With the Union Budget coming out on February 29, it is an opportune time to reflect on the state of India's finances. This is the first in a three part series that will talk about India's financial situation. This post explains how the Indian government gets gathers money, the subsequent post will explain how it spends it, and the last post will outline the challenges that the country is currently facing (and how it might fall into a debt trap if it does not mend its ways).

What exactly is the budget about?

Put simply, the budget is the government’s spending and earning plan for the financial year. The government estimates how much revenue it will make in the coming financial year, and also allocates its expenditure into various departments and initiatives. If the government plans to spend more than it earns (which has been the case over the past few years), it also starts the process to raise the required money from external sources (usually through bonds).


As India has grown, so has its budget.


This does not mean that the government has started spending profligately, or is beginning to extort more money from its citizens. The country has grown significantly over this period, and it’s nominal GDP (i.e., GDP that does not take inflation into account), has increased by almost 6 times. As a proportion of GDP, India’s expenditure and receipts have remained roughly stable.

How does the government get all this money?

As you saw in the charts above, the government spends significantly more than what it earns. It makes up for this gap by borrowing money from its citizens, domestic companies, or foreign investors. This gap between earnings and spending is called the fiscal deficit.

Running too high a fiscal deficit is dangerous, especially for a country like India which has to pay an extremely high interest rate of close to 8% for its borrowings. For comparison, Germany only pays a 0.3% interest rates on its borrowings while China pays a 2.9% interest rate. We will come back to the issue of a fiscal deficit in the third post of this series.

India’s non-borrowed revenues largely come from taxes. A plurality of people that I informally surveyed seemed to believe that Income taxes are the largest source of taxes in India, but this is a misconception. Corporate Taxes are currently the primary drivers of revenue for India.


15 years ago, however, India’s tax base looked very different. The country got more than 60% of its revenues from excise duties and customs (additional tariffs that the government levied on commodities like petrol, alcohol and cigarettes as well as goods like foreign-made cars). Since then, the country’s tax base has changed dramatically.

The changing face of India's tax base, and the rise and rise of service tax

The biggest change of the past 15 years has been the meteoric rise of service tax in India. With the proposed GST Bill, this amount is likely to increase further.



There has been an increase in Corporate Taxes as a percentage of overall taxes, as well as a decline in excise duties and custom tariffs. Given that India started liberalizing its economy and started attracting more investment, from the early 2000’s, this is somewhat expected. You would also service taxes have increased significantly in the last 15 years. In 2000-01, they only made up 1.8% of the overall tax base, while they currently make up 14.5%. The service tax is expected to increase further with the coming budget, which might yield in them providing an increased proportion to the exchequer.

What will an increased service tax mean for you?

While the GST is expected to potentially reduce costs for producers - especially for the production of goods that have a complex supply chain - a simple increase in service tax might have an adverse effect on the middle class. Expect a trip to the cafe or the the movie theater to become more expensive in the coming months.

What about other taxes? Are we in for a spate of continual tax increases?

Probably not. The government announced last year that it aims to lower the corporate tax rate from 30% to 25%, while also removing certains exemptions to simplify the tax process. There is little expectation of a drop in income taxes, however, and the government has cited a lack of ‘fiscal space’ as the reason. Effective excise duty on petrol has already risen in the country as the government has looked to take advantage of falling oil prices.


One of the key problems in India is the high rate of tax avoidance. Currently, only 3.7% of households in the country pay tax, and small business are widely perceived to underpay taxes significantly. The government has announced multiple initiatives to curb tax avoidance.


All things considered, you are unlikely to pay more taxes on your income or your business in the coming years, but might have to pay more while eating out or going for a movie. At the same time, if you have been undeclaring your income and avoiding taxes, you might have to start paying significantly more. As we will see in part 3, it is imperative that the country starts to rake in more in direct taxes.


And that, in summary, is an overview of how the government of India earns its revenues. I hope you found this useful! If you have further questions, or would like to give feedback about this post, do drop me a line at [email protected]!


Part 2 : How does the Indian government spend its money?

Part 3 (coming soon) : Is there a looming debt trap? What India needs to get right very soon.