Impact of Government Spending on the Economy

19 June 2023
5 mins read
by Angel One
The government collects taxes from us, which it spends on various developmental and social welfare programs. Let’s understand how government spending has an impact on the Indian economy.
Impact of Government Spending on the Economy

The government plays a vital role in stimulating the economy, influencing both the supply and demand sides. Understanding the role of the government is crucial for policymakers, investors, and citizens alike, as it helps evaluate the effectiveness of public policies and shape strategies for sustainable economic development in India. In this article, we will examine the effects of government spending on the country’s economy and how it might impact your everyday life. 

The Role of The Government In Boosting the Economy 

Government plays a vital role in shaping the economic landscape of a country. One important role that the government plays is to keep the economy functioning by boosting economic growth through spending. Through its activities, the government stimulates economic activity, promotes job creation, enhances public services, and addresses socioeconomic inequalities.

Government’s Sources of Income

The government needs money to supply goods and services to the sectors not covered by the private sector such as defence, and merit goods such as hospitals, schools etc. The Indian government raises funds through various sources. The primary sources of government revenue in India include taxation, borrowings, and non-tax revenue.

  1. Taxation is often the primary source of revenue for the government. It includes direct taxes such as income tax, corporate tax, and wealth tax, and indirect taxes like Goods and Services Tax (GST), excise duty, customs duty, and sales tax. These taxes are levied on individuals, businesses, and the import and export of goods.
  2. Borrowing is another source through which the government raises money from domestic and international entities. Domestic borrowing avenues include issuing government bonds, treasury bills, and other securities, while international borrowing involves obtaining loans from international financial institutions or issuing sovereign bonds.
  3. The government’s non-tax income sources include dividends and profits from state-owned enterprises, revenue from licensing and permits, fees for public services, and proceeds from asset sales.

Government’s Expenditures 

The government’s expenses have two broad categories – revenue expenditure and capital expenditure. Revenue expenditure refers to the expenses made towards paying salaries to government employees, ministers, etc. Capital expenditure includes the formation of assets in the economy such as building infrastructures, schools, hospitals etc. A significant amount is spent on providing services such as education, healthcare, defence, infrastructure, social welfare etc. 

Mentioned below are the key areas where government spending fosters economic growth. 

  1. Infrastructure Development: The government allocates a significant portion of its budget to build roads, railways, airports, ports, and power generation units. These investments help enhance connectivity, facilitate trade, and improve the overall quality of transportation and logistics.
  2. Education and Skill Development: A sizable portion of the fund is spent on providing education and skill development facilities for sustainable growth. The money is directed towards promoting research and innovation and implementing skill development programs to equip the workforce with the necessary skills for the evolving job market.
  3. Healthcare and Public Health: The government aims to provide affordable healthcare for all, which includes building and upgrading hospitals, medical research facilities, and public health infrastructure.
  4. Agriculture and Rural Development: The government spends on agricultural research, irrigation projects, rural infrastructure, and subsidies to support farmers.
  5. Social Welfare and Poverty Alleviation: The government allocates funds for social welfare programs like pensions, housing schemes, food subsidies, and employment generation initiatives to alleviate poverty and uplift marginalised sections of society.
  6. Defence and Security: Defence spending is a major part of the government’s spending, directed to the modernisation of the armed forces, defence research programs, and border infrastructure development.
  7. Environmental Conservation and Renewable Energy: Promoting renewable energy sources, and implementing policies to address climate change and reduce pollution is a major agenda of the government, and it allocates a significant amount towards it.

What Is Deficit?

Government spending is not always restricted to cost-benefit analysis. Sometimes the government will spend more to create economic stimulus. 

When expenses exceed income, it creates a deficit. The deficit is the aggregate of the revenue account deficit and the capital account deficit. The government then finances its expenses through borrowing. This concept is called deficit financing.

It helps create a multiplier effect in the economy. For instance, if an increase in government spending creates new employment opportunities, then more people will have the income to spend. It will further increase aggregate demand. In this situation, the spare capacity in the economy gets utilised and may eventually increase the country’s GDP.   

Impact of Government Spending on the Economy 

As mentioned, government spending aims to create multiplier effects in the economy. A fiscal multiplier will increase economic output in some ways, which will result in growth and an increase in GDP. The theory proposes that initial government spending flows through the economy and is re-spent multiple times, leading to overall economic growth.  


The government’s spending has an extensive impact on the Indian economy. It stimulates the economy through investments in infrastructure, education, and healthcare. Government spending influences employment rates, consumer spending, and business activity, which shape the overall economic landscape of a country.