Understanding the Budget formulation

Context: With the economy still hurting from the pandemic, the Budget on February 1 is likely to address concerns around growth, inflation and spending.
Key Points

• The Union Budget will be tabled in Parliament by Finance Minister on February 1.
• A budget is an estimation of revenue and expenses over a specified future period of time. It provides the Government’s blueprint on expenditure, taxes it plans to levy, and other transactions.

Budget components

• There are three major components of the Budget — expenditure, receipts and deficit indicators.

Expenditure

• Total expenditure is an economic term used to describe the total amount of money that is spent by the government in the fiscal year.
• Depending on the manner in which they are defined, the major classifications of expenditure are as follows.

Classification based on impact on assets and liabilities

• Based on their impact on assets and liabilities, total expenditure can be divided into capital and revenue expenditure.

Classification based on the effect on different sectors

Receipts

• The receipts of the Government have three components —revenue receipts, non-debt capital receipts and debt-creating capital receipts.

Deficit

• The gap between revenues and expenditures creates deficits.

Fiscal deficit

• Fiscal deficit means the difference between total expenditure and the sum of revenue receipts and non-debt receipts which implies the difference between total expenditure and total non-debt receipts.
• Fiscal deficits need to be financed by a debt-creating capital receipt.

Primary deficit

• Primary deficit is the difference between fiscal deficit and interest payments on debts incurred in earlier years.

Fiscal policy

• Fiscal policy refers to the use of government spending and tax policies to influence economic conditions, especially macroeconomic conditions, including aggregate demand for goods and services, employment, inflation, and economic growth.
• Fiscal policy is largely based on ideas from John Maynard Keynes, who argued governments could stabilize the business cycle and regulate economic output.
• During a recession, the government may employ expansionary fiscal policy by lowering tax rates to increase aggregate demand and increasing government expenditure to fuel economic growth.
• In the face of mounting inflation and other expansionary symptoms, a government may pursue a contractionary fiscal policy.

Implications of Budget on the economy

• Budget is an important tool of the fiscal policy and thus has a marked impact on the various macroeconomic indicators.

Aggregate demand

• Government expenditure generates aggregate demand in the economy since it involves the purchase of private goods and services by the Government sector.
• Tax and non-tax revenue reduces the net income of the private sector and thereby leads to a reduction in private and aggregate demand.
• Thus reduction in expenditure GDP ratio, reduction in fiscal deficit-GDP ratio or increase in revenue receipt-GDP ratio indicates the Government’s policy to reduce aggregate demand and vice-versa.

Income distribution

• Since different components of expenditure and revenue can have different effects on the income of different classes and social groups, the Budget has implications for income distribution as well.
• Revenue expenditure such as employment guarantee schemes or food subsidies can directly boost the income of the farmer.
• Concession in corporate tax may directly and positively affect corporate incomes.

Fiscal rules

• Fiscal rules provide specific policy targets on the basis of which fiscal policy is formed. In India’s case, its present fiscal rule is guided by the recommendations of the N.K. Singh Committee Report. 
• Allowing for some deviations under exceptional times, it has three policy targets — maintaining a specific level of debt-GDP ratio (stock target), fiscal deficit-GDP ratio (flow target) and revenue deficit-GDP ratio (composition target). 
• These fiscal rules hence call for a cap on expenditure by imposing the above three policy targets.
• Under any situation when the debt-ratio or deficit ratio is greater than the targeted level, expenditure is adjusted in order to meet the policy targets even though there might be a need for an expansionary fiscal policy.

Challenges and recommendations for the upcoming budget

• With the economy still hurting from the pandemic, the Budget will have to address the contemporary challenges of unemployment, low-income levels and low output growth rate even as it tries to curtail the rising inflation rates and fiscal deficit.
• Private consumption, which makes up almost 55% of GDP, is below pre-pandemic levels amid rising household debt, while retail prices have swelled almost a tenth since the COVID-19 outbreak in early 2020.
• While the government will have to increase expenditure and reduce taxes to address the issues of low income and low growth, this risks increasing the fiscal deficit and inflation rates.
• In the midst of the inadequacies of fiscal policy to address the contemporary challenges, the article argues that the nature and objective of fiscal rules in India would have to be re-examined. 
• There is an urgent need for pushing further capital expenditure in the Indian economy which can help revive the economy.