Government Budgeting

Refer: Indian constitution, Articles 264 to 300A

● prepared by the Budget Division, Department of Economic Affairs, Ministry of Finance
● Article 112: President shall, in respect of every financial year, cause to be laid before both the houses of
the parliament, the Annual Financial Statement (Budget) of estimated receipts and expenditures of the
government in respect of every financial year from 1st April to 31st March.
● Approval of taxes/receipts through Finance bill, and for expenditure through appropriations bill.
● Three set of figures of every budget:
○ Budget Estimate (BE) for the next FY 2023-24
○ Budget and Revised Estimate (RE) for the current FY 2022-23
○ Actual figures for the preceding FY 2021-22
● Three kinds of budget:
○ Full budget: estimate for expenditure and receipts for the entire financial year
○ Interim budget: during election year, complete set of accounts, including both expenditure and
receipts but only for the part of the year, after new govt, full budget will be prepared.
○ Vote on account: only for expenditures, for part of the year, usually two months, for a sum equivalent
to one sixth of estimated expenditure for the entire year.
◆ Constitution authorised Lok Sabha to grant in advance, pending the completion of the voting
of the demand for grants and enactment of appropriations bill.
Budget classification based on themes:
. Zero based budgeting: begins from scratch, not based on previous data/trends in contrast to incremental
(conventional) budget
. Outcome budget: converting outlays into outcomes by planning expenditure, fixing appropriate targets and
quantifying deliverables.
○ Effort to be transparent and accountable.
. Gender budget: gender sensitive formulation of legislation, policies, plans, programs, schemes, resource
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allocation, implementation, monitoring, audit and impact assessment of programs and schemes.
○ Promote equality through budget
○ First introduced in 2005-06
○ Published every year with union budget
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○ Has two parts
◆ Part A: 100% allocation for women
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◆ Part B: at least 30% of funds for women
Budget procedure:

Detailed discussion on demand for grants:

● demand for grants of various ministries/ departments are considered by the "Departmentally Related
Standing Committees" (DRSC).
● Total 24 DRSCs and approximately 100 ministries (around 5 ministries each per DRSC TO PREPARE
DEMAND FOR GRANTS
● After time for discussion over, on last day all outstanding demands will be voted out. (Guillotine).
● Only discussion in Rajya Sabha
● Article 113 of the Constitution: expenditure which is charged upon the Consolidated Fund of India shall not
be submitted to the Vote of the Parliament, but discussion can happen in either House of the Parliament on
 ●

any of those estimates.

● Demands for grants of union territories without legislature Is approved along with u union budget

Appropriation bill:
● Article 114: introduction of appropriate bill by govt.
● give authority to the Govt. to incur expenditure and meet grants from and out of the Consolidated Fund of
India.

Finance bill:
● Article 110: considered after appropriation bill is passed.
● However certain provisions in the Bill related to levy and collection of fresh duties or variations in the
existing duties come into effect immediately on the expiry of the day on which the Bill is introduced by
virtue of a declaration under the Provisional Collection of TaxesAct 1931.
● Finance Bill should be passed within 75 days of its introduction.
● Both are money bills, passed to Rajya Sabha, but it’s upto Lok Sabha to accept its recommendations.
● To change direct taxes, amendment in particular act is required through finance act.
● But to change indirect taxes, ceiling rates are fixed, if it exceeds ceiling rate, amendments is required
otherwise not necessary.

Supplementary demand for grants: when need has risen during the current financial year for supplementary or
additional expenditure upon some 'new service' not contemplated in the budget for that year.
● Presidents lays before both the houses.
● Made before end of the financial year.

Demand for excess grants: president presents before Lok Sabha

● Brought to notice of parliament by the CAG by report on appropriations accounts. In turn examined by
public accounts committee.
● Made after the financial year which it relates to has expired.

Government accounts:
. Consolidated fund of India (CFI):
○ Means of credit: all revenues (direct, indirect) other receipts in connection to conduct of
government business credited to CFI.
○ All loans raised by govt by issue of public notifications, treasury bills and loans obtained from
foreign governments and international institutions
○ Means of debit: all expenditures incurred by govt for conduct of business, repayment of internal/
external debts, release of loans to states/UTs debited against this fund, with authorisation from
parliament.
. Contingency fund of India:
○ Imprest account (fixed fund for specific purpose)
○ At the disposal of president (by secretary to GOI, ministry of finance, department of economic
affairs)
○ Meet unforeseen expenses pending authorisation of parliament.
○ Provides immediate relief to victims of natural calamities, implement new policy decision.
○ After the Parliament votes the Bill, the money already spent out of the Contingency Fund is
recouped/ withdrawn from the Consolidated Fund of India to ensure that the corpus of the
Contingency Fund remains intact.
○ The corpus of the fund has been increased to Rs. 30,000 crores (as proposed in budget 2021-22,
earlier it was Rs. 500 crore)
. Public account of India:
○ All public money other than CFI
○ Receipts and disbursements out of it are not subject to vote by parliament.
 ○ Receipts mainly flow from the sale of Savings Certificates, contributions into General Provident
Fund, Public Provident Fund, Security Deposits and Earnest Money Deposits (a kind of security
deposits) received by the government.
○ Govt as banker/trustee
○ State Governments/UTs with legislature has their own Consolidated Fund, Public Account and
Contingency Fund (as mandated by the Constitution). (As per the union territories act, 1963)

Budget Classification:
Article 112: budget must distinguish the expenditures on revenue
account from other expenditures (capital account). Therefore, the budget comprises of the Revenue Budget and
Capital Budget.

Revenue receipts: which neither create liability nor reduce the assets (physical/financial) of the govt
● Non redeemable
● Two types:
○ Tax revenue: direct and indirect taxes
○ non tax revenue: interest receipts on account of loans given by central government, dividend and
profits on investments made by the central government (i.e.,PSUs), fees and fines and other
receipts for services rendered by the government like passport fees etc. Cash rants-in-aid from
foreign countries and international organisations are also part of the non-tax revenue.
Revenue expenditure: which neither create any assets (physical/financial) nor reduce the liabilities of the govt

Capital receipts: receipts of the government which either creates liability or reduces the assets (physical or
financial)
● loans raised by the government from the public (market borrowings), borrowing by the government from
the RBI, commercial banks and other financial institutions through the sale of government securities
(treasury bills/dated securities), loans received from foreign governments and international organizations,
and recovery of loans previously granted by the central government. It also includes small savings
schemes (Post office savings accounts, National Savings Certificates etc.), Provident Funds and net
receipts obtained from the sale of shares in PSUs (disinvestment).

Capital expenditure: expenses of the government which either creates assets (physical or financial) or reduces
liabilities
● acquisition of land, building, machinery, equipment, purchase of shares by the government and loans and
advances by the central government to state and union territory governments, PSUs and other parties.

Government deficits:
● When govt spend more than it collects revenue, incurs deficit.
 ● Three ways of capturing deficit:
. Revenue deficit = Revenue Expenditure - Revenue Receipts
○ will have to use up the savings of other sectors of the economy to finance its consumption
expenditure.
○ Major part of revenue expenditure (salary, pension, interest payments, subsidies etc.) is committed
expenditure, it cannot be reduced.
○ generally reduces the productive capital expenditure and welfare expenditure to cover up the excess
revenue expenses. means lower future growth and adverse welfare implications.
. Fiscal deficit: difference between the government's total expenditure (Revenue and Capital) and its
total receipts (Revenue and Capital) except the borrowings.
○ Fiscal Deficit = Total Expenditure - Total Receipts except borrowing
= (Rev Exp. + Cap Exp.) - (Rev Rec. + Cap Rec. except borrowing)
= (Rev Exp. - Rev Rec.) + (Cap Exp. - Cap Rec. except borrowing)
= Revenue Deficit + Cap Exp. - Cap Rec. except borrowing
= Total borrowing
= Net borrowing at home + borrowing from RBI + Borrowing from abroad
○ Fiscal deficit indicates the total borrowing of the government from all sources i.e. domestic
borrowing plus borrowing from external sources.
○ Domestic borrowing includes government’s debt securities like Treasury Bills and Dated Securities.
○ Commercial banks, other financial institutions, RBI purchase these securities.
○ A large share of revenue deficit in the fiscal deficit indicates that a large part of borrowing is being
used to meet its consumption expenditure needs rather than investment.
. Primary deficit:
○ Primary Deficit = Fiscal Deficit - Net interest liabilities
○ Goal is to focus on present fiscal imbalances.
● Effective Revenue Deficit = Revenue Deficit - Grants given to states for creation of capital assets
● Effective Capital Expenditure = Capital Expenditure + Grants given to states for creation of capital assets.
● Deficit financing: It is a practice adopted for financing the excess expenditure with outside resources by
either printing of additional currency or through borrowing.

Fiscal policy:
● means by which government adjusts its spending levels and tax rates to monitor and influence a nation’s
economy.
● Fiscal policy and monetary policy are used in various combinations to direct a country's economic goals.

Main objectives:
● Economic Growth (Stabilisation of business cycles)
● Maintain high level of employment
● Control inflation
● Equitable distribution of wealth
● Welfare (subsidies, income support, health, education etc.)

It can be expansionary/contractionary:
● Expansionary fiscal policy: ↑ spending, ↓ tax levels to ↑ aggregate demand in the economy.
● Pump priming: pumping money into economy by ↑ government spending, ↓ tax levels
● More money in economy, less taxes to pay, ↑ consumer demands, rekindles businesses and turns the
cycle around from stagnant to active.
● Contractionary fiscal policy: ↓ govt spending, ↑ tax levels, sucks money out of the economy, ↓ aggregate
consumer demand.
● Ex: when inflation is high, may need economic slowdown.
● ↓ money circulation, ↓ demand, ↓ money to pay, ↓ inflation.
Phases of a business cycle
● Expansion: An economic growth phase when real GDP increases for two or more quarters. This phase is
also known as an economic recovery.
○ Should not explode bigger
● Peak: The phase when the economy reaches its maximum productive output.
● Contraction: An economic decline phase when real GDP declines. This phase is also known as a
recession.
○ Shouldn’t be allowed to grow into deep recession.
● Trough: The lowest point in the business cycle. This phase is characterized by higher unemployment,
lower availability of credit, and falling prices.
Amplifying business cycle is dangerous.
Factors affecting business cycles
Factors that affect business cycles include:
interest rates, trade, production costs, investments, consumer spending, and inflation.
Measuring business cycles
The National Bureau of Economic Research (NBER) is a leading source for indicating the length of a business
cycle.
Other terms for business cycle phases
● A period of economic expansion is also known as a boom.
● A period of economic decline is also known as a recession or depression.
Practically fiscal policy responses using taxation and expenditure can go in two ways in response to the business
cycle: Countercyclical and pro-cyclical.
Counter cyclical: works against on going boom/recession, trying to stabilise economy.
● During boom: tries to ↓ aggregate demand by ↓ govt expenditure and ↑ tax levels.
● During recession: ↑ aggregate demand, ↑ govt expenditure, ↓ tax levels.
● cool down the economy when there is a boom and stimulate the economy when there is a slowdown.
Pro cyclical: fiscal policy goes in line with the current mood of the business cycle i.e., amplifying them.

The Economic Survey 2016-17 has acknowledged that India's fiscal stance has an in-built bias toward higher
deficits, because spending rises pro-cyclically during growth surges boom period), while revenue and spending
are deployed counter-cyclically during slowdowns.

Fiscal consolidation policy:

Fiscal responsibility and budget management (FRBM) Act 2003

In 2000, Gross fiscal deficit reached 6% of GDP.
Act became effective from July 2004.
Main objectives:
● ensure inter-generational equity (equality)
● Long term macroeconomic stability.
achieved by:
● Achieving sufficient revenue surplus
● Removing fiscal obstacles to monetary policy
● Effective debt management by limiting deficits and borrowing.

Important features of FRBM act 2003:

Trends in fiscal deficit of centre and states:

Central:
2018-19 3.4%
2019-20 4.6%
2020-21 9.2%
2021-22 6.9%
2022-23 6.4%
2023-24 5.8%
2024-25 4.8%
Karnataka:

Article 293: States need to take prior approval from the Centre for
borrowing if:
● States have taken debt from Centre and there are pending dues; or
● There is any outstanding loan on States with respect to which Central Govt. has given guarantee.

Debt:
● Article 292: government of India can borrow amounts specified by the Parliament from time to time, both
internal and externally
● Mandates state govts can only borrow from internal sources.
● As per recommendations of 12th Finance commission, access to external financing by the various states is
facilitated by the Central Government which provides the Sovereign guarantee for these borrowings.
● From 1st April 2005 all General Category states borrow from multilateral and bilateral agencies (World
Bank, ADB etc)
● Debt is basically in the name of Central govt
. Internal debt: GOI borrows by issuing debt securities, ex: Treasury Bills and Dated Securities in the
domestic market
. External debt: from other govts (bilateral debt) and multilateral agencies like WB, ADB etc, and FPI
purchasing G-Secs
. Public account liability: National Small Savings Schemes like Public Provident Fund, Kisan Vikas Patra etc.
 . Off budget liabilities: financial liabilities of any corporate or other entity owned/controlled by the Central
Government, which the Govt. has to repay or service from the Annual Financial Statement.
GOI (central govt) total debt/liabilities = 1 + 2 + 3 + 4

Internal debt+ external debt = Public debt contracted against(on the security of)CFI

External debt of India= debt owed by residents of the country to non residents of the country. (Further read:
debts of Karnataka)

● Commercial borrowings remained the largest component of external debt followed by non-resident
deposits
● Multilateral assistance includes loans from multilateral institutions such as International Bank for
Reconstruction and Development (IBRD), International Development Agency (IDA) (IBRD and IDA are
together called World Bank), International Fund for Agriculture Development (IFAD), Asian Development
Bank (ADB), Organization of Petroleum Exporting Countries (OPEC) etc. Loan from IMF has been included
under other govt. debt.
● Bilateral assistance includes loans from Japan, Germany, US, France, Russia.

Monetisation of deficit and deficit financing:

Before 1997, monetisation of deficit: GOI issued ad hoc Treasury bills to RBI, in return, printed currency, which
resulted in increase in debt of GOI.
● It was primary market transaction b/w GOI & RBI
● Stopped in 1997, by Ways and means Advance (WMA): govt took advances to accommodate temporary
mismatches in govts receipts and payments.
● Fiscal Responsibility and Budget Management (FRBM) Act 2003 also prohibits direct monetization of
deficit but allows it in exceptional circumstances.
● Agreed RBI would only operate in secondary market, through open market operation (OMO).
● RBI would use the OMO route but as a liquidity instrument to manage the balance between the policy
objectives of supporting growth, checking inflation and preserving financial stability.

When govt. should go for direct monetisation??

Answer: When the banks do not have sufficient liquidity i.e., there is shortage of liquidity in the economy then if
govt will try to borrow from banks then it will further deteriorate the liquidity situation and will result in increase in
interest rate which will hamper the investments (for which govt is trying hard presently) in the economy and
recovery may be slow. So, in this situation, govt can go for direct monetisation. BUT if banks are flush with
liquidity, then first govt should try to borrow from banks.

Impact of “Monetization of Deficit”

● ↑ aggregate demand in the economy thereby resulting in economic growth
● Results in increase in debt on Government thereby impacting overall macro-economic stability and may
result in ratings downgrade
● ↑ inflation due to ↑ money supply
● ↑ money supply may result in depreciation of rupee which can lead to flight of capital from the country
● RBI can be seen as losing control over its monetary policy
● As such there is no issue if it is done once in exceptional circumstances but in India the problem is once it
is done, then it will lure future governments of an easy route of financing their deficit.

Deficit Financing": It generally means that Govt. is having deficit (as expenses are more than receipts) which can
be financed from different sources like from market borrowing or borrowing from abroad or there can also be the
case that Govt may ask RBI to finance its deficit by printing more money.

Fiscal Council: Need, Issues, and Arguments

What is a Fiscal Council?
A permanent independent agency that evaluates the government’s fiscal plans against macroeconomic
sustainability, ensuring transparency and accountability. It provides forecasts, independent budget
assessments, and advises on deviations from fiscal rules.

Issues with the Current System

1. Chronic Fiscal Irresponsibility – Overstated GDP and revenue projections, understated expenditures.
2. Unrealistic Revenue Targets – Leading to aggressive tax collection measures.
3. Budget Manipulation – Use of off-budget financing (e.g., borrowing from National Small Savings Fund
(NSSF) to meet food subsidy bills).

Arguments in Favor of a Fiscal Council

• Improves Fiscal Discipline – Research shows countries with fiscal councils produce more accurate budget
forecasts and adhere better to fiscal rules.
• Increases Transparency – Provides an independent assessment of fiscal policies, aiding informed debate in
Parliament.
• Fills a Gap Left by CAG – Unlike the Comptroller and Auditor General (CAG), which audits expenditures
after they occur, a fiscal council would verify budget sustainability before execution.
• Global Precedent – Around 50 countries have established fiscal councils with varying success (IMF
Report).
• XIV Finance Commission recommended setting up an independent fiscal council.

Arguments Against a Fiscal Council

• Existing Institutions Already Provide Forecasts – NSO, RBI, and private agencies already offer
macroeconomic projections.
• Dilutes Finance Ministry’s Accountability – If government relies on an external agency’s estimates, it can
shift blame if projections go wrong.
• Parliamentary Neglect of Fiscal Policy – The FRBM Act (2003) requires submission of a Fiscal Policy
Strategy Statement (FPSS), but it rarely sparks debate in Parliament. Without demand for accountability, an
additional institution may not be effective.

India’s tax system:

Several ways of classification:
● Progressive tax
● Proportional tax
● Regressive tax

– Specific tax: per unit price

– Ad Valorem tax: based on value in market

. Production tax
. Consumption tax

● Direct tax
● Indirect tax

Basic features of above taxes:

● Personal income tax: imposed by combining all sources of the individual's income like salary, rental
income, interest income etc.
○ Two tax regimes: old and new according to income tax act, 1961

New Tax Regime Old Tax Regime

Introduction Introduced in April 2023 Traditional tax regime existing
prior to the new regime
Basic Income Exemption Limit Rs 3 lakh for all taxpayers Varies depending on taxpayer
category and deductions
Tax Rates and Slabs More income tax slabs with Fewer slabs with comparatively
lower rates higher rates
Standard Deduction Rs 50,000 from salary/pension Available, but limited to
income specific categories
Employer’s NPS Contribution Up to 10% of salary (14% for Deductions available for
government employees)
 Employer’s NPS Contribution Up to 10% of salary (14% for Deductions available for
government employees) employer’s NPS contribution
Deductions Available Limited to standard deduction Wide range of deductions
and employer’s NPS under various sections (80C,
contribution 80D, etc.)
Flexibility vs. Simplicity Simplified structure with fewer Offers flexibility with multiple
deductions deductions
Tax Planning Strategies Requires careful planning due Offers more options for tax
to limited deductions planning and optimization
Long-term Financial Goals May be suitable for individuals Beneficial for those prioritizing
seeking simplicity tax savings through
deductions
Considerations Individual income level, Long-term financial goals, tax
eligibility for deductions planning objective

In the old tax regime, till Rs. 5 lakh there is no tax. But individuals can claim
exemptions related to savings under various schemes like PPF, NPS etc. up till
certain limit. But if income is more than Rs. 5 lakhs then the following slab will be
applicable:
Rs. 0 to 2.5 lakhs Nil
Rs. 2.5 lakhs to 5 lakhs 5%
Rs. 5 lakhs to 10 lakhs 20%
Above Rs. 10 lakhs 30%
New Income Tax Slab Rates
Income Range (₹) Tax Rate (%)
Up to ₹4,00,000 NIL
₹4,00,000 – ₹8,00,000 5
₹8,00,000 – ₹12,00,000 10
₹12,00,000 – ₹16,00,000 15
₹16,00,000 – ₹20,00,000 20
₹20,00,000- ₹24,00,000 25
Above 24,00,000 30
● Corporate income tax (CIT): imposed on the profits of the corporates/ companies/ entities.
● Presently two structures of CIT exist and the companies can opt anyone. If a company does not claim any
tax exemptions, then it needs to pay 25.17 % CIT, but if a company claims tax exemptions, then it needs to
pay 34.94% as CIT.
Minimum alternate tax (MAT):
Zero tax paying companies: in spite of having earned substantial book
profits and having paid handsome dividends, do not pay any tax due to various tax concessions and incentives
provided under the Income tax Law.
(A) normal tax liability:34.94% of taxable income
(B) Tax computed @ 15% (plus cess & surcharge) (17.16%) on book profit called the MAT.
A company has to pay whichever is higher.

The companies claiming for the new tax rate of 25.17% CIT, would not be eligible for claiming tax exemptions/
rebates and hence MAT will not be applicable on them. Those which will claim exemptions, the tax rate of
34.94% or MAT will be applicable.

Capital gains tax: the gain/profit realized on the sale of an asset that was purchased at a cost amount that was
lower than the amount realized on the sale. Ex: shares/stocks etc.

Dividend distributions tax DDT: Dividend is the distribution of a portion of company's profits/earnings to its
owners/ shareholders.
● DDT abolished in budget 2019-20, dividend made taxable in the hands of shareholders.

Securities transactions tax SST: levied at the time of purchase and sale of securities like shares, bonds,
debentures, mutual funds etc. listed on stock exchanges in India.
● This tax varies on type of security trades and whether it’s sold or purchased

Equalisation levy: (google tax):

● Independent levy introduced through Finance act 2016.
● So, if an e-commerce firm (say Amazon which is registered in US, and in India its status is non-resident)
earns a REVENUE (and not profit) of say Rs. 100 from its online platform (e-commerce) by sale to Indian
people (Indian resident) then out of Rs. 100 they need to give Rs. 2 (2%) to Govt. of India as Equalization
Levy but NO income tax under Income Tax Act 1961.
● if Amazon would have a permanent establishment in India (physical presence) then they would
automatically pay "Income Tax" on their profits as per Income Tax Act 1961.
● "EQUALISATION LEVY" is a Direct Tax and is levied on "REVENUE" and not "Profit".

Global minimum corporate tax: (GMCT):

● Countries reduce corporate taxes to attract companies, which led to loss of tax revenue to the home
country govt.
● if companies shift their business revenues to tax havens, then also, they will have to pay a minimum tax to
 ●

home country govts.

● GMCT has two pillars
○ Pillar 1: ensure a fairer distribution of profits and taxing rights among countries with respect to the
largest Multi-National Enterprises (MNEs), including digital companies.(Equalisation levy may not be
required anymore because of this pillar)
○ Pillar 2: put a floor on competition over corporate taxes to through GMCT that countries can use to
protect their tax bases. ( related to 15% GMCT)

Land revenue: as per diff state govt acts, and fixed on classification of different types of land and cash value of
the avg yield of the land.
● Factors afffecting productivity is considered.

Property tax: government appraising the monetary value of each such property and assessing the tax in
proportion to its value.
● This Tax amount used to develop local amenities.
● Varies according to location.
● Urban local bodies like municipal boards/ municipal corporations/ town area committees levy property tax
under the relevant Acts.

All indirect taxes are regressive in nature: same taxes irrespective of the income of the individual
Excise duty: imposed on manufactured goods and was levied when the goods moved out of the factory area.
Customs duty:ON EXPORTS AND IMPORTS
Service tax: on sale of services
Central sales tax:levied by centre on sale of goods from one state to another state, but taxes kept by origin state
hence called origin based tax
Value added tax:(VAT):sale of goods within the state
Input tax credit mechanism, prevents tax avoidance.

● Entry Tax was a tax on the movement of goods from one state to another imposed by the state
governments in India. It was levied by the recipient state to protect its tax base.

● Stamp Duty is a tax imposed on all legal property transactions. A physical stamp had to be attached to or
impressed upon the document to denote that the stamp duty had been paid. Since it is imposed by states,
the rate varies from state to state.

Goods and service tax (GST):

Background: VAT is being imposed even on excise duty, creating tax on tax and cascading effect and increasing
the effective tax rate
● Both govt levied their own taxes resulted in cascading effect leading to costly products in market.
● different states had different VAT rates (1%, 4%, 12.5%, 20%) and gave exemptions on different category
of products.
● Due to this effective tax was different in different states on various goods and services.
● fragmented the whole of India into a heterogeneous market affecting business and investment.
GST:
● Best example of cooperative federalism
● The States agreed to give up their right to impose sales tax on goods (VAT), and the Centre gave up its
right to impose excise and services tax. In exchange they will each get a share of the unified GST collected
nationally. The anticipated additional gains in efficiency, competitiveness, ease of doing business and
overall tax collections are what drove this bargain.
● Subsumed 17 central and states indirect taxes
● CGST, SGST, IGST (integrated GST) If sold across state, basically a VAT
 ● 101 amendment act 2016
● interstate transactions and GST (Compensation to States) Act 2017
● Refer

Supreme Court Judgement [May 2022]

● The recommendations of the GST Council are recommendatory in nature and not binding on the Union and
States.
● The Parliament and State Legislatures posses’ simultaneous power to legislate on GST.
● The recommendations of the GST Council are binding on the Government for only secondary/subordinate
legislations like changes in tax rates or framing of rules under CGST/SGST/IGST but not for primary
legislations. For primary legislations (like amendment in acts.... CGST/SGST), the recommendations have
only persuasive value

Input Tax Credit Mechanism as the taxes paid by B on the purchase of inputs from A i.e. Rs. 18 is credited by the
government back to B.

Since there is only one tax i.e., GST and credits of input taxes paid at each stage is available in the subsequent
stage of value addition across India (whereas in case of VAT input credit was available only within the State),
hence it will prevent the dreaded cascading effect of taxes. This is the basic feature and advantage of GST.

● consumption based and destination-based tax.

● So effectively there is no tax on exports and hence we say that exports are "zero rated" supplies. Supplies
to SEZs are also zero rated.

● In case of imports, first Customs Duty and then on top of it IGST is imposed as imports are also considered
to be Inter-State supplies.
● E way bill: Mandatory for products more than 50k, document issued by a carrier giving details and
instructions relating to the shipment of a consignment of goods like name of consignor, consignee, the
point of origin of the consignment, its destination, and route.
● Generates on GST portal
● Effective way to track movement of goods

Composition levy: alternative method of levy of tax designed for small businesses whose turnover is up to Rs. 1.5
crore.
● Optional, can either pay 1% flat rate of his turnover. Similarly small service providers with turnover of 50L
can choose composition scheme and pay 6% GST.

GST compensation cess:

● tax revenue growth of State's indirect taxes from 2012-13 to 2013-14, 2013-14 to 2014-15 and 2014-15 to
2015-16 i.e. for three years and it found an average annual growth of 14%.
● Centre collects "GST compensation Cess" in Consolidated Fund of India and then transfers it to “GST
Compensation Fund” under "Public Account of India" and then it goes to States Consolidated Fund.

Benefits of GST:
● For business and industry:
○ Easy compliance: Robust and comprehensive IT system as foundation of GST regime.
○ Easy online services
○ New One return vs old separate returns
○ Uniformity of tax rates and structures: GST has made doing business in the country tax neutral,
irrespective of the choice of place of doing business.
 ◆ a structure of multiple rates (as much as 10 times X 4 times) has been reduced to a structure
of 6 rates.
○ Removal of cascading:seamless tax credits throughout the value chain, and across boundaries of
states.
◆ ↑ competitiveness for trade and industry.
○ Gain to manufacturers and exporters: ↓ cost of locally manufactured goods and services.
◆ ↑ competitiveness of Indian goods and services in the international market, boost to Indian
exports.
● For central and state govts:
○ Furthering cooperative federalism: Domestic indirect tax decisions to be taken jointly by both govts.
○ Simple and easy to administer: multiple indirect taxes subsumed under one GST.
◆ Backed with robust end to end IT system.
◆ Easy to administer compared to other previous indirect tax regimes.
◆ ↓ compliance scrutiny for inter state movement of goods, (used to be major concern).
○ Better controls on leakage and reducing corruption:
◆ GST is self policing in nature
◆ Fosters better compliance
◆ seamless transfer of input tax credit from one stage to another in the chain of value addition,
there is an in-built mechanism in the design of GST that has incentivized tax compliance by
traders.
○ ↑ tax base and tax buoyancy: new agents, formerly outside tax net sought GST registration.
○ Higher revenue efficiency:↓ cost of collection of tax revenues, ↑ revenue efficiency.
● For the consumer:
○ Single and transparent tax proportionate to the value of goods and services: cost of most goods
and services in the country used to be laden with many hidden taxes.
◆ Transparency of taxes paid to the final consumer
○ Relief in overall tax burden:↓ tax burden due to efficiency gains, prevention of leakages and removal
of cascading effect

GST has led to formalisation of industry:

● GST regime good at formalising ares where India’s formal sector interacts with informal industry, through
inputs tax credit mechanisms.
○ Biggest companies, across various industries have incentives to bring their informal supply chain
into the formalised tax net to avail the benefits of input tax credit.
○ Previously, some parts of the value chain, especially fabrics, were outside the tax net, leading to
informalization and evasion but now the textile and clothing sector is fully part of the GST tax net.
○ Exemption threshold in gst is 40L, previously used to be 1.5cr. thousands of hitherto informal or
unorganised MSMEs have now registered for GST and have come into the tax net. Hence, GST has
brought these informal enterprises into the formal economy and curbed tax evasion practices and
has expanded India’s tax base.
● Challenges:
○ Four rate structure: 5%, 12%, 18%, 28%, in addition exemptions category 0%, and gold 3% and
additional cesses charged on top of certain products. This six/ seven tax rate slab structure
complicated.
○ Alcohal, petroleum and energy products, electricity, land and real estate transactions, are outside
GST base and taxed by centre/states outside GST.
○ Goes against most basic principles of increasing revenue:↓ rate of taxation, ↑ no of people and
businesses that will comply.
○ GST threshold limit exemptions are exploited to under report the sales figures.
○ Out of roughly 6cr firms in informal sector, 2.5 cr businesses are within threshold limit. Other 4cr
don’t own computer, not digitally literate, to hire new accountants, computerise their operations to
comply with new gst regime, their operations cost ↑. ultimately making some of the firms in this
sector unviable. heavy filing requirements for service providers under GST makes it worse.
○ Major issues: inverted duty structure: Ideally the raw material should have less tax rate and final
 ○

products should have more tax rate, but if this is not followed then it creates an inverted duty
structure.

Remission of duties or taxes on exported products (RoDTEP)

● Before GST, any taxes on import (customs duties) of inputs required to manufacture exported products
were refunded through Merchandise Export of India Scheme (MEIS) by giving Duty Credit Scrips to
exporters.
● MEIS replaced by RoDTEP to comply with WTO standards
● Under GST regime, Govt. exempts GST/IGST (taxes paid in case of domestic production and import of raw
materials) in case of exports and this is called "exports are zero rated".
● The scheme is available for all kinds of exports from 1st Jan 2021.

Direct tax reforms

● Around 7.5 cr direct taxpayers
. Faceless assessment: randomly picked by computer, no face to face grilling, only through electronic mode
of communication.
○ Improve transparency, efficiency and governance, improves quality of assessment and monitoring.
. Faceless appeal:
○ Appeals to be randomly allotted to any officer in the country
○ The identification of the officers deciding appeal will remain unknown
○ The tax payer will not be required to visit the income tax office or the officer
○ The appellate decision will be team-based and reviewed
● Income Tax Act 1961 has been amended to introduce faceless assessment & faceless appeal.
. Taxpayers’ charter: two way document for assessor and assessee

● provide fair, courteous, and reasonable treatment

● Treat taxpayer as honest
● To provide mechanism for appeal and review
● To provide complete and accurate information
● To provide timely decisions
● To collect the correct amount of tax
● To respect privacy of taxpayers
● To maintain confidentiality
● To hold its authorities accountable
● To enable representative of choice
● To provide mechanism to lodge complaint and provide a fair and just system
● To publish service standards and report periodically
● To reduce cost of compliance

Obligations of the taxpayer:

● To be honest, informed and compliant
● To keep accurate records
● To know what your representative does on your behalf
● To respond in time and to pay in time

Funds transfer from centre to states outside GST/UTs

. Finance commission grants: article 280: President is required to appoint a Finance Commission after every
five years (or such earlier time if President considers it necessary) which shall consist of a chairman and
four other members appointed by the President.

Finance Commission and Its Recommendations (2021-26)

The Finance Commission recommends
1. Vertical Devolution – Distribution of central tax revenue between the Centre and States.
2. Horizontal Devolution – Allocation of states’ share among them.
3. Grants-in-Aid – Principles for Centre’s financial assistance to states.
4. Augmentation of State Consolidated Funds – Support for Panchayats and Municipalities based on State
Finance Commission recommendations.
5. Other Matters – As referred by the President for sound financial management.

XV Finance Commission (2021-26) Recommendations

• Vertical Devolution: 41% of the divisible pool of central taxes allocated to 28 states as untied grants. UTs
do not receive this share.
• Divisible Pool: Excludes cost of collection, cess & surcharge, UT tax revenue, and National Calamity
Contingency Duty.

Horizontal Distribution Criteria

1. Income Distance – 45%
2. Population (2011 Census) – 15%
3. Demographic Performance – 12.5%
4. State Area – 15%
5. Forest & Ecology – 10%
6. Tax & Fiscal Effort – 2.5%

Grants in aid Article-275 (charged on consolidated fund of India) 5 types:

. Revenue deficit grants: FC recommends post devolution revenue deficit grants. But discourages
inadequate revenue efforts or excessive expenditure.
. Local body grants: FFC has recommend total of Rs. 4,36,361 crores for the five year period. Out of the
total grants earmarked for panchayati raj institutions, 60 per cent is earmarked for national priorities like
drinking water supply and rainwater harvesting and sanitation, while 40 per cent is untied and is to be
utilised at the discretion of the panchayat raj institutions for improving basic services.
○ Grants recommended to all 3 tiers of panchayats
○ the ratio of inter se distribution of the grants recommended for rural and urban local bodies
gradually moves from 67.5:32.5 to 65:35.
○ For the inter se distribution of grants among the States, the weightage is 90% on population and
10% on area.
. Disaster management grants: ratio of contribution by Union and States to the State-level allocations for
disaster management recommended by FFC is 75:25 (for NE states, 90:10)
○ Total states allocation for State disaster risk management fund (SDRMF) divided into State disaster
response fund (SDRF) gets 80% and state disaster mitigation fund (SDMF) gets 20%.
. Sector specific grants: performance-based incentives/grants linked with certain performance benchmarks.
(a) Sectoral Grants for Health
(b) School Education
(c) Higher Education
(d) Implementation of Agricultural Reforms (Performance based incentives covering policies,
investments, development initiatives and outcomes in the following four areas will be rewarded viz.
(i) land lease reforms (ii) sustainable and efficient water use in agriculture (iii) export promotion, (iv)
Contribution towards Aatma
Nirbhar Bharat in terms of oilseeds, pulses and wood and wood based products.)
(e) Maintenance of PMGSY roads
(f) Judiciary
(g) Statistics
 (h) Aspirational Districts and Blocks
(i) Power Sector: (A performance-based incentive has been developed for the power sector (and
there is no grant), but opens up additional borrowing window for States)
. State Specific Grants: tied grants and help overcome special needs and cost disabilities of States that
could not be covered under formula-based devolution (41%) and other sector specific grants.
recommended to all the 28 States and fall under six broad themes:
(a) social needs
(b) administrative governance and related infrastructure
(c) conservation and sustainable use of water, drainage and sanitation, (d) preserving culture and historical
monuments
(e) high-cost physical infrastructure
(f) tourism.

Defence and internal security:

In keeping terms of reference, FFC recommended Modernisation Fund for Defence and Internal Security by the
Union Government to bridge the gaps between the projected budgetary requirement and budget allocation for
capital expenditure on defence and internal security.

the fund will be utilised for the following three purposes:

● Capital investment for modernisation of defence services
● Capital investment for CAPFs and modernisation of state police forces
● A small component as welfare fund for our soldiers and para-military personnel

The fund shall have the standard notified rules for its administration, public reporting, and audit by the CAG.

Fund will have four specific sources of incremental funding:

● Transfers from the Consolidated Fund of India
● Disinvestment proceeds of DPSEs (Directorate of planning, statistics and evaluation)
● Proceeds from the monetisation of surplus defence land, including realisation of arrears of payment for
defence land used by State Governments and for public projects and cost recovered of encroached land
● Proceeds of receipts from defence land likely to be transferred to State Governments and for public
projects in future

Other Grants, Loans, and Transfers

States receive additional financial support through:
• Special Assistance Grants
• Additional Central Assistance (Grants & Loans)
• National Disaster Response Fund (NDRF) Assistance

Central Sector & Centrally Sponsored Schemes:

The Public Finance (Central) Division (Ministry of Finance) and the Budget Division (Department of Economic
Affairs) allocate funds for Central Sector Schemes (CSs) and Centrally Sponsored Schemes (CSSs).

Centrally Sponsored Schemes (CSSs)

• Funded jointly by Centre & States (ratios: 50:50, 70:30, 75:25, 90:10).
• Implemented by State Governments to encourage development in State List subjects.
• Since 2014-15, all CSS funds are routed through State Consolidated Funds (earlier, direct transfers to
state agencies were allowed).
CSS Categorization (NITI Aayog Recommendations)
1. Core Schemes – Essential for National Development Agenda (e.g., Pradhan Mantri Gram Sadak Yojana).
2. Core of the Core Schemes – Social protection & inclusion (e.g., MGNREGA).
3. Optional Schemes – States choose implementation; funds given as a lump sum by the Ministry of Finance.

Central Sector Schemes (CSs)

• 100% funded by the Centre and implemented by Central agencies on Union List subjects.
• Not part of State fund transfers.
• Examples: Namami Gange, Sagarmala, Pradhan Mantri Fasal Bima Yojana.