Rameshwar's IAS

Fiscal Deficit Concept

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Components of the Fiscal Deficit Calculation

The two components of the Fiscal Deficit Calculation are Income and Expenditure as detailed under:

Income - The revenue derived from non-tax variables and the revenue derived from taxes imposed by the Center comprises the income component. Corporation tax, income tax, customs duties, excise duties, and GST are all included in a person's taxable income. In the meantime, the non-taxable income comes from things like receipts from Union Territories, interest, dividends, and profits, among other things.

Expenditure - In its Budget, the government allocates funds for a variety of projects, including the payment of salaries, pensions, emoluments, the creation of assets, funds for infrastructure, development, health, and a plethora of other expenditure-related areas.

Balancing out Fiscal Deficit

While the government faces challenges in the long run from a growing deficit, the government looks to market borrowings by issuing bonds and selling them in through banks to balance it in short-term macroeconomics. These bonds are purchased by banks using currency deposits, and investors then purchase them. The interest rate paid on loans to the government is considered a risk-free investment because government bonds are regarded as an extremely safe investment instrument. Additionally, the government sees a deficit as an opportunity to expand programs and policies, including welfare programs, without having to cut spending or raise taxes in the budget.

Does Fiscal Deficit lead to Inflation?

The straightforward answer is No, it does not. Two contentions are by and large provided to connect an escalating fiscal deficit to inflation. The first argument is that an increase in the money stock is caused by the portion of the Fiscal Deficit that is funded by borrowing from the RBI. Since "more money chases the same goods," some hold the unproven belief that a higher money stock will automatically result in inflation. However, there are two errors in this argument. First, the "same goods" that the new money stock seeks are not the "same goods," as the increased Fiscal Deficit may result in an increase in the production of goods. A high Fiscal Deficit may be accompanied by increased demand and output in an economy that has resources that have not been utilized. This holds output in check and prevents the economy from expanding. Second, changes in other economic variables influence the rate at which money "chases" goods. This rate is not constant. Therefore, inflation need not occur even if a portion of the Fiscal Deficit results in the larger money stock. The second argument that Fiscal Deficits are linked to inflation is that higher prices will result from an increase in demand brought on by a larger Fiscal Deficit in an economy where the production of some essential commodities cannot be increased. This argument also has a number of problems. First of all, the Indian economy in 2002, which is in the midst of an industrial recession and has abundant supplies of foodgrains and foreign currency, clearly ignores this argument. Second, rationing and other similar tactics can prevent a price increase even if certain commodities are in short supply. At long last, assuming that the economy is in a state which the defenders of this contention trust it to be in, that is to say, with yield compelled by supply as opposed to the request, then, at that point, Financial Shortages, as well as some approach to expanding request (like confidential venture), is inflationary.

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