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What is Fiscal Deficit?

  • Apr 18, 2024

Fiscal Deficit means that the total expenditure of a country is more than the total revenue of the nation. It is an indication of how the country will perform in the upcoming financial year. It represents how much the government will have to borrow to compensate for the fiscal deficit in the economy.

It is very easy for a country to be in fiscal deficit as the revenue generated by the Indian government comes from taxes (GST, custom duties, income tax, etc.). Still, the expenditure is primarily on public projects, schemes, etc., which are of no monetary benefit to the government.

Fiscal Deficit Formula

Fiscal Deficit = Total Government Expenditure – Total Government Revenue

Total Government Revenue = Revenue Receipts Recoveries of Loans Other Capital Receipts

Total Government expenditure = Revenue Expenditure Capital Expenditure


Total Government Revenue

It includes Tax Revenue and Non-Tax Revenue. The Tax Revenue includes all the taxes, such as GST, taxes from Union Territories, income tax, etc., which the central government collects. The Non-Tax Revenues include dividends and profits, interest receipts and other non-tax revenues.

Total Government Expenditure

Total expenditure comprises capital expenditure, revenue expenditure (salary and pension payments), infrastructure, healthcare, interest payments and grants for the creation of capital assets.

Factors Which Contribute to Fiscal Deficit

1.Economic slowdown

The earnings of the government fall when there is a recession. The government receives fewer tax collections while pressure on the government to spend more on social welfare programs increases.

2. High Expenditure

Governments that consistently spend more money than they collect in revenue can lead to a fiscal deficit. This situation can either be due to inefficient expenditure or high public investments in areas like infrastructure, defence or social programs.

3.Huge Interest

High debt that requires the government to pay a very high amount in the form of interest is a significant contributor to Fiscal Deficit.

4. External factors

Natural disasters, wars and other situations that require emergency spending lead to a fiscal deficit if the government needs to borrow money to cope with these situations.

5. Cut in Tax Rates

Reductions in tax rates or implementation of tax breaks without corresponding cuts in government spending can result in lower revenues and contribute to a fiscal deficit.

Consequences of Large Fiscal Deficit

1.High Government Debt

When the government is spending more than it earns, it results in borrowing money, which leads to a situation where there is an accumulation of government debt. This debt affects the government's finances over time, which results in an increased amount of interest payments, and the money for important expenses gets limited.

2. Investors and Markets

Investors and markets lose trust and interest in the economy of a country if it continuously suffers from a deficit, resulting in less investment and, ultimately, higher borrowing. Thus, they need to be convinced of the county's ability to handle its finances.

3. Crowding out Private Investment

When the government borrows heavily to cover its deficit, it competes with businesses for available funds, pushing up interest rates. This can discourage businesses from investing, slowing down economic growth.

How to Reduce Fiscal Deficit?

Inadequately managed deficits can burden future generations with higher taxes and diminished government services as the government has to repay its debts together with interests. To decrease the Fiscal Deficit, an increase in taxes or a decrease in expenditure could be the solution.

However, the major focus should be on reducing government spending and it may be done through making government activities more effective using proper planning of programs and improved administration.

Conclusion

To conclude, a fiscal deficit represents a situation where a country's total expenditure surpasses its total revenue, which signifies the amount the government must borrow to cover it. The governments must employ strategies to reduce fiscal deficits, such as increasing tax revenue through direct taxes or asset sales and cutting government expenditure.

By maintaining a balance between total expenditure and total revenue, governments can safeguard future generations from the burdens of excessive taxation and diminished services while fostering economic stability and prosperity.

Team Sharekhan
by Team Sharekhan

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