provision of various
services to citizens.
• Usually expenditures that do not result in the creations
of assets are considered revenue expenditure.
• It is recurring in nature.
• It is incurred on normal functioning of the government.
• Examples: Payment of salaries, pensions, interests
 . Expenses included in Revenue
Expenditure
In general revenue expenditure includes following
• Expenditure by the government on consumption of goods and
services.
• Expenditure on agricultural and industrial development, scientific
research, education, health and social services.
• Expenditure on defence and civil administration.
• Expenditure on exports and external affairs.
• Grants given to State governments even if some of them may be
used for creation of assets.
• Payment of interest on loans taken in the previous year.
• Expenditure on subsidies.
 Capital receipts
• Receipts which create a liability or result in a
reduction in assets are called capital receipts.
They are obtained by the government by raising
funds through borrowings, recovery of loans and
disposing of assets.
• A receipt is a capital receipt if it satisfies any one
of the two conditions
• The receipt must create a liability for the government
• The receipts must cause a decrease in the assets
 Sources of capital receipts
The main items of Capital receipts (income) are :-
• Loans raised by the government from the public through the sale of
bonds and securities. They are called market loans.
• Borrowings by government from RBI and other financial institutions
through the sale of Treasury bills.
• Loans and aids received from foreign countries and other
international Organisations like International Monetary Fund (IMF),
World Bank, etc.
• Receipts from small saving schemes like the National saving
scheme, Provident fund, etc.
• Recoveries of loans granted to state and union territory
governments and other parties
• Proceeds from disinvestment.
 Capital expenditure
• Any projected expenditure which is incurred for creating asset
with a long life is capital expenditure.
• Thus, expenditure on land, machines, equipment, irrigation
projects, oil exploration and expenditure by way of
investment in long term physical or financial assets are capital
expenditure
 Development and non development
expenditure
Budget Expenditure can also be classified as
Developmental and Non-Developmental Expenditure.
1) Developmental Expenditure: It refers to the expenditure which is
directly related to economic and social development of the
country. For example, expenditure on education, health, social
welfare etc. It adds to the flow of goods and services in the
economy.

2 )Non Developmental Expenditure: It refers to the expenditure which

is incurred on the essential general services of the government. For
example, expenditure on defence, administrative services, police,
justice etc.
It does not directly contribute to economic development, but it
indirectly helps in the development
 Measures of Government dficits
Budgetary deficit is defined as the excess of
total estimated over total estimated revenue.
When the government spends more than it
collects, then it incurs a budgetary deficit.
With reference to budget of Indian government, budgetary
deficit can be of 3 types:
• Revenue Deficit
• Fiscal Deficit
• Primary Deficit
 Revenue Deficit
• Revenue Deficit is concerned with the revenue expenditures
and receipts of the government.

• It refers to excess of revenue expenditure over revenue

receipts during the given fiscal year.
Revenue Deficit = Revenue Expenditure – Revenue Receipts
• It signifies that government’s own revenue is insufficient to
meet the expenditures on normal functioning of government
departments and provisions for various services
 Implications of Revenue deficit
• It indicates the inability of the government to meet its regular and
recurring expenditure I the proposed budget.
• It implies that government is dissaving, i.e. government is using up
savings of other sectors of the economy to finance its consumption
expenditure.
• It also implies that the government has to make up this deficit from
capital receipts, i.e. through borrowings or Disinvestment
• Use of capital receipts for meeting the extra consumption
expenditure leads to an inflationary situation in the economy.
• Higher borrowings increase the future burden in terms of loan
amount and interest payments.
• A high revenue deficit gives a warning signal to the government to
either curtail its expenditure or increase its revenue.
 Fiscal deficit
• Fiscal deficit presents a more comprehensive view of budgetary
imbalances.
• Fiscal Deficit refers to the excess of total expenditure over total
receipts (excluding borrowings) during the given fiscal year.
• Fiscal Deficit= Total Expenditure – Total Receipts excluding
borrowings
Sources Of Financing Fiscal Deficit
Government has to look out for different options to finance the fiscal
deficit. The main two sources are:
• Borrowings: Fiscal Deficit can be met by borrowings from the
internal sources or external sources.
• Deficit Financing: Government may borrow from RBI against its
securities to meet the fiscal deficit.
• RBI issues new currency for this purpose.
• This process is known as deficit financing.
 Implication of Fiscal deficit
The implications of fiscal deficit

• Debt Trap: Fiscal deficit indicates the total borrowings requirements

of the government. Borrowings not only involve repayment of
principal amount, but also require payment of interest.
• Inflation: Government mainly borrows from Reserve Bank of India
(RBI) to meet its fiscal deficit. RBI prints new currency to meet the
deficit requirements.
• Foreign Dependence: Government also borrows from rest of the
world, which raises its dependence on other countries.
• Hampers the Future growth: Borrowings increase the financial
burden for future generations. It adversely affects the future
growth and development prospects of the country.
 Primary deficit
• Primary deficit refers to difference between fiscal deficit of
the current year and interest payments on the previous
borrowings.
• Primary Deficit = Fiscal Deficit – Interest Payments
Implications Of Primary Deficit:
• It indicates, how much of the government borrowings
are going to meet expenses other than the interest
payments.
• The difference between fiscal deficit and primary deficit
shows the amount of interest payments on the borrowings
made in past.
• So, a low or zero primary deficit indicates that interest
commitments have forced the government to borrow.
 Impact of budget on Business
How does government spending affect businesses?
• The level of government spending has many direct and
indirect effects on all businesses.
• Increased government spending may mean higher
taxes
• Higher taxes reduce the ability of customers to
purchase goods and services, which is likely to reduce
consumer spending
• Consequently increased government spending is often
at the expense of private sector spending and is
therefore potentially harmful to some firms
 government spending affect
businesses
• Taxes finance government spending;
therefore, an increase in government
spending increases the tax burden on
citizens—either now or in the future—which
leads to a reduction in private spending and
investment. This effect is known as crowding
out.
 Impact of budget on Business
• Many businesses rely on government spending
for their revenues and profits.
• For businesses that supply services to the public
sector, demand is directly linked to how much
government is spending. Good examples include:
• Construction firms that build and repair the road
network
• Publishers who supply schools and colleges
• IT systems consultants who develop computer
systems for public sector organisations
• A change in government budgets may impact
private saving.
• The government can implement a policy that
changes the social behaviour in the business
environment.
• For example, the government can levy taxes
on the use of carbon-based fuels and grant
subsidies for businesses that use renewable
energy.
• Imposing on a particular sector more taxes or
duties than are necessary will make the investors
lose interest in that sector.
• Similarly, tax and duty exemptions on a particular
sector trigger investment in it and may generate
growth.
• For example, a high tax rate on imported goods
may encourage local production of the same
goods.
• On the other hand, a high tax rate for raw
materials hampers domestic production.
• Governments get money to spend from taxation.
• Increased spending requires increases in taxes or
borrowing.
• Any tax increase will discourage investment, especially
among entrepreneurs, who take the risks of starting
and managing businesses.
• Increased spending also eats into the limited pool of
savings, leaving less money for private investment.
• Reduction in private investments shrinks production of
goods and services. That, in turn, may lead to the
elimination of jobs.