Dalton’s observation is the standard opening and it is genuinely the organising idea: a private individual adjusts expenditure to income, while a public authority decides what it must do and then raises the revenue for it. Everything else follows — compulsory taxation, budgeting a year ahead, and borrowing on a scale no household could.
Public finance covers four areas: public revenue, public expenditure, public debt and financial administration, the last being the budget itself.
| Source | Nature | Examples |
|---|---|---|
| Tax revenue | Compulsory, no direct quid pro quo | Income tax, corporation tax, customs, excise, goods and services tax |
| Non-tax revenue | Received for something given | Interest receipts, dividends and profits from public enterprises, fees, fines, user charges |
| Capital receipts | Create a liability or reduce an asset | Borrowing, recovery of loans, disinvestment |
Direct against indirect is the distinction to have exact: the burden of a direct tax cannot be shifted — the person assessed bears it. An indirect tax is levied on one person and its burden passed to another, usually the consumer. Unit 1 computed exactly how far it is passed, and the answer was: it depends on the elasticities, not on the law.
Progressive, proportional, regressive describe how the rate behaves as income rises — rising, constant, falling. Indirect taxes are typically regressive in effect, because a poorer household spends a larger share of its income on taxed goods.
Later writers added productivity (adequate yield), elasticity (yield rises with income without new legislation), simplicity, diversity (no over-reliance on one tax) and flexibility.
Impact, shifting and incidence are three different things and the distinction is examined constantly: the impact is on whoever pays it first, the shifting is the process of passing it on, and the incidence is where it finally rests. For an indirect tax the impact is on the seller, the incidence usually on the buyer.
A budget separates flows that recur from flows that change the balance sheet:
| Revenue account | Capital account | |
|---|---|---|
| Receipts | Tax and non-tax revenue | Borrowing, recovery of loans, disinvestment |
| Expenditure | Salaries, interest, subsidies, pensions — consumed in the year | Asset creation, loans given — lasting beyond the year |
The split is the whole basis of the deficits. Borrowing to build a road is not the same as borrowing to pay salaries: the first leaves an asset behind and the second does not, and the deficit measures below are designed to make exactly that visible.
Given an illustrative budget:
| Item | Amount |
|---|---|
| Revenue receipts | 9,200 |
| Capital receipts other than borrowing | 600 |
| Revenue expenditure | 10,400 |
| of which: interest payments | 1,900 |
| of which: grants for creation of capital assets | 400 |
| Capital expenditure | 2,300 |
Revenue deficit — the shortfall on the recurring account alone:
\[ \text{RD} = \text{Revenue expenditure} - \text{Revenue receipts} = 10400 - 9200 = 1,200 \]It means the government is borrowing to meet running costs. That is the figure to be uncomfortable about, because nothing is left behind for it.
Fiscal deficit — total expenditure less all receipts that are not borrowing. It is exactly how much the government must borrow:
\[ \text{FD} = (10400 + 2300) - (9200 + 600) = 12700 - 9800 = 2,900 \]Primary deficit — the fiscal deficit less interest payments, which are the cost of past borrowing:
\[ \text{PD} = 2900 - 1900 = 1,000 \]It isolates this year’s fresh imbalance. A primary deficit near zero with a large fiscal deficit says the problem is inherited debt, not current profligacy — a distinction that changes the policy answer entirely.
Effective revenue deficit — the revenue deficit less grants given for creating capital assets, since those do leave an asset behind even though they sit in the revenue account:
\[ \text{ERD} = 1200 - 400 = 800 \]Internal debt is owed to residents; repaying it redistributes within the economy. External debt is owed abroad; repaying it transfers resources out, and it must be serviced in foreign exchange, which links this topic to Unit 5.
Deficit financing in the Indian usage means meeting a deficit by borrowing from the central bank — in effect creating new money. Its effects:
Crowding out is the other objection: heavy government borrowing raises interest rates and displaces private investment. Whether it bites depends on whether the economy is near capacity — in a slump there is idle saving to absorb.
Inflation is a sustained rise in the general price level — not a one-off jump and not a rise in one price.
The two need opposite treatments, which is why diagnosis matters: squeezing demand when the cause is cost-push buys lower output without much lower inflation. Stagflation — inflation with stagnant output — is the case where that goes visibly wrong.
By speed: creeping, walking, running and hyperinflation. Deflation is a falling price level, disinflation a fall in the rate of inflation, and reflation a deliberate raising of demand out of a slump. Those three are routinely confused and are worth separating once, carefully.
Inflation is measured by the movement of a price index:
\[ \text{Inflation rate} = \frac{P_t - P_{t-1}}{P_{t-1}} \times 100 \]The index itself — wholesale or consumer, Laspeyres or Paasche, and the tests a good index must satisfy — is a statistics topic, and it is worked in full on this site: Index Numbers constructs them and tests them, and Index Numbers (Advanced) covers the consumer and wholesale price indices, base shifting and deflation.
Control divides the same way the causes do: monetary measures (raising the reserve ratios and the policy rate, open market sales — Unit 3), fiscal measures (cutting expenditure, raising taxes, reducing the deficit) and direct measures (price controls, rationing, imports to raise supply).
The parallel or black economy is income that is unreported, whether earned legally and concealed to evade tax, or earned illegally.
Causes: high tax rates that make evasion worth the risk, shortages that create premiums, controls and licensing that create rents, cash-heavy transactions, and weak enforcement.
Effects, and the statistical one is the point of including it here:
Remedies reverse the causes: moderate rates, fewer discretionary controls, wider use of banking and digital payment, and enforcement that raises the expected cost of evasion. Demonetisation is the drastic version, and its effectiveness turns on how much of the concealed wealth is actually held as cash rather than as property, gold or foreign assets.