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Deciphering the Economics

Important Questions of Government Budget

20 most Important questions of Government Budget and The Economy.

Government Budget

1. What is the significance of measuring fiscal deficit?

Ans. “The fiscal deficit is an important indicator for governments because it shows how much they depend on borrowing to pay for their spending. For instance, a significant fiscal deficit (let’s say 5% of GDP) indicates that 5% of the government’s spending is being funded by borrowing. Numerous effects may result from this, including increased interest rates, a disincentive for private investment, and inflationary pressures. Therefore, calculating the fiscal deficit assists governments in evaluating their financial situation and making the required changes to maintain economic stability.”

2. Revenue Deficit can be managed through borrowings or disinvestment but fiscal deficit can be managed only by borrowings. Do you agree?

Ans. I agree with the statement. While the fiscal deficit can only be controlled by borrowing, the revenue deficit can be handled through both borrowing and disinvestment.
1. Revenue deficit: This occurs when total government spending (revenue expenditure), surpasses total revenue receipts. Borrowing is one way to handle a revenue deficit; the government borrows money to make up the difference. The government can also raise money by disinvesting, which is the process of selling its ownership stake in public sector businesses, to manage the revenue shortfall.

2. Fiscal Deficit: This refers to borrowing to pay for capital expenditures as well as a revenue shortfall. In other words, it is the difference between total expenditure and total receipts. Disinvestment cannot be used as a management strategy for the fiscal deficit because it is already included in capital receipts. The only way the government may control the fiscal imbalance is by borrowings and therefore, fiscal deficit equals borrowings.

3. How does a progressive taxation system help to reduce inequalities of income and wealth?

Ans. By applying higher tax rates to those with higher incomes, a progressive taxation system contributes to the reduction of income and wealth disparities. The ability to pay principle, which underpins this system, states that those with higher earnings should be expected to pay a bigger share of their income in taxes than people with lower incomes. This is how it operates:
1. Redistribution of Income: Under a progressive tax system, income is redistributed from the rich to the poor by taxing higher incomes at higher rates. This contributes to closing the income disparity between the rich and the poor.
2. Diminishing Wealth Concentration: Tax policies that promote progressiveness also contribute to lessening the concentration of wealth among a select few. Richer people paying higher taxes restrict their capacity to amass an enormous fortune, encouraging a fairer distribution of income across society.
3. Encouraging Social Welfare: Programmes that assist the less fortunate can be financed with the proceeds from progressive taxation. These can include social security, healthcare, and education initiatives that work to raise general living standards and lower poverty.
For instance:
Assume that A and B are two people who earn Rs. 10,00,000 and Rs. 5,00,000, respectively. Individual A may pay more tax than Individual B (taxed at 20%) in a progressive tax system, maybe at a rate of 30%. Accordingly, individual A would pay taxes totaling Rs. 3,00,000 and individual B would pay taxes totaling Rs. 1,00,000. The system of progressive taxes guarantees those who can afford to contribute more do so, thereby helping to reduce income and wealth inequalities.

4. The government has raised its expenditure on free services like education, and health to the poor. Explain the economic value it reflects.

Ans. The government’s increased spending on health and education programs for the underprivileged is a reflection of the economic importance placed on human capital development and welfare maximization.

1. Welfare Maximisation: The government ensures that all citizens have access to a minimal quality of living by giving the poor free health and education services. This enhances the general quality of life and lessens poverty, which benefits social welfare. For instance, by providing free primary education to all children, the government guarantees that all children, regardless of their financial situation, have access to an education, which over time may result in improved job prospects and economic expansion.

2. Development of Human Capital: Education and health spending enhances human capital, or people’s knowledge, abilities, and general well-being. Because of the increase in worker productivity and efficiency, this promotes economic development. For instance, giving the impoverished access to free healthcare improves their health outcomes, lowers absenteeism, and boosts productivity.
3. Reduction of inequities: The government contributes to the reduction of inequities in society by giving the impoverished free services. A fairer distribution of opportunities and resources can result from providing the rich and the poor with access to free healthcare and education.
In conclusion, increasing funding for free services for the poor indicates the government’s dedication to social welfare, developing human capital, and minimizing inequality—all of which are critical for sustainable economic growth and development.

5. Does Public debt impose a burden? Explain.

Ans. Government debt or public debt refers to the amount of money that a central government owes. This amount may be borrowings of the government from banks, public financial institutions, and other external and internal sources. Public debt imposes a burden on the economy as a whole which is described as follows: (ANY TWO)

(a) Adverse effect on productivity and investment: – A government may impose taxes or get money printed to repay the debt. This, however, reduces the people’s ability to work, save money, and invest, thus hampering the development of a country.

(b)  The burden on future generations: The government transfers the burden of reduced consumption to future generations. Higher government borrowings in the present lead to higher taxes levied in the future to repay past obligations.

(c)  Lowers private investment: The government attracts more investment by raising rates of interest on bonds and securities. As a result, a major part of the savings of citizens goes into the hands of the government, thus crowding out private investments.

(d)  Leads to the drain of National wealth: The wealth of the country is drained out at the time of repaying loans taken from foreign countries and institutions.

6. Taxation is an effective tool to reduce the inequality of income. Justify the state with valid reasons.

Ans. Because it can redistribute wealth and advance social well-being, taxes are a useful tool for reducing income inequality. This is the reason why:

1.  Progressive Taxation: Income disparity is directly addressed by progressive taxation, which levies greater rates of taxation on individuals with higher incomes. Increased revenue from taxing the wealthy can be used to pay for social welfare programs that assist the less fortunate. Income disparity is lessened, for instance, by the progressive tax systems of nations like Sweden and Denmark, which have high tax rates for high earnings.

2. Redistribution of Wealth: By allowing the government to transfer wealth from the wealthy to the underprivileged, taxes contribute to the closing of income gaps. Numerous strategies, including cash transfers, social security benefits, and subsidies for essentials, might be used to achieve this. To effectively reduce economic disparity, low-income working individuals in the United States can get a tax credit through the Earned Economic Tax Credit (EITC).

3. Finance Public Services: Public services, which are critical for lowering income disparity, are financed in part by tax revenue. Examples of these services include infrastructure, healthcare, and education. For example, having access to high-quality healthcare and education can assist people from lower-income families to become healthier and more skilled, which will increase their earning potential and lessen economic inequality.
In summary, taxes can effectively mitigate income inequality by facilitating wealth transfer, financing social welfare initiatives, and delivering public services that assist the less fortunate.

7. The government raises its expenditure on producing public goods which economic value does it reflect explain?

Ans. The government’s decision to increase spending on public goods production is a reflection of the economic benefits of improving public welfare and correcting market failures.

1. Market Failure Correction: Because of the free-rider problem, the market frequently underproduces public goods like national defense and street lighting. The government’s investment in manufacturing these items ensures that everyone in society, regardless of financial situation, may access them, so correcting this market fails. For instance, all residents profit from government spending on public road construction and upkeep, including those who do not directly pay for it through taxes.

2. Public Welfare Enhancement: Public goods facilitate economic activity and improve living standards, which both contribute to the general welfare of society. For instance, public infrastructure projects like ports and bridges increase the effectiveness of transportation, which is advantageous to both private and public sectors. As a result, the economy expands and develops, eventually raising the population’s well-being.

3. Reduction of Inequalities: By giving impoverished populations access to infrastructure and necessary services, government spending on public goods can aid in the reduction of inequality. In terms of access to essential services, for instance, the presence of public schools and healthcare facilities in rural areas can aid in closing the gap between them.
In conclusion, public goods production by the government is a reflection of its commitment to improving public welfare, lowering inequality, and fixing market failures—all of which support long-term economic growth.

8. The government decide to give budgetary investors incentives for investing in backward regions. Explain the possible incentives.

Ans. The government can provide various incentives to budgetary investors for investing in backward regions. Some possible incentives include:

1. Tax Incentives: The government can offer tax incentives such as tax holidays, where investors are exempt from paying taxes for a certain period, or tax credits, where investors can deduct a certain percentage of their investment from their taxes. For example, the government of India offers tax incentives for investments in specified backward areas under the Income Tax Act.

2. Financial Assistance: The government can provide financial assistance in the form of grants, subsidies, or low-interest loans to encourage investment in backward regions. This can help offset the higher costs and risks associated with investing in these regions. For instance, the government of Malaysia offers grants and soft loans to investors in certain backward areas through agencies like the Malaysia Industrial Development Authority (MIDA).

3. Infrastructure Development: The government can invest in infrastructure development in backward regions to improve connectivity, access to markets, and availability of utilities such as electricity and water. This can make the region more attractive to investors by reducing the cost of doing business. An example of this is the development of industrial parks and special economic zones (SEZs) with infrastructure facilities like roads, power, and water supply to attract investors.

In conclusion, providing incentives to budgetary investors for investing in backward regions can help stimulate economic development in these areas, create employment opportunities, and reduce regional inequalities.

9. The government budget of a country cannot have a fiscal deficit without the existence of a revenue deficit. Defend or Refute.

Ans. Refute: A nation’s fiscal deficit can occur in its budgetary system even in the absence of a revenue shortfall.
Fiscal Deficit: The difference between the government’s total outlays and its total income, excluding borrowings, is known as the fiscal deficit. It illustrates the amount of borrowing required by the government to cover its expenses.
Conversely, a revenue deficit occurs when the government’s total revenue receipts (loans excluded) fall short of its entire revenue expenditures. It shows that the government’s regular revenue streams are insufficient to cover its ongoing costs.
For instance:
Imagine a government with 100 crore rupees in total revenue receipts and 90 crore rupees in total revenue expenditures. In this instance, there is a 10-crore rupee revenue surplus (100 – 90). The government will, however, have a budget deficit if all of its spending, including capital spending, surpasses all of its receipts of revenue. For example, even though there is no revenue deficit, the government would have a fiscal deficit of Rs. 20 crores (120 – 100) if its total expenditures (including capital expenditure) were Rs. 120 crores.
In conclusion, even if revenue deficit is a part of fiscal deficit, revenue deficit does not always follow from fiscal deficit.

10. How consumption surplus budget be used in inflation?

Ans. Reducing the economy’s aggregate demand can be accomplished through the deployment of a consumption surplus budget to combat inflation. How to do it is as follows:
1. Cutting Government Spending: When tax money from the government surpasses expenditures on goods and services, a consumption surplus budget is created. In this case, the government can cut back on expenditure on non-essential products and services, which will lower the economy’s total demand for goods and services.
2. Raising Taxes: The government may also decide to raise taxes on certain products and services that are fuelling inflation by using a budget surplus for consumption. Lower prices may result from a decrease in the demand for these products and services.

Example: Let’s say that a nation is dealing with significant inflation as a result of an overabundance of demand for products and services. By raising taxes on luxury goods and cutting back on non-essential spending, the government can create a consumption surplus budget. By lowering the economy’s aggregate demand, these policies would aid in containing inflation.

11. Fiscal deficit is inflationary. Do you agree?

Ans. No, I don’t think there is always an inflationary fiscal deficit. Although there are situations in which a fiscal deficit might lead to inflation, this is not always the case. Whether a fiscal deficit will cause inflation or not depends on several factors:

Cases for Inflation:

  1. Deficit Financing: The process of borrowing money to pay for government expenses is known as “deficit financing,” and it is usually accomplished by issuing bonds to the government. The government’s debt, which will eventually need to be repaid with interest, is increased by this borrowing. If borrowed money is utilized to boost aggregate demand above the economy’s potential for productivity, deficit financing may result in inflation.
  2. Printing New Currency: The act of directly raising the money supply, frequently by the printing of extra currency, to finance government spending is referred to as “monetizing the debt,” or printing new currency. This strategy is usually applied as a last resort because, if not handled appropriately, it might result in hyperinflation. Generally speaking, printing money to cover deficits is a dangerous tactic since it can devalue the currency and cause economic instability.

Cases for not Inflation:

  1. Use of Borrowed Funds: Increased productivity and economic growth can help counteract inflationary pressures if the government borrows money and utilizes it for worthwhile projects like building infrastructure or investing in human capital.
  2. Effect on Demand: As a result of deficit financing, the economy’s money supply grows, raising overall demand. Inflation may result if supply cannot keep up with demand. On the other hand, deficit spending can boost demand without contributing to inflation if the economy has idle resources, such as high unemployment or underutilized capacity.

12. Do you approve of disinvestment as an appropriate policy for financing budgetary deficit?

Ans. Disinvestment occurs when the government chooses to sell its stake in the public sector or joint sector enterprises. This leads to privatization. Presently, this seems to be the only effective remedy available to the government to finance the deficit. However, the government should be careful about two points:

(a)  It should unload shares of only inefficient enterprises. Otherwise, it would not only be lowering its asset holding, but also closing a regular source of income, and

(b) Money received through disinvestment should not be used for the purpose of political popularity (to garner votes). Instead, it should be used as a productive investment.

13. The Finance Minister has announced that steps would be taken to rationalize subsidies that presently dominate the economy of the nation.

What is the economic value of this statement?

Ans. The statement comes in the wake of a consistently high fiscal deficit arising out of the high expenditure of the government on subsidies. Expenditure on subsidies is mostly unproductive. Because it just focuses on lowering the market price of certain goods. To the extent money is spent on subsidies, it is not available for investment in strategic sectors of the economy like infrastructure. Rationalizing the subsidies means the provision of subsidies only for the below-poverty-line population. The government has already initiated this process by withdrawing subsidies on petrol and diesel.

14. Financing the fiscal deficit should not be confused as the solution to the problem of fiscal deficit. True or false give the reason in support of your answer.

Ans. Financing the fiscal deficit and solution to the problem of fiscal deficit are different propositions. The fiscal deficit may be financed through borrowing. But this is not the solution to the problem. The solution to the problem of fiscal deficit is to be found in terms of (i) lowering the government expenditure, and (ii) raising the government revenue. However, it is not so easy to lower government expenditure in a country like India where a sizeable percentage of the population belongs to the BPL category. The BPL population deeply depends on the government for food, shelter, clothing, and education. Likewise (in India), it is not so easy for the government to increase its revenue.

Taxation is the principal source of revenue. But when the bulk of the population lives on low incomes, a high rate of direct taxation (income and wealth tax) would only lead to a high rate of tax evasion or unbearable hardship on marginal families. Also, high rate of indirect. taxation (like excise duty) would increase the cost of production and lower the inducement to invest.

The permanent solution to the problem of high fiscal deficit is to be found in economic expansion: GDP level and disposable income of the people should rise. A higher level of GDP would automatically generate higher revenue for the government. Also, at a higher level of income, government expenditure on public welfare would automatically shrink. A rise in revenue and a fall in expenditure would bring fiscal discipline.

15. Why should revenue deficit be curbed?

Ans. A revenue deficit often occurs when the unproductive expenditure of the government (like expenditure on subsidies and purchases relating to law & order and defense of the country) is more than the tax and non-tax revenue receipts. Thus, it contributes to the fiscal deficit without adding much to the flow of goods and services in the economy. Revenue deficit compels the government to resort to borrowing or disinvestment. Borrowing leads to a rise in national debt. Disinvestment leads to the transfer of asset ownership from the public sector to the private sector. It implies a shift in focus from social welfare to profit maximization. Thus, we conclude that the revenue deficit should be curbed.

Ans. A balanced budget causes a modest increase in the level of AD. Because expenditure by the government raises AD by the same amount, while tax receipts reduce AD by ‘MPC times’ the tax receipts. A modest increase in AD would push the economy towards the point of full employment when it is marginally away from this point.

Also, a balanced budget is a good strategy during periods of modest recession when aggregate demand needs a modest rise.

17. Should we rely exclusively on direct taxes for mobilizing tax revenue because indirect taxes are inequitable? Comment.

Ans. As we know, direct and indirect taxes are complementary to each other i.e., they are not substitutes for each other. We cannot depend solely on direct taxes because they are progressive and there is the possibility of tax evasion. But as against it indirect taxes are proportional (regressive) in nature and are imposed on goods and services that every individual purchases. So, direct and indirect taxes are important for providing funds for investment and other social welfare considerations.

18. The revenue deficit is the real deficit and not the fiscal deficit. How?

Ans. It is incorrect to assert that the revenue deficit is the primary deficit over the fiscal deficit. While both deficits are crucial indicators of a government’s financial health, they represent distinct aspects of budgetary management.

The revenue deficit arises when a government’s total revenue receipts fall short of its total revenue expenditures, reflecting an inability to cover monthly expenses using regular revenue streams like taxes and non-tax earnings.

In contrast, the fiscal deficit is the disparity between the government’s total outlays (comprising both capital and revenue expenditures) and its total receipts (excluding borrowings). It signifies the entirety of borrowing required by the government to fund its expenditures.

While the revenue deficit is a component of the fiscal deficit, it does not encapsulate the entirety of the deficit. The fiscal deficit encompasses both the borrowing necessary to finance capital expenditures and the revenue shortfall.

For example, if a government receives Rs. 100 crores in total revenue, spends Rs. 90 crores on revenue, and incurs Rs. 120 crores in total expenditure (including capital expenditure), there would be a fiscal deficit of Rs. 20 crores (120 – 100) and a revenue deficit of Rs. 10 crores (100 – 90). Thus, the fiscal deficit provides a more comprehensive view of the government’s borrowing requirements, considering both revenue and capital expenditures.

However, a fiscal deficit is not inherently alarming for several reasons:

1. During Economic Downturns: In periods of economic recession or downturn, governments may deliberately increase fiscal deficits to stimulate economic growth. This may involve tax cuts and increased government spending to spur demand and support businesses. A temporary rise in the fiscal deficit is deemed necessary to bolster the economy under such circumstances.

2. Infrastructure Investment: Fiscal deficits incurred for productive endeavors such as infrastructure projects can contribute to long-term economic growth. These investments can enhance GDP, boost employment, and improve overall economic competitiveness. If the returns from these investments outweigh the borrowing costs, the fiscal deficit may not be a cause for concern.

3. Low Debt Levels: Countries with strong economic fundamentals and low public debt levels may be able to sustain higher fiscal deficits without immediate risk. If the government can present a credible plan to manage its debt levels over the medium to long term, a temporary increase in the fiscal deficit may not be alarming.

In conclusion, while the revenue deficit is an important aspect of the fiscal deficit, it does not fully capture the deficit’s magnitude. The fiscal deficit provides a more comprehensive picture of the government’s borrowing requirements, including both revenue and capital expenditures. Moreover, a fiscal deficit is not necessarily alarming and can be justified under certain circumstances to support economic growth and development.

19. Inclusive growth is not within the ambit of budgetary policy of the government.

Ans. False.

Economic development that helps all facets of society—especially the underprivileged and marginalized—is referred to as inclusive growth. Although economic structure and social dynamics, among other things, have an impact on inclusive growth, government budgetary decisions and policies are crucial in fostering inclusive growth.
The government distributes funds to industries like healthcare, education, infrastructure development, and social welfare programs through its fiscal strategy. For instance, more investments in healthcare and education can boost productivity and human capital, resulting in more equitable growth.
To encourage inclusive growth, the government may also incorporate tax policy into its budgetary policies. More equitable growth can result from progressive taxation, which requires higher earners to pay a larger share of their income in taxes. This can help redistribute wealth and lessen income inequality.
Allocating funds from the budget for welfare and subsidy programs that help underprivileged people can also promote inclusive growth. For instance, financial support for small-scale farmers or food subsidies for low-income households can help combat poverty and advance inclusive growth.
In summary, the government’s financial decisions and policies are critical in fostering inclusive growth through resource allocation, taxation, and social welfare programs, even if inclusive growth is impacted by a variety of factors.

20. It is said that fiscal deficit is a reflection of fiscal indiscipline. How?

Ans. Fiscal deficit is a reflection of fiscal indiscipline. It is particularly true when a fiscal deficit is incurred on account of non-development expenditure (like expenditure on freebies to garner votes during elections). Such expenditures only contribute to an inflationary spiral in the country, leading to economic instability.

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