Budget, Taxation and Fiscal Policy

Every family makes a plan at the start of the month: how much will come in, how much must go out, and what is left for emergencies. A government does exactly the same, only on a gigantic scale and for a full year. This plan is the Budget. The Constitution does not use the word 'Budget'; Article 112 calls it the Annual Financial Statement, an estimate of the receipts and expenditure of the Government of India for one financial year (1 April to 31 March). It is presented in the Lok Sabha by the Finance Minister, on 1 February since 2017 (earlier it was the last working day of February).

Appropriation Bill and Finance Bill. These two are often confused. The Appropriation Bill (Article 114) gives the government legal power to spend the amounts voted, so it deals with expenditure. The Finance Bill carries the Finance Minister's proposals to impose, change or remove taxes, so it deals with receipts. The estimates of revenue receipts in the Budget already assume that the tax proposals in the Finance Bill will be passed. If the new financial year begins before the Budget is passed, the Lok Sabha passes a Vote on Account (Article 116), a temporary permission to spend for a few months. In an election year, the outgoing government presents an Interim Budget: a statement of the accounts along with a vote on account, leaving the big policy decisions to the new government. 'Interim Budget' is a convention and is not named in the Constitution.

A budget has three goals that Musgrave described: allocation (providing public goods such as roads and defence that the market will not supply), redistribution (taxing the rich more and supporting the poor through subsidies and transfers) and stabilisation (using spending and taxes to keep growth steady and prices stable). In the budget, a surplus budget means receipts exceed expenditure, a balanced budget means they are equal and a deficit budget means expenditure exceeds receipts. A deficit budget is usually preferred in a depression or recession, because the government's extra spending lifts demand.

The Budget is a ledger with two columns. On one side is money coming in (receipts); on the other, money going out (expenditure). Each column is again cut in two by one simple test, and if you master that test, every classification question in the Budget becomes easy. The test is: does the item create a liability or reduce an asset (for receipts), or create an asset or reduce a liability (for expenditure)? If yes, the item is capital. If not, it is revenue, that is, a normal, recurring, day-to-day item.

Capital receipts are of two kinds. Debt-creating capital receipts are borrowings, because they must be repaid with interest. Non-debt creating capital receipts bring money without creating a repayment burden: recovery of loans and disinvestment (selling government shares in PSUs). The government often calls disinvestment 'asset sale', and since it reduces the government's assets, it is a capital, not a revenue, receipt. In contrast, the dividend a PSU pays to the government is a revenue receipt, because the shares remain with the government.

Subsidies and transfers. A subsidy is money the government pays to lower the price of a good or service for consumers or producers, for example on food, fertiliser and cooking gas. Subsidies are revenue expenditure, since they do not create an asset. The biggest subsidies are on food, fertiliser and petroleum. A transfer payment is a payment made without receiving any good or service in return, such as an old-age pension, a scholarship or a subsidy. The government tries to reduce wastage through Direct Benefit Transfer (DBT), which sends the subsidy to the beneficiary's bank account. Committed expenditure (interest, defence, salaries and pensions) is hard to cut, because it is fixed by past decisions and national security.

Why are grants for asset creation still revenue expenditure? When the Centre gives a grant to a state for building a school or a road, the asset belongs to the state, not to the Centre. Since the Centre does not create an asset of its own, its books record the grant as revenue expenditure. To show how much of the spending really goes to creating assets, the Budget also reports 'effective capital expenditure' = capital expenditure + grants given for creation of capital assets.

Think of Radhika's family. In a month it earns Rs 50,000 and spends Rs 60,000, including a Rs 8,000 instalment on an old loan. The family is Rs 10,000 short, and must borrow that much. This shortfall is a deficit. A government is in the same position when its expenditure is more than its receipts, but it can measure the shortfall in several ways, and each way tells a different story. That is why India's Budget reports four main deficit measures: the revenue deficit, the fiscal deficit, the primary deficit and the effective revenue deficit.

Worked example. Suppose, in Rs lakh crore: revenue receipts 30, non-debt capital receipts 2, revenue expenditure 38, capital expenditure 8, and interest payments 10. Then total expenditure = 38 + 8 = 46. Revenue deficit = 38 - 30 = 8. Fiscal deficit = 46 - (30 + 2) = 14. Primary deficit = 14 - 10 = 4. Notice that the fiscal deficit is always at least as large as the revenue deficit (since capital expenditure is added and only non-debt capital receipts are subtracted), and that a large share of the fiscal deficit (here 10 of 14) merely pays interest on the past borrowing.

Why do deficits matter? A deficit is not always bad. In a recession, deficit spending lifts demand and jobs (this is the idea behind a 'deficit budget' in depression). But a persistent deficit, especially a revenue deficit, is dangerous: it means borrowing to pay salaries and subsidies, not to build roads, so there is nothing to show for the debt. The costs are crowding out (government borrowing raises interest rates and leaves less credit for private firms), higher inflation if the deficit is monetised, and the debt trap, where new borrowing is needed only to pay the interest on old borrowing. The old 'budgetary deficit' (total expenditure minus total receipts, financed by RBI's ad hoc treasury bills) was discontinued from 1997-98 after the ad hoc bills were abolished.

The FRBM Act, 2003. The Act's aim is fiscal discipline: to bring down the deficits and the debt to levels that are sustainable, and to be fair to future generations (inter-generational equity), who would otherwise inherit the debt. Its main features are listed below. The Act binds the Union Government; the states have passed their own FRBM Acts, which aim at a fiscal deficit of about 3 per cent of their GSDP.

After the N. K. Singh Committee (2017) the framework moved from fixing only deficit targets to also fixing a debt anchor: the Centre's debt at 40 per cent of GDP (and general government debt at 60 per cent, with 20 per cent for states) over the medium term. Budget 2025-26 shifted the Centre's anchor to debt-to-GDP (to be brought down to about 50 per cent, plus or minus one point, by March 2031) and set the fiscal deficit target for 2025-26 at 4.4 per cent of GDP. Why debt? Because the deficit is only the yearly flow, while debt is the accumulated stock, and interest is paid on the stock.

Think of tax as the price a citizen pays for roads, police, schools and defence. The first question about any tax is simple: who actually bears the burden? If the person who pays the tax to the government is the same person who bears its burden, it is a direct tax. If the burden can be passed on to someone else, usually the consumer, it is an indirect tax. Under the Constitution, Article 265 says that no tax can be levied or collected except by authority of law, and the Seventh Schedule divides the power to tax between the Union and the States.

Impact and incidence. The impact of a tax is on the person who first pays it to the government. The incidence is on the person who finally bears the burden. In a direct tax, impact and incidence fall on the same person. In an indirect tax, the impact is on the seller and the incidence is on the consumer. This is why indirect taxes are called regressive: a poor household spends most of its income on goods and so pays a larger share of its income as tax than a rich household does.

Income tax in brief. Income tax is governed by the Income Tax Act, 1961, and a new Income-tax Act, 2025 replaced it from 1 April 2026 (as of 2026). The tax is charged on a person's income of the previous year, which the law calls the previous year, in the assessment year. Agricultural income is outside the Centre's income tax, because it is a State subject. The new tax regime has become the default regime. For FY 2025-26 its slabs were: nil up to Rs 4 lakh, 5 per cent from 4 to 8 lakh, 10 per cent from 8 to 12 lakh, 15 per cent from 12 to 16 lakh, 20 per cent from 16 to 20 lakh, 25 per cent from 20 to 24 lakh, and 30 per cent above Rs 24 lakh, with a rebate that makes income up to Rs 12 lakh tax-free (as of Budget 2025).

Before 2017, a pair of shoes travelled through a maze. The Centre charged excise on the maker and service tax on the services, and each State charged its own VAT, entry tax and octroi. A tax was often charged on top of another tax, which is called cascading. GST (Goods and Services Tax) was built to end that maze: one tax on the supply of goods and services, charged at every stage, with credit for the tax already paid at the earlier stage. It is a destination-based tax, meaning the tax goes to the State where the good is consumed, not where it is made.

Why a dual GST? India is a federation, and both the Centre and the States have always taxed goods. So GST is also dual: on one sale within a State, the Centre charges CGST and the State charges SGST (Union Territories with a legislature use SGST; others use UTGST). When a good crosses a State border, the Centre charges one tax, IGST, and then passes the State's share to the State where the good is consumed. Imports also attract IGST. Input tax credit (ITC) lets a seller deduct the GST it paid on its inputs from the GST it collects, so tax is paid only on the value added at each stage.

Are the Council's recommendations binding? The Constitution says the Council makes recommendations on rates, exemptions, thresholds and similar matters. In Mohit Minerals (2022) the Supreme Court held that these recommendations are persuasive, not binding, and that Parliament and State Legislatures have simultaneous power to make GST laws under Article 246A. In practice, the Centre and States have followed the Council's decisions. The States were also promised compensation for any loss of revenue for five years from the start of GST.

Fiscal policy is the government's use of its own spending and taxation to steer the economy. When growth is weak and jobs are scarce, the government spends more or cuts taxes: that is expansionary (or loose) fiscal policy, and it pushes up demand. When prices are rising too fast, it spends less or raises taxes: that is contractionary (or tight) fiscal policy, and it cools demand. Fiscal policy is run by the Finance Ministry and passed by Parliament through the Budget. Monetary policy, by contrast, works through money supply and interest rates, and is run by the RBI.

Crowding out. When the government borrows heavily to pay for its deficit, it competes with private firms for the same pool of savings. That pushes interest rates up, making loans costlier for businesses, and so private investment falls. This is called crowding out. It is the main argument against large, persistent deficits. It is weaker when the economy has idle savings and low private demand, as in a deep recession.

Public debt. The Centre borrows under Article 292 and the States under Article 293. The Centre's debt has an internal part (market borrowings through government securities, treasury bills, and so on) and an external part (loans from abroad). For the Centre, internal debt is far larger. For short-term mismatches between receipts and payments, the RBI gives the Centre Ways and Means Advances (WMA). Since 1 April 2006, the FRBM Act has barred the RBI from subscribing directly to the Centre's primary issues of securities, so the Centre must borrow from the market. NITI Aayog's Fiscal Health Index (first edition, 2025) ranks States on five sub-indices: quality of expenditure, revenue mobilisation, fiscal prudence, debt index and debt sustainability.

Duties of the Finance Commission (Article 280(3)): to recommend (a) how the net proceeds of taxes are to be divided between the Union and the States (vertical sharing) and among the States (horizontal sharing); (b) the principles for grants-in-aid to States under Article 275; (c) measures to augment a State's Consolidated Fund so that it can supplement the resources of Panchayats and Municipalities, on the basis of the State Finance Commission's recommendations; and (d) any other matter referred to it by the President. It does not evaluate the fiscal policy of States, and its recommendations are advisory, not binding.