Government Budget PDF

Government Budget Govt. budget is a statement of the estimates of Govt. receipts and Govt. expenditure during the period of the financial year.  Objectives of Govt. budget: 1. Redistribution of Income and Wealth: The govt. uses fiscal instruments of taxation and subsidies with a...

Government Budget Govt. budget is a statement of the estimates of Govt. receipts and Govt. expenditure during the period of the financial year.  Objectives of Govt. budget: 1. Redistribution of Income and Wealth: The govt. uses fiscal instruments of taxation and subsidies with a view to improving the distribution of income and wealth in the economy. Equitable distribution of income and wealth is a sign of social justice. 2. Reallocation of resources: The govt. through its budgetary policy, directs the allocation of resources in a manner such that there is a balance between the goals of profit maximisation and social welfare. For e.g production of goods which are injurious to health is discouraged through heavy taxation. 3. Economic stability: The govt. through its budgetary policy corrects the situations of deflation and inflation and tries to save the economy from trade cycles and helps to achieve economic stability. 4. Managing Public Enterprises: The budgetary policy of the govt. focuses on growth through public enterprises. Growth through public enterprises focuses on social welfare rather than profit maximisation.  Structure of budget Budget receipts Budget expenditure A. Revenue receipts A. Revenue expenditure B. Capital receipts B. Capital expenditure Budget receipts refer to estimated money receipts of the Government from all sources during the fiscal year. Budget receipts are classified as: A) Revenue receipts and B) Capital receipts. Revenue receipts: these receipts of the govt. have the following two characteristics: 1) These receipts do not create any corresponding liability for the government. For e.g tax receipt 2) These receipts do not cause any reduction in assets of the government. Tax Receipts A tax is a compulsory payment to the government by the households, firms or other institutional units. Taxes are broadly classified as follows: 1) Progressive and Regressive taxes: A) Progressive tax implies that the rate of tax increases with increase in income. The burden is more on the rich and less on the poor. B) Regressive tax implies that the rate of tax decreases with increase in income. For e.g a person with monthly income of 1 lakh pays 10% tax and a person with Rs.5000 also pays 10% tax. 2) Value Added Tax or VAT and Specific taxes: VAT is an indirect tax which is imposed on value added at the various stages of production. Specified taxation system: when tax is levied on a commodity on the basis of units, size, weight. 3) Direct and Indirect taxes: A) Direct taxes- the burden of the direct tax has to be borne by the person on whom it is imposed. E.g income tax, corporation tax, gift tax. B) Indirect taxes- are those taxes whose initial burden is on one person but succeeds in shifting the burden to another person. Non-Tax Receipts: are those receipts which are received from sources other than taxes. 1) Fees: Fee is a payment to the government for the services that it renders to the people. E.g land registration fees, passport fees, birth registration etc. 2) Fines: Fines are those payments which are made by the law breakers to the government by way of economic punishment. 3) Escheat: Escheat refers to that income of the state which arises out of the property left by the people without a legal heir. 4) Special Assessment: special assessment is that payment which is made by the owners of those properties whose value has appreciated due to developmental activities of the government. 5) Income from Public enterprises: Several enterprises are owned by the government. Profit of these enterprises are a source of revenue for the government. 6) Income from the Sale of Spectrum: Income from sale of spectrum has emerged as a significant source of non-tax receipts of the government. 7) Grants/Donations: In the event of some natural calamities citizens of the country often make some donations and grants to the government. Capital Receipts: Capital receipts are those monetary receipts which either create liability for the government or cause reduction in the assets of the government. Capital receipts of the govt. budget are classified as follows: 1) Recovery of Loans: Loans offered to others are assets of the government. Hence recovery of loans causes a reduction in assets of the government. These are therefore treated as capital receipts. 2) Borrowings and other liabilities: Borrowing creates liability. Hence it is treated as capital receipts. Governments borrow money from the general public, the reserve Bank of India and the rest of the world. 3) Other receipts: These include items like disinvestment. Disinvestment occurs when the government sells off its shares of public sector enterprises to private sector. Money received through disinvestment is treated as capital receipts. Budget Expenditure It refers to estimated expenditure of the government on its development and non-development programmes or on its Plan and non-plan programmes during the fiscal year. Budget expenditure of the government is classified as: A) Revenue Expenditure and B) Capital Expenditure B) Revenue Expenditure: Revenue expenditure refers to that expenditure of the government which does not create assets or cause a reduction in liabilities for the govt. Items of revenue expenditure in the Indian Budget: ▪ Wage bill of the govt. ▪ Interest payments ▪ Expenditure on subsidies ▪ Expenditure on defence. B) Capital Expenditure Capital expenditure refers to the estimated expenditure of the government in a fiscal year which either creates assets or causes a reduction in liabilities. Important items of capital expenditure are: Expenditure on land and building Expenditure on machinery and equipment Purchase of shares Loans by central government to state government and state corporations. Development and Non-Development Expenditure Development Expenditure: Relates to growth and development activities of the government. This includes expenditure on education, health, industry, agriculture, transport, roads, rural development, canals, Water works and power generation. It also includes loans by the government to enterprises like Air India for the purpose of development. Non-Development Expenditure: Relates to expenditure on non-developmental activities of the government such as administration, defence, collection of taxes, interest on loans, payment of old age pension, subsidies,etc. Plan and Non-Plan Expenditure Plan Expenditure: Refers to that expenditure which is related to programmes under Five Year Plans. It includes both revenue expenditure (payment of salaries) and capital expenditure (construction of hospital). However once a particular project formulated under the Five year plan is completed, plan expenditure of the government is taken to be as over. Non-Plan Expenditure: Refers to all such government expenditures which are not related to programmes formulated under Five Year Plans. Expenditure on defence and subsidies are examples of non-plan expenditure.  Budget Deficit Budget deficit refers to a situation when budget expenditures of the government are greater than the budget receipts. There are three types of budget deficits: 1. Revenue Deficit: is the excess of revenue expenditure over revenue receipts. 2. Fiscal Deficit: is the excess of total expenditure (revenue plus capital) over total receipts (revenue plus capital other than borrowings) Fiscal deficit is equal to total borrowings of the government. It is expressed as a percentage of GDP. 3. Primary Deficit: is the difference between fiscal deficit and interest payment. Balanced and Unbalanced budget Balanced Budget: is that budget in which government receipts are equal to government expenditure. Unbalanced Budget: is that budget in which receipts and expenditure of the government are not equal. Such as: 1) Surplus budget: this is a budget in which government receipts are greater than government expenditures. 2) Deficit budget: this is a budget in which government expenditures are greater than government receipts.  Measures to curtail budgetary deficits: 1. Lowering government expenditure: Government expenditure is broadly classified as development and non-development expenditure. With a view to limiting its development expenditure, the government must assign to the private sector an increasing role in the process of development. Non-development expenditure of the government can be curtailed through a cut on grants and aid offered by the government simply to enhance its vote bank. 2. Raising government receipts: government receipts can be Raised through taxation and disinvestment. a) Taxation: taxation is broadly classified as direct taxation and indirect taxation. Direct taxation is generally progressive in nature. Indirect taxation is regressive as its impact is equally shared by the rich and poor. Hence the government has to strike a balance between direct and indirect taxation, so that its revenue needs are served. b) Disinvestment: This is a process of privatisation of public sector enterprises. This is a route adopted by the government when budgetary deficit becomes alarming. Disinvestment of public enterprises is not a bad idea in so far it is confined to inefficient enterprises of the government which have been causing recurring losses. Foreign Exchange Rate: It refers to the rate at which one unit of currency of a country can be exchanged for the number of units of currency of another country. It is the price paid in domestic currency in order to get one unit of foreign currency. There are two systems of exchange rate systems:- Fixed Exchange Rate System: it refers to rate of exchange as fixed by the government. It has two important variants: i) Gold Standard System of Exchange Rate: According to this system, each country was to define value of its currency in terms of gold. Accordingly, value of one currency in terms of the other currency was fixed considering gold value of each currency. ii) Bretton Woods System of Exchange or Adjustable Peg System of Exchange Rate. Even though this is a fixed system of exchange rate, some adjustments were allowed. So, it was called adjustable peg system of exchange rate. According to this system, different currencies were pegged (or related to) one currency, that is US dollar. US dollar was assigned gold value at a fixed price. Value of one currency in terms of US dollar ultimately implied value of that currency in terms of gold. Gold continued the ultimate unit of parity between any two currencies. Flexible Exchange Rate System: It is that exchange rate which is determined by the demand for and supply of different currencies in the foreign exchange market. It is determined by market forces, like price of any other commodity.  Determination of exchange rate in a free market. In the market exchange rate is determined is determined by the demand for and supply of its currency. Other things remaining constant, if the demand for foreign exchange rises, its value will also rise and if demand for foreign exchange falls, its value will also fall.similarly supply of foreign exchange also influences the exchange rate. Other things remaining constant, greater the supply, lower the rate of exchange. Demand for foreign exchange: Foreign exchange is demanded for the purpose of: i) Payments of international loans ii) Gifts and grants to rest of the world iii) Investment in rest of the world iv) Direct purchase abroad as well as imports from rest of the world v) Speculative trading in foreign exchange by our residents.  Supply of foreign exchange Supply of foreign exchange depends on the following factors: i) Exports of the country to rest of the world ii) Foreign direct investment iii) Direct purchase of goods and services by the non-residents in the domestic market iv) Speculative purchases by non-residents in the domestic market v) Remittances by the non-residents living in foreign countries. Supply of foreign currency and rate of exchange are directly related. Hence the supply curve is an upward slopping curve. Demand for foreign currency and rate of exchange are negatively related. Hence the demand curve is a downward slopping curve.  Y D s R1 R E exchange R2 Rate of s D O Q X Demand and supply of foreign currency SS is the supply curve of foreign currency and DD is the demand curve for foreign currency. Both these curves intersect at point E. It is an equilibrium point and OR is the equilibrium rate of exchange. If the rate of exchange rises to OR1 then supply of foreign currency Exceeds its demand. Supply being more than demand, rate of exchange will start slipping toward OR. On the contrary if the rate of exchange falls to OR2 then demand for foreign currency will be more than its supply and exchange rate will rise toward OR. Rate of exchange will ultimately be determined at a point where demand for and supply of foreign currency are equal. Foreign Exchange Market Foreign exchange market refers to the market for national currencies of different countries in the world. Functions of foreign exchange market: i) Transfer function: it implies transfer of purchasing power in terms of foreign exchange across different countries of the world. ii) Credit Function: It implies provision of credit in terms of foreign exchange for the export and import of goods and services across different countries of the world. iii) Hedging Function: It implies protection against risk related to variation in foreign exchange rate. Demand for and supply of foreign exchange is committed at some commonly agreed rate of exchange even when the commitments are to be honoured on some future date. Appreciation and Depreciation of Domestic currency Appreciation of the domestic currency occurs when the value of our currency increases in relation to the value of other currencies. Example: Depreciation of the domestic currency occurs when the value of our currency decreases in relation to the value of other currencies. Example: Managed Floating is a system that allows adjustments in exchange rate according to a set of rules and regulations which are officially declared in the foreign exchange market. Dirty Floating is a concept related to the managed floating system of exchange rate. It refers to a situation when ‘managed floating’ is exercised without caring for the rules and regulations. Dirty Floating occurs when one country manipulates exchange rate to foster its economic interest, even when it hurts economic interest of other countries in the international money market. Wider Bands is a system that allows wider adjustments in the fixed exchange rate system. It allows adjustment upto 10 per cent around the parity between any two currencies in the international money market. Crawling Peg allows small but regular adjustments in the exchange rate for different currencies. not more than (+,-) 1 per cent adjustment is allowed at a time. Purchasing Power Parity (PPP) It refers to the ratio of purchasing power of the currencies of trading partners. It is the ratio of price levels in different countries. Exchange rate between the two countries is simply equal to the ratio of price levels in different countries. Balance of Payments (BoP) BoP refers to the statement of accounts recording all economic transactions of a country with rest of the world. Components of BoP Account BoP accounts are broadly classified as current account and capital account. Current Account Current account is that account which records imports and exports of goods and services and unilateral transfers. Export and import of services is considered as trade in invisibles. Payments on account of invisible trade include i) factor payments ii) non-factor payments (like payments for shipping). Unilateral transfers refer to one way payments like aid to flood victims in other countries.  Capital Account Capital account is that account which records all such transactions between residents of a country and rest of the world which cause a change in the asset or liability status of the residents of a country or it government. Components of capital account: 1) Foreign Investment: it has two sub-components a) FDI (Foreign Direct Investment) refers to the purchase of asset in rest of the world which allows control over that asset. example: purchase of Jaguar by Tata. b) Portfolio Investment refers to purchase of an asset in rest of the world, without any control over that asset. example: purchase of shares. 2) Loans/ Borrowing: it has two sub-components a) Commercial borrowings refer to borrowing by a country (including govt. and private sector) from international money market. This involves market rate of interest without any concession. b) Borrowings as external assistance, refers to borrowing by a country with considerations of assistance. It involves lower rate of interest compared to that prevailing in the open market. 3) Changes in reserves of gold and foreign exchange with the central bank of the country.