Public Finance and Fiscal Policy

What public finance is

• Public finance studies how a government raises money and spends it.
• It raises money mainly through taxes.
• It spends on goods, services and welfare.
• That covers salaries, subsidies, roads and hospitals.
• How it taxes and spends shapes growth, jobs and fairness.
• Every budget is a statement of public finance. It shows the year’s plan for revenue and spending.

Direct and indirect taxes

• A direct tax is paid straight by the person or company earning the income.
• Income tax on a salary is one example.
• An indirect tax is paid on goods and services.
• It can be passed on to the final buyer.
• The key difference is who finally bears the burden.
• Direct taxes fall on the earner. Indirect taxes fall on the buyer.
• Corporation tax and income tax are direct. GST and customs duty are indirect.
• Governments use both. Together they raise more and spread the burden across incomes and consumption.

What GST changed

• The Goods and Services Tax (GST) began on 1 July 2017.
• It replaced a patchwork of separate central and state indirect taxes with one nationwide tax.
• GST is a destination-based tax.
• It is collected at each stage, but credited against tax already paid on inputs.
• It removed cascading, where tax was paid on top of tax.
• It created a common national market.

Fiscal deficit

• The fiscal deficit is the gap between total spending and total revenue, excluding borrowings.
• It shows how much the government must borrow in a year.
• It means living beyond current income, financed by borrowing.
• That adds to the government’s debt.
• A large one can crowd out private investment and raise interest rates.
• The fiscal deficit as a share of GDP is the most-watched number in the budget.

Revenue deficit

• A revenue deficit occurs when revenue spending exceeds revenue income.
• The fiscal deficit is the total borrowing need, for both revenue and capital spending.
• A country can run a fiscal deficit without a revenue deficit.
• This happens if the shortfall comes entirely from capital spending on assets.
• Take a government building highways. It can have a fiscal deficit but no revenue deficit.
• That is why a capital-led deficit is seen as healthier than one driven by routine spending.

Primary deficit

• The primary deficit is the fiscal deficit minus interest payments.
• It strips out the burden of past borrowing.
• It shows only the current year’s borrowing need.
• A low primary deficit means the government is not borrowing just to pay old interest.

Revenue and capital expenditure

• Revenue expenditure covers day-to-day running costs.
• Salaries, subsidies and interest payments are examples.
• Capital expenditure creates long-term assets.
• Roads, railways and hospitals are examples.
• Capital spending builds future capacity. Revenue spending just keeps things running.
• Economists judge a deficit by what it finances, not just its size.
• Borrowing for infrastructure can generate future returns.
• Borrowing for routine spending adds interest burden and builds no asset.
• The quality of spending matters as much as the size of the deficit.

The FRBM Act

• The Fiscal Responsibility and Budget Management (FRBM) Act was passed in 2003.
• It set targets to limit India’s fiscal deficit and debt.
• It aimed to bring discipline to government borrowing, which had been rising.
• In practice, targets have been relaxed and pushed back, especially after economic shocks.
• A review committee has recommended a debt-to-GDP roadmap.
• It proposed 60% combined debt-to-GDP by 2023: 40% for the Centre and 20% for the States.
• Article 293 guards state borrowing.

Crowding out and the tax-to-GDP ratio

• India’s tax-to-GDP ratio is the share of GDP collected as tax.
• It has stayed lower than in many developed economies.
• A low ratio limits how much the government can spend without borrowing.
• Heavy borrowing can trigger the crowding-out effect.
• Government demand for loanable funds pushes up interest rates.
• That discourages private investment.
• Raising the tax-to-GDP ratio and avoiding crowding out are linked goals.

The Finance Commission

• The Finance Commission is a constitutional body, appointed every five years.
• It decides how tax revenue is divided between the Centre and the States.
• It recommends each state’s share of central taxes, plus grants.
• This sharing keeps the federal system fair and gives states money to run their affairs.

The Railway Budget merger

• India merged its separate Railway Budget into the Union Budget from 2017.
• That ended a practice 92 years old.
• A single budget shows all government spending in one place.
• That improves accountability to Parliament and the public.

The fiscal deficit target

• India targets a fiscal deficit of 4.3% of GDP for FY 2026-27.
• The figure for FY 2025-26 was 4.4%.
• This continues a 2021-22 commitment to bring the deficit down year on year.
• The goal is a debt-to-GDP level of about 50% by 2031.
• Source: PIB, Highlights of Union Budget 2026-27.

Is it on track?

• By end-July 2026, the Centre’s fiscal deficit reached ₹4.55 lakh crore.
• That is 26.8% of the full FY27 target.
• A year earlier, the deficit had reached 29.9% of the FY26 target by the same point.
• So this year’s pace is better.
• Source: Controller General of Accounts.

The pattern examiners keep testing

• The recurring trap is computing the wrong deficit.
• Another is confusing what one deficit strips out of another.
• Numeric questions expect you to subtract, not just recall.
• Finance Commission questions test the numbers of one named Commission.
• Free government goods are not free. The cost shifts from the direct consumer to the taxpaying public.
• Before answering, find which deficit or which Commission the question names.