India’s public finances are governed through the Union Budget, tax policy, and Finance Commission recommendations that shape how revenue is raised and shared.
1. Budgeting Method and Tax Reform
- ZBB Zero-Based Budgeting requires every expense to be justified from scratch each budget cycle. It doesn’t just build on the previous year’s figures.
- GST India’s Goods and Services Tax replaced multiple indirect taxes. It created a single, unified tax structure.
2. Institutions Behind Fiscal Policy
- Finance Commission Constituted under Article 280, it recommends how tax revenue is shared between the Union and States.
- Economic Survey Published annually, it reviews the country’s economic performance ahead of the Union Budget.
- FIT India’s Flexible Inflation Targeting framework was given statutory basis through an amendment to the RBI Act.
3. Government Receipts: Capital vs. Revenue
- Capital Receipts These create a liability or reduce the government’s assets. Borrowings and disinvestment are both capital receipts.
- Revenue Receipts These don’t create a liability or reduce assets. Tax collections and interest received on loans given out are both revenue receipts.
4. Fiscal Policy in a Recession, and Financing a Deficit
- Recession Response In a recession, governments usually raise spending on public projects, like roads and infrastructure. This creates jobs and demand directly.
- Why Not Rates Cutting tax rates while also raising interest rates works against itself. One step encourages spending, the other discourages borrowing.
- Financing Methods A government can finance a budget deficit by borrowing from the public, borrowing from banks, or creating new money.
- Most Inflationary Creating new money adds fresh purchasing power with no matching rise in goods and services. This makes it the most inflationary of the three methods.
- Borrowing, By Contrast Borrowing from the public or from banks only moves existing money to the government. It barely changes the total money supply.
1. Fiscal Ratios and Debt Targets
- Tax-to-GDP Ratio This measures how much tax revenue a country collects relative to its overall economic output.
- FRBM Review Committee It recommended specific targets for India’s combined general government debt-to-GDP ratio.
2. Tax Identification
- PAN Card A PAN card’s fourth letter indicates the holder’s category, such as individual or company.
3. International Tax: BEPS
- BEPS Base Erosion and Profit Shifting is when multinational companies exploit gaps in tax rules. They shift profits to low-tax countries to cut their tax bills.
- MLI India ratified the OECD’s Multilateral Instrument in 2019 to fight BEPS. It updates India’s tax treaties to close these loopholes.
Test Yourself
1. Why These Reforms Matter
- GST GST’s introduction was one of India’s most significant tax reforms. It unified a fragmented indirect tax system across all States.
- FIT Flexible Inflation Targeting shifted India’s monetary policy toward a clearer, rules-based framework. It reduced ambiguity about the RBI’s core mandate.
- FRBM Act Fiscal responsibility frameworks like the FRBM Act aim to prevent excessive government borrowing. They balance development spending against long-term debt sustainability.
What a Falling Tax-to-GDP Ratio Does and Doesn’t Signal
A falling tax-to-GDP ratio usually signals a slowing economy. Tax revenue is elastic: it rises and falls with economic activity. When growth slows, corporate profits and consumer spending drop, so tax collections shrink relative to GDP. But the ratio does not measure income distribution. How equitably national income is spread is tracked separately, through tools like the Gini coefficient or income quintiles. A country can have a falling tax-to-GDP ratio with income distribution getting more equal, less equal, or staying the same.
What Actually Reduces the Fiscal Deficit
Governments have several levers for closing a persistent budget deficit. Only some of them actually shrink it.
Reducing revenue expenditure cuts the deficit directly. Revenue expenditure covers day-to-day running costs, like salaries and interest payments. Spending less on it lowers the gap between income and outgo.
Rationalizing subsidies also reduces the deficit. Subsidies are a large share of government spending. Trimming poorly targeted subsidies frees up money without new borrowing.
Introducing new welfare schemes moves the wrong way. New schemes add fresh spending commitments. That widens the deficit instead of closing it.
Reducing import duty widens the deficit too. Import duty is a source of government revenue. Cutting it lowers that revenue, unless the government offsets the loss elsewhere.
What the Capital Budget Includes
The Capital Budget has two sides: capital expenditure and capital receipts. Capital expenditure covers spending on acquiring assets, like roads, buildings, and machinery. It also covers loans and advances the Centre grants to States and Union Territories. Capital receipts cover the government’s own borrowing, including loans it receives from foreign governments. So asset-acquisition spending, foreign loans, and loans to States and UTs all sit inside the Capital Budget.
How Tax Revenue and Fiscal Deficit Actually Moved, 2007–2017
Neither ratio moved in a straight line over this decade. India’s tax revenue as a share of GDP stood at about 12% in 2007-08. It then fell to under 10% by 2009-10, and only partly recovered afterward.
The fiscal deficit followed a similar break, not a steady climb. It was around 2.6% of GDP in 2007-08, spiked sharply to 6.6% after the 2008 global financial crisis, then gradually declined back toward 3.5% by 2016-17.
So a claim that either ratio “steadily increased” over the decade doesn’t hold up against the actual data. Both moved up and down instead.
Previous Year Questions.
UPSC CSP 2025 — Capital Receipts, Borrowings, and Disinvestment
UPSC CSP 2022 — What Counts as Capital Expenditure
- UPSC 2022 Asked as: “Acquiring new technology is capital expenditure; debt financing is capital expenditure while equity financing is revenue expenditure.” The correct answer is (a) 1 only.
- UPSC 2022 Debt and equity financing are both ways of raising capital receipts, not classifications of expenditure. See this question.
UPSC CSP 2022 — Household Savings and Government Borrowing
- UPSC 2022 Asked as: “A share of household financial savings goes toward government borrowings; dated securities issued at market rates form a large component of internal debt.” The correct answer is (c) Both 1 and 2.
- UPSC 2022 Both statements are correct. See this question.
UPSC CSP 2021 — Countering an Economic Recession
- UPSC 2021 Asked as: “Which among the following steps is most likely to be taken at the time of an economic recession?” See this question.
UPSC CSP 2021 — What Is Most Inflationary
- UPSC 2021 Asked as: “Which one of the following is likely to be the most inflationary in its effects?” See this question.
UPSC CSP 2017 — Tax Revenue and Fiscal Deficit, the Real Decade Trend
UPSC CSP 2016 — Base Erosion and Profit Shifting
- UPSC 2016 Asked as: “The term ‘Base Erosion and Profit Shifting’ is sometimes seen in the news in the context of” See this question.
UPSC CSP 2016 — Reducing a Persistent Fiscal Deficit
UPSC CSP 2016 — What the Capital Budget Includes
- UPSC 2016 Asked as: “Which of the following is/are included in the capital budget of the Government of India?” See this question.
UPSC CSP 2015 — Tax-to-GDP Ratio, Growth, and Income Distribution
- UPSC 2015 Asked as: “A decrease in tax to GDP ratio of a country indicates which of the following?” See this question.
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