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ExplainSpeaking: The nuts and bolts of a Union Budget

How is a Union Budget prepared? What is its scope? What are the forces that shape it? Here are some fundamentals to provide understanding and perspective

Union Finance Minister Nirmala Sitharaman before presenting the Union Budget in New Delhi last year. (Express Photo by Tashi Tobgyal)

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Dear Readers,

On February 1, Finance Minister Nirmala Sitharaman will present the Union Budget for the next financial year (2023-24). Given that the next general elections will be in early 2024, this Budget is likely to be the last full-fledged Budget for the current government. As such, the economics of making a budget might also have to reconcile with the politics around it.

Be that as it may, here are some of the fundamentals of budget-making that one needs to know before the Union Budget is presented. Familiarity with the nuts and bolts of how a budget is prepared will help readers to see the Union Budget in perspective.

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An Annual Financial Statement

The Union Budget is more technically called the Annual Financial Statement. It is true that the budget has traditionally been seen as the most influential tool in the hands of any government to signal its choice of policies, but at the heart of the exercise lies some basic accounting.

Any budget essentially provides three big details.

One, the total amount of money that the government will raise in the coming year; this is called the total receipts.

Two, the total amount of money it will spend; this is called the total expenditure.

Three, the total amount of money it will borrow from the market to plug the gap between what it spends and what it earns; this is referred to as the fiscal deficit.

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Forces that shape a Budget

Let’s start with something that is dominating the news flow at the moment. Notwithstanding considerable secrecy around budget-making, newspapers are full of stories about what to expect from the Union Budget.

Essentially, all demands can be placed in three different categories.

One set of demands, essentially, is for a lower rate of taxation and/or a higher rate of exemptions. In other words, people and firms lobby to get their tax burden reduced.

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For instance, salaried taxpayers may be demanding that income tax exemption levels — that is, the annual income level which escapes any taxation — should be raised. That’s because over the past few years, inflation has been high, and as such, even if someone’s salary went up by, say, Rs 1 lakh annually, that additional money might largely be going into paying higher prices. In other words, Rs 4 lakh per annum salary today may have the same purchasing power that a salary of Rs 3 lakh per annum had 2-3 years ago. As such, an argument can be made that the government should raise the income tax exemption limit from Rs 3 lakh to Rs 4 lakh. That is to say that no income tax will be charged if your annual income is Rs 4 lakhs.

To be sure, the numbers used in this example are just for illustrating a point.

The second set of demands is from people/firms wanting higher or newer subsidies. An example could be a firm that produces green energy or produces products that run on cleaner fuels. Such a firm/entrepreneur may argue that subsidising (or increasing existing subsidies) will help India transition to a cleaner environment in the coming years. There might also be sectors — such as travel and tourism — that have been most severely hit by the pandemic (and have struggled to recover adequately) and want some special help from the government.

The supporting argument in both types of demands is the same: In the absence of lower taxes or higher subsidies, such people/firms/sectors will struggle to grow, thus dragging down the overall growth of the economy. These demands are made not from the perspective of the Union Budget but from the demands of their individual budgets.

There is a third category of demands. It is a small group but it is influential. This group demands something called “fiscal rectitude or prudence”. Simply put, they demand the exact opposite of the first two categories. They demand that the government cuts down on its fiscal deficit (essentially the total amount of money the government borrows from the market in order to bridge the gap between its total expenditure and its total receipts). More often than not, cutting down the deficit, in turn, requires the government to maximise revenues and prune subsidies.

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The final details of the Union Budget are the compromise solution between the pulls and pressures of these three demands.

Scope of the Union Budget

On the face of it, the Union Budget appears to be the single biggest economic news event in any year. Before the Budget it might appear that all the problems of India’s economy can be solved by the Union Budget. [To be sure, when one refers to the Union Budget in this context one refers to the total expenditure pencilled in by the Union government.]

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It is expected that as the size of the Union Budget increases, the higher government expenditure will push the economy forward.

But there are two reasons why such expectations should be tempered.

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One, there was a time in India’s history when the Union Budget was the biggest game in town. In other words, the total budgeted expenditure of the Union government was not only much more than the budgeted expenditure of any one state but also significantly more than the total budgeted expenditure of all states put together. In those days, the Union Budget was the prime mover of the Indian economy.

But over the years, this has changed. Nowadays, the size of the Union Budget is smaller than the combined budgets of all the state governments. For instance, in the current financial year (2022-23), the Union government is expected to spend Rs 39.5 lakh crore while all the states put together are expected to spend Rs 47.6 lakh crore. This means states will spend 20% more than the Centre in FY23.

With states spending more, the ability of the Union Budget to influence the economy is coming down even though the Union Budget remains the single biggest budget of the year.

Two, while on the face of it, the Union government spends something like Rs 40 lakh crore, not all this expenditure is completely new. In fact, as Pronab Sen, former Chief Statistician of India, recently said in a conference (organised by the International Growth Centre), year on year, the Finance Minister has just about 7% of the total budget at her disposal for fresh allocation. The first 93% goes into expenditures that are already committed — think of all the ministries and all the schemes that are already in play. So the FM doesn’t exactly have Rs 40 lakh crore to allocate; rather just about 7% of it for new allocations.

These two factors provide a context for what to expect from any given Union Budget.

Preparation of a Union Budget: Key steps

Before the Union government can decide on its revenue and expenditure plans it needs to know how the overall economy would do in the coming year. That’s because its revenues will depend on the size of the overall economy and its growth rate. To arrive at that number, the government has to first figure out what is the likely size of the economy in the current financial year (April to March); it is noteworthy that at the time of the Budget presentation, the current financial year would still not have ended.

1: Nominal GDP (or what will the size of the economy be next year?)

So the starting point of next year’s Union Budget is to ascertain the “nominal” GDP of the current year. Nominal GDP is nothing but the total market value of all the goods and services produced in India in a financial year. For purposes of analysing the economy one often uses the “real” GDP but for preparing the budget, it is the nominal GDP that matters. The real GDP is “derived” from the nominal GDP by removing the effect of inflation. Prof N R Bhanumurthy, vice chancellor of Dr. B. R. Ambedkar School of Economics (BASE) University, refers to nominal GDP as “Lord Ganesha” of budget making.

Once the government knows the nominal GDP of the current financial year, it uses this number to project the likely nominal GDP in the next financial year (in this case, 2023-24) for which the budget is being made.

The “Budget At a Glance” document in the Union Budget clearly mentions this projection. For instance, last year’s Union Budget stated the following: “GDP for BE 2022-2023 has been projected at Rs 2,58,00,000 crore assuming 11.1% growth over the estimated GDP of Rs 2,32,14,703 crore for 2021-2022.”

2: Fiscal Deficit (or how much money can the government borrow?)

Typically in India, as indeed is the case with most developing economies, the governments are forced to spend more than they earn. That means they have to borrow money from the market. But overtime India instituted strict rules limiting how much the Union government can borrow. These limits are set by the Fiscal responsibility and Budget Management (FRBM) Act. The FRBM Act stipulates that the total borrowings (fiscal deficit) cannot be more than 3% of the (nominal) GDP.

So once the government has arrived at an estimate of the nominal GDP it then calculates the total amount of money it can raise from borrowings. At present, the fiscal deficit is much higher than 3%, thanks to the additional spending (for example, additional food subsidy to the poor) the government has had to do in the wake of the pandemic.

3: Total Revenues (or how much money can the government raise on its own?)

Once the government knows the maximum money it can raise from borrowings, it trains its attention towards its revenues. The challenge now is to figure out how much money can be raised through various means. There are three main ways to raise revenues — tax revenues (by levying taxes), non-tax revenues (such as the dividends earned by government-owned enterprises etc.), and money raised through disinvestment of public sector undertakings.

4: Total Expenditure (or what is the maximum it can spend and where?)

By now the government knows both how much money it can raise on its own and how much money it can borrow. Taken together, they provide it with the total money it can spend on different schemes — old or new. The next step is to apportion this money among different ministries and departments.

That completes the budget-making process.

Do you have any specific queries about the Union Budget or any of its subcomponents? Are there any specific terms that you’d like to be explained? Do you have any queries about the Economic Survey that is released just before the Union Budget?

Share your queries and thoughts at udit.misra@expressindia.com and we will try to answer them in the next edition of ExplainSpeaking, which comes out just before the Union Budget.

Until then, best wishes.

Udit

First published on: 23-01-2023 at 08:49 IST
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