Government Budget and the Economy

🧠 First Principles — Read This First

A budget sorts every rupee by one question: does it belong to this year, or does it change what the government owns and owes? Receipts and spending that concern only the current year go to the revenue account (taxes, fees, salaries, interest, subsidies). Receipts that create a liability or sell an asset, and spending that creates an asset or cuts a liability, go to the capital account (borrowing, disinvestment, roads, loans to states). Every deficit in this chapter is a total taken over these four boxes.

Deficits measure borrowing. The fiscal deficit is total spending minus all receipts that are not borrowing, so it is the year's borrowing requirement. The revenue deficit is the part of that borrowing that pays for current spending. The primary deficit removes interest on past debt, leaving this year's own imbalance. In the Union Budget of February 2026 the three stand at 4.3, 1.5 and 0.7 per cent of GDP for 2026-27.

Government spending, taxes and transfers move income through the multiplier of chapter 4. With marginal propensity to consume c, a rise in government purchases raises income by 1 ÷ (1 − c) times itself; a tax cut or a transfer works through disposable income and raises income by only c ÷ (1 − c) times itself; spending matched by an equal lump-sum tax raises income by exactly its own amount; a proportional income tax at rate t shrinks the multiplier to 1 ÷ [1 − c(1 − t)]. NCERT works each of these with numbers, and the exercises test them.

Cross-paper relevance

• GS3: government budgeting, fiscal policy, deficits and public debt, the FRBM Act, GST and tax reform.
• GS2: the Annual Financial Statement laid before Parliament under Article 112; the Finance Commission under Article 280 and the states' share of Union taxes.

PART 1 — Quick Reference

The Chapter at a Glance

The Union Budget, Dated (record, not NCERT)

NCERT's Table 5.1 shows one year's budget as shares of GDP. The Union Budget presented in February 2026 gives three columns: the actual result for 2024-25, the revised estimate for 2025-26 and the budget estimate for 2026-27. Figures are ₹ crore; the per cent of GDP printed by the Budget is in brackets.

Source: Ministry of Finance, Budget at a Glance 2026-27, p. 1.

Three ways to read the table:

• By basis. A budget estimate is a plan, a revised estimate is the year's second look, and only an actual is a result. Capital expenditure for 2025-26 was budgeted at ₹11,21,090 crore and revised to ₹10,95,755 crore.
• By identity. NCERT's identities hold to the rupee: for 2026-27, revenue deficit 41,25,494 − 35,33,150 = 5,92,344; non-debt receipts 35,33,150 + 38,397 + 80,000 = 36,51,547; fiscal deficit 53,47,315 − 36,51,547 = 16,95,768, equal to borrowings and other liabilities; primary deficit 16,95,768 − 14,03,972 = 2,91,796.
• By the GDP it divides by. The Budget's ratios use the GDP it assumed: "The GDP for FY 2026-27 is estimated at ₹393,00,393 crore, which is 10% over the Advance Estimates for FY 2025-26 of ₹357,13,886 crore released by NSO." That Advance Estimate came before MoSPI moved national accounts to the new 2022-23 base on 27 February 2026; on the new base, 2025-26 GDP is ₹345.37 lakh crore (see National Income Accounting). Divided by that, the 2025-26 fiscal deficit of ₹15,58,492 crore is about 4.5 per cent of GDP. This is arithmetic, not a published figure; the Budget's own ratio is 4.4.

NCERT's Table 5.1 rebuilt with the 2026-27 budget estimates (shares of the Budget's assumed GDP of ₹393,00,393 crore, computed from the table above): revenue receipts 9.0 (tax 7.3, non-tax 1.7); revenue expenditure 10.5, of which interest 3.6; revenue deficit 1.5; non-debt capital receipts 0.3; borrowings 4.3; capital expenditure 3.1; non-debt receipts 9.3; total expenditure 13.6; fiscal deficit 4.3; primary deficit 0.7.

PART 2 — Concepts & Narrative

Opening and 5.1 Government Budget: Meaning and its Components

An economy with both a private sector and a government is a mixed economy. The government influences economic life in many ways; this chapter takes only those that work through the budget. Article 112 of the Constitution requires the government to lay before Parliament a statement of estimated receipts and expenditure for every financial year (1 April to 31 March). This "Annual Financial Statement" is the main budget document.

A budget relates to one year, but its effects run into later years. So it keeps two accounts: the revenue account (revenue budget) for transactions of the current year only, and the capital account (capital budget) for those that change the government's assets and liabilities.

5.1.1 Objectives of Government Budget

Public provision is not public production. Public provision means the good is financed through the budget and used without direct payment. The good itself may be produced by the government (public production) or by the private sector.

Redistribution function. National income goes to the private sector (private income) or to the government (public income). Of private income, what reaches households is personal income, and what they can spend is personal disposable income (chapter 2). Through taxes and transfers the government changes personal disposable income and so moves the distribution towards one society considers "fair".

Stabilisation function. Employment and prices depend on aggregate demand, which depends on the spending of millions of private agents as well as the government. Demand may fall short of what full use of labour and other resources needs; since wages and prices do not fall below a level, employment does not recover by itself, and the government must raise demand. When demand runs ahead of output at high employment, it causes inflation, and restrictive measures are needed. Expanding or restraining demand is the stabilisation function.

5.1.2 Classification of Receipts

Revenue receipts create no claim on the government; NCERT calls them non-redeemable.

• Tax revenue. Direct taxes fall on persons (income tax) and firms (corporation tax). Indirect taxes include excise duties (on goods produced in the country), customs duties (on imports and exports) and service tax; footnote 1 adds that GST replaced much of this from 1 July 2017. Wealth tax, gift tax and estate duty never raised much and were called "paper taxes".
• How taxes redistribute. Income tax is progressive (the higher the income, the higher the rate); firms are taxed proportionally (a fixed share of profits). Excise spares or lightly taxes necessities, moderately taxes comforts and semi-luxuries, and heavily taxes luxuries, tobacco and petroleum products.
• Non-tax revenue. Interest on loans given by the Centre, dividends and profits on its investments, fees for its services, and cash grants-in-aid from foreign countries and international organisations.
• The Finance Bill, presented with the Annual Financial Statement, sets out the imposition, abolition, remission, alteration or regulation of taxes proposed in the Budget; the revenue estimates include its effects.

Capital receipts either create a liability (loans, which must be repaid with interest) or reduce the government's financial assets (sale of shares in public sector undertakings, called PSU disinvestment, after which the earnings from the asset disappear). So capital receipts are debt-creating (borrowing) or non-debt-creating (recovery of loans, disinvestment).

5.1.3 Classification of Expenditure

Revenue expenditure creates no physical or financial asset of the Centre: the running of departments and services, interest on debt, and grants to state governments and others (even when some grants pay for assets).

Capital expenditure creates physical or financial assets or reduces financial liabilities: land, buildings, machinery and equipment, investment in shares, and loans and advances by the Centre to states, union territories, PSUs and others.

NCERT also describes the old split of both into plan expenditure (central Five-Year Plans and central assistance for state and union territory plans) and non-plan expenditure (general, economic and social services; mainly interest, defence, subsidies, salaries and pensions), and Chart 1 draws the budget with these branches. The Union Budget has "done away with the plan and non-plan classification of expenditure" since 2017-18 (Budget Speech 2017-18), which is why NCERT's own Table 5.1 prints dashes in the plan and non-plan rows.

Within non-plan revenue expenditure, NCERT notes that interest is the single largest item; defence is committed expenditure with "little scope for drastic reduction"; and subsidies, explicit (exports, interest, food, fertilisers) and implicit (under-priced education and health), were 2.02 per cent of GDP in 2014-15, 1.8 in 2015-16, 1 in 2018-19, 3.6 in 2020-21 and 1.2 in 2022-23 (budget estimate), as NCERT prints them.

The budget is also a policy statement. With it, the FRBM Act, 2003 requires three statements: the Medium-term Fiscal Policy Statement (three-year rolling targets for fiscal indicators), the Fiscal Policy Strategy Statement (the government's fiscal priorities and reasons for any deviation) and the Macroeconomic Framework Statement (prospects for growth, the fiscal balance and the external balance). The February 2026 volume presents them as a Macroeconomic Framework Statement and a "Medium-term Fiscal Policy cum Fiscal Policy Strategy Statement". NCERT's footnote 5 adds that the 2005-06 Budget introduced a statement on the gender sensitivities of allocations (gender budgeting), enlarged in 2006-07.

5.2 Balanced, Surplus and Deficit Budget

A balanced budget spends what it collects; a surplus budget collects more than it spends; a deficit budget, the usual case, spends more than it collects. NCERT's footnote 6 records that the older measure called "budget deficit" (total expenditure over total receipts, both revenue and capital) has not been shown since the 1997-98 Budget.

5.2.1 Measures of Government Deficit

Revenue deficit = Revenue expenditure − Revenue receipts. It covers only transactions that affect current income and spending. A revenue deficit means "the government is dissaving and is using up the savings of the other sectors of the economy to finance a part of its consumption expenditure". The government then borrows for consumption as well as investment, debt and interest build up, and since much revenue spending is committed, the cut eventually falls on capital or welfare spending, with lower growth and welfare as the cost.

NCERT Table 5.1: Receipts and Expenditures of the Central Government (per cent of GDP), as printed

Source: NCERT, Table 5.1, titled "2024–25 (P.A.)", citing Economic Survey 2024-25, Statistical Appendix. Its deficit figures (revenue 2.6, fiscal 5.6, primary 2.0) are the 2023-24 actuals as printed in Budget at a Glance 2025-26 (p. 1); the 2024-25 actuals are 1.7, 4.8 and 1.4 (Budget at a Glance 2026-27, table above). Total expenditure is 11.8 + 3.2 = 15.0, and only 15.0 gives the printed fiscal deficit (15.0 − 9.4 = 5.6).

Fiscal deficit = Total expenditure − (Revenue receipts + Non-debt-creating capital receipts). Non-debt-creating capital receipts are not borrowings and create no debt: recovery of loans and PSU sale proceeds. In Table 5.1 non-debt receipts are 9.2 + 0.1 + 0.1 = 9.4 per cent of GDP, so the fiscal deficit is 15.0 − 9.4 = 5.6 per cent. The fiscal deficit has to be borrowed, so it "indicates the total borrowing requirements of the government from all sources". From the financing side:

Fiscal deficit = Net borrowing at home + Borrowing from RBI + Borrowing from abroad.

Net borrowing at home includes borrowing directly from the public (small savings schemes, for example) and indirectly from commercial banks through the Statutory Liquidity Ratio. Rearranging the definitions:

Fiscal deficit = Revenue deficit + Capital expenditure − Non-debt-creating capital receipts. In Table 5.1: 2.6 + 3.2 − 0.2 = 5.6. A large share of the revenue deficit in the fiscal deficit means much of the borrowing pays for consumption rather than investment. In the 2026-27 budget estimates the revenue deficit is 5,92,344 ÷ 16,95,768 = 35 per cent of the fiscal deficit (arithmetic on Budget at a Glance 2026-27).

Primary deficit = Fiscal deficit − Net interest liabilities, where net interest liabilities are interest payments minus interest receipts on the government's net domestic lending. Removing interest on past debt isolates the present imbalance. In Table 5.1, 5.6 − 3.6 = 2.0. Budget at a Glance subtracts gross interest payments ("Fiscal Deficit less interest payments"), so its primary deficit is a little smaller than NCERT's definition would give.

Effective revenue deficit (Budget concept, not in NCERT) = revenue deficit − grants-in-aid for creation of capital assets. It entered the Union Budget in 2011-12; the next year's speech called it "the concept of Effective Revenue Deficit, introduced in the last Budget" (Budget Speech 2012-13). For 2026-27 it is ₹99,642 crore, 0.3 per cent of GDP.

Box 5.1 Fiscal Policy

One of Keynes's main ideas in The General Theory was that fiscal policy should stabilise output and employment. By changing spending and taxes, the government runs a surplus or a deficit rather than a balanced budget. NCERT now adds the government to the income-determination model of chapter 4. The government affects equilibrium income in two ways: its purchases G add to aggregate demand, and taxes and transfers change the gap between income Y and disposable income Y_D.

Lump-sum taxes. Let taxes T be lump-sum (independent of income) and transfers a constant TR̄. Then

• Consumption: C = C̄ + cY_D = C̄ + c(Y − T + TR̄) (eq. 5.1). Someone earning Rs 1 lakh who pays Rs 10,000 in tax has the same disposable income as someone earning Rs 90,000 who pays none.
• Aggregate demand: AD = C̄ + c(Y − T + TR̄) + I + G (eq. 5.2). A lump-sum tax shifts the consumption line, and with it the AD line, down in parallel.
• Equilibrium: Y = C̄ + c(Y − T + TR̄) + I + G (eq. 5.3), so Y* = [1 ÷ (1 − c)] × (C̄ − cT + cTR̄ + I + G) (eq. 5.4).

Government expenditure multiplier. Raise G to G + ΔG with taxes unchanged (when G exceeds T the government runs a deficit). AD shifts up, demand exceeds output at the old income, firms expand, and the chapter 4 multiplier works: putting G + ΔG and Y + ΔY into eq. 5.4 and subtracting gives ΔY = ΔG ÷ (1 − c) (eq. 5.5), so ΔY ÷ ΔG = 1 ÷ (1 − c) (eq. 5.6). NCERT's Fig. 5.1 shows income rising from Y to Y′.

Tax multiplier. A tax cut raises disposable income at every income level, shifting AD up by c times the cut (Fig. 5.2). From eq. 5.3, ΔY(1 − c) = −cΔT (eq. 5.7), so ΔY ÷ ΔT = −c ÷ (1 − c) (eq. 5.8). It is negative: a tax cut raises output and a tax rise lowers it. It is smaller in absolute value than the spending multiplier because government spending is itself spending, while a tax change enters only through disposable income: a tax cut of ΔT first raises spending by cΔT, not ΔT.

Example 5.1 (NCERT). MPC c = 0.8.

• Government expenditure multiplier = 1 ÷ (1 − 0.8) = 1 ÷ 0.2 = 5. A rise of 100 in G raises equilibrium income by 5 × 100 = 500.
• Tax multiplier = −0.8 ÷ 0.2 = −4. A tax cut of 100 (ΔT = −100) raises equilibrium income by 400, less than under the rise in G.

Balanced budget multiplier. For any c, "the tax multiplier is always one less in absolute value than the government expenditure multiplier". So if a rise in G is matched by an equal rise in taxes, keeping the budget balanced, output rises by exactly the rise in G:

ΔY ÷ ΔG = 1 ÷ (1 − c) + [−c ÷ (1 − c)] = (1 − c) ÷ (1 − c) = 1 (eq. 5.9).

In Example 5.1, G up 100 adds 500, the matching tax rise of 100 subtracts 400, and income rises by 100. Through the rounds: the spending raises income by ΔG(1 + c + c² + …) (eq. 5.10), while the tax enters only from the second term, −ΔT(c + c² + …) (eq. 5.11); with ΔG = ΔT the difference is ΔG. Directly from eq. 5.3, with investment unchanged, ΔY = ΔG + c(ΔY − ΔT) (eq. 5.12), and with ΔG = ΔT, ΔY ÷ ΔG = (1 − c) ÷ (1 − c) = 1 (eq. 5.13). The equilibrium is the income reached once all rounds of the multiplier have worked out.

Proportional taxes. More realistically, the government takes a fixed fraction t of income, T = tY. Then

• C = C̄ + c(Y − tY + TR̄) = C̄ + c(1 − t)Y + cTR̄ (eq. 5.14): consumption is lower at every income and its slope falls from c to c(1 − t).
• AD = Ā + c(1 − t)Y, where autonomous expenditure Ā = C̄ + cTR̄ + I + G (eq. 5.15). The AD line becomes flatter (Fig. 5.3).
• Y = Ā + c(1 − t)Y (eq. 5.16), so Y* = Ā ÷ [1 − c(1 − t)] (eq. 5.17) and the multiplier is ΔY ÷ ΔĀ = 1 ÷ [1 − c(1 − t)] (eq. 5.18), smaller than with lump-sum taxes because each round of extra income now raises consumption by c(1 − t), not c.
• For a change in G: ΔY = ΔG + c(1 − t)ΔY (eq. 5.19), so ΔY = ΔG ÷ [1 − c(1 − t)] (eq. 5.20) (Fig. 5.4). A cut in the tax rate works like a rise in the propensity to consume: AD swings up and income rises (Fig. 5.5).

Example 5.2 (NCERT). Keep c = 0.8 and add a tax rate t = 0.25. Each extra unit of income now raises consumption by c(1 − t) = 0.8 × 0.75 = 0.60 instead of 0.80. The government expenditure multiplier is 1 ÷ (1 − 0.6) = 1 ÷ 0.4 = 2.5, and a rise of 100 in G raises output by 2.5 × 100 = 250, against 500 with lump-sum taxes.

Automatic stabilisers and discretionary fiscal policy. A proportional income tax acts as "an automatic stabiliser – a shock absorber": when GDP rises, part of the rise is taken in tax, so disposable income and consumption rise less; when GDP falls, disposable income and consumption fall less, so the fall in demand is smaller. Welfare transfers do the same (paid out more in slumps), and so does private behaviour: corporations hold dividends steady in the short run and households try to keep their living standards. These work without anyone deciding to act, but they absorb only part of a fluctuation. Deliberate changes are discretionary fiscal policy: if investment falls from I₀ to I₁, the government can raise spending from G₀ to G₁ so that C̄ + I₀ + G₀ = C̄ + I₁ + G₁ and income is unchanged.

Transfers. A rise in transfers TR̄ raises autonomous spending by only cΔTR̄, because part of any transfer is saved. So ΔY = [c ÷ (1 − c)] × ΔTR̄ (eq. 5.21), and the transfer multiplier ΔY ÷ ΔTR̄ = c ÷ (1 − c) (eq. 5.22), the tax multiplier with the sign reversed.

Example 5.3 (NCERT). c = 0.75, lump-sum taxes. A rise of 20 in government purchases raises income by [1 ÷ (1 − 0.75)] × 20 = 4 × 20 = 80. A rise of 20 in transfers raises it by [0.75 ÷ 0.25] × 20 = 3 × 20 = 60.

Debt

Deficits are financed by taxation, borrowing or printing money; governments mostly borrow, which creates government debt. A deficit is a flow that adds to the stock of debt; continued borrowing piles up debt, and the interest on it adds to future deficits.

Is debt a burden? NCERT warns that the whole economy is not one trader: unlike a trader, the government can tax and print money.

• Burden on future generations. Bonds sold to people today may be repaid twenty years later out of taxes on the young who have just started work; their disposable income and consumption fall, so national saving falls. Government borrowing also takes saving that private investment could have used; to the extent that cuts capital formation and growth, debt burdens the future.
• Traditional view. When taxes are cut and a deficit is run, consumers spend more, either because they are short-sighted or because they expect future taxes to fall on others.
• Ricardian equivalence. Forward-looking consumers see that borrowing today means taxes tomorrow, and care about their children and grandchildren, so they save more now and fully offset the government's dissaving: national saving does not change. The view is named after David Ricardo, who first argued that people save more in the face of high deficits. It is "equivalence" because borrowing now and taxing later has the same effect as taxing now.
• "We owe it to ourselves." NCERT reports the argument that "debt does not matter because we owe it to ourselves": purchasing power stays within the nation even as it moves between generations. Debt owed to foreigners is different, because goods must be sent abroad to pay the interest.

Other perspectives. Deficits are called inflationary because higher spending or lower taxes raise demand that firms may not meet at going prices; but with unused resources output is held back by lack of demand, and a high fiscal deficit brings more demand and more output, so it need not be inflationary. Deficits are also said to reduce private investment: government bonds compete with corporate bonds for saving, and some private borrowers are "crowded out". But saving is not fixed if deficits raise output, since more income brings more saving. And if borrowing pays for infrastructure whose return exceeds the interest rate, future generations may be better off, and the growth of debt should be judged against the growth of the economy.

Deficit reduction. The deficit can be cut by raising taxes or cutting spending. NCERT records reliance on direct taxes (indirect taxes being regressive), PSU share sales, and above all spending cuts through better planning and administration; it cites a Planning Commission evaluation that "to transfer Re1 to the poor, government spends Rs 3.65 in the form of food subsidy", an argument for cash transfers. Cutting vital programmes (agriculture, education, health, poverty alleviation) would hurt the economy. Finally, "larger deficits do not always signify a more expansionary fiscal policy": in a recession tax revenue falls with incomes, so the deficit widens with no change in policy, and it narrows in a boom.

NCERT's Summary

1. Public goods are non-rival and non-excludable, so fees are hard to collect, private firms will not in general provide them, and the government must.
2. Allocation, redistribution and stabilisation work through the government's spending and receipts.
3. The budget is split into a revenue budget and a capital budget, separating current needs from investment in the capital stock.
4. A rising share of the revenue deficit in the fiscal deficit signals worse-quality spending and lower capital formation.
5. Proportional taxes reduce the autonomous expenditure multiplier because they reduce the marginal propensity to consume out of income.
6. Public debt is a burden if it reduces future growth of output.

Box 5.2: The FRBM Act, 2003, and What It Says Now

NCERT's box presents the Fiscal Responsibility and Budget Management Act as a rule binding present and future governments, enacted in August 2003, with rules from July 2004. Its eight features, as NCERT lists them:

1. Reduce the fiscal deficit to not more than 3 per cent of GDP and eliminate the revenue deficit by 31 March 2009 (NCERT's footnote: the revenue-deficit date was later moved by one year), then build up a revenue surplus.
2. Cut the fiscal deficit by 0.3 per cent of GDP a year and the revenue deficit by 0.5 per cent; if tax revenue falls short, cut spending.
3. Deficits may exceed targets only on grounds of "national security or natural calamity or such other exceptional grounds" as the Centre may specify.
4. The Centre shall not borrow from the RBI except by way of advances to meet temporary excess of cash disbursements over cash receipts.
5. The RBI "must not subscribe to the primary issues of central government securities from the year 2006-07".
6. Greater transparency in fiscal operations.
7. Three statements laid before Parliament with the Annual Financial Statement (see 5.1.3).
8. A quarterly review of receipts and expenditure placed before Parliament.

NCERT adds that 26 states had passed fiscal responsibility laws, that some feared welfare spending would be cut to meet targets, and that the FRBM Review Committee was given the task of revamping the framework.

Box 5.3: GST, One Nation, One Tax, One Market

NCERT's box: the Goods and Services Tax is a single comprehensive indirect tax on the supply of goods and services, from manufacturer or service provider to consumer, in operation from 1 July 2017. It is a destination-based consumption tax with input tax credit: tax paid at the previous stage is set off at the next, so it is in effect a tax on the value added at each stage. The old regime taxed the full value at each stage, including taxes already paid on inputs, which is cascading. GST subsumed central taxes (central excise duty, service tax, central sales tax, cesses such as KKC and SBC) and state taxes (VAT or sales tax, entry tax, luxury tax, octroi, entertainment tax, taxes on advertisements and on lottery, betting and gambling, state cesses). Five petroleum products are outside GST for now; states still levy VAT on alcoholic liquor for human consumption; tobacco attracts both GST and central excise. The 101st Constitution Amendment Act received assent on 8 September 2016 and inserted Article 246A, empowering Parliament and state legislatures to make laws on GST; the CGST, UTGST and SGST Acts followed. Payment, registration and returns are online at the common portal www.gst.gov.in.

PART 3 — UPSC Integration

Three Frameworks

1. Classify first, then total. Every budget item answers two questions: revenue or capital, and (for capital receipts) debt-creating or not. Once each item is in its box, the deficits are subtractions: revenue deficit from the revenue boxes, fiscal deficit from everything except borrowing, primary deficit by removing interest. Most Prelims questions on the budget are classification questions in disguise.

2. Size and quality of the deficit. The fiscal deficit says how much the government borrows; the revenue deficit's share in it says what the borrowing pays for; the primary deficit says how much is new imbalance rather than old interest. In 2026-27 (budget): fiscal 4.3, revenue 1.5 (35 per cent of the fiscal deficit), primary 0.7; interest takes 39.7 per cent of revenue receipts (14,03,972 ÷ 35,33,150, arithmetic). A Mains answer on fiscal health uses all three, plus debt (55.6 per cent, target 50 ± 1 by 2030-31).

3. Fiscal policy through the multiplier. Spending works directly (1 ÷ (1 − c)); taxes and transfers work through disposable income (c ÷ (1 − c)); a proportional tax both stabilises and shrinks the multiplier (1 ÷ [1 − c(1 − t)]). Whether a deficit is a burden depends on what it buys, whether resources are idle, and how fast the economy grows: NCERT's debt section is the checklist.

Confused Pairs

Exam Strategy

• Prelims: classification questions (which receipts are capital, which spending is revenue, what is subtracted for the fiscal deficit); the deficit identities with NCERT's Table 5.1 numbers; NCERT's multiplier numbers (5, −4, 1 and 2.5 at c = 0.8; 80 and 60 at c = 0.75); the FRBM history (ad hoc Treasury Bills ended 1997; RBI primary-issue bar from 2006-07; 3 per cent by 31 March 2021 in the Act now); and the current Budget's ratios (fiscal 4.3, revenue 1.5, primary 0.7, debt 55.6, target 50 ± 1 by 2030-31). Know which number is an estimate and which an actual.
• Mains (GS3): for fiscal consolidation, quality of spending or public debt, define the three deficits, give the dated record (actual, revised and budget columns; debt path; the 16th Finance Commission's 3.5 per cent recommendation), then argue with NCERT's debt section: burden on future generations versus Ricardian equivalence, inflation only near full use of resources, crowding out versus higher saving from higher income, and borrowing for infrastructure that earns more than the interest rate.
• Numericals: write C on disposable income, put T and TR̄ in, solve for Y*, then use the multiplier table. Check: for a balanced-budget change the answer equals ΔG; for a proportional tax the multiplier uses c(1 − t).

Practice Questions

Prelims (UPSC-pattern, not past papers)

1. Which one of the following is a capital receipt of the Union Government? (a) Dividends from public sector enterprises (b) Surplus transferred by the Reserve Bank of India (c) Recovery of loans given to states (d) Grants-in-aid received from a foreign government Answer: (c). Recovery of loans reduces the government's financial assets. Dividends, the RBI surplus and foreign grants are non-tax revenue receipts (NCERT 5.1.2; the Receipt Budget counts the RBI surplus under "Dividends and Profits").

2. A government's revenue deficit is 2.6, its capital expenditure 3.2 and its non-debt-creating capital receipts 0.2, all as per cent of GDP. Interest payments are 3.6. Its fiscal and primary deficits are: (a) 5.6 and 2.0 (b) 5.8 and 2.2 (c) 5.6 and 9.2 (d) 6.0 and 2.4 Answer: (a). Fiscal deficit = 2.6 + 3.2 − 0.2 = 5.6; primary deficit = 5.6 − 3.6 = 2.0 (NCERT Table 5.1).

3. Consider the following statements:

   1. The fiscal deficit equals the total borrowing requirement of the government.
   2. In NCERT's definition, the primary deficit subtracts net interest liabilities, that is, interest payments minus interest receipts.
   3. A zero primary deficit means the government is not borrowing at all.

   Which of the statements given above are correct? (a) 1 and 2 only (b) 2 and 3 only (c) 1 and 3 only (d) 1, 2 and 3 Answer: (a). With a zero primary deficit the government still borrows to pay interest on past debt.

4. With a marginal propensity to consume of 0.8 and lump-sum taxes, the government raises its purchases by 100 and finances them with a tax rise of 100. Equilibrium income rises by: (a) 0 (b) 100 (c) 400 (d) 500 Answer: (b). +500 from spending (multiplier 5), −400 from the tax (multiplier −4): the balanced budget multiplier is 1.

5. In the economy of question 4 the government replaces the lump-sum tax with a proportional income tax of 25 per cent. A rise of 100 in government purchases now raises income by: (a) 500 (b) 400 (c) 250 (d) 125 Answer: (c). c(1 − t) = 0.6; multiplier 1 ÷ 0.4 = 2.5 (NCERT Example 5.2).

6. With a marginal propensity to consume of 0.75 and lump-sum taxes, which one of the following is correct? (a) A rise of 20 in transfers raises income by 80 (b) A rise of 20 in government purchases raises income by 60 (c) A rise of 20 in government purchases raises income by 80 and a rise of 20 in transfers by 60 (d) Purchases and transfers of 20 each raise income by the same amount Answer: (c). Spending multiplier 4, transfer multiplier 3 (NCERT Example 5.3): part of a transfer is saved.

7. Consider the following statements based on NCERT:

   1. A proportional income tax acts as an automatic stabiliser.
   2. Ricardian equivalence holds that consumers save a deficit-financed tax cut because they expect higher future taxes.
   3. A larger fiscal deficit always signals a more expansionary fiscal policy.

   Which of the statements given above are correct? (a) 1 and 2 only (b) 2 and 3 only (c) 1 and 3 only (d) 1, 2 and 3 Answer: (a). In a recession tax revenue falls and the deficit widens with no change in policy.

8. Consider the following statements:

   1. The issue of ad hoc Treasury Bills to the RBI was discontinued from 1 April 1997.
   2. The FRBM Act, as amended, sets a fiscal deficit limit of 3 per cent of GDP by 31 March 2021.
   3. The 16th Finance Commission raised the states' share of the divisible pool to 42 per cent.

   Which of the statements given above are correct? (a) 1 and 2 only (b) 2 and 3 only (c) 1 and 3 only (d) 1, 2 and 3 Answer: (a). The 16th Commission kept the share at 41 per cent; 42 per cent was the 14th Commission's.

NCERT Exercises 1-15 (worked answers)

1. Why public goods must be provided by the government. Public goods are non-rival (one person's use does not reduce what is left for others) and non-excludable (no feasible way to keep non-payers out). Users can free-ride, so fees cannot be collected, private firms will not supply them, and the government must provide them through the budget. Provision means financing; production may still be private.
2. Revenue versus capital expenditure. Revenue expenditure creates no physical or financial asset of the Centre: salaries and running costs, interest, subsidies, grants to states. Capital expenditure creates assets or reduces liabilities: land, buildings, machinery, shares, loans and advances to states, union territories and PSUs. In 2026-27 (budget) revenue expenditure is ₹41,25,494 crore and capital expenditure ₹12,21,821 crore.
3. "The fiscal deficit gives the borrowing requirement of the government." Fiscal deficit = total expenditure − (revenue receipts + non-debt-creating capital receipts): the part of spending not covered by any receipt other than borrowing. It must be borrowed, at home (from the public and from banks through SLR), from the RBI or from abroad. In the 2026-27 budget the fiscal deficit (₹16,95,768 crore) equals "borrowings and other liabilities" exactly.
4. Revenue deficit and fiscal deficit. Fiscal deficit = revenue deficit + capital expenditure − non-debt-creating capital receipts. The revenue deficit is part of the fiscal deficit; the larger its share, the more borrowing pays for consumption rather than assets. Table 5.1: 2.6 + 3.2 − 0.2 = 5.6.
5. I = 200, G = 150, net taxes = 100, C = 100 + 0.75Y_D. (a) Y = 100 + 0.75(Y − 100) + 200 + 150 = 375 + 0.75Y, so Y* = 375 ÷ 0.25 = 1,500. Check: Y_D = 1,400, C = 1,150, and 1,150 + 200 + 150 = 1,500. (b) Government expenditure multiplier = 1 ÷ 0.25 = 4; tax multiplier = −0.75 ÷ 0.25 = −3. (c) ΔG = 200 raises income by 4 × 200 = 800, to 2,300. (If C is read as a function of Y, net taxes drop out and Y* = 450 ÷ 0.25 = 1,800; the multipliers and the change of 800 are the same.)
6. C = 20 + 0.80Y_D, I = 30, G = 50, TR = 100. (a) Y = 20 + 0.8(Y + 100) + 30 + 50 = 180 + 0.8Y, so Y* = 900; autonomous expenditure multiplier = 1 ÷ 0.2 = 5. Check: Y_D = 1,000, C = 820, and 820 + 30 + 50 = 900. (b) ΔG = 30 raises income by 5 × 30 = 150, to 1,050. (c) A lump-sum tax of 30 lowers income by 4 × 30 = 120, so income ends at 1,050 − 120 = 930: 30 above the original 900, as the balanced budget multiplier of 1 predicts.
7. A 10 per cent rise in transfers and in lump-sum taxes (economy of Exercise 6). Transfers rise by 10 per cent of 100 = 10: ΔY = [0.8 ÷ 0.2] × 10 = +40. Lump-sum taxes, 30 after Exercise 6(c), rise by 3: ΔY = −4 × 3 = −12. Rupee for rupee the two multipliers are equal and opposite (+4 and −4), so equal changes would cancel; the effects differ here only because the bases (100 and 30) differ.
8. C = 70 + 0.70Y_D, I = 90, G = 100, T = 0.10Y. (a) Y_D = 0.9Y, so Y = 70 + 0.63Y + 90 + 100 = 260 + 0.63Y and Y* = 260 ÷ 0.37 = 702.70 (multiplier 1 ÷ 0.37 = 2.70). Check: C = 70 + 0.7 × 632.43 = 512.70, and 512.70 + 190 = 702.70. (b) Tax revenue = 0.10 × 702.70 = 70.27. Spending of 100 exceeds it by 29.73, so the budget is not balanced: there is a deficit.
9. c = 0.75, t = 0.20. c(1 − t) = 0.6, multiplier = 1 ÷ 0.4 = 2.5. (a) Purchases up 20: ΔY = 2.5 × 20 = +50. (b) Transfers down 20: autonomous spending falls by c × 20 = 15, so ΔY = 2.5 × (−15) = −37.5.
10. Why the tax multiplier is smaller in absolute value. Government purchases are spending: the first round adds ΔG to demand. A tax change works only through disposable income, and households change consumption by c times it, so the first round is cΔT. Every later round is the same multiple, so the tax multiplier is c ÷ (1 − c), exactly 1 less than 1 ÷ (1 − c): 4 against 5 at c = 0.8.
11. Deficit and debt. The deficit is a flow over a year; debt is the stock accumulated from past borrowing. Each year's fiscal deficit, financed by borrowing, adds to debt, and interest on the larger debt raises future spending and deficits. The Union's debt is 56.1 per cent of GDP (revised 2025-26) and 55.6 per cent (budget 2026-27), with a target of 50 ± 1 per cent by 2030-31.
12. Does public debt impose a burden? It can: future taxes to repay bonds cut the young generation's disposable income and consumption, and borrowing takes saving away from private investment, lowering capital formation and growth; debt owed abroad requires sending goods out to pay interest. Against this, Ricardian equivalence says private saving rises to offset it; domestic debt is largely owed to ourselves; and borrowing for infrastructure that earns more than the interest rate can leave future generations better off. NCERT's test: debt is a burden if it reduces future growth of output.
13. Are fiscal deficits inflationary? Only near full use of resources. A deficit raises demand; if firms cannot produce more at going prices, prices rise. With unemployment and idle capacity, output responds instead, so a high deficit brings more output and need not be inflationary.
14. Deficit reduction. Raise taxes (with more reliance on direct taxes, since indirect taxes are regressive), sell PSU shares, and cut spending through efficiency (better planning and administration; NCERT cites the Rs 3.65 spent to transfer Re 1 through food subsidy) or by withdrawing from some areas, without cutting vital programmes in agriculture, education, health and poverty alleviation. Rules such as the FRBM Act cap deficits. A wider deficit in a recession may reflect falling revenue, not looser policy.
15. GST. GST is a single destination-based tax on the supply of goods and services, with input tax credit so that only value added is taxed at each stage. Against the old system it removes cascading, replaces many central and state taxes with one, standardises laws, procedures and rates across the country, creates a common market, lowers business costs and moves compliance online. Its categories: central GST (CGST) and state or union territory GST (SGST, UTGST) on supplies within a state, and integrated GST (IGST) on inter-state supplies; its rates now are 5 per cent (merit), 18 per cent (standard) and 40 per cent (special de-merit), plus nil-rated items (56th GST Council, from 22 September 2025).

📦 Revision Capsule

Sources

• NCERT, Introductory Macroeconomics (Class XII), ch. 5 "Government Budget and the Economy", Reprint 2026-27: ncert.nic.in PDF.
• Ministry of Finance, Budget at a Glance 2026-27 (pp. 1-3, paras 2-5): indiabudget.gov.in PDF.
• Ministry of Finance, Budget at a Glance 2025-26, 2024-25 and 2023-24 (deficit statistics, one actual year each): 2025-26 PDF; 2024-25 PDF; 2023-24 PDF.
• Ministry of Finance, Budget Speech 2026-27 (paras 92-97 and 99): indiabudget.gov.in PDF.
• Ministry of Finance, Statements of Fiscal Policy as required under the Fiscal Responsibility and Budget Management Act, 2003, February 2026: indiabudget.gov.in PDF.
• Ministry of Finance, Receipt Budget 2026-27 (Annex-1; non-tax revenue notes): indiabudget.gov.in PDF.
• Ministry of Finance, Explanatory Memorandum on the Report of the Sixteenth Finance Commission, February 2026 (paras 3 and 26): indiabudget.gov.in PDF.
• Ministry of Finance, Economic Survey 2025-26, ch. 2, para 2.4: indiabudget.gov.in PDF.
• Ministry of Finance, Budget Speech 2017-18 (plan and non-plan; para 135 on the FRBM Review Committee): indiabudget.gov.in PDF; Budget Speech 2012-13 (effective revenue deficit): indiabudget.gov.in PDF.
• Ministry of Finance, Economic Survey 1997-98, ch. 4, para 35 (ad hoc Treasury Bills): indiabudget.gov.in PDF; Economic Survey 2003-04, ch. 2 (FRBM Act features): indiabudget.gov.in PDF.
• Reserve Bank of India, press releases on the 623rd (22 May 2026) and 616th (23 May 2025) meetings of the Central Board: 22 May 2026; 23 May 2025.
• PIB, Recommendations of the 56th Meeting of the GST Council, 3 September 2025: GST Council PDF; PIB, GST revenue collection for April 2024, 1 May 2024: pib.gov.in.
• PIB, 14th Finance Commission report tabled in Parliament, 24 February 2015: pib.gov.in.