How does the budget affect the economy and development? In a pandemic year, is fiscal policy ready to address the contemporary challenges of unemployment and low output growth?
the story So FarWith the economy still reeling from the pandemic, the February 1 budget is likely to address concerns around growth, inflation and spending. The budget, which will be presented in Parliament by Finance Minister Nirmala Sitharaman, is the government’s blueprint on spending, plans to levy taxes, and other transactions that affect the economy and the lives of citizens.
What are the major components of the budget?
There are three major components – expenditure, receipts and deficit indicators. Depending on the way in which they are defined, there can be many classifications and indicators of expenditure, receipts and deficit.
Based on their impact on assets and liabilities, total expenditure can be divided into capital and revenue expenditure. Capital expenditure is made with the aim of increasing assets of a durable nature or reducing recurring liabilities. Consider the expenses incurred for building new schools or new hospitals. All these are classified as capital expenditure as they lead to the creation of new assets. Revenue expenditure includes any expenditure that does not increase assets or reduce liabilities. Expenditure on payment of wages and salaries, subsidies or interest payments would normally be classified as revenue expenditure.
Expenditure is also classified into (i) general services, (ii) economic services, (iii) social services and (iv) grants-in-aid and contributions, depending on the way in which it affects various sectors. The sum of expenditure on economic and social services together constitutes development expenditure. Economic services include expenditure on transport, communication, rural development, agriculture and allied sectors. Expenditure on the social sector, including education or health, is classified as social services. Again, depending on its effect on asset creation or liability reduction, development expenditure can be further classified as revenue and capital expenditure.
Government receipts have three components—revenue receipts, non-debt capital receipts, and debt-creating capital receipts. Revenue receipts include receipts that are not linked to an increase in liabilities and include revenue from taxes and non-tax sources. Non-debt receipts are the part of capital receipts that do not generate additional liabilities. Income from debt recovery and disinvestment will be considered non-debt receipts because generating revenue from these sources does not directly increase liabilities, or future payment commitments. Debt-creating capital receipts are those that involve high liabilities and future payment commitments of the government.
Fiscal deficit by definition is the difference between total expenditure and the sum of revenue receipts and non-debt receipts. It shows how much the government is spending in net form. Since a positive fiscal deficit reflects the amount of expenditure exceeding revenue and non-debt receipts, it needs to be financed by debt-creating capital receipts. Primary deficit is the difference between fiscal deficit and interest payments. Revenue deficit is worked out by deducting capital expenditure from fiscal deficit.
What is the effect of budget on the economy?
The budget has an effect on the aggregate demand of the economy. All government expenditure generates aggregate demand in the economy as it involves the purchase of private goods and services by the government sector. All tax and non-tax revenues reduce the net income of the private sector and thereby reduce private and aggregate demand. But except in exceptional circumstances, GDP, revenue receipts and expenditure generally show a tendency to increase over time. Thus, the trend of absolute value of expenditure and receipts is of little use for meaningful analysis of the budget. The trend of expenditure and revenue is analyzed either by GDP or as a growth rate after accounting for the inflation rate.
A decrease in the expenditure GDP ratio or an increase in the revenue receipt-GDP ratio indicates the policy of the government to reduce aggregate demand and vice versa. For similar reasons, a reduction in the fiscal deficit-GDP ratio and the primary deficit-GDP ratio indicates the government’s policy of reducing demand and vice versa.
Since different components of expenditure and revenue can have different effects on incomes of different classes and social groups, budgets also have an impact on income distribution. For example, revenue expenditures such as employment guarantee schemes or food subsidies can directly increase the income of the poor. Corporate tax exemptions can directly and positively impact corporate income. While an increase in spending for employment guarantee schemes or a reduction in corporate tax will both increase the fiscal deficit, the implications for income distribution will be different.
What are fiscal rules and how do they affect policy?
Fiscal rules provide specific policy targets on the basis of which fiscal policy is made. Policy goals can be accomplished by using various policy tools. There is no specific financial rule that applies to all countries. Rather, policy goals are sensitive to the nature of economic theory and depend on the specificity of an economy.
In the case of India, its current financial rules are guided by the recommendations of the NK Singh Committee report. While allowing 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 (structure target). Keep.
Although both expenditure and revenue receipts can potentially serve as policy instruments to meet specific sets of fiscal rules, tax rates within the current policy framework are determined independent of the spending requirement of the economy. Accordingly, in the current institutional framework in India, it is primarily expenditure that is adjusted to meet fiscal norms at given tax-ratios.
Such an adjustment mechanism has at least two related, but analytically distinct, implications for fiscal policy. First, the current fiscal rules provide a cap on expenditure by imposing three policy targets, independent of the extent of expenditure required to stimulate the economy or boost labor income. Second, in any situation when the debt-to-ratio or deficit ratio is higher than the target level, expenditure is adjusted to meet the policy targets. By implication, independent of the state of the economy and the need for expansionary fiscal policy, current policy targets may prompt the government to reduce expenditure.
Amidst the inadequacy of fiscal policy to address the contemporary challenges of unemployment and low output growth rates, the nature and purpose of fiscal regulations in India need to be re-examined.
Ziko Dasgupta is an assistant professor at the School of Arts and Sciences, Azim Premji University, Bengaluru
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