What is Fiscal Deficit?

What is Fiscal Deficit?

Economy

  • Fiscal deficit occurs in a country when the expenditure of the government exceeds its revenue in a year. It is a difference between Expenditure and revenue.
  • It is calculated both in absolute terms and as a percentage of the country’s gross domestic product (GDP).
  • In either case, the income figure includes only taxes and other revenues and excludes money borrowed to make up the shortfall.

Calculation

  • Fiscal deficit = total revenue generated — total expenditure
  • Income component: The income component is made of two variables, revenue generated from
  1. Taxes levied by the Centre
  2. The income generated from non-tax variables
  • The taxable income consists of the amount generated from corporation tax, income tax, Customs duties, excise duties, GST, among others.
  • The non-taxable income comes from external grants, interest receipts, dividends and profits, receipts from Union Territories, among others.
  • Expenditure component: The government in its Budget allocates funds for several works, including payments of salaries, pensions, emoluments, creation of assets, funds for infrastructure, development, health and numerous other sectors that form the expenditure component.

Fiscal deficit can be financed in two ways

  1. Borrowing by the government from the market, both inside and outside the country. On this borrowing, the government has to pay rate of interest annually. Apart from that it has to pay back the internal and external debt taken.
  2. The government can finance the fiscal deficit by borrowing from the Reserve Bank of India which issues new notes against government securities.
  • Thus, borrowing from the Reserve Bank results in expansion of high powered money in the economy and is popularly called deficit financing.
  • It is in fact monetisation of fiscal deficit which, if undertaken to an excessive extent, leads to inflation in the economy.
  • On the other hand, if the Government borrowing from the market to finance fiscal deficit adds to the public debt and increases burden on future generations on whom heavy taxes have to be imposed for repaying the loans.

Implications

  1. When a government borrow money (inside or outside country) to meet its fiscal deficit leads to the increase in public debt and its burden.
  2. If fiscal deficit is financed through monetisation of fiscal deficits, it leads to the creation of new money and rise in prices or inflation.
  3. A large fiscal deficit adversely affects economic growth. Due to large revenue deficit, a very large part of borrowed funds by the Government is used to finance current consumption expenditure of the Government. As a result, a smaller amount of resources are left for productive investment in infrastructure and social capital (i.e. education and health) by the Government. This lowers the rate of economic growth.
  4. More borrowing by the Government leaves less resources for private sector investment.