12
PUBLIC FINANCE
(Fiscal Policy and Government Budget)
QUICK
Fiscal Policy
1. Fiscal Policy: Fiscal policy refers to the policy of the Government under which the instruments of taxation
public expenditure and public borrowing are used to achieve various objectives of economic policy.
2. Objectives: The main objectives of fiscal policy are:
(i) To reduce inequalities of income and wealth.
(ii) To make provision for public goods (roads, bridges, education, health care, street lightening, etc.)
(ii) To attain the level of full employment.
(iv) To promote/accelerate economic growth.
(v) To achieve price stability.
3. Instruments of Fiscal Policy:
A) Public Revenue: Public revenue means income of the Government from taxes and non-tax sources.
Types of Taxes:
(i) Direct Taxes and Indirect Taxes: Direct taxes are imposed on income and wealth whereas indirect taxes are
imposed on goods and services.
(ii) Proportional, Progressive, Regressive and Degressive Taxes:
Proportional Tax: A tax is proportional when the rate of tax remains unchanged.
Progressive Tax: Rate of tax increases as income increases
Regressive Tax: Rate of tax decreases as income increases.
Degressive Tax: Rate of tax increases upto a certain limit and there after remains unchanged.
(B) Public Expenditure: It refers to the expenditure incurred by the Government.
(C) Public Debt: Borrowing by the Government from inside or outside the country.
Redemption of public debt means repayment of debt. Public debt is to be repaid by the Government within the
time limit fixed for its repayment. The various methods of debt redemption are:
(i) Debt Conversion: In this method the debt with high interest rate is converted into new debt when the market
rate of interest falls. The Government borrows at low rate of interest and repays the past debt even before it
matures.
(ii) Budgetary Surplus: A policy of surplus budget may be followed annually for clearing of public debt
gradually instead of creating a fund for its repayment on maturity.
(iii) Terminal Annuities: Under this method the physical authorities clear-off part of public debt on the basis
of terminal annuities into equal annual instalments including interest along with the principal amount.
(iv) Refunding: In this method, there is issue of new bonds and securities by the Government in order to repay
the matured loans.
ISC HANDBOOK OF ECONOMICS 1
,MARKET
(v) Sinking Fund: In this system, the Government establishes a separate fund known as sinking fund. A fixed
amount of money is credited by the Government to this fund every year. By the time one debt matures there is
enough amount in fund to pay-off loans along with the rate of interest.
(vi) Capital Levy: It refers to a very heavy tax on property and wealth. It is a once for all taxes imposed on the
capital assets above the certain value.
(vii) Reduction of Rate of Interest: Sometimes the Government takes statuary decision to reduce the rate of
interest payable on its public debt. The creditors are forced to accept the reduced rate of interest. This method
is normally used by the Government during financial crisis.
(viii) Export Surplus: This method is used to repay the external loan taken by the Government.
(D) Deficit Financing: Deficit financing is defined as financing the budgetary deficit through public loans and
creation of new money. Deficit financing in India means the expenditure which in excess of current revenue
and public borrowing. The Government may cover the deficit in the following ways:
(i) By running down its accumulated cash reserve from RBI.
(ii) Issue of new currency by Government itself.
(iii) Borrowing from Reserve Bank of India (RBI) gives the loans by printing more currency notes.
GOVERNMENT BUDGET
1. Meaning of Budget: Budget is an annual financial statement containing estimates of estimated receipts and
expenditures of the Government for the coming financial year.
2. Objectives of Budget:
(1) There has been phenomenal growth in Government activities and hence public expenditure. This calls for
a definite planning with regard to anticipate revenue and expenditure.
(ii) Budgetary policies are used for allocation of resources in the economy.
(iii) Government budget has to play an important role in reducing inequalities of income and wealth.
(iv). Budgetary policies are used to stabilize price level.
3. Types of Budget:
(i) Union Budget: Union budget is the budget prepared by the Central Government for the country as a whole.
(ii) State Budget: State budget is the budget prepared by the State Government such as the budget of U.P.
Government, budget of West Bengal Government.
The budget is divided into two parts: (A) The revenue budget and (B) Capital budget.
(A) Revenue Budget: Revenue budget comprises of revenue receipts and expenditure met from such revenue.
(i) Revenue receipts include all types of tax and non-tax revenue.
(ii) A tax is a compulsory payment imposed on the persons or companies by the Government to meet the
expenditure incurred on providing common benefits to the people.
(iii) Non-tax revenue consists of income earned by the Government from sources other than tax. e.g., interest,
profit and dividend, fees and fines, special assessment, grants in aid.
(iv) Revenue expenditure includes all types of plan and non-plan expenditures of the Government. Revenue
account covers those items which are recurring in nature and are non- redeemable. They create no liabilities
or involve no sale of assets.
(B) Capital Budget: It comprises of capital receipts and capital expenditures of the Government.
(i) Capital receipts are the receipts of the Government which create liabilities or reduces financial assets for
example-foreign loan or repayment of loan.
ISC HANDBOOK OF ECONOMICS 2
, MARKET
(ii) Capital expenditures refers to those expenditure of the Government which lead to the creation of physical
or financial asset or reduction in the financial liabilities for, e.g., expenditure on building and other
constructions, purchasing machinery, investment in shares, etc.
Balanced Budget: A Government budget is said to be a balanced budget in which Government receipts (revenue
and capital) are shown equal to the Government expenditure, thus
Balanced budget = Estimated Government receipts = Estimated Government expenditure.
Surplus Budget: When Govt. budget receipts are more than Government expenditure in the budget, the budget
is called a surplus budget. In other words, a surplus budget implies a situation where in Government revenue
is in excess of Government expenditure. Thus,
Surplus budget = Estimated Government receipts > Estimated Government expenditure.
A surplus budget shows that the Government is taking away more money than what it is pumping in the
economic system as a result aggregate demand tends to fall which helps in reducing price level. Therefore, in
times of severe inflation a surplus budget is the appropriate budget. But in the case of deflation and recession
surplus budget should be avoided.
Deficit Budget: When Government expenditure exceeds Government receipts in the budget, the budget is said
to be a deficit budget.
Deficit budget = Estimated Government expenditure > Estimated Government revenue
Types of Budget Deficit:
(i) Revenue Deficit: Revenue deficit refers to the excess of total revenue expenditure of the Government over
its total revenue receipts.
Revenue deficit = Total revenue expenditure - Total revenue receipts.
(ii) Fiscal Deficit: Fiscal deficit may be defined as a position where total expenditure of the Government is more
than its sum total of revenue receipts and non-debt capital receipts. Thus,
Fiscal deficit = Total expenditure - Total revenue receipts - Non-debt capital receipts.
(iii) Primary Deficit: It is equal to fiscal deficit reduced by interest payments. It is a measure of budget deficit
which is obtained by deducting interest payments from fiscal deficit.
Primary deficit = Fiscal deficit - Interest payments.
1 MARK
QUESTIONS
A. FILL IN THE BLANKS
1. Budget of Central Government is known as ________
2. The main components of budget are ________ and ________
3. Primary deficit = ________ - ________
4. Fiscal deficit = Total expenditure - ________
5. Budgetary deficit = ________ - ________
ISC HANDBOOK OF ECONOMICS 3
PUBLIC FINANCE
(Fiscal Policy and Government Budget)
QUICK
Fiscal Policy
1. Fiscal Policy: Fiscal policy refers to the policy of the Government under which the instruments of taxation
public expenditure and public borrowing are used to achieve various objectives of economic policy.
2. Objectives: The main objectives of fiscal policy are:
(i) To reduce inequalities of income and wealth.
(ii) To make provision for public goods (roads, bridges, education, health care, street lightening, etc.)
(ii) To attain the level of full employment.
(iv) To promote/accelerate economic growth.
(v) To achieve price stability.
3. Instruments of Fiscal Policy:
A) Public Revenue: Public revenue means income of the Government from taxes and non-tax sources.
Types of Taxes:
(i) Direct Taxes and Indirect Taxes: Direct taxes are imposed on income and wealth whereas indirect taxes are
imposed on goods and services.
(ii) Proportional, Progressive, Regressive and Degressive Taxes:
Proportional Tax: A tax is proportional when the rate of tax remains unchanged.
Progressive Tax: Rate of tax increases as income increases
Regressive Tax: Rate of tax decreases as income increases.
Degressive Tax: Rate of tax increases upto a certain limit and there after remains unchanged.
(B) Public Expenditure: It refers to the expenditure incurred by the Government.
(C) Public Debt: Borrowing by the Government from inside or outside the country.
Redemption of public debt means repayment of debt. Public debt is to be repaid by the Government within the
time limit fixed for its repayment. The various methods of debt redemption are:
(i) Debt Conversion: In this method the debt with high interest rate is converted into new debt when the market
rate of interest falls. The Government borrows at low rate of interest and repays the past debt even before it
matures.
(ii) Budgetary Surplus: A policy of surplus budget may be followed annually for clearing of public debt
gradually instead of creating a fund for its repayment on maturity.
(iii) Terminal Annuities: Under this method the physical authorities clear-off part of public debt on the basis
of terminal annuities into equal annual instalments including interest along with the principal amount.
(iv) Refunding: In this method, there is issue of new bonds and securities by the Government in order to repay
the matured loans.
ISC HANDBOOK OF ECONOMICS 1
,MARKET
(v) Sinking Fund: In this system, the Government establishes a separate fund known as sinking fund. A fixed
amount of money is credited by the Government to this fund every year. By the time one debt matures there is
enough amount in fund to pay-off loans along with the rate of interest.
(vi) Capital Levy: It refers to a very heavy tax on property and wealth. It is a once for all taxes imposed on the
capital assets above the certain value.
(vii) Reduction of Rate of Interest: Sometimes the Government takes statuary decision to reduce the rate of
interest payable on its public debt. The creditors are forced to accept the reduced rate of interest. This method
is normally used by the Government during financial crisis.
(viii) Export Surplus: This method is used to repay the external loan taken by the Government.
(D) Deficit Financing: Deficit financing is defined as financing the budgetary deficit through public loans and
creation of new money. Deficit financing in India means the expenditure which in excess of current revenue
and public borrowing. The Government may cover the deficit in the following ways:
(i) By running down its accumulated cash reserve from RBI.
(ii) Issue of new currency by Government itself.
(iii) Borrowing from Reserve Bank of India (RBI) gives the loans by printing more currency notes.
GOVERNMENT BUDGET
1. Meaning of Budget: Budget is an annual financial statement containing estimates of estimated receipts and
expenditures of the Government for the coming financial year.
2. Objectives of Budget:
(1) There has been phenomenal growth in Government activities and hence public expenditure. This calls for
a definite planning with regard to anticipate revenue and expenditure.
(ii) Budgetary policies are used for allocation of resources in the economy.
(iii) Government budget has to play an important role in reducing inequalities of income and wealth.
(iv). Budgetary policies are used to stabilize price level.
3. Types of Budget:
(i) Union Budget: Union budget is the budget prepared by the Central Government for the country as a whole.
(ii) State Budget: State budget is the budget prepared by the State Government such as the budget of U.P.
Government, budget of West Bengal Government.
The budget is divided into two parts: (A) The revenue budget and (B) Capital budget.
(A) Revenue Budget: Revenue budget comprises of revenue receipts and expenditure met from such revenue.
(i) Revenue receipts include all types of tax and non-tax revenue.
(ii) A tax is a compulsory payment imposed on the persons or companies by the Government to meet the
expenditure incurred on providing common benefits to the people.
(iii) Non-tax revenue consists of income earned by the Government from sources other than tax. e.g., interest,
profit and dividend, fees and fines, special assessment, grants in aid.
(iv) Revenue expenditure includes all types of plan and non-plan expenditures of the Government. Revenue
account covers those items which are recurring in nature and are non- redeemable. They create no liabilities
or involve no sale of assets.
(B) Capital Budget: It comprises of capital receipts and capital expenditures of the Government.
(i) Capital receipts are the receipts of the Government which create liabilities or reduces financial assets for
example-foreign loan or repayment of loan.
ISC HANDBOOK OF ECONOMICS 2
, MARKET
(ii) Capital expenditures refers to those expenditure of the Government which lead to the creation of physical
or financial asset or reduction in the financial liabilities for, e.g., expenditure on building and other
constructions, purchasing machinery, investment in shares, etc.
Balanced Budget: A Government budget is said to be a balanced budget in which Government receipts (revenue
and capital) are shown equal to the Government expenditure, thus
Balanced budget = Estimated Government receipts = Estimated Government expenditure.
Surplus Budget: When Govt. budget receipts are more than Government expenditure in the budget, the budget
is called a surplus budget. In other words, a surplus budget implies a situation where in Government revenue
is in excess of Government expenditure. Thus,
Surplus budget = Estimated Government receipts > Estimated Government expenditure.
A surplus budget shows that the Government is taking away more money than what it is pumping in the
economic system as a result aggregate demand tends to fall which helps in reducing price level. Therefore, in
times of severe inflation a surplus budget is the appropriate budget. But in the case of deflation and recession
surplus budget should be avoided.
Deficit Budget: When Government expenditure exceeds Government receipts in the budget, the budget is said
to be a deficit budget.
Deficit budget = Estimated Government expenditure > Estimated Government revenue
Types of Budget Deficit:
(i) Revenue Deficit: Revenue deficit refers to the excess of total revenue expenditure of the Government over
its total revenue receipts.
Revenue deficit = Total revenue expenditure - Total revenue receipts.
(ii) Fiscal Deficit: Fiscal deficit may be defined as a position where total expenditure of the Government is more
than its sum total of revenue receipts and non-debt capital receipts. Thus,
Fiscal deficit = Total expenditure - Total revenue receipts - Non-debt capital receipts.
(iii) Primary Deficit: It is equal to fiscal deficit reduced by interest payments. It is a measure of budget deficit
which is obtained by deducting interest payments from fiscal deficit.
Primary deficit = Fiscal deficit - Interest payments.
1 MARK
QUESTIONS
A. FILL IN THE BLANKS
1. Budget of Central Government is known as ________
2. The main components of budget are ________ and ________
3. Primary deficit = ________ - ________
4. Fiscal deficit = Total expenditure - ________
5. Budgetary deficit = ________ - ________
ISC HANDBOOK OF ECONOMICS 3
