Government Budget, Fiscal Policy and FRBM

1. Why a government budget: market failure and the three functions

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India is a mixed economy, where the private sector and the government work side by side. The budget is the government's main tool for shaping economic life. Class 12, Government Budget and the Economy names three objectives. Richard Musgrave's "three branches" of public finance is the standard label for them.

Allocation function

• Allocation function: the budget provides goods and services that the market cannot supply through normal buying and selling, such as national defence, roads and government administration.
• The reason lies in how public goods differ from private goods.

Feature	Private goods (clothes, chocolate, cars, a cinema ticket)	Public goods (a public park, clean air, defence)
Rivalry	Rival: a chocolate I eat is not available to you	Non-rivalry: one person's use doesn't reduce what others get
Excludability	Excludable: no ticket, no movie	Non-excludability: non-payers can't feasibly be kept out
Who supplies	Market	Government (market under-supplies)

• Free-rider problem: people enjoy a non-excludable good without paying and expect others to pay. Nobody pays voluntarily for what they get free, so the payment link between producer and consumer breaks. Markets therefore under-provide public goods and the state steps in.
• Club goods (toll roads, cable TV, private parks) are excludable but non-rival up to a congestion point.
• Merit goods (education, health) are goods society values more than private demand does, so the state subsidises them.
• Demerit goods (tobacco, alcohol) are harmful and over-consumed because people underestimate their costs, so the state taxes or bans them. Example: the 40% GST rate on sin and luxury goods since September 2025 (detail in taxation).
• Public provision vs public production (NCERT):
• Public provision means the good is financed through the budget and used without direct payment.
• Public production means the government itself produces the good.

• A public good can be privately produced but publicly provided. Example: a highway built by a private contractor but paid for from the budget.

• Lindahl equilibrium is the theoretical benchmark. Each person pays a tax share equal to their own marginal benefit, which gives efficient provision. It fails in practice because people hide their true preferences to pay less (free riding again).

• Market-failure theory in general is covered in market-structures-competition. Here goods are framed by who pays for them.

Redistribution function

• National income goes either to the private sector (firms and households) or to the government. What finally reaches households is personal income. What they can spend is personal disposable income.
• Redistribution function: the government changes personal disposable income through taxes and transfers to reach a distribution that society considers "fair".
• Tools: progressive income tax (a higher rate on higher income) and welfare transfers such as pensions and cash support.

Stabilisation function

• Stabilisation function: correcting swings in income and employment by managing aggregate demand (AD).
• When demand is too low:
• Resources such as labour sit idle.
• Wages and prices don't fall below a certain level (they are sticky downward), so employment doesn't recover on its own.

• The government must raise AD.

• When demand is too high:

• Demand exceeds output at high employment, which causes inflation.

• The government restricts demand.

• All three functions work through the budget's expenditure and receipts (NCERT summary point 2).

2. Constitutional framework: the Annual Financial Statement and the three funds

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Article 112: the Annual Financial Statement

• Government budget: the statement of the government's estimated receipts and expenditure for a year. Art. 112 requires it to be laid before Parliament. The Constitution calls it the Annual Financial Statement (AFS) and never uses the word "budget".
• Financial year: 1 April to 31 March.
• The budget affects later years as well, so it has two accounts:
• Revenue account (revenue budget): transactions of the current year only.
• Capital account (capital budget): transactions that change the government's assets and liabilities.

The three funds

Fund	Article	What goes in	How money comes out
Consolidated Fund of India	266(1)	All revenues, loans raised, loan recoveries	Only under a law of appropriation passed by Parliament
Public Account of India	266(2)	Money held as banker or trustee: provident funds, small savings, deposits, reserve funds	No parliamentary vote needed (the money belongs to others)
Contingency Fund of India	267	A fixed corpus at the President's disposal	For urgent, unforeseen spending; later recouped from the CFI through supplementary demands

• National Small Savings Fund (NSSF): set up in 1999-2000 inside the Public Account. It pools collections from small-savings schemes such as PPF, NSC and post-office deposits, and lends them to the Centre (and earlier to states) to finance deficits.
• Contingency Fund corpus: raised from ₹500 crore to ₹30,000 crore by the Finance Act 2021.

Charged vs voted expenditure (Arts. 112(3), 113)

• Charged expenditure is "charged" on the Consolidated Fund. Parliament may discuss it but does not vote on it. This protects key offices from political pressure.
• Charged items:
• The President's emoluments and allowances.
• Salaries of the Speaker and Deputy Speaker (Lok Sabha) and the Chairman and Deputy Chairman (Rajya Sabha).
• Salaries and pensions of Supreme Court judges, and pensions of High Court judges.
• The CAG's salary and the UPSC's expenses.
• Debt charges (interest, sinking funds, repayment).

• Sums required to satisfy court decrees or awards.

• Voted expenditure: everything else, voted as demands for grants in the Lok Sabha.

The budget-document set

• AFS; Demands for Grants; Appropriation Bill; Finance Bill; Receipt Budget; Expenditure Budget; Budget at a Glance; FRBM statements (see §11); plus the Gender Budget Statement, the Outcome Budget and the statement on extra-budgetary resources.

2017 reforms

• The budget date moved to 1 February, so that money is available from 1 April without a vote on account.
• The Railway Budget was merged into the Union Budget on the recommendation of the Bibek Debroy panel.
• The plan/non-plan split was ended from 2017-18 (see §5).

3. Passing the budget: from demands for grants to the Finance Act

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Stages in Parliament

1. Presentation in the Lok Sabha by the Finance Minister, with the AFS laid in the Rajya Sabha.
2. General discussion in both Houses on the budget as a whole. No voting at this stage.
3. Scrutiny by Departmentally Related Standing Committees (DRSCs), in place since 1993. The House adjourns while the committees examine ministry-wise demands.
4. Voting on demands for grants (Art. 113): - A demand for grants is the form in which expenditure estimates for each ministry or department are presented for voting. - Only the Lok Sabha votes. The Rajya Sabha can only discuss. - Members can move a cut motion to reduce a demand:

Cut motion	Amount	Purpose
Policy cut	Reduce the demand to ₹1	Disapproves the underlying policy
Economy cut	Reduce by a specified amount	Seeks a specific saving
Token cut	Reduce by ₹100	Airs a particular grievance

• Guillotine: on the last allotted day, the Speaker puts all remaining demands to vote together, without discussion.

5. Appropriation Bill (Art. 114): authorises withdrawal from the Consolidated Fund for the voted grants and the charged expenditure. Without it, no money can be drawn. No amendment may vary the amount of charged expenditure.
6. Finance Bill: gives effect to the tax proposals, i.e. imposition, abolition, remission, alteration or regulation of taxes (NCERT footnote). Under the Provisional Collection of Taxes Act, 1931, new tax rates apply at once but the Finance Bill must be enacted within 75 days.

Money Bill vs Financial Bill

• Money Bill (Art. 110): deals only with matters such as taxes, borrowing and the Consolidated Fund.
• It can be introduced only in the Lok Sabha.
• The Speaker's certificate is final.

• The Rajya Sabha can only recommend changes, and must return the bill within 14 days (Art. 109). The Lok Sabha may ignore the recommendations.

• Financial Bills (Art. 117) contain money-bill matters plus other matters. The Rajya Sabha has fuller powers over them.

• Controversy: the Aadhaar Act (2016) was passed as a money bill and upheld in Puttaswamy (2018). Rojer Mathew (2019) referred the scope of the money-bill route to a larger bench, where it is pending (verify current).

Special grants

Grant	Article	When used
Vote on account	116(1)(a)	Advance grant for part of the year, usually two months (longer in election years), until the full budget is passed
Interim budget	Convention	Budget of an outgoing government in an election year. By convention it avoids major policy changes (2019, 2024) and is usually passed with a vote on account
Supplementary / additional grant	115	The sanctioned amount proves insufficient, or a new service arises during the year
Excess grant	115(1)(b)	Money spent beyond the grant. The CAG reports it, the Public Accounts Committee (PAC) scrutinises it, and the Lok Sabha then regularises it
Vote of credit	116(1)(b)	An unexpected demand whose size or nature can't be detailed, like a blank cheque to the executive
Exceptional grant	116(1)(c)	A grant not part of any current year's service

4. Budget receipts: revenue vs capital, tax vs non-tax, debt vs non-debt

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Revenue budget vs capital budget

• Revenue budget: revenue receipts and revenue expenditure of the current year.
• Capital budget: receipts and spending that change assets or liabilities.

Revenue receipts

• Revenue receipts are non-redeemable: they create no claim on the government. They come in two kinds.
• Tax revenue:
• Direct taxes: personal income tax and corporation tax.
• Indirect taxes: customs (on imports and exports), excise (on goods produced in India) and formerly service tax, now GST.
• The Union reports tax revenue net of states' share.
• Wealth tax, gift tax and estate duty (all now abolished) yielded little and were called "paper taxes".

• Design (NCERT): income tax is progressive; corporation tax is proportional; under excise, necessities were exempt or taxed low, while luxuries, tobacco and petroleum were taxed heavily.

• Non-tax revenue: interest on loans given by the Centre; dividends and profits from PSUs, including the RBI's surplus transfer; fees for services; and cash grants-in-aid from foreign countries and international bodies.

• Revenue estimates reflect the tax proposals in the Finance Bill.
• NCERT Table 5.1: revenue receipts 9.2% of GDP (tax 7.9%, non-tax 1.4%). See §6 for the year label.

GST as a reform of budget receipts

• From 1 July 2017, GST replaced central excise, service tax, central sales tax and cesses such as KKC and SBC, as well as state VAT, entry tax, octroi, luxury and entertainment taxes. The 101st Constitution Amendment (2016) inserted Art. 246A.
• It widened the tax base, ended cascading (tax on tax) and created "one nation, one tax, one market".
• Class 11, Liberalisation, Privatisation and Globalisation says GST was expected to raise revenue and curb evasion.
• NCERT outdated: Box 5.3 lists six rates (0, 3, 5, 12, 18, 28%). Now: from September 2025, rates were rationalised to 5% and 18%, plus 40% for demerit and luxury goods. Mechanics are in taxation.

Capital receipts

• Capital receipts either create a liability (loans must be repaid with interest) or reduce assets (future income from the asset stops).
• Debt-creating capital receipts: market borrowings (G-secs, T-bills), small savings (NSSF), external loans.
• Non-debt-creating capital receipts: recovery of loans, disinvestment (sale of PSU shares), and other receipts.

Disinvestment record and critique (Class 11, Liberalisation, Privatisation and Globalisation)

• 1991-92: target ₹2,500 crore; about ₹3,040 crore mobilised. NCERT's wording "₹3,040 crore more than the target" is an error; it should read "₹3,040 crore, above the target".
• 2022-23: about ₹46,000 crore per NCERT (verify against DIPAM).
• Critiques:
• PSE assets were undervalued, a loss to the public.

• Proceeds were used to plug revenue gaps instead of developing PSEs or building social infrastructure.

• Milestones:

• Department of Disinvestment renamed DIPAM (2016).
• New PSE Policy 2021: strategic vs non-strategic sectors, with minimum presence in strategic ones.
• Air India sold to Tata (January 2022).
• LIC IPO (2022).
• Maharatna/Navratna policy is in industrial-policy-psu-msme.

Asset monetisation

• Asset monetisation means leasing brownfield public assets such as roads, pipelines and transmission lines to private players for upfront or periodic payments, without transferring ownership. It counts as a non-debt receipt.
• National Monetisation Pipeline (August 2021): ₹6 lakh crore for FY22-25.
• NMP 2.0: ₹10 lakh crore for FY26-30 (verify current).

5. Budget expenditure: revenue vs capital, committed spending and why spending grows

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Revenue vs capital expenditure

• Revenue expenditure creates no physical or financial asset for the Centre. It covers:
• running departments and services;
• interest payments;
• subsidies, salaries and pensions;

• grants to states and others, even when those grants build assets (a classic trap).

• Capital expenditure creates assets or reduces liabilities. It covers:

• land, buildings, machinery and equipment;
• investment in shares;
• loans and advances to states, UTs, PSUs and others;
• loan repayment.

Item	Revenue or capital?
Grant to a state for building schools	Revenue expenditure
Loan to a state	Capital expenditure
Interest paid	Revenue expenditure
Repayment of loan principal	Capital expenditure
Buying equity in a PSU	Capital expenditure

• Effective capital expenditure = capital expenditure + grants for creation of capital assets. It captures all spending on asset creation, including assets that states build with central grants.

Committed expenditure

• Committed expenditure leaves little room for cuts: interest, defence, salaries and pensions.
• Interest payments on market loans, external loans and reserve funds are the single largest item of revenue expenditure (NCERT; formerly classed as non-plan).
• 3.6% of GDP in Table 5.1.

• About 37-40% of the Centre's revenue receipts (verify current).

• Defence: 1.0% of GDP (revenue side, Table 5.1). National security leaves little scope for drastic cuts.

Plan/non-plan: abolished

• Plan and non-plan expenditure was the former classification:
• Plan spending: central Five-Year Plan schemes and central assistance for state and UT plans.

• Non-plan spending: interest, defence, subsidies, salaries and pensions.

• NCERT outdated: Table 5.1 and the text still use this split. It was abolished from 2017-18 on the Rangarajan Committee's (2011) recommendation.

• Spending is now shown as the Centre's own expenditure (establishment, central sector schemes) vs transfers to states (centrally sponsored schemes, Finance Commission grants).
• NCERT's footnote critique, still valid:
• The split encouraged starting new schemes while neglecting maintenance of existing assets.
• It branded non-plan spending as wasteful, which hurt education and health, where salaries are the main cost.

The capex push

• Central capex rose from about 1.7% of GDP (2019-20) to about 3.1% (2025-26).
• In money terms, ₹11.2 lakh crore (2025-26) to ₹12.2 lakh crore (2026-27 BE) (verify current).
• Table 5.1 shows capex at 3.2% of GDP.

Social spending

• Social sector expenditure: spending on education, health, social security and welfare. It builds human capital, and its returns come over the long run.
• Welfare expenditure: tax-funded spending on programmes that improve people's quality of life.
• Class 11, Liberalisation, Privatisation and Globalisation argues that reforms limited public spending, especially in social sectors.

Why public spending grows

• Wagner's law: public spending grows faster than national income as economies industrialise, because of more regulation, urban services and demand for education and health.
• Peacock-Wiseman hypothesis (displacement effect):
• Spending rises in steps. It jumps in wars and crises, and people accept higher taxes then.
• It does not fall back to the old level afterwards.
• Indian example: COVID in 2020-21.

6. Measuring the gap: balanced, surplus and deficit budgets

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Types of budget

• Balanced budget: expenditure = revenue.
• Surplus budget: receipts exceed expenditure.
• Deficit budget: expenditure exceeds receipts. This is the most common case.
• Budget deficit (old Indian measure): total expenditure − total receipts (revenue + capital, including borrowing). This was the gap covered by RBI ad hoc T-bills. It was discontinued from 1997-98 (NCERT footnote 6).

Deficit formulas

• Revenue deficit (RD) = Revenue expenditure − Revenue receipts
• Government dissaving: the government uses the savings of other sectors to pay for part of its consumption.

• Chain of harm:

  • It borrows for consumption as well as investment, so debt and interest pile up.
  • Committed spending can't be cut.
  • So it cuts productive capex or welfare, which means lower growth and worse welfare.

• Effective revenue deficit (ERD) = RD − Grants for creation of capital assets

• It shows the borrowing that truly funds consumption.

• Introduced in Budget 2011-12; made a target by the FRBM amendment of 2012.

• Fiscal deficit (FD) = Total expenditure − (Revenue receipts + Non-debt creating capital receipts)

• This is the total borrowing requirement from all sources.
• Equivalently, FD = RD + Capital expenditure − NDCR, so RD is part of FD.

• It is the key measure of public-sector financial health.

• Primary deficit (PD):

• NCERT: PD = FD − Net interest liabilities, where net interest liabilities = interest payments − interest receipts on net domestic lending.
• Budget practice: PD = FD − Interest payments.
• PD removes interest on past debt, so it shows the current fiscal imbalance.

NCERT Table 5.1 (Central Government, % of GDP)

Item	% of GDP
1. Revenue receipts (a + b)	9.2
(a) Tax revenue (net of states' share)	7.9
(b) Non-tax revenue	1.4
2. Revenue expenditure, of which	11.8
(a) Interest payments	3.6
(b) Major subsidies	1.4
(c) Defence	1.0
3. Revenue deficit (2 − 1)	2.6
4. Capital receipts, of which	5.8
(a) Recovery of loans	0.1
(b) Other receipts (mainly disinvestment)	0.1
(c) Borrowings and other liabilities	5.6
5. Capital expenditure	3.2
6. Non-debt receipts [1 + 4(a) + 4(b)]	9.4
7. Total expenditure [2 + 5]	15.0
8. Fiscal deficit [7 − 1 − 4(a) − 4(b)]	5.6
9. Primary deficit [8 − 2(a)]	2.0

• Check the maths:
• FD = 15.0 − 9.4 = 5.6.
• FD = RD 2.6 + capex 3.2 − NDCR 0.2 = 5.6.

• PD = 5.6 − 3.6 = 2.0.

• NCERT errors:

• The table is labelled "2024-25 (P.A.)" but its values match the 2023-24 actuals.
• "Total expenditure 1.5" is a misprint for about 15.0.
• The plan/non-plan rows are empty because that split is abolished.

Latest figures (Centre, % of GDP)

Year	Fiscal deficit	Note
2020-21	9.2	COVID peak
2023-24	5.6	Actuals (= Table 5.1)
2024-25	4.8	Actuals
2025-26	4.4	RE; the glide-path target of below 4.5% was met
2026-27	4.3	BE; RD 1.5% (verify current)

Quality of government expenditure

• A rising RD/FD ratio means a growing part of borrowing funds consumption rather than capital formation, i.e. the quality of government expenditure is getting worse (NCERT summary point 4).
• Example: in Table 5.1, RD/FD = 2.6/5.6 ≈ 46%, so nearly half of borrowing went to revenue spending.

7. Financing deficits: borrowing, RBI, small savings and hidden liabilities

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The financing identity (NCERT)

• Gross fiscal deficit = Net borrowing at home + Borrowing from RBI + Borrowing from abroad
• Net borrowing at home has two parts:
• Directly from the public, through small savings schemes: debt instruments such as PPF, NSC, post-office deposits and Sukanya Samriddhi.
• Indirectly from banks, which must hold G-secs under the Statutory Liquidity Ratio (SLR).

Deficit financing and monetisation

• Deficit financing: financing a deficit through borrowing or new money. In Indian usage it usually means borrowing from the RBI, i.e. money creation.
• Monetised deficit: the part of the FD financed by the central bank, measured as the increase in the RBI's net credit to the government.

• History of RBI financing: 1. Ad hoc Treasury Bills: these gave automatic, unlimited monetisation. The government issued them to the RBI whenever cash ran short. 2. 1994 GoI-RBI agreement to phase out ad hoc T-bills. 3. 1 April 1997: ad hoc T-bills ended and Ways and Means Advances (WMA) began.

• Ways and means advances: RBI advances that cover a temporary mismatch between receipts and payments.

• Limits are fixed by the RBI in consultation with the government.
• Borrowing beyond the limit becomes an overdraft.

• Under FRBM, WMA is the only permitted borrowing from the RBI.

• FRBM bar: the RBI may not subscribe to primary issues of G-secs from 2006-07.

• 2018 amendment: direct RBI subscription is allowed when the escape clause is invoked. This became a live question during the 2020 pandemic.

Small savings and the NSSF

• Collections flow into the NSSF (Public Account). The NSSF lends to the Centre, which finances part of the FD (share: verify current).
• Small-savings interest rates are usually above market rates, so this is a costly source.

Hidden deficits

• Off-budget borrowing: borrowing by public entities on the government's behalf that does not appear in the fiscal deficit, so the true position looks better than it is.

• Example: FCI borrowed from the NSSF to cover unpaid food subsidy. Budget 2021-22 brought this on budget, which is one reason the FD looked higher.

• Extra-budgetary resources (EBRs): funds raised through PSUs and SPVs (for example NHAI and IRFC) to fund budget schemes.

• A disclosure statement has come with the budget since 2019-20.

• The CAG has criticised the practice for hiding the true deficit.

• Contingent liabilities: potential obligations, such as government guarantees on PSU and SPV loans. They become real debt only if the borrower defaults.

• FRBM rules cap new guarantees at 0.5% of GDP a year.

• State-level off-budget borrowing is covered in fiscal-federalism.

8. Fiscal policy and the multipliers

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Setting up the model (Class 12, Government Budget and the Economy, Box 5.1)

• Fiscal policy: using government expenditure and taxes to stabilise output and employment. This produces surplus or deficit budgets rather than balanced ones. Keynes argued for it in The General Theory of Employment, Interest and Money (1936).
• The government affects income in two ways:
• G (purchases of goods and services) adds directly to AD.

• T (taxes) and TR (transfers) work indirectly, through disposable income: YD = Y − T + TR.

• Lump-sum tax: a tax T that doesn't depend on income. It shifts the consumption schedule, and so the AD curve, down in parallel.

• Model equations:
• Consumption: C = C̄ + c(Y − T + TR) (5.1)
• Aggregate demand: AD = C̄ + c(Y − T + TR) + I + G (5.2)
• Equilibrium: Y* = (C̄ − cT + cTR + I + G) / (1 − c) (5.4)

The multipliers

Multiplier	Formula	c = 0.8	c = 0.75	Why
Government expenditure multiplier	1/(1 − c)	5	4	G enters AD directly
Tax multiplier	−c/(1 − c)	−4	−3	Negative. Taxes act only through consumption, so the first round is cΔT, not ΔT. Always one less in absolute value than the G multiplier
Transfer multiplier	c/(1 − c)	4	3	Part of any transfer is saved
Balanced budget multiplier	1/(1 − c) − c/(1 − c) = 1	1	1	Equal ΔG and ΔT raise Y by exactly ΔG
With proportional tax T = tY	1/[1 − c(1 − t)]	2.5 (t = 0.25)	2.5 (t = 0.2)	Smaller: less consumed per rupee of income

Why the balanced budget multiplier is 1 (round by round)

• Spending side: ΔY = ΔG(1 + c + c² + …)
• Tax side: ΔY = −ΔT(c + c² + …)
• If ΔG = ΔT, all terms cancel except the first, so ΔY = ΔG.
• Alternative derivation: ΔY = ΔG + c(ΔY − ΔT). With ΔG = ΔT, this gives ΔY/ΔG = (1 − c)/(1 − c) = 1.

Proportional taxes

• With T = tY: C = C̄ + c(1 − t)Y + cTR.
• The MPC out of income falls to c(1 − t). AD becomes flatter.
• Y* = Ā / [1 − c(1 − t)], where Ā = C̄ + cTR + I + G.
• The multiplier is smaller than with lump-sum taxes (NCERT summary point 5).
• A cut in t works like a rise in the propensity to consume: AD shifts up and pivots.

NCERT worked examples

• Example 5.1 (c = 0.8):
• ΔG = 100 gives ΔY = 5 × 100 = +500.
• A tax cut of 100 gives ΔY = 4 × 100 = +400.

• ΔG = ΔT = 100 gives 500 − 400 = +100.

• Example 5.2 (c = 0.8, t = 0.25): c(1 − t) = 0.8 × 0.75 = 0.6. Multiplier = 1/0.4 = 2.5, so ΔG = 100 gives +250, less than 500.

• Example 5.3 (c = 0.75):
• ΔG = 20 gives 4 × 20 = +80.

• ΔTR = 20 gives 3 × 20 = +60.

• Practice (NCERT exercise 5): C = 100 + 0.75Y, I = 200, G = 150, net taxes = 100.

• Y = 100 + 0.75(Y − 100) + 350, so 0.25Y = 375 and Y = 1,500.
• G multiplier = 4; tax multiplier = −3.

• ΔG = 200 gives ΔY = +800.

• Practice (NCERT exercise 9): c = 0.75, t = 0.2, so c(1 − t) = 0.6.

• ΔG = +20 gives ΔY = 2.5 × 20 = +50.
• ΔTR = −20 gives ΔY = (0.75/0.4) × (−20) = −37.5.

Real-world fiscal multipliers

• Fiscal multiplier: the change in output from a one-unit change in government spending or taxes.
• NIPFP (Bose and Bhanumurthy, 2015): capex multiplier about 2.45, vs about 0.99 for revenue spending and transfers. This is why the "quality" of the deficit matters (verify current RBI estimates).
• Size depends on:
• slack in the economy (bigger in recessions);
• import leakage (spending on imports leaks out);

• whether monetary policy accommodates (keeps rates low).

• The investment-multiplier derivation is in income-determination-keynes.

9. Stabilisation in practice: automatic vs discretionary, cycles and fiscal space

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Automatic stabilisers

• Automatic stabilisers are shock absorbers that dampen swings in disposable income and consumption without any decision by anyone.
• Proportional income tax:
• In a boom, part of the rise in GDP is taken as tax, so consumption rises less.

• In a slump, disposable income falls less than GDP, so consumption and AD fall less.

• Welfare transfers: they rise in slumps and so sustain consumption. In booms, higher tax receipts restrain spending.

• Private-sector stabilisers: corporations keep dividends steady in the short run, and households try to maintain their living standards.
• Limit: they absorb only part of a fluctuation. Deliberate policy must handle the rest.

Discretionary fiscal policy

• Discretionary fiscal policy: a deliberate change in G or T to stabilise the economy.
• NCERT example: investment falls from I₀ to I₁, so G is raised from G₀ to G₁ such that C̄ + I₀ + G₀ = C̄ + I₁ + G₁. Autonomous spending and equilibrium income stay unchanged.

Deficit size vs policy stance

• NCERT caution: a larger deficit does not always mean a more expansionary policy.
• In a recession, tax revenue falls, so the deficit rises with no policy change.

• In a boom, the deficit shrinks.

• Structural deficit (cyclically adjusted): the part of the deficit that would remain even with output at potential. Removing the business-cycle effect shows the true fiscal stance.

Countercyclical vs procyclical policy

• Countercyclical fiscal policy: saves in booms and spends in slumps, so it smooths cycles.
• Procyclical fiscal policy: spends in booms and tightens in slumps, so it amplifies cycles. It is common in developing countries and under rigid deficit rules.

Indian stimulus episodes

• Fiscal stimulus: a rise in spending or a cut in taxes to boost AD in a slowdown.
• 2008-09 (Global Financial Crisis):
• excise and service-tax cuts;
• FRBM targets paused;

• FD about 6% of GDP.

• 2020 (COVID):

• The Atmanirbhar Bharat package had a headline of about ₹20 lakh crore, but it was mostly credit guarantees and liquidity. The direct fiscal cost was much smaller.
• Recovery that followed was capex-led.

Limits and risks

• Fiscal space: room in the budget to spend more or cut taxes without endangering sustainability. It is limited by:
• the debt level and the interest burden (see §5);

• sovereign ratings: S&P upgraded India to BBB in August 2025 (verify current).

• Austerity: deep spending cuts and tax rises to reduce deficits and debt, often in a crisis.

• Example: the eurozone and Greece after 2010, where cuts deepened the recessions.

• The "expansionary austerity" debate asks whether cuts can boost confidence and growth. Evidence is mostly against it in slumps.

• Fiscal drag: inflation or income growth pushes taxpayers into higher brackets (bracket creep) when slabs aren't indexed. The tax burden rises without any explicit tax increase, which dampens demand.

• Raising the income-tax rebate threshold to ₹12 lakh (new regime, 2025-26) partly offsets it.

10. Public debt: burden, Ricardian equivalence, crowding out and sustainability

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Deficits and debt

• Deficits can be financed by taxation, borrowing or printing money. Governments mostly borrow.
• Public debt is the stock of borrowing. Deficits are the flow that adds to it.
• Interest on the debt raises future deficits, which raise debt again: a snowball.
• The government's debt differs from a trader's. It can raise money through taxation and printing money, so "the whole must be treated differently from the part".

Is debt a burden?

• Burden of debt argument:
• Bonds are sold today and repaid, say twenty years later, through taxes on the young. That lowers their disposable income and consumption.
• Government borrowing reduces the savings available to the private sector, which lowers capital formation and growth.

• This conflicts with intergenerational equity, i.e. fairness between present and future generations, which is an explicit FRBM objective.

• Counter-argument: "we owe it to ourselves." Resources shift between generations, but purchasing power stays within the nation.

• But external debt is a definite burden: goods must be sent abroad to pay the interest.

Ricardian equivalence

• Traditional view: after a tax cut financed by a deficit, short-sighted consumers spend more. They ignore future taxes, or expect those taxes to fall on others.
• Ricardian equivalence (David Ricardo; revived by Robert Barro):
• Consumers are forward-looking. The family is a continuing, dynastic unit that cares about its children.
• They know borrowing today means taxes tomorrow, so they save more now.
• Their extra saving fully offsets government dissaving, so national saving doesn't change.

• "Equivalence" means borrowing and taxation have the same effect.

• Limits:

• myopia (people don't look ahead);
• liquidity constraints (poor households can't save even if they want to);
• finite horizons (not everyone has heirs or cares about them).

Crowding out and crowding in

• Crowding out:
• Government bonds compete with corporate bonds for a fixed pool of savings.
• Private borrowers get squeezed out, and interest rates rise.

• In India, SLR pre-emption adds to this, because banks must hold G-secs.

• NCERT rebuttal: savings aren't fixed. If deficits raise output, then income and saving rise too, so both government and industry can borrow more.

• Crowding in: public investment in infrastructure raises private returns and demand, which draws in private investment.

Are deficits inflationary?

• Inflationary effect of deficits: higher AD pushes up prices only if output can't expand, i.e. near full capacity.
• With unutilised resources, a high deficit brings more output and need not be inflationary.

Debt that is not a burden

• If public investment earns a return above the interest rate, growth pays off the debt.
• Debt is burdensome only if it reduces future growth (NCERT summary point 6).
• Debt growth must be judged against growth of the whole economy.

Sustainability

• Debt-to-GDP ratio: debt as a share of GDP, the key indicator of capacity to service and repay debt.
• Centre's outstanding liabilities: 55.6% of GDP (2026-27 BE).

• The 16th FC projects combined Centre + states debt falling from 77.3% (2026-27) to 73.1% (2030-31) (verify current).

• Debt sustainability: the ability to meet debt obligations without default or impossible adjustments. It depends on the primary balance and the growth-interest gap.

• Debt dynamics: Δd ≈ [(r − g)/(1 + g)]·d + primary deficit, where d is the debt/GDP ratio, r is the interest rate and g is nominal growth.
• Interest rate-growth differential (r − g): when g > r (the Domar condition), the debt ratio can stabilise or fall even with modest primary deficits.

• India has had r < g in most recent years. This is a key assumption behind current fiscal plans. If r rises above g, the debt ratio snowballs.

• Twin deficit: a fiscal deficit and a current account deficit at the same time. Government dissaving lowers national saving, which can widen the external gap.

The 1991 crisis (Class 11, Liberalisation, Privatisation and Globalisation)

• 1980s: spending ran far beyond revenue. Development spending didn't generate revenue, PSU income was low, and even foreign borrowing was used for consumption.
• Late 1980s: borrowing became unsustainable, prices of essentials rose sharply, and imports grew faster than exports.
• 1991: foreign-exchange reserves covered only about two weeks of imports, and India couldn't pay interest to foreign lenders.
• Response: India took a $7 billion loan from the IMF and World Bank, on condition of liberalisation (the NEP).
• BoP detail is in balance-of-payments-exchange-rate.

11. Fiscal rules: FRBM Act 2003 to the debt anchor, and deficit reduction

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Why a fiscal rule

• In a multi-party democracy, electoral pressure favours spending.
• A fiscal responsibility rule is a legislated limit on deficits or debt that binds present and future governments. It is more credible than a promise.

FRBM Act (enacted August 2003; rules effective July 2004)

Main features (Class 12, Government Budget and the Economy, Box 5.2):

1. Targets: FD ≤ 3% of GDP and RD eliminated by 31 March 2008 (rescheduled to 2009, then 2009-10), then build a revenue surplus.
2. Annual cuts: FD by 0.3% of GDP and RD by 0.5% a year. If taxes fall short, expenditure must be cut.
3. Deviation allowed only for national security, natural calamity or other exceptional grounds.
4. No borrowing from the RBI except WMA for temporary cash mismatches.
5. No RBI subscription to primary G-sec issues from 2006-07.
6. Measures for greater transparency.

7. Three statements laid with the AFS. These are the fiscal policy statements: - Medium-term Fiscal Policy Statement: three-year rolling targets. It checks whether revenue spending can be met from revenue receipts and how productively borrowing is used. - Fiscal Policy Strategy Statement: fiscal priorities, and justification for any deviation. - Macroeconomic Framework Statement: outlook for GDP growth, the fiscal balance and the external balance.

8. Quarterly review of receipts and expenditure placed before Parliament.

• Fear: welfare spending might be cut to meet targets.
• NCERT outdated:
• "26 states have enacted fiscal responsibility laws". Now: all states had FRLs by 2010-11 (see fiscal-federalism).
• NCERT treats the FRBM Review Committee as pending. It reported in January 2017.

Timeline

1. 2008-09: targets paused for the global crisis stimulus.
2. 2012 amendment: introduced the ERD target and a Medium-Term Expenditure Framework statement.
3. N.K. Singh FRBM Review Committee (report January 2017). It proposed retaining the 2003 framework but revamping it, with debt as the anchor.

4. 2018 amendment: - Debt anchor: general government debt 60% of GDP (Centre 40%, states 20%). - FD 3% as the operational target. - RD target dropped. - Escape clause: deviation of up to 0.5% of GDP is allowed for war, national security, national calamity, collapse of agriculture, structural reforms with fiscal cost, or real output growth in a quarter at least 3 percentage points below its average of the previous four quarters. - Fiscal council: an independent body to check forecasts and compliance with the rules. It was recommended but never set up.

5. COVID suspension: FD 9.2% in 2020-21.

6. Glide path: FD below 4.5% by 2025-26, met at 4.4% (RE).

7. Debt anchor from 2026-27: the Centre's debt is to reach 50 ± 1% of GDP by 31 March 2031. - Debt anchor means a medium-term debt/GDP target replaces an annual deficit target as the main rule. It allows flexibility year to year.

8. 16th Finance Commission: recommends the Centre bring FD to 3.5% of GDP by 2030-31 (verify current).

Deficit reduction: NCERT's toolkit

• Deficit reduction comes through higher taxes or lower spending.
• Raise tax revenue, with more reliance on direct taxes.
• Disinvest: sell PSU shares.
• Main thrust: reduce expenditure. Make government more efficient through better planning and administration (for example, cash transfers instead of the costly PDS, see §12). Or withdraw from some areas.

• Don't cut agriculture, education, health or poverty alleviation, because that harms the economy.

• NCERT error: it says indirect taxes are regressive because "they impact all income groups equally". Correct reason: a uniform rate takes a larger share of a poor household's income, since the poor consume a bigger part of what they earn.

Critique (Class 11, Liberalisation, Privatisation and Globalisation)

• Reforms limited public spending, especially in social sectors.
• Tax-rate cuts did not raise tax revenue as hoped.
• Tariff cuts reduced customs revenue.
• Tax incentives to foreign investors narrowed the base.
• Net result: less room for development and welfare spending.

12. Spending better: subsidies, DBT and budgeting innovations

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Subsidies

• Subsidy: government support that lowers prices.
• Explicit: food, fertiliser, LPG and petroleum, interest subvention, exports.

• Implicit: under-pricing of public services such as education, health and power.

• NCERT data (subsidies, % of GDP):

Year	% of GDP
2014-15	2.02
2015-16	1.8
2018-19	1.0
2020-21	3.6 (COVID; FCI dues brought on budget)
2022-23 (BE)	1.2

• Table 5.1 shows major subsidies at 1.4% of GDP.
• Free foodgrains under PMGKAY were extended for five years from 1 January 2024.
• In national accounts, subsidies are added back when moving from market prices to factor cost (see national-income-accounting).

Cash vs in-kind transfers

• The Planning Commission's PEO study, "Performance Evaluation of the Targeted Public Distribution System", found the government spent ₹3.65 to deliver ₹1 of food subsidy to the poor.
• Cash transfers: direct money payments in place of subsidised goods. They are argued to be cheaper and less leaky.
• DBT (Direct Benefit Transfer): launched 1 January 2013.
• JAM trinity: Jan Dhan bank accounts + Aadhaar biometric ID + Mobile phones, proposed in the Economic Survey 2014-15 to deliver DBT efficiently.

• Examples: LPG PAHAL (DBT for LPG) and PM-KISAN (₹6,000 a year to farmers).

• Targeting errors:

• Inclusion error: benefits go to ineligible people, for example ghost or duplicate beneficiaries.
• Exclusion error: eligible people are left out, for example through Aadhaar authentication failures or outdated lists.

Universal Basic Income and freebies

• Universal Basic Income (UBI): an unconditional periodic cash payment to all, proposed as a replacement for many targeted subsidies.
• The Economic Survey 2016-17 costed about ₹7,620 a year for 75% of the population, at about 4.9% of GDP.

• States run quasi-UBI schemes for farmers and for women.

• Freebies: goods, services or cash given free by governments. The debate is whether they are productive welfare or unsustainable populism.

• Supreme Court: the 2022 PIL by Ashwini Upadhyay.
• RBI has warned about the strain on state finances.
• 16th FC has called for rationalising unconditional cash transfers.
• State angle is in fiscal-federalism.

Budgeting innovations

Approach	What it is	India milestone
Performance budget	Presents spending by functions, programmes and activities, with targets to measure performance	Recommended by the Administrative Reforms Commission (1968)
Outcome budget	Links each ministry's outlays to measurable outputs and outcomes	2005-06; Output-Outcome Monitoring Framework with NITI's DMEO from 2017-18
Zero-based budgeting	Every item is justified afresh from zero, not just increased from last year's figure	Devised by Peter Pyhrr (1970s); tried in India from 1986-87
Gender budgeting	Turns gender commitments into budget allocations and checks how public spending affects women	Gender Budget Statement from 2005-06, enlarged 2006-07 (NCERT footnote 5)
Green budgeting	Tags and assesses the environmental and climate impact of revenues and spending	Odisha and Bihar climate/green budgets from 2020-21; sovereign green bonds from January 2023
Participatory budgeting	Citizens directly decide or influence part of a (usually local) budget	Porto Alegre, Brazil (1989); Kerala People's Plan Campaign (1996); Pune

• Gender Budget Statement structure:
• Part A: 100% women-specific schemes.
• Part B: schemes with 30-99% of the allocation for women.

• Part C: schemes below 30%, added in 2024-25.

• Gender budget share: about 8.9% of total expenditure in 2025-26 (verify current).

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Exam angles

Prelims — high-yield facts and traps

• FD = RD + Capex − NDCR. PD = FD − interest payments (NCERT: net interest liabilities). ERD = RD − grants for creation of capital assets. FD = total borrowing requirement.
• The old "budget deficit" (including borrowing, met by ad hoc T-bills) was dropped from 1997-98.
• Capital receipts: borrowings, disinvestment, recovery of loans. Revenue receipts: PSU dividends, interest received, RBI surplus, external grants. "Disinvestment is a revenue receipt": FALSE.
• Grants to states for asset creation are revenue expenditure. Loans to states are capital expenditure. "All grants that create assets are capital expenditure": FALSE.
• Asset monetisation is a non-debt receipt without ownership transfer.
• Multipliers: G = 1/(1 − c); tax = −c/(1 − c), always one less in absolute value; transfer = c/(1 − c); balanced budget = 1; proportional tax = 1/[1 − c(1 − t)].

• c = 0.8: 5, −4, 4. c = 0.75: 4, −3, 3. c = 0.8, t = 0.25: 2.5. c = 0.75, t = 0.2: 2.5.

• Articles:

• 112 AFS; 110 Money Bill; 109 Rajya Sabha has 14 days; 113 demands for grants; 114 Appropriation Bill; 115 supplementary and excess grants; 116 vote on account, vote of credit and exceptional grants; 117 Financial Bills; 266(1) CFI; 266(2) Public Account; 267 Contingency Fund.

• The word "budget" doesn't appear in the Constitution.

• Charged items are discussed, not voted. The Rajya Sabha cannot vote on demands. Public Account withdrawals need no vote. The Contingency Fund is at the President's disposal (₹30,000 crore since 2021).

• Cut motions: policy (to ₹1) / economy (a specific amount) / token (₹100). The guillotine puts all remaining demands to vote at once. The Speaker's money-bill certificate is final. Finance Bill within 75 days (PCTA 1931).
• Goods grid: public (non-rival, non-excludable); private (rival, excludable); club (excludable, non-rival up to congestion); common-pool (rival, non-excludable). Merit vs demerit goods. Free rider. Public provision ≠ public production. Lindahl pricing fails because preferences are hidden.
• Wagner's law: spending grows faster than income. Peacock-Wiseman: step-jumps in crises (displacement effect).
• FRBM:
• Enacted 2003; rules 2004. FD 3%; RD zero. Annual cuts 0.3/0.5.
• RBI primary-market bar from 2006-07. WMA since 1 April 1997.
• Three statements: MTFPS, FPSS, MFS.
• 2012: ERD. 2018: debt 60/40/20, RD target dropped, 0.5% escape clause, trigger of growth 3 percentage points below average.

• Debt anchor from 2026-27: 50 ± 1% by March 2031. The fiscal council has not been set up.

• Dates: gender budgeting 2005-06; outcome budget 2005-06; 1 February budget and rail merger 2017; plan/non-plan abolished 2017-18; DBT 1 January 2013; NSSF 1999-2000; NMP August 2021; GST 1 July 2017 (rates now 5/18/40).

• Definitions:
• Ricardian equivalence: borrowing = taxation; national saving is unchanged.
• Crowding out vs crowding in.
• Twin deficit = FD + CAD.
• Domar condition: g > r.

• Monetised deficit = rise in the RBI's net credit to government.

• NCERT slips to know: Table 5.1 is 2023-24 data, and its total expenditure is 15.0, not 1.5. Indirect taxes are regressive because they take a bigger share of poor incomes, not because they are "equal". The disinvestment wording error.

Mains — GS-III themes

1. Quality of the fiscal deficit: revenue vs capital composition. Capex-led growth (1.7% to 3.1% of GDP) and its high multiplier (2.45 vs 0.99). Crowding in vs crowding out. Effective capex and grants to states.
2. Fiscal consolidation vs growth and welfare: rules vs discretion; the shift from deficit targets to a debt anchor; the case for an independent fiscal council; procyclicality risks.
3. Debt sustainability: r − g dynamics; the Centre's debt at 55.6% of GDP; the 16th FC roadmap (FD 3.5% by 2030-31); interest taking about two-fifths of revenue receipts; lessons from 1991.
4. Fiscal transparency: off-budget borrowing (the FCI-NSSF case), EBRs, contingent liabilities, CAG findings and the credibility of numbers.
5. Subsidy reform: in-kind vs cash transfers (the ₹3.65 study); DBT and JAM; targeting errors; UBI; the freebies-vs-welfare debate and its effect on state finances.
6. Is public debt a burden? Internal vs external debt; intergenerational equity; Ricardian equivalence in India, where liquidity constraints and myopia matter; whether deficits are inflationary when there is slack.
7. Accountability tools: gender, green, outcome and zero-based budgeting. Parliamentary financial control and the money-bill controversy (GS-II overlap).
8. Disinvestment and asset monetisation: efficiency vs "selling the family silver". Class 11's critique of undervaluation and of proceeds used to plug revenue gaps. NMP 2.0.
9. Stabilisation: automatic stabilisers vs discretionary stimulus; lessons from 2008-09 and 2020; structural vs headline deficit; austerity debates.

Current-affairs hooks

• Union Budget (1 February) and the Economic Survey; interim budgets and votes on account in election years; FRBM statements and progress on the debt-anchor path.
• CGA monthly accounts and fiscal-deficit data; RBI Annual Report (surplus transfer, WMA limits, borrowing calendar); sovereign rating actions (S&P BBB, 2025); IMF Article IV reviews and the Fiscal Monitor.
• The 16th Finance Commission's fiscal roadmap; CAG audits of off-budget borrowing and cess use.
• Capex allocation trends; NMP 2.0 progress; DIPAM disinvestment and OFS news; PSU dividend receipts.
• Subsidy bills (food, fertiliser, LPG); the PMGKAY extension; DBT savings claims; the share in the Gender Budget Statement; state freebie debates and Supreme Court proceedings; GST rate changes and their revenue effect.