Formulation of the Union Budget


    In Context

    • With the economy still hurting from the pandemic, the upcoming Budget is likely to address concerns around growth, inflation and spending

    About Budget 

    • The Union Budget of India is referred to as the Annual Financial Statement in Article 112 of the Constitution of India.
      • The term ‘Union Budget’ is nowhere mentioned in the Indian Constitution.
    • It is the annual budget of the Republic of India, presented each year in February by the Finance Minister of India in Parliament. 
    • It is the Government’s blueprint on expenditure, taxes it plans to levy, and other transactions which affect the economy and lives of citizens.

    Historical Background 

    • The term ‘budget’ has been derived from the old French word ‘bougette’, which means a leather bag or wallet. 
    • The first use of the term ‘budget’ may date back to the 1733 financial statement by Walpole as Prime Minister and Chancellor of the Exchequer.
      •  A cartoon of him opening a patent medicine seller’s wares was published at the time, as a satirical comment with the caption ‘The Budget Opened’. (‘Budge’ is an old word for a bag or small case).
    • Initially, “budget” referred solely to the Chancellor’s annual speech on the nation’s finances. 
      • Now, the term is used for an annual financial statement of income and expenditure of a government.
    • References to a budget can be found in Kautilya’s Arthashastra. It states that the Chancellor should first estimate revenue from each place and sphere of activity under different heads of accounts and then arrive at a grand total
    • The origins of the modern Budget can be traced to the Norman period, where two departments dealt with finance—the Treasury and the Exchequer.

    Major components of the Budget

    • There are three major components—expenditure, receipts and deficit indicators.
    •  Depending on the manner in which they are defined, there can be many classifications and indicators of expenditure, receipts and deficits.
      • Expenditure: Based on their impact on assets and liabilities, total expenditure can be divided into capital and revenue expenditure. 
    • Capital expenditure is incurred with the purpose of increasing assets of a durable nature or of reducing recurring liabilities.
      • Consider the expenditure incurred for constructing new schools or new hospitals. 
      • All these are classified as capital expenditures as they lead to the creation of new assets. 
    • Revenue expenditure: It involves any expenditure that does not add to assets or reduce liabilities
      • Expenditure on the payment of wages and salaries, subsidies or interest payments would be typically classified as revenue expenditure.
    • Other classifications: Depending on the manner in which it affects different sectors, expenditure is also classified into (i) general services (ii) economic services, (iii) social services and (iv) grants-in-aid and contribution. 
      • The sum of expenditure on economic and social services together form the development expenditure. 
      • Economic services include expenditure on transport, communication, rural development, agricultural and allied sectors. 
      • Expenditure on the social sector including education or health is categorised 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.
    • Receipts: The receipts of the Government have three components —revenue receipts, non-debt capital receipts and debt-creating capital receipts. 
      • Revenue receipts involve receipts that are not associated with an increase in liabilities and comprise revenue from taxes and non-tax sources.
      • Non-debt receipts are part of capital receipts that do not generate additional liabilities. Recovery of loans and proceeds from disinvestments would be regarded as non-debt receipts since generating revenue from these sources does not directly increase liabilities or future payment commitments.
      •  Debt-creating capital receipts are ones that involve higher liabilities and future payment commitments of the Government.
    • Fiscal deficit: It is the difference between total expenditure and the sum of revenue receipts and non-debt receipts. It indicates how much the Government is spending in net terms. 
      • Since positive fiscal deficits indicate the amount of expenditure over and above revenue and non-debt receipts, it needs to be financed by a debt-creating capital receipt. 
        • A primary deficit is a difference between fiscal deficit and interest payments. 
        • Revenue deficit is derived by deducting capital expenditure from fiscal deficits.

    Budget Process and Stages 

    • The budget is prepared by the Finance Minister with the assistance of a number of advisors and bureaucrats. 
      • The Finance Minister seeks the view of the industry captains and economists prior to preparation. 
      • Various accounting and finance-related organisations send in their opinions and suggestions.
    • The budget has four stages viz.
      • Estimates of expenditures and revenues :
        •  Part A: Estimates of expenditure: The process begins with various ministries providing initial estimates of plan and non-plan expenditures. 
          • The ministries discuss the plan expenditures with the Planning Commission. 
          • The financial advisors of the ministries prepare the non-plan expenditures. 
    • Part B: Estimates of revenue
    • Apart from estimating the expenditure, an assessment of expected revenues likely to flow into the government treasury has to be done as a concurrent exercise. 
    • First estimates of the deficit: After the estimates of revenue and expenditure are made, they are matched together. 
      • This provides the first estimate of the expected shortfall in revenue to meet projected expenditure. The government then, in consultation with the chief economic advisor, decides on the optimum level of borrowings to meet this deficit. 
    • Narrowing of the deficit: After the targets for the fiscal deficits and the overall budget deficit is decided, any remaining shortfall is filled through a revision in tax rates if feasible, keeping in mind the fiscal incentive structure the government wishes to put in place to stimulate the growth in different sectors.
    • Presentation and approval of the budget: The presentation of the Budget for the ensuing fiscal year is done in February. 
      • The Indian constitution has made the Parliament supreme in financial matters. 
      • It can levy taxes or disburse funds only on approval in both houses of Parliament. 

    Objectives and Significance:

    • Resource allocation is in the best interest of society and allocating resources optimally for public welfare.
    • Creating programmes for citizens so that they get basic needs such as food, shelter, education and health care.
    • Make sure that there is a fair distribution of income through taxes and subsidies.
    • The Budget of any country is crucial as it has widespread implications on that country’s economic stability and general life as such.

    Implications of the Budget on the economy

    • The Budget has an implication for the aggregate demand of an economy
      • All Government expenditure generates aggregate demand in the economy since it involves the purchase of private goods and services by the Government sector. 
      • All tax and non-tax revenue reduces the net income of the private sector and thereby leads to a reduction in private and aggregate demand
      • But except for exceptional circumstances, the GDP, revenue receipt and expenditure typically show a tendency to rise over time. 
      • Thus, the trend in the absolute value of expenditure and receipts in themselves has little use for meaningful analysis of the Budget.
      •  The trend in expenditures and revenue is analysed either by the GDP or as growth rates after accounting for the inflation rate.
      • Reduction in expenditure GDP ratio or increase in revenue receipt-GDP ratio indicates the Government’s policy to reduce aggregate demand and vice-versa. 
        • For similar reasons, reduction in fiscal deficit-GDP ratio and primary deficit-GDP ratios indicate Government policy of reducing demand and vice versa.
      • Since different components of expenditure and revenue can have different effects on the income of different classes and social groups, the Budget also has implications for income distribution.
        •  For example, revenue expenditure such as employment guarantee schemes or food subsidies can directly boost the income of the poor. 
        • Concession in corporate tax may directly and positively affect corporate incomes. 
        • Though both a rise in expenditure for employment guarantee schemes or reduction in the corporate tax would widen the fiscal deficit, its implications for income distribution would be different.

    Source: TH