FACULTY OF COMMERCE

2024-25

(SPECIALISATION: TAXATION, FINANCE & ECONOMICS)

SUBJECT – BUSINESS ENVIRONMENT AND PUBLIC

ECONOMICS

UNIT – 6 INDIAN PUBLIC FINANCES

COMPILED BY

DR. NAISHAL RAVAL DR. HASTIMAL SAGARA

STUDY MATERIAL FOR REFERENCE

1
UNIT 6 INDIAN PUBLIC FINANCES

Syllabus

 Indian Tax structure: Trends, Structure and Reforms.

 Budget: Meaning and Types of Budget, Latest Indian Budget, Concept of Deficits, Types
of Deficit, Status of Deficits in India.
 Fiscal Federalism in India, Fiscal Responsibility of Budget Management (FRBM),
Recent Fiscal situation of Indian Government.
 Long Questions
 Short Questions
 Multiple Choice Questions
…………………………………………………………..……………………………………

Introduction

The tax system in India plays a pivotal role in shaping the country's economy by mobilizing
resources, redistributing wealth, and providing financial support for development programs.
This section delves into the trends, structure, and significant reforms of the Indian tax system,
providing an in-depth understanding for graduate-level learners.

Evolution of Taxation in India

Pre-Independence taxation in colonial India primarily served the interests of the British Empire,
with land revenue being the dominant source. Post-Independence, the focus shifted to
economic development and social welfare, leading to the introduction of progressive direct
taxes and various indirect taxes.

Contribution of Direct and Indirect Taxes

Direct Taxes, including Income Tax and Corporate Tax, have seen their share in total tax
revenue increase over the years, reflecting efforts to make the tax system more progressive.
Indirect Taxes, which were historically dominant, have been significantly restructured post-
GST implementation, leading to better compliance and simplification.

Tax-to-GDP Ratio

2
India’s tax-to-GDP ratio remains lower than many advanced economies, hovering around 10-
12%. Reforms like GST and measures to expand the tax base aim to improve this metric. The
government has introduced several initiatives to enhance tax compliance, widen the tax base,
and address tax evasion. Despite these efforts, India's tax-to-GDP ratio remains significantly
lower than developed nations, which often exceed 30%. The low ratio reflects challenges such
as a large informal sector, tax evasion, and structural inefficiencies. Strengthening institutional
frameworks and promoting digitization in tax administration are essential steps to improving
this critical economic indicator over time.

Global Influence

India has adopted global practices, such as double taxation avoidance agreements (DTAA) and
transfer pricing norms, to align its tax policies with international standards.

Structure of Indian Taxes

India’s tax structure is classified into two main categories: Direct Taxes and Indirect Taxes.

3
Direct Taxes
Direct taxes are levied directly on individuals and entities based on income or profits. Examples
include Income Tax, which applies progressive rates based on income slabs, Corporate Tax
levied on the profits of corporations with recent reductions making rates globally competitive,
and Capital Gains Tax, applicable on profits from the sale of capital assets. Over the years, the
structure of direct taxes has been refined to promote equity, ease compliance, and encourage
voluntary disclosures. Simplified filing procedures and exemptions for specific sectors and
demographics reflect India's commitment to equitable taxation policies.

Income Tax

Income-tax Act, 1961 imposes a tax on the income of the individuals or Hindu undivided
families or firms or co-operative societies (other than companies) and trusts or every artificial
juridical person. The inclusion of a particular income in the total income of a person for an
income tax in India is based on his residential status. There are three residential status, which
are
 Resident and Ordinary Residents
 Resident but not ordinarily Residents and
 Non Resident
There are several steps involved in determining the residential status of a person. All residents
are taxable for all their income, including income outside India, Non-residents are taxable only
for the income received in India or income accrued in India. Not ordinary residents are taxable
in relation to income received in India or income accrued in India and income from business
or profession controlled from India.

Corporation Tax

The companies and business organizations in India are taxed on the income from their
worldwide transactions under the provision of the Income-tax Act, 1961. A corporation is
deemed to be resident in India if it is incorporated in India or if its control and management are
situated entirely in India. In the case of a non-resident corporation tax is levied on the income

4
which is earned from their business transactions in India any other Indian sources depending
on the bilateral agreement of that country.

Property Tax

Property Tax or house tax is a local tax on buildings, along with appurtenant land, and imposed
owners. The tax power is the states and it is delegated by law to the local bodies, specifying
the valuation method, rate band, and collection procedures.

Inheritance Tax

An Inheritance tax or death duty is a tax which arises on the death of an individual. It is a tax
on the estate or total value of the money and property of a person who has died. India enforced
estate duty from 1953 to 1985 on after 16th march, 1985 death tax has been abolished under
the Estate Duty (Amendment) Act 1985.

Gift Tax

Gift tax in India is regulated by the Gift Tax Act which was constituted on 1st April 1958. It
came into effect in all parts of the country except Jammu and Kashmir. As per the Gift Act,
1958 all gifts in excess of ₹ 25,000 in the form of cash, draft, check or others received from
one who doesn’t have blood relations with the recipient were taxable.

On the 1st October 1998 gift tax got demolished and all the gifts made on or after the date were
free from tax. but in 2004, the act was again revived partially. A new provision was introduced
in the Income-tax Act 1961 under section 56(2). According to it, the gifts received by any
individual or Hindu undivided family in excess of ₹ 50,000 in a year would be taxable.

5
Indirect Taxes
Indirect taxes are levied on goods and services, paid by consumers but collected by
intermediaries. Examples include Goods and Services Tax (GST), which replaced multiple
indirect taxes and created a unified tax regime, Customs Duty levied on imports and exports to
regulate trade, and Excise Duty, which is limited to certain products like petroleum post-GST.
The GST regime's introduction has been transformational, enhancing transparency, reducing
cascading effects, and fostering interstate commerce. This shift has harmonized the tax
structure, enabling better revenue predictability and compliance.

An Indirect tax is a tax collected by an intermediary from the person who bears the ultimate
economic burden of the tax. An Indirect tax is one that can be shifted by the taxpayer to
someone else. It is one that is imposed on someone but borne by someone else. An Indirect
tax may increase the price of goods so that consumers are actually paying the tax by paying
more for the products. Some important indirect taxes proposed in India are under as:-

Custom Duty

The custom act was formulated in 1962 to prevent illegal imports and exports of goods. Duties
of customs are levied on goods imported or exported from India at the rate specified customs
tariff Act, 1975 as amended from time to time or any other law for the time being in force.

Central Excise duty

The Central Government levies excise duty under the Central Excise Act, 1944 and the Central
Excise Tariff Act, 1985. Central excise duty is a tax that is charged on such excisable goods
that are manufactured in India and are meant for domestic consumption.

Service Tax

The service provides in India except those in the state of Jammu and Kashmir are required to
pay a service tax under the provision of the Finance Act of 1994. The interesting thing about
service tax in India is that the Government depends heavily on the voluntary compliance of the
service provides for collecting service tax in India.

6
Sales Tax

It is the Tax in India is a form of tax that is imposed by the government on the sale or
purchases of a particular commodity within the country. Sales tax is imposed under
both, central government (central sales tax) and state government (sales tax) legislation.

Goods and Service Tax

In India, the three government bodies collected direct and indirect taxes until 1 July 2017 when
the Goods and Services Act (GST) was implemented. GST incorporates many of the indirect
taxes levied by states and the central government. The Tax Structure in India is very complex
before GST.

Some of the taxes GST replaced include:

* Sales Tax * Central Excise Duty * Entertainment Tax
* Octroi * Service Tax * Purchase Tax

It is a multi-stage destination-based tax. Multi-stage because it is levied on each stage of the

supply chain right from purchase of raw material to the sale of the finished product to the end
consumer whenever there are value addition and each transfer of ownership. Destination-based
because the final purchase is the place whose government can collect GST. If a fridge is
manufactured in Delhi but sold in Mumbai, the Maharashtra government collects GST. A major
benefit is the simplification of taxation in India for government bodies. GST has three
components:

1. CGST-Stands for Central Goods and Services Act. The central government collects this
tax on an intrastate supply of goods or services.
2. SGST: Stands for State Goods and Services Tax. The state government collects this tax
on an intrastate supply of goods or services.
3. IGST: Stands for Integrated Goods and Services Tax. The central government collects
this for inter-state sale of goods or services

7
Other Taxes
Other taxes in India include Stamp Duty, levied on property transactions; Professional Tax,
collected by states on professions; and Wealth Tax, which was abolished in 2015 and replaced
with a surcharge on the super-rich. These taxes, though smaller in revenue contribution, play a
critical role in targeted fiscal policies. For instance, stamp duty helps state governments
mobilize resources, while professional tax reflects the principle of ability to pay. The evolving
nature of these taxes underscores India's focus on adaptability and fiscal responsiveness.

Key Reforms in Indian Tax System

Introduction of GST (2017)

The introduction of the Goods and Services Tax (GST) in 2017 marked a landmark reform in
India's indirect tax structure. GST unified multiple indirect taxes like VAT, service tax, excise
duty, and others into a single tax regime. By eliminating the cascading effect of taxes, GST
reduced the overall tax burden on consumers and businesses. The adoption of a multi-rate
structure allowed differentiation based on the nature of goods and services, accommodating
essential and luxury items. GST's technological backbone, the GST Network (GSTN), has
enhanced compliance, improved transparency, and provided real-time tracking of transactions,
ensuring a seamless flow of input tax credits across the value chain.

Direct Tax Code (DTC)

The Direct Tax Code (DTC) was proposed to consolidate and simplify India's direct tax laws,
replacing the existing Income Tax Act, 1961. Although the DTC has not yet been implemented,
its intent is to reduce ambiguity, improve clarity, and make the tax system more taxpayer-
friendly. The DTC aims to ensure better compliance by removing redundant provisions and
introducing contemporary regulations that align with the evolving economic landscape.

Faceless Tax Assessments

Faceless tax assessments, introduced in 2020, represent a significant step toward transforming
India's tax administration. This reform eliminates the need for physical interaction between
taxpayers and tax officials, reducing the scope for corruption and subjective biases. By
leveraging technology and anonymizing assessments, faceless taxation enhances transparency

8
and ensures uniformity in tax proceedings. The system also includes a robust mechanism for
e-appeals and dispute resolution, streamlining the entire process and making it more efficient.

Reduction in Corporate Tax Rates

In 2019, India undertook a bold reform by reducing corporate tax rates to 22% for existing
domestic companies and 15% for new manufacturing companies. This move aimed to attract
investment, boost industrial growth, and make India globally competitive. The reduction in tax
rates aligns with global trends, positioning India as a favorable destination for both domestic
and foreign investors. This reform also supports the "Make in India" initiative by encouraging
manufacturing activity and job creation.

Digital Initiatives

India has embraced digital transformation in its tax administration, introducing several
initiatives to simplify compliance and enhance efficiency. The e-filing of income tax returns,
the Tax Information Network (TIN), and the GST Network (GSTN) are notable examples.
These platforms enable taxpayers to file returns, pay taxes, and track transactions seamlessly.
The use of artificial intelligence and data analytics has also strengthened the detection of tax
evasion and fraud, ensuring greater compliance.

Dispute Resolution Mechanisms

Tax disputes have been a significant challenge in India, leading to prolonged litigation and
revenue loss. The "Vivad se Vishwas" scheme, launched in 2020, aims to resolve pending
disputes by offering taxpayers an opportunity to settle cases amicably. By waiving interest and
penalties on disputed taxes, the scheme encourages prompt resolution and reduces the burden
on the judiciary. This initiative has received positive responses, helping the government
recover substantial revenue while fostering trust among taxpayers.

Expansion of the Tax Base

Expanding the tax base has been a consistent focus for the government. Measures like
mandatory linkage of Permanent Account Number (PAN) with Aadhaar, incentivizing digital

9
payments, and introducing Tax Deducted at Source (TDS) on new income categories have
widened the tax net. These steps aim to bring more individuals and entities under the formal
economy, reducing reliance on indirect taxes and ensuring a fairer distribution of the tax
burden.

Anti-Tax Evasion Measures

The implementation of General Anti-Avoidance Rules (GAAR) reflects India's commitment to

curbing aggressive tax planning and evasion. GAAR empowers tax authorities to scrutinize
transactions that lack commercial substance and are designed solely to avoid taxes. Alongside
GAAR, initiatives like the Black Money Act and the Benami Transactions (Prohibition) Act
address undisclosed foreign income and properties, promoting greater transparency and
accountability.

Challenges in the Indian Tax System

Low Tax Compliance

India’s tax compliance remains a challenge, with a significant proportion of the population
outside the tax net. Only a small percentage of the population pays income tax, attributed to
widespread tax evasion and the predominance of the informal economy. Addressing this
requires a combination of stricter enforcement measures, enhanced taxpayer education, and
incentivizing voluntary compliance.

Complexity of Tax Laws

Frequent amendments and overlapping provisions create confusion among taxpayers. The
complexity of tax laws often leads to unintentional non-compliance, necessitating professional
assistance for filing and assessments. Simplification of tax laws, such as the introduction of a
Direct Tax Code, is essential for creating a taxpayer-friendly ecosystem.

High Reliance on Indirect Taxes

India continues to rely heavily on indirect taxes, which are regressive in nature. Despite the
introduction of GST, lower-income groups disproportionately bear the burden of indirect taxes

10
on essential goods and services. Transitioning toward a tax system with a higher share of direct
taxes would promote equity and reduce the tax burden on the economically weaker sections.

Disparities in State Revenues

GST compensation issues have exposed the financial vulnerabilities of states, particularly those
with lower tax revenues. The centralization of tax collections under GST has reduced states’
fiscal autonomy, leading to reliance on compensation from the central government. Addressing
this requires a balanced approach to revenue sharing and capacity building for states.

International Tax Challenges

The rise of the digital economy has posed significant challenges for India’s tax system. Issues
related to taxing digital giants, cross-border transactions, and transfer pricing require
innovative solutions. Aligning with global frameworks like the OECD’s Base Erosion and
Profit Shifting (BEPS) initiative is crucial for ensuring fair taxation in the digital era.

India’s tax system has undergone significant changes, particularly in the last two decades, with
the introduction of landmark reforms like GST and the push towards digitalization. However,
challenges like low compliance and the complexity of laws persist. Continued efforts to
simplify the system, broaden the tax base, and promote progressive taxation will be essential
for sustainable economic growth.

Budget: Meaning and Types of Budget

Introduction:

In a government context, the budget is the annual financial statement that reflects the country’s
economic policy, revenue generation strategies, and expenditure plans. It lays down the
government’s priorities and determines how public funds will be allocated to different sectors
such as defense, healthcare, education, infrastructure, and welfare. The budget also highlights
revenue sources, which can include taxes, borrowing, and other income-generating activities.
A carefully crafted budget is essential for managing economic growth, controlling inflation,
addressing unemployment, and reducing inequalities.

Meaning of Budget:

11
A budget is a detailed financial plan that outlines a government’s or an organization’s estimated
revenues and expenditures over a specific period, typically one fiscal year. It is a crucial tool
for managing financial resources, ensuring that income and spending are balanced and that
financial goals are met. Budgets help ensure that resources are allocated efficiently and provide
transparency to taxpayers, investors, and the public.

Types of Budget:

Balanced Budget:

A balanced budget occurs when the government’s total revenue is equal to its total expenditure.
In other words, there is no deficit or surplus. Governments strive for a balanced budget to
maintain fiscal discipline and ensure that their spending does not exceed the means available
to them. It is considered an ideal budget from an economic stability point of view but may be
difficult to achieve, especially in times of economic downturn or large-scale public welfare
programs.

Advantages: It avoids an increase in national debt and inflationary pressures. It promotes fiscal
discipline and ensures sustainable public finance.

Disadvantages: Achieving a balanced budget during economic slowdown can be challenging,

and it may result in cuts in essential services or public investments to meet the revenue-
expenditure balance.

Surplus Budget:

A surplus budget is one in which the government’s revenue exceeds its expenditure, resulting
in a surplus. This surplus can be used to pay down existing debts, save for future requirements,
or invest in development projects. A surplus budget is generally seen as an indication of good
financial management, as it shows that the government has been able to generate more revenue
than it has spent.

Advantages: A surplus budget can help reduce national debt, increase savings for future needs,
and provide a cushion against unforeseen financial challenges.

12
Disadvantages: If a surplus is generated at the cost of underfunding essential sectors such as
education, healthcare, or infrastructure, it may harm long-term economic development.

Deficit Budget:

A deficit budget is when the government’s expenditure exceeds its revenue, leading to a fiscal
deficit. To cover the gap, the government borrows money, often issuing bonds or borrowing
from international lenders. A deficit budget is often used to stimulate economic growth,
especially during recessions, by increasing government spending. However, continuous
deficits can lead to rising national debt and potentially higher interest rates.

Advantages: It allows the government to fund important projects, provide social welfare
programs, and invest in long-term infrastructure development during tough economic times.

Disadvantages: Persistent deficits lead to rising debt levels and may cause inflation. If not
controlled, they could result in a debt crisis and undermine investor confidence.

Union Budget of India (FY 2024-25)

The Union Budget of India for the fiscal year 2024-25, presented by Finance Minister Nirmala
Sitharaman, outlines several key initiatives and financial allocations aimed at fostering
economic growth, job creation, and infrastructure development, while maintaining fiscal
prudence.

Economic Growth Projections: The government forecasts a nominal economic growth rate
of 10.5% for the upcoming fiscal year, with real growth anticipated between 6.5% and 7%.

Fiscal Deficit:

The fiscal deficit target has been set at 4.9% of GDP, a reduction from the previous year's 5.6%,
indicating a commitment to fiscal consolidation. Infrastructure and Development: Gross
borrowing is projected at ₹14.01 trillion, with plans to invest ₹11.11 trillion in infrastructure
projects, underscoring the government's focus on enhancing physical infrastructure. A financial
support package of ₹11,500 crore is allocated for projects such as the Kosi-Mechi intra-state

13
link and other schemes in Bihar, aiming to improve regional connectivity and water
management.

Social Sector Initiatives:

The budget allocates more than ₹3 lakh crore for schemes benefiting women and girls,
reflecting a commitment to gender equality and women's empowerment. The Pradhan Mantri
Janjatiya Unnat Gram Abhiyan is introduced to improve the socio-economic conditions of
tribal communities, covering 63,000 villages and benefiting 5 crore tribal people.

Taxation and Revenue:

The government plans to reduce the corporate tax rate on foreign companies from 40% to 35%,
aiming to attract more foreign investment and enhance the business environment. Increased
taxes on long-term and short-term capital gains, as well as a higher securities transaction tax,
are introduced to moderate market activities and increase revenue.

Employment and MSMEs:

A significant allocation of $24 billion is designated for job creation initiatives over five years,
focusing on generating employment opportunities across various sectors. The budget
emphasizes support for Micro, Small, and Medium Enterprises (MSMEs) through financing,
regulatory changes, and technology support to boost the sector's growth and competitiveness.

Regional Development:

More than 100 branches of India Post Payment Bank will be set up in the North East region to
expand banking services and promote financial inclusion. Assistance is provided for the
development of temples, monuments, craftsmanship, wildlife sanctuaries, natural landscapes,
and pristine beaches in Odisha, aiming to boost tourism and preserve cultural heritage.

Overall, the Union Budget 2024-25 focuses on balancing increased spending on job creation,
rural development, and infrastructure with a commitment to reducing the fiscal deficit, thereby
promoting sustainable economic growth and social welfare.

14
Concept of Deficits

A deficit in the context of government finance refers to a situation where the expenditure
exceeds the income or revenue generated over a specified period. A government running a
deficit needs to borrow money to make up for the gap between its income and expenditure, and
this borrowing increases the national debt. Deficits are common during periods of economic
slowdown, when governments increase spending to stimulate growth, or when there is a need
for increased social welfare programs.

There are several types of deficits, each reflecting different aspects of fiscal health and
economic management:

Fiscal Deficit:

The fiscal deficit is the most significant deficit measure, as it represents the total amount of
borrowing needed by the government to meet its expenditure requirements. It is calculated by
subtracting the total revenue (including borrowings) from the total expenditure. A fiscal deficit
is a clear indicator of how much the government is borrowing to meet its obligations. The
government usually borrows to finance the fiscal deficit, which can be through domestic or
external debt. A high fiscal deficit can lead to inflationary pressures, higher interest rates, and
an increase in national debt. A high fiscal deficit often signals unsustainable government
spending and potential risks to the country’s financial stability, especially if the borrowed funds
are used for consumption rather than productive investment. Formula: Fiscal Deficit = Total
Expenditure – Total Revenue (excluding borrowings)

15
Revenue Deficit:

A revenue deficit occurs when the government’s revenue (from taxes, duties, etc.) is less than its revenue
expenditure (on wages, interest payments, subsidies, etc.). A revenue deficit means that the government
is borrowing to meet its day-to-day operating expenses rather than to fund capital expenditure, which
is less sustainable. A revenue deficit is seen as more concerning than a fiscal deficit because it implies
that the government is borrowing for current expenditure rather than investment in infrastructure or
long-term development. Persistent revenue deficits indicate that the government is unable to
generate enough revenue to cover its operating expenses and may lead to rising debt and
inflation. Formula: Revenue Deficit = Revenue Expenditure – Revenue Receipts

Primary Deficit:

The primary deficit is the fiscal deficit minus the interest payments on the government’s existing debt.
It reflects the government’s current fiscal situation, excluding the burden of past debt. A primary deficit
indicates whether the government is borrowing to finance its ongoing activities or simply to pay interest
on past borrowings. A primary deficit suggests that the government is borrowing for its
operational needs and may not yet be generating enough revenue to meet its long-term

16
obligations. Reducing the primary deficit is an important part of fiscal consolidation. Formula:
Primary Deficit = Fiscal Deficit – Interest Payments

Current Account Deficit (CAD):

A current account deficit occurs when a country’s total imports of goods, services, and income
payments exceed its total exports. It reflects a country’s reliance on foreign capital to finance
domestic consumption. A high CAD may indicate that the country is consuming more than it
produces, which can lead to depreciation of the currency and higher borrowing costs.

Trends in Deficits in India

India’s fiscal deficits have been a persistent challenge for economic policymakers, with the
country often running budget deficits due to high public spending, especially on subsidies,
welfare programs, and infrastructure development. The government has been working towards
reducing the fiscal deficit through a combination of increased revenue generation and cost-
cutting measures.

Fiscal Deficit in India:

In recent years, the Indian government has aimed to bring down the fiscal deficit to more
sustainable levels. For the 2023-24 fiscal year, the government estimated a fiscal deficit of

17
about 6.4% of GDP. However, this remains high compared to global standards. India’s long-
term target is to bring the fiscal deficit down to 4.5% by the 2025-26 fiscal year.

Challenges:

Despite efforts, the fiscal deficit remains elevated due to large expenditures in sectors like
defense, infrastructure, subsidies, and social welfare programs, while tax revenues have not
been able to keep pace with the rising costs.

Revenue Deficit in India

India has historically experienced a revenue deficit, meaning that its revenue receipts (tax
collections, duties, etc.) have not been enough to cover its operating expenditures. The
government has made strides to increase tax collection and reduce inefficiencies, but the
revenue deficit remains a significant concern.

Primary Deficit in India

The primary deficit in India has fluctuated over time, reflecting the government’s ability to
finance its operations without relying excessively on borrowing to pay interest on past debt. A
high primary deficit indicates a need for fiscal consolidation and a focus on improving the
government’s revenue base.

Current Account Deficit (CAD) in India:

India’s current account deficit has been another area of concern, particularly due to rising
imports, especially crude oil and gold. The CAD can put pressure on the Indian Rupee and
increase the country’s dependency on foreign capital inflows.

India’s strategy for managing deficits revolves around enhancing tax collection, improving
efficiency in government spending, and stimulating economic growth through investment in
infrastructure and social programs. However, maintaining fiscal discipline while addressing
the needs of a growing population remains a challenging task.

18
Fiscal Federalism in India

Meaning:

Fiscal federalism refers to the distribution of fiscal powers and responsibilities between
different levels of government, such as the central government, state governments, and local
governments. In India, fiscal federalism involves the allocation of financial resources and
decision-making powers across the Union (central government) and the States (state
governments), as well as local governments. The aim is to create a system where the different
levels of government can finance their functions, maintain financial autonomy, and contribute
to the country's overall economic stability and development.

Key Features:

1. Constitutional Framework:

The Constitution of India provides the legal and institutional framework for fiscal federalism.
It delineates the powers of taxation and financial allocation between the Union and the States
through various articles (Article 246, Article 268-293).

The Union List, State List and Concurrent List under the Seventh Schedule of the Constitution
define the division of responsibilities between the two levels of government. The Union List
comprises matters that only the central government can legislate upon (such as defense, foreign
affairs), while the State List covers matters under the jurisdiction of state governments (such
as police, public health, and education).

2. Revenue Sharing:

Revenue Division:

The Constitution mandates a division of tax revenues between the Union and States. The Union
government primarily collects taxes like Income Tax, Customs Duty, Excise Duty, and GST.
State governments collect taxes like State VAT, Stamp Duty, Land Revenue, and Sales Tax.

19
Finance Commission:

The Finance Commission of India plays a crucial role in recommending the distribution of tax
revenues between the Union and States. The Commission is constituted every five years by the
President of India and aims to reduce fiscal disparities between states.

Central Assistance:

The Union government provides financial assistance to the states through grants, loans, and
schemes. This assistance is meant to supplement state budgets and promote development across
states, especially in less developed regions.

3. Fiscal Autonomy of States:

States in India have a degree of fiscal autonomy, but their autonomy is limited compared to the
central government. This is because a significant portion of state revenues comes from the
Union government in the form of grants and transfers.

Additionally, the central government has considerable control over state spending through
directives and through the planning process (now replaced by NITI Aayog).

4. Challenges in Fiscal Federalism:

Vertical Fiscal Imbalance:

The central government generates more revenue than it needs, while states often have a larger
responsibility for providing public services, leading to a mismatch between revenue and
expenditure.

Horizontal Fiscal Imbalance:

There are disparities in the fiscal capacity of different states. Richer states like Maharashtra,
Gujarat, and Tamil Nadu generate higher revenues than poorer states like Bihar, Uttar Pradesh,
and Odisha, leading to unequal development.

Control over State Borrowing:

20
The central government regulates state borrowing limits, which can sometimes restrict states’
fiscal autonomy and their ability to finance development projects.

Fiscal Responsibility and Budget Management (FRBM) Act

Introduction to the FRBM Act:

The Fiscal Responsibility and Budget Management (FRBM) Act, 2003 was enacted by the
Government of India to institutionalize fiscal discipline, control fiscal deficits, and ensure
sound public finances. The Act aims to reduce the fiscal deficit and ensure that the
government's fiscal policies are consistent with the medium-term fiscal objectives. It was
introduced to bring transparency, accountability, and sustainability in the public finance
system.

Key Features of the FRBM Act:

1. Fiscal Deficit Targets:

The FRBM Act set specific targets for reducing the fiscal deficit (the difference between the
government’s total expenditure and revenue). Initially, the Act aimed to reduce the fiscal deficit
to 3% of GDP by 2008-09.

Over time, the target has been adjusted due to various challenges, but the primary objective
remains to bring fiscal discipline and reduce dependence on borrowing.

2. Debt Management:

The Act introduced guidelines for reducing the central government’s total debt by setting limits
on the ratio of government debt to GDP. The goal is to gradually lower the public debt burden
and reduce the cost of borrowing.

It also mandates a reduction in the government’s borrowings to ensure sustainability of fiscal

policies.

3. Transparency and Accountability:

21
The FRBM Act mandates that the government must present its fiscal policy and outcomes
through clear and transparent documentation, including the Medium-Term Fiscal Policy
Statement and the Fiscal Policy Strategy Statement. These statements outline the government’s
fiscal goals, fiscal deficit targets, and the overall fiscal policy framework.

4. Exceptions and Relaxations:

The FRBM Act allows for exceptions to the fiscal deficit targets in case of extraordinary
circumstances, such as natural disasters, security threats, or economic crises (e.g., the COVID-
19 pandemic). In such cases, the government can temporarily exceed the fiscal deficit target
but must bring the deficit back within the prescribed limit over the medium term.

Importance of the FRBM Act:

 The FRBM Act aims to ensure macroeconomic stability by controlling inflation, reducing
public debt, and making government borrowing sustainable.
 It helps in building investor confidence by signaling that the government is committed to
maintaining fiscal discipline.
 The Act provides a framework for better public sector management and improved
efficiency in public spending.

Criticism of the FRBM Act:

 The targets set by the FRBM Act may be too rigid and fail to take into account changing
economic conditions, such as downturns or financial crises.
 Some argue that the Act's focus on deficit reduction may limit government spending on
essential sectors like healthcare, education, and infrastructure.
 The impact of the FRBM Act on state finances has been limited since it applies only to the
central government, and states have their own fiscal management systems.

Recent Fiscal Situation of the Indian Government

Current Fiscal Trends: India's fiscal situation has been under significant strain due to the
combination of several challenges:

1. COVID-19 Pandemic:

22
The pandemic led to an unprecedented fiscal crisis, as the government had to ramp up
expenditure on health infrastructure, economic stimulus packages, and welfare programs while
witnessing a steep decline in tax revenues.

2. Declining Tax Revenues:

The economic slowdown and reduced consumption have resulted in a reduction in tax
collections, particularly GST revenues, which have not fully recovered to pre-pandemic levels.

3. Increase in Government Expenditure:

The government has significantly increased expenditure to support the economy, especially
through infrastructure spending and social welfare schemes like PMGKY (Pradhan Mantri
Garib Kalyan Yojana) and Atmanirbhar Bharat package.

4. Fiscal Deficit:

The fiscal deficit for 2020-21 was estimated at 9.5% of GDP, a sharp increase from the targeted
3.5%. The fiscal deficit for 2023-24 is projected at around 6.4% of GDP, and the government
aims to reduce it to 4.5% by 2025-26.

5. Debt Levels:

India’s public debt has risen as a result of fiscal deficits. The government’s debt-to-GDP ratio
has increased, with concerns about its long-term sustainability. However, the government has
committed to bringing down the debt levels gradually by improving the fiscal deficit-to-GDP
ratio.

Challenges in Managing the Fiscal Situation:

1. Revenue Mobilization:

Despite initiatives like the Goods and Services Tax (GST), tax revenue growth has been slower
than expected. Expanding the tax base, improving compliance, and addressing tax evasion
remain key challenges.

2. Welfare and Subsidies:

23
Increasing demands for subsidies (fuel, food, fertilizers) and welfare programs (rural
employment schemes, health, and education) add to fiscal pressures. Balancing social security
measures with fiscal discipline is a challenge.

3. State-Level Fiscal Constraints:

State governments are also facing fiscal stress, as they are dependent on central transfers, which
are often not sufficient to meet their development and welfare needs. The fiscal imbalance
between states remains a critical issue.

4. Inflation and External Shocks:

Inflationary pressures, particularly from food and fuel prices, have further complicated the
fiscal situation. Additionally, external shocks like geopolitical tensions and global economic
slowdowns have made managing fiscal policy more challenging.

Recent Reforms and Measures:

Focus on Infrastructure and Investment:

To boost growth, the government has focused on infrastructure development, including

projects under the National Infrastructure Pipeline (NIP), which aims to invest in roads,
railways, ports, and digital infrastructure.

 Privatization and Disinvestment:

The government has intensified efforts towards disinvestment and privatization of public sector
enterprises to generate revenue and reduce fiscal burdens.

 Fiscal Consolidation Roadmap:

The government has laid out a fiscal consolidation roadmap aiming to reduce the fiscal deficit
to below 4.5% by 2025-26, with a focus on rationalizing subsidies, improving tax collections,
and reducing wasteful expenditure.

India’s fiscal situation is currently facing significant pressures due to the COVID-19 pandemic,
a slow recovery in tax revenues, and rising expenditure on welfare programs. However, with

24
careful management, including fiscal consolidation measures and targeted reforms, India can
achieve sustainable public finances in the medium-to-long term. The government’s focus on
infrastructure investment, fiscal reforms, and better revenue mobilization is expected to drive
economic growth and stabilize the fiscal situation.

Exercises:

A. Answer in detail for the following questions.

1. Discuss the evolution of the Indian tax structure, highlighting trends and major reforms.
2. Explain the different types of budgets and their relevance to managing economic challenges.
3. Analyze the concept of fiscal deficits. Discuss their types and the current status of deficits
in India.
4. What is Fiscal Federalism? Discuss its significance and the role of the Finance Commission
in maintaining it.
5. Elaborate on the impact of GST on India’s tax system and its contribution to economic
growth.
6. Describe the key features and objectives of the latest Indian Budget. How does it address
economic priorities?
7. What is the FRBM Act? Discuss its objectives, key provisions, and challenges in ensuring
fiscal discipline.
8. Differentiate between direct and indirect taxes. Discuss their respective roles in India's
revenue generation.
9. What are the challenges in implementing fiscal federalism in India? Suggest measures for
improvement.
10. Discuss the relationship between fiscal discipline and economic stability. How can the
government achieve fiscal consolidation?

B. Answer in short for the following questions.

1. What are the main trends in India's tax system over the past decade?
2. Define the concept of a budget and its importance in economic management.
3. What is a fiscal deficit, and why does it matter?
4. Explain the primary goals of the FRBM Act in India.
5. How does the Finance Commission promote Fiscal Federalism in India?

25
6. Mention the differences between revenue deficit and fiscal deficit.
7. What is the concept of zero-based budgeting?
8. Highlight one major reform in the Indian tax system introduced in recent years.
9. What is the significance of revenue expenditure in a government budget?
10. Explain the purpose of the Tax-to-GDP ratio in assessing fiscal health.

C. Answer in very brief for the following questions.

1. What is GST?
2. When the Indian Budget is usually presented in the Parliament?
3. Define fiscal federalism.
4. What does FRBM stand for?
5. Name one example of a direct tax.
6. What is a balanced budget?
7. Who prepares the Economic Survey in India?
8. What does capital expenditure focus on?
9. What is meant by deficit financing?
10. Name a type of budget deficit.

D. Answer in very brief for the following MCQs.

1. The Indian tax structure includes which of the following?

a) Direct Taxes
b) Indirect Taxes
c) Both a and b
d) None of the above
2. The main trends in the Indian tax structure over recent years focus on:
a) High tax rates
b) Expansion of GST
c) Reduced government spending
d) Increase in customs duties
3. Which of the following reforms was introduced to improve the tax system in India?
a) Introduction of Income Tax Act
b) Implementation of GST

26
 c) VAT system
d) Abolition of sales tax
4. The term "Budget" in the Indian context refers to:
a) Only government spending
b) The annual financial statement
c) A set of tax reforms
d) The collection of indirect taxes
5. The types of budget commonly used in India include:
a) Union Budget
b) State Budget
c) Both a and b
d) None of the above
6. The latest Indian budget is primarily focused on:
a) Reducing taxation
b) Economic recovery post-pandemic
c) Tax cuts for corporations
d) International trade agreements
7. The concept of "Deficits" in the budget refers to:
a) Government savings
b) The excess of expenditure over revenue
c) Surplus funds
d) Payment of interest on loans
8. Which of the following types of deficit is concerned with the overall fiscal shortfall?
a) Revenue Deficit
b) Fiscal Deficit
c) Primary Deficit
d) Budget Deficit
9. The Fiscal Deficit in India primarily measures:
a) Revenue shortfall
b) Total government borrowing requirements
c) Government spending
d) External debt
10. As of the latest Indian budget, the government aims to reduce the Fiscal Deficit by:
a) Implementing cost-cutting measures

27
 b) Raising taxes significantly
c) Increasing foreign investments
d) Printing more currency
11. Fiscal Federalism in India refers to:
a) Allocation of funds to private entities
b) The financial relationship between the Union and State governments
c) Centralized financial control
d) Decentralized tax collection
12. The concept of Fiscal Federalism was introduced in India to:
a) Ensure equitable distribution of resources
b) Increase central revenue generation
c) Centralize tax administration
d) Reduce tax evasion
13. The Fiscal Responsibility and Budget Management (FRBM) Act was enacted to:
a) Lower tax rates
b) Limit the fiscal deficit
c) Increase government expenditure
d) Regulate financial markets
14. According to the FRBM Act, the government aims to limit the fiscal deficit to:
a) 5% of GDP
b) 3% of GDP
c) 4% of GDP
d) 2% of GDP
15. Which of the following is not a component of fiscal responsibility in India?
a) Free spending on subsidies
b) Targeting fiscal deficit reduction
c) Reducing government borrowing
d) Controlling inflation through fiscal measures
16. The recent fiscal situation of the Indian government indicates:
a) High surplus in the budget
b) A focus on reducing deficits and managing debt
c) Large scale privatization
d) High tax revenues

28
17. Which of the following is true about Indian tax reforms?
a) Tax rates have significantly increased across the board
b) GST was implemented to simplify the tax structure
c) Only income tax was reformed
d) All states have independent tax systems
18. The term "Revenue Deficit" refers to:
a) The shortfall between revenue and expenditure
b) Excessive borrowing
c) Non-tax revenue generation
d) Debt repayment
19. The concept of "Primary Deficit" focuses on:
a) Total debt burden
b) Government borrowing excluding interest payments
c) Revenue collection
d) Capital expenditure
20. In India, the Union Budget is presented by:
a) The President
b) The Finance Minister
c) The Prime Minister
d) The Reserve Bank of India
21. The Indian Government uses fiscal policy to manage:
a) Inflation and employment
b) Education policies
c) Only tax revenue
d) Foreign exchange rates
22. Which of the following is a recent reform related to the Indian tax system?
a) Introduction of Digital Taxation
b) GST on various goods and services
c) Abolition of Corporate Tax
d) New import-export tax policies
23. In the context of Indian public finances, "Fiscal Deficit" is an indicator of:
a) Government revenue
b) Total borrowing needs of the government

29
 c) Tax collection efficiency
d) Expenditure on infrastructure
24. "Revenue Deficit" is an indication of:
a) Excess government savings
b) Excess government expenditure over its revenue
c) Government borrowing from the public
d) Financial surplus
25. The main focus of the 2024 Indian Budget was to:
a) Reduce the number of taxes
b) Revive the economy post-pandemic
c) Increase government spending
d) Privatize government enterprises
26. The Fiscal Responsibility and Budget Management (FRBM) Act helps control:
a) Tax rates
b) Government borrowing and deficits
c) Inflation levels
d) Public sector wages
27. Which of the following is a type of budget deficit in India?
a) Income Deficit
b) Fiscal Deficit
c) State Deficit
d) Tax Deficit
28. The concept of Fiscal Federalism aims to:
a) Increase tax revenues for the central government
b) Ensure fair distribution of resources between Union and States
c) Consolidate tax powers in the central government
d) Limit state taxes
29. The Union Budget of India is presented annually to:
a) The Parliament
b) The President
c) The Chief Justice
d) The Cabinet
30. In India's fiscal policy, "Deficit Financing" refers to:
a) Borrowing from international banks

30
b) Printing money to meet budgetary gaps
c) Increasing tax revenue
d) Reducing government spending

31. Which tax in India is based on the principle of "ability to pay"?

a) Goods and Services Tax
b) Income Tax
c) Customs Duty
d) Excise Duty
32. GST is an example of which type of tax?
a) Direct Tax
b) Indirect Tax
c) Progressive Tax
d) Regressive Tax
33. What does the term "progressive tax" imply?
a) Higher income groups pay a larger percentage of their income as tax
b) Everyone pays the same tax rate
c) Tax rates decrease as income increases
d) Taxes are based on goods and services
34. Which of the following taxes is NOT part of the GST framework?
a) Stamp Duty
b) Central GST (CGST)
c) State GST (SGST)
d) Integrated GST (IGST)
35. The Indian Budget is presented annually in:
a) January
b) February
c) March
d) April
36. The Economic Survey, a precursor to the Budget, is prepared by:
a) The Ministry of Finance
b) The Reserve Bank of India
c) The Planning Commission
d) The Comptroller and Auditor General

31
37. The term "capital budget" includes:
a) Expenditure on building infrastructure
b) Day-to-day government expenses
c) Collection of indirect taxes
d) Revenue from taxes
38. Which of the following deficits measures the gap between revenue receipts and
revenue expenditure?
a) Revenue Deficit
b) Fiscal Deficit
c) Primary Deficit
d) Current Account Deficit
39. What is the main goal of the Fiscal Responsibility and Budget Management (FRBM)
Act?
a) Increase foreign reserves
b) Boost exports
c) Achieve fiscal discipline
d) Control inflation
40. Which of these components is NOT part of government revenue?
a) Tax revenue
b) Non-tax revenue
c) Capital expenditure
d) Dividends from public enterprises
41. The concept of "Zero-Based Budgeting" means:
a) Preparing budgets with surplus funds
b) Carrying forward previous expenditures
c) Justifying every expense from scratch
d) Budgeting only revenue receipts
42. Which type of deficit occurs when the government borrows money to meet its
operating expenses?
a) Fiscal Deficit
b) Budget Deficit
c) Revenue Deficit
d) Trade Deficit

32
43. Which of the following taxes has been subsumed under GST?
a) Income Tax
b) Corporate Tax
c) Service Tax
d) Property Tax
44. The term "Non-Tax Revenue" includes:
a) Profits from public enterprises
b) GST collections
c) Corporate Tax collections
d) Excise duties
45. In India, the responsibility for managing the fiscal deficit lies primarily with:
a) State Governments
b) Reserve Bank of India
c) Central Government
d) NITI Aayog
46. Which of the following is a feature of a "Balanced Budget"?
a) Revenue exceeds expenditure
b) Revenue equals expenditure
c) Expenditure exceeds revenue
d) No borrowing is allowed
47. Fiscal Federalism is aimed at:
a) Sharing of resources between the Centre and States
b) Making the central government more powerful
c) Abolishing state-level taxes
d) Increasing export duties
48. A major disadvantage of a high Fiscal Deficit is:
a) Increase in government borrowing
b) Reduction in government spending
c) Excessive budget surplus
d) Decrease in public sector growth
49. Which of the following is an example of a direct tax?
a) Corporate Tax
b) GST

33
 c) Excise Duty
d) Customs Duty
50. The concept of "deficit financing" is used for:
a) Reducing tax rates
b) Bridging the gap between expenditure and revenue
c) Managing foreign investments
d) Increasing exports
51. A "Surplus Budget" indicates that:
a) Expenditure exceeds revenue
b) Borrowing is required
c) Revenue exceeds expenditure
d) The government is running a deficit
52. Which of the following reforms helped simplify India's tax structure?
a) Implementation of GST
b) Introduction of the FRBM Act
c) Abolition of Wealth Tax
d) Introduction of excise duties
53. "Primary Deficit" is calculated as:
a) Revenue Deficit + Fiscal Deficit
b) Fiscal Deficit - Interest Payments
c) Total Borrowings - Revenue Expenditure
d) Revenue Deficit - Tax Collections
54. In India, direct taxes are administered by:
a) The Central Board of Direct Taxes (CBDT)
b) The Reserve Bank of India
c) The Finance Commission
d) NITI Aayog
55. The Constitution of India assigns the responsibility for levying income tax to:
a) The Central Government
b) State Governments
c) Both Centre and States
d) Local Bodies
56. The term "Tax to GDP ratio" indicates:
a) Growth of GDP

34
 b) Share of taxes in the economy
c) Tax revenue from exports
d) Government borrowing levels
57. The FRBM Act was enacted in which year?
a) 1995
b) 2003
c) 2010
d) 2014
58. An important recommendation of the Finance Commission is:
a) Collection of indirect taxes
b) Distribution of tax revenue between Centre and States
c) Setting interest rates
d) Managing public sector companies
59. What does "Goods and Services Tax" replace?
a) Multiple indirect taxes like VAT, Excise, and Service Tax
b) Income Tax
c) Wealth Tax
d) Capital Gains Tax
60. Which deficit directly impacts government savings?
a) Fiscal Deficit
b) Revenue Deficit
c) Primary Deficit
d) Trade Deficit
61. The Indian Budget is approved by:
a) The Finance Minister
b) The President
c) The Parliament
d) The Supreme Court
62. What is the primary aim of India's recent budget reforms?
a) Reduction in state taxes
b) Promotion of exports
c) Simplification and digitalization of processes
d) Increase in corporate tax rates

35
63. Which deficit occurs when capital receipts exceed capital expenditure?
a) Capital Surplus
b) Revenue Surplus
c) Primary Deficit
d) Fiscal Deficit
64. Tax evasion primarily affects:
a) Private companies
b) Government revenue
c) Foreign exchange
d) Public sector enterprises
65. The introduction of GST primarily aimed to:
a) Increase income tax rates
b) Reduce foreign investments
c) Unify the tax structure across India
d) Promote exports
66. The largest source of revenue in the Indian Budget is:
a) Customs Duty
b) Goods and Services Tax (GST)
c) Corporate Tax
d) Excise Duty
67. The Reserve Bank of India plays a role in:
a) Managing public debt
b) Framing fiscal policies
c) Presenting the Budget
d) Collecting taxes
68. The concept of "Outcome Budgeting" focuses on:
a) Reducing fiscal deficit
b) Tracking expenditure
c) Measuring the impact of government spending
d) Increasing tax revenue
69. Which organization reviews fiscal federalism in India?
a) Planning Commission
b) Finance Commission

36
 c) Reserve Bank of India
d) Ministry of Corporate Affairs
70. The term "effective revenue deficit" was introduced to:
a) Differentiate between productive and unproductive expenditure
b) Measure fiscal surplus
c) Track public borrowing
d) Limit government savings

References

Sr. Name of Authors Name of Book/Article Name of Publisher

No. (Year, Place)
1 M. Govinda Rao Indian Fiscal Federalism Oxford University Press
(2019, New Delhi)
2 Amaresh Bagchi Readings in Public Finance Oxford University Press
(2005, New Delhi)
3 R. Kavita Rao & Goods and Services Tax in India: Cambridge University
Pinaki Chakraborty Challenges and Opportunities Press (2020, New Delhi)
4 Parthasarathi Shome India's Fiscal Policy: Prescriptions, Oxford University Press
Pragmatics, and Practice (2012, New Delhi)
5 Sudipto Mundle Fiscal Responsibility and Budget Economic and Political
Management Act: Review and Weekly (2006, Mumbai)
Outlook
6 Kaushik Basu & S. Budgeting and Fiscal Policies in Oxford University Press
Roy Emerging Markets: Indian (2019, New Delhi)
Perspectives
7 C. Rangarajan & D. K. Reforms in Budgetary Processes in Academic Foundation
Srivastava India (2005, New Delhi)
8 D. K. Srivastava Fiscal Deficit of India: Trends and Economic and Political
Concerns Weekly (2000, Mumbai)
9 Richard Musgrave The Theory of Public Finance: A McGraw-Hill (1959, New
Study in Public Economy York)
10 Joseph E. Stiglitz Economics of the Public Sector W.W. Norton & Company
(2015, New York)
11 Harvey S. Rosen Public Finance McGraw-Hill Education
(2013, New York)
12 Alan J. Auerbach & Handbook of Public Economics Elsevier (2013,
Raj Chetty Amsterdam)
13 Nicholas Barr The Economics of the Welfare State Oxford University Press
(2020, Oxford)
14 Richard A. Brealey & Principles of Corporate Finance McGraw-Hill Education
Stewart C. Myers (2020, New York)
15 Jonathan Gruber Public Finance and Public Policy Worth Publishers (2019,
New York)

37