Topic 4

🟢 Lite — Quick Review (1h–1d)

Rapid summary for last-minute revision before your exam.

• Fiscal Deficit = (Total Expenditure − Total Receipts excluding borrowings)/GDP × 100; RBI targets < 3% of GDP (FRBM Act)
• Direct Taxes: Income Tax, Corporate Tax, Capital Gains Tax — paid directly by person whose income it is
• Indirect Taxes: GST, Customs, Excise — embedded in price; collected by seller; passed on to government
• GST Council: Chaired by Union Finance Minister; 75% special majority needed for decisions; states have significant voice
• Zero-based Budgeting: Every budget item must be justified from scratch; not just incremental increase from previous year
• ⚡ FRBM Act (Fiscal Responsibility and Budget Management Act, 2003): Required government to eliminate revenue deficit and reduce fiscal deficit to 3% of GDP — hasn’t been achieved yet

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🟡 Standard — Regular Study (2d–2mo)

Standard content for students with a few days to months.

Government Budgeting and Taxation

Understanding the budget and taxation is essential for banking exams as it determines government spending, credit demand, and overall economic conditions.

The Union Budget — Overview

The Union Budget is the government’s annual financial statement, presented to Parliament by the Finance Minister.

Article 112 of the Constitution: Requires the President to lay before Parliament an annual financial statement (budget) showing estimated receipts and expenditure for that year.

Budget Cycle:

1. Pre-Budget Meeting: Finance Minister meets stakeholders
2. Budget Formulation: Ministry of Finance prepares budget with inputs from all ministries
3. Parliamentary Approval: Lok Sabha passes Finance Bill and Appropriation Bill
4. Implementation: Budget implemented from April 1 (new financial year)

Financial Year (FY)

• April 1 to March 31
• Budget is for the upcoming FY (e.g., Budget 2024-25 = April 2024 to March 2025)

Components of the Budget

A. Receipts

Revenue Receipts (do not create liability):

1. Tax Revenue (Net):

   • Direct Taxes: Income tax, corporation tax, wealth tax, gift tax, expenditure tax
   • Indirect Taxes: GST, customs duties, excise duties

2. Non-Tax Revenue:

   • Interest receipts (from states, PSEs, external loans)
   • Dividends and profits (from PSU dividends, RBI surplus transfer)
   • Fees, penalties, licenses

Capital Receipts (create liability/reduce assets):

1. Recovery of Loans: Loans given by government to states, PSUs
2. Other Capital Receipts: Small savings (post office savings), state provident funds
3. Borrowings and Liabilities: Net government borrowing (G-Sec issuance), Treasury Bills, external debt

B. Expenditure

Revenue Expenditure: Day-to-day running of government (salaries, subsidies, interest payments, grants to states)

Capital Expenditure: Investment in assets (infrastructure, defence equipment, loans to states)

Major Expenditure Heads:

• Interest payments (largest; ~20% of revenue expenditure)
• Defence
• Subsidies (food, fertiliser, petroleum)
• Grants to state governments (devolution)
• Centrally Sponsored Schemes

Budget Deficits — The Key Numbers

Revenue Deficit

Revenue Deficit = Revenue Receipts − Revenue Expenditure

When revenue deficit exists, government is borrowing to meet current expenses (not investing).

Target: FRBM Act requires revenue deficit to be zero (or eliminated).

Fiscal Deficit

Fiscal Deficit = Total Expenditure − Total Receipts (excluding borrowings)

Or equivalently: Fiscal Deficit = Revenue Deficit + Capital Expenditure − Net Recoveries of Loans and Other Capital Receipts

Fiscal Deficit = Borrowings and Other Liabilities This is the “gap” the government must fill through borrowing.

Target: FRBM Act mandates fiscal deficit of 3% of GDP

Primary Deficit

Primary Deficit = Fiscal Deficit − Interest Payments

Shows deficit before interest costs — indicates how much borrowing is needed for non-interest expenditure.

Interpretation: If Primary Deficit is zero, government is only borrowing to pay interest (not for spending).

FRBM Act, 2003

The Fiscal Responsibility and Budget Management Act was enacted to ensure fiscal discipline.

Key Targets:

• Revenue Deficit to be reduced to zero and eventually eliminated
• Fiscal Deficit to be reduced to 3% of GDP
• Medium-Term Fiscal Policy Statement to be laid before Parliament
• Fiscal deficit to be achieved through reduction in revenue deficit
• Debt Management objectives: Total liabilities to be reduced over time

FRBM Review: In 2020s, the 3% target was considered too restrictive; FRBM Act may be revised to allow more fiscal space for capital expenditure.

Taxation System in India

Direct Taxes (Income Tax Act, 1961)

Tax on income earned; paid directly to government by the taxpayer.

Types of Direct Taxes:

1. Individual/HUF Income Tax:

   • Based on income slabs (new regime vs old regime)
   • Rebate under Section 87A: Up to ₹25,000 rebate for individuals with income up to ₹7 lakh
   • New Regime (2020 onwards): Lower rates, fewer deductions; default from FY2024
   • Old Regime: Higher rates, more deductions; optional

2. Corporate Tax:

   • Domestic companies: 30% (25% for new manufacturing companies under new regime)
   • Foreign companies: 40% (branch profits: 21.84%)
   • Minimum Alternate Tax (MAT): 18.5% of book profit (if tax payable is less than MAT)

3. Capital Gains Tax:

   • Short-term (assets held < 12 months for listed securities): 15%
   • Long-term (listed securities held > 12 months): 10% without indexation (₹1 lakh exemption per year)
   • Unlisted shares: 20% (indexed)

4. Securities Transaction Tax (STT): Tax on stock market transactions; levied on purchase/sale of equity shares, derivatives

Indirect Taxes

GST (Goods and Services Tax)

Implemented July 1, 2017.

Subsumed Taxes:

• Central Excise Duty
• Service Tax
• VAT / CST
• Entry tax, Octroi
• Luxury tax, Entertainment tax
• Over 17 indirect taxes eliminated

Structure (5-slab + exemptions):

• 0%: Essential items (milk, bread, curd, education, healthcare)
• 5%: Lower necessities (sugar, tea, edible oil, economy rail travel)
• 12%: Intermediate goods (computers, processed food, business class air travel)
• 18%: Most goods and services (white goods, AC restaurants, telecom)
• 28%: Luxury and sin goods (cars > ₹10 lakh, pan masala, aerated drinks)
• Special cess: On specified goods above 28%

GST Council:

• Chaired by Union Finance Minister
• 3/4th (75%) majority for decisions
• States have significant voice (requires states’ consent on many matters)
• One nation, one market: GST unified India’s fragmented indirect tax system

Customs Duty (Import Tariffs)

Levied on imported goods:

• Basic Customs Duty (BCD): Applied to import value
• Social Welfare Surcharge: 10% on BCD value
• Agricultural Infrastructure and Development Cess (AIDC): On agriculture goods

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🔴 Extended — Deep Study (3mo+)

Comprehensive coverage for students on a longer study timeline.

Budget Documents

1. Annual Financial Statement (AFS): Main budget document; shows receipts and expenditure
2. Demand for Grants: Detailed demands from each ministry
3. Finance Bill: Contains tax proposals; passed with the budget
4. Appropriation Bill: Authorises expenditure from Consolidated Fund
5. Medium-Term Fiscal Policy Statement: 3-year rolling targets
6. Fiscal Policy Strategy Statement: Government’s fiscal strategy
7. Debt Management Statement: Debt sustainability analysis

Consolidated Fund, Public Account, Contingency Fund

Consolidated Fund of India (CFI):

• All government revenues, loans received, and money raised
• Parliamentary approval required for all expenditure from CFI
• Appropriation Bill gives authority to withdraw from CFI

Public Account of India:

• Money held by government in trust (small savings, provident funds)
• Expenditure from Public Account doesn’t need parliamentary approval (already authorised by law)
• Post Office Savings, State PF, etc. are in Public Account

Contingency Fund:

• ₹500 crore corpus (as advance from CFI)
• For emergent expenditure authorised by President
• Later replenished from Parliament

Deficit Financing and Borrowing

Market Borrowing:

• Government issues G-Sec (Government Securities) to borrow
• Auctions conducted by RBI on behalf of Government
• G-Secs include: T-bills (short-term), Dated G-Secs (long-term)

Small Savings:

• Post office savings schemes (PPF, NSC, Senior Citizens Savings, etc.)
• Flow into National Small Savings Fund (NSSF)
• Used by government to borrow

External Aid:

• Bilateral (country to country) and multilateral (World Bank, ADB) loans
• Tied aid (specific purpose) vs untied aid

Zero-Based Budgeting (ZBB)

• Every budget item must be justified from scratch
• Not merely incremental increase from previous year
• Government of India introduced ZBB in 2023 for select ministries
• Challenges: Time-intensive; departmental resistance; difficulty in implementing across government

Budget and Banking Sector

The budget directly affects banking through:

• Government borrowing: Large G-Sec issuance absorbs bank liquidity; impacts credit availability
• PSU bank recapitalisation: Budget allocates capital for public sector banks
• Differential interest rates: Small savings schemes vs bank deposit rates
• Sectoral credit incentives: Budget may announce credit guarantees for specific sectors

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