Fiscal policy, budget and taxation: previous-year questions
38 real UPSC Prelims questions (2011–2026) with the official answer and a clear explanation. 11 of them came in the last five papers.
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Which one of the following best describes the 'Crowding Out Effect' in the context of fiscal policy ?
Answer (b) & explanation
Crowding out means government borrowing raises interest rates and cuts private investment (b). When the government borrows heavily, it competes with companies for the same pool of savings. Interest rates rise, and some private projects no longer pay, so private investment is pushed out. Option (a) is wrong: it describes the opposite, "crowding in". Option (c) is wrong: higher taxes usually reduce, not raise, private spending. Option (d) is wrong: government spending does affect aggregate demand.
Notice the policy link: this is why high fiscal deficits worry the RBI and investors. India's FRBM Act (2003) set limits on deficits. The Centre aims to cut its fiscal deficit below 4.5% of GDP and then shift to a debt-to-GDP target.
Answer as per the official UPSC answer key.
With reference to the Government of India, consider the following information :
| | Organization | Some of its functions | It works under
| I. | Directorate of Enforcement | Enforcement of the Fugitive Economic Offenders Act, 2018 | Internal Security Division-I, Ministry of Home Affairs
| II. | Directorate of Revenue Intelligence | Enforces the Provisions of the Customs Act, 1962 | Department of Revenue, Ministry of Finance
| III. | Directorate General of Systems and Data Management | Carrying out big data analytics to assist tax officers for better policy and nabbing tax evaders | Department of Revenue, Ministry of Finance
In how many of the above rows is the information correctly matched?
Answer (a) & explanation
Only one row is correctly matched (a). Row II is right: the Directorate of Revenue Intelligence (DRI) is the main anti-smuggling body, enforcing the Customs Act, 1962, under the Department of Revenue. Row I is wrong: the Enforcement Directorate does enforce the Fugitive Economic Offenders Act, 2018, along with PMLA and FEMA, but it works under the Department of Revenue, not the Home Ministry. Row III is wrong: DG Systems runs the IT systems of Customs and GST; big-data analytics to catch evaders is the job of a separate body, DGARM, under the CBIC.
Notice the trick: UPSC often gets the function right but the parent ministry wrong. Read every column. The ED was in the news for big money-laundering cases.
row III has the right parent department. The function belongs to a sister directorate with a similar name.
Answer as per the official UPSC answer key.
Consider the following statements :
Statement I :
In India, income from allied agricultural activities like poultry farming and wool rearing in rural areas is exempted from any tax.
Statement II :
In India, rural agricultural land is not considered a capital asset under the provisions of the Income-tax Act, 1961.
Which one of the following is correct in respect of the above statements?
Answer (d) & explanation
Statement I is wrong, Statement II is right (d). Statement II is right: rural agricultural land is excluded from the meaning of "capital asset" under Section 2(14) of the Income-tax Act, so its sale attracts no capital gains tax. Statement I is wrong: only agricultural income, from land used for cultivation as defined in Section 2(1A), is exempt. Poultry, dairy and wool rearing do not use land for cultivation, so their income is taxable like business income. So options (a), (b) and (c) fail.
Notice that the power to tax agricultural income lies with the States (State List, Entry 46), not the Centre. The new Income-tax Act, 2025, replacing the 1961 Act from April 2026, keeps this exemption.
"allied agricultural activities" sounds like agriculture. For tax law, only income from the land itself counts.
Answer as per the official UPSC answer key.
Consider the following statements :
- I. Capital receipts create a liability or cause a reduction in the assets of the Government.
- II. Borrowings and disinvestment are capital receipts.
- III. Interest received on loans creates a liability of the Government.
Which of the statements given above are correct?
Answer (a) & explanation
Statements I and II are correct (a). Statement I is right: a capital receipt either creates a liability, such as borrowing, or reduces an asset, such as selling shares. Statement II is right: borrowings and disinvestment are capital receipts. Statement III is wrong: interest received on loans is a revenue receipt, the government's own income, and creates no liability. Taxes and dividends are revenue receipts too. So options (b), (c) and (d) fail.
Notice the matching spending terms: capital expenditure creates assets, like roads and dams, while revenue expenditure, like salaries and interest paid, does not. The fiscal deficit equals total spending minus revenue receipts and non-debt capital receipts, basically what the government borrows.
interest "on loans" makes one think of debt. The government is receiving the interest, so it is income.
Answer as per the official UPSC answer key.
Suppose the revenue expenditure is ₹ 80,000 crores and the revenue receipts of the Government are ₹ 60,000 crores. The Government budget also shows borrowings of ₹ 10,000 crores and interest payments of ₹ 6,000 crores. Which of the following statements are correct?
- I. Revenue deficit is ₹ 20,000 crores.
- II. Fiscal deficit is ₹ 10,000 crores.
- III. Primary deficit is ₹ 4,000 crores.
Select the correct answer using the code given below.
Answer (d) & explanation
All three statements are correct (d). Statement I is right: revenue deficit = revenue expenditure − revenue receipts = 80,000 − 60,000 = ₹20,000 crore. Statement II is right: fiscal deficit = total borrowings = ₹10,000 crore. Statement III is right: primary deficit = fiscal deficit − interest payments = 10,000 − 6,000 = ₹4,000 crore. So options (a), (b) and (c) fail.
Notice the oddity: a fiscal deficit smaller than the revenue deficit simply means non-debt capital receipts, such as disinvestment, covered part of the gap. Primary deficit shows borrowing for needs other than past interest. India's fiscal deficit target is 4.4% of GDP for 2025-26, and the government now aims to cut its debt-to-GDP ratio.
Answer as per the official UPSC answer key.
A country's fiscal deficit stands at ₹50,000 crores. It is receiving ₹10,000 crores through non-debt creating capital receipts. The country's interest liabilities are ₹1,500 crores. What is the gross primary deficit?
Answer (a) & explanation
The gross primary deficit is ₹48,500 crore (a). Gross primary deficit = gross fiscal deficit − interest payments = 50,000 − 1,500 = ₹48,500 crore. Non-debt capital receipts are already counted inside the fiscal deficit, so they play no further part. That figure is there only to tempt you into adding or subtracting it. Option (b), ₹51,500 crore, wrongly adds interest. Option (c), ₹58,500 crore, wrongly brings in the non-debt receipts. Option (d) fails because (a) is right.
Notice what each deficit tells you: fiscal deficit shows total borrowing need; primary deficit removes the burden of past debt; revenue deficit shows borrowing to meet day-to-day spending. A primary surplus means today's spending is covered without new debt, apart from interest.
the ₹10,000 crore figure. Subtract it and you get a wrong answer; add it and you land on (c).
Answer as per the official UPSC answer key.
Which of the following statements with regard to recommendations of the 15th Finance Commission of India are correct?
- I. It has recommended grants of ₹4,800 crores from the year 2022-23 to the year 2025-26 for incentivizing States to enhance educational outcomes.
- II. 45% of the net proceeds of Union taxes are to be shared with States.
- III. ₹45,000 crores are to be kept as performance-based incentive for all States for carrying out agricultural reforms.
- IV. It reintroduced tax effort criteria to reward fiscal performance.
Select the correct answer using the code given below.
Answer (c) & explanation
Statements I, III and IV are correct (c). The 15th Finance Commission, chaired by N.K. Singh, made these recommendations. Statement I is right: it gave ₹4,800 crore of grants for better educational outcomes. Statement III is right: it kept ₹45,000 crore as an incentive for agricultural reforms. Statement IV is right: it brought back tax effort, with a 2.5% weight, in the devolution formula. Statement II is wrong: it fixed the States' share at 41% for 2021-26, not 45%; the 14th FC had given 42%.
Notice the drop to 41%: it reflected the move of Jammu and Kashmir to a Union Territory. The 16th Finance Commission, under Arvind Panagariya, kept the share at 41% for 2026-31.
the number 45 appears twice. It is right for the agriculture incentive (₹45,000 crore), wrong for the tax share (41%).
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Answer as per the official UPSC answer key.
Consider the following :
- 1. Demographic performance
- 2. Forest and ecology
- 3. Governance reforms
- 4. Stable government
- 5. Tax and fiscal efforts
For the horizontal tax devolution, the Fifteenth Finance Commission used how many of the above as criteria other than population, area and income distance?
Answer (b) & explanation
Three of the five were criteria (b). The 15th Finance Commission, chaired by N.K. Singh, shared central taxes among States using: income distance 45%, population (2011 Census) 15%, area 15%, forest and ecology 10%, demographic performance 12.5% and tax and fiscal effort 2.5%. So items 1, 2 and 5 count. Item 3 is wrong: governance reforms was not a criterion. Item 4 is wrong: stable government was never used. The States' total share was 41% of the divisible pool.
Notice that demographic performance rewards States that brought down fertility, mostly southern States, which feared losing out by the use of the 2011 Census. The 16th Finance Commission, chaired by Arvind Panagariya, covers 2026–31.
Answer as per the official UPSC answer key.
Which one of the following situations best reflects "Indirect Transfers" often talked about in media recently with reference to India ?
Answer (d) & explanation
Indirect transfer means shares abroad deriving value from Indian assets (d). An indirect transfer happens when shares of a foreign company change hands abroad, but those shares get their substantial value from assets located in India. India claims the right to tax the gain. Options (a) and (b) describe ordinary cross-border investment and taxing of profits. Option (c) describes a direct sale of foreign assets by an Indian firm.
Notice the Vodafone case: its 2007 purchase of Hutchison's Indian business through a Cayman Islands company led to a tax demand. The Supreme Court ruled for Vodafone in 2012, and the government then passed a retrospective tax amendment. The Taxation Laws (Amendment) Act, 2021 withdrew that retrospective tax, ending the Cairn dispute as well.
Answer as per the official UPSC answer key.
With reference to the expenditure made by an organisation or a company, which of the following statements is/are correct ?
- 1. Acquiring new technology is capital expenditure.
- 2. Debt financing is considered capital expenditure, while equity financing is considered revenue expenditure.
Select the correct answer using the code given below :
Answer (a) & explanation
Only statement 1 is correct (a). Statement 1 is right: capital expenditure buys assets that last for years, such as machines, buildings and new technology. Revenue expenditure meets day-to-day costs, such as wages, rent and repairs. Statement 2 is wrong: debt and equity are not expenditure at all; they are sources of funds. A firm raises money by borrowing (debt) or selling shares (equity), and then spends it as capital or revenue expenditure. The statement mixes up how money is raised with how it is spent.
Notice the same split in the Union Budget: the revenue account and the capital account. Interest payments are the largest item of the Centre's revenue expenditure; capital spending builds roads, railways and defence assets.
Answer as per the official UPSC answer key.
With reference to the Indian economy, consider the following statements :
- 1. A share of the household financial savings goes towards government borrowings.
- 2. Dated securities issued at market-related rates in auctions form a large component of internal debt.
Which of the above statements is/are correct ?
Answer (c) & explanation
Both statements are correct (c). Statement 1 is right: household savings kept in banks, insurance, provident funds and small savings schemes are partly lent to the government, because these institutions buy G-Secs, and small savings funds go into the National Small Savings Fund. Statement 2 is right: dated securities, long-term bonds sold through RBI auctions at market rates, are the largest part of the Centre's internal debt, far ahead of Treasury Bills and other items.
Notice the difference: internal debt is owed within India; external debt is owed abroad. India's public debt is mostly internal and in rupees, which lowers risk. The RBI manages government borrowing as its debt manager.
Answer as per the official UPSC answer key.
Which among the following steps is most likely to be taken at the time of an economic recession?
Answer (b) & explanation
Raising spending on public projects is the likely step (b). In a recession, demand is weak, factories cut output and jobs are lost. The government tries to add demand through expansionary fiscal policy. Spending more on public works such as roads, housing and irrigation creates jobs and incomes, and those incomes are spent again (the multiplier effect). Option (a) is wrong: it pairs a tax cut (expansionary) with a rate hike (contractionary). Option (c) is wrong: it pairs a tax hike (contractionary) with a rate cut (expansionary). Option (d) is plainly contractionary and would deepen the slump.
Notice Keynes, who argued for public spending in the Great Depression. India raised capital expenditure sharply after COVID to revive growth.
options (a) and (c) each contain one correct half. In a recession, both tax and interest should move down.
Answer as per the official UPSC answer key.
Which one of the following effects of creation of black money in India has been the main cause of worry to the Government of India?
Answer (d) & explanation
The main worry is loss of tax revenue (d). Black money is income hidden from the tax authorities, whether earned legally or illegally. All four options describe real effects, but the government's main concern is the loss of revenue from tax evasion, which shrinks its ability to spend on health, education and infrastructure, and forces honest taxpayers to carry more of the load. Options (a) and (b) describe where black money is parked, such as real estate, gold and jewellery. Option (c) describes its political misuse.
Notice the White Paper on Black Money (2012), the Black Money (Undisclosed Foreign Income and Assets) Act, 2015, and demonetisation of ₹500 and ₹1,000 notes in November 2016.
Answer as per the official UPSC answer key.
With reference to India's decision to levy an equalization tax of 6% on online advertisement services offered by non-resident entities, which of the following statements is/are correct ?
- 1. It is introduced as a part of the Income Tax Act.
- 2. Non-resident entities that offer advertisement services in India can claim a tax credit in their home country under the "Double Taxation Avoidance Agreements".
Select the correct answer using the code given below :
Answer (d) & explanation
Neither statement is correct (d). Statement 1 is wrong because the 6% equalisation levy (2016) was introduced through a separate chapter of the Finance Act, 2016, not the Income Tax Act. The Indian business paying a foreign firm like Google or Facebook for online ads deducted it. Statement 2 is wrong because the levy is not an income tax, so the foreign firm cannot claim credit for it under a DTAA in its home country. This is exactly why it was designed outside the Income Tax Act.
A 2% levy on e-commerce was added in 2020 and dropped in 2024. The 6% levy on ads ended in April 2025. Notice the reason: India is moving towards the OECD Two-Pillar global tax deal and is also under US trade pressure.
statement 2 sounds fair. Tax treaties cover taxes on income; the levy was kept outside the Income Tax Act for exactly this reason.
Answer as per the official UPSC answer key.
Consider the following statements :
- 1. The Fiscal Responsibility and Budget Management (FRBM) Review Committee Report has recommended a debt to GDP ratio of 60% for the general (combined) government by 2023, comprising 40% for the Central Government and 20% for the State Governments.
- 2. The Central Government has domestic liabilities of 21% of GDP as compared to that of 49% of GDP of the State Governments.
- 3. As per the Constitution of India, it is mandatory for a State to take the Central Government's consent for raising any loan if the former owes any outstanding liabilities to the latter.
Which of the statements given above is/are correct ?
Answer (c) & explanation
Statements 1 and 3 are correct (c). The N. K. Singh FRBM Review Committee (2017) suggested a general government debt limit of 60% of GDP by 2023: 40% for the Centre and 20% for the States (1). It also proposed a fiscal council. Statement 2 is wrong because it reverses the numbers. The Centre's liabilities are far larger, about 49% of GDP, against about 21% for the States. Statement 3 is right because, under Article 293(3), a State that owes money to the Centre needs the Centre's consent to borrow.
Kerala challenged the Centre's borrowing limits in the Supreme Court in 2024, and the case went to a Constitution Bench. Notice that the Centre now aims for a debt-to-GDP ratio of about 50% by 2031.
statement 2 has the right numbers in the wrong places.
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Answer as per the official UPSC answer key.
If a commodity is provided free to the public by the Government, then
Answer (c) & explanation
The opportunity cost moves from the users to the taxpaying public (c). Nothing is truly free. The resources used to make a "free" good could have produced something else, and that lost alternative is its opportunity cost. When the government gives something away free, the users do not pay, but taxpayers do, because the government's money comes from taxes. The cost is not zero (a), and it is not ignored (b). Option (d) is wrong because the government is only the channel, spending the public's money.
This is the logic behind the "freebies" debate. The Supreme Court and the Election Commission have looked at the line between welfare and freebies. Notice the related idea of merit goods, such as education and health, where free supply is justified.
option (d) says the government bears the cost. The government spends; taxpayers finally pay.
Answer as per the official UPSC answer key.
Consider the following items :
- 1. Cereal grains hulled
- 2. Chicken eggs cooked
- 3. Fish processed and canned
- 4. Newspapers containing advertising material
Which of the above items is/are exempted under GST (Goods and Services Tax) ?
Answer (c) & explanation
Items 1, 2 and 4 are exempt (c). Under GST, basic, unprocessed and unbranded food is exempt to keep everyday essentials cheap. This covers hulled cereal grains (1) and eggs (2), including the cooked eggs listed in the exemption. Printed newspapers (4) are exempt even if they carry advertisements, although the ad services themselves are taxed. Processed and canned fish (3) is a value-added, packaged product, so it is taxed, which is why (d) is wrong.
GST came into force on 1 July 2017 after the 101st Amendment. Notice GST 2.0 (September 2025), which simplified rates into mainly two slabs of 5% and 18%, plus a 40% rate for luxury and sin goods.
eggs "cooked" sound processed. The GST exemption entry covers birds' eggs "in shell, fresh, preserved or cooked".
Answer as per the official UPSC answer key.
With reference to the 'Prohibition of Benami Property Transactions Act, 1988 (PBPT Act)', consider the following statements :
- 1. A property transaction is not treated as a benami transaction if the owner of the property is not aware of the transaction.
- 2. Properties held benami are liable for confiscation by the Government.
- 3. The Act provides for three authorities for investigations but does not provide for any appellate mechanism.
Which of the statements given above is/are correct ?
Answer (b) & explanation
Only statement 2 is correct (b). The 2016 amendment to the Benami Act made benami property liable to confiscation by the government (2), along with jail of up to seven years and fines. Statement 1 is wrong because a transaction where the owner denies knowing about it, or which is held in a fictitious name, is specifically counted as benami. Statement 3 is wrong because the Act sets up four authorities: the Initiating Officer, Approving Authority, Administrator and Adjudicating Authority. It also provides an Appellate Tribunal, with further appeal to the High Court.
In Ganpati Dealcom (2022), the Supreme Court said the 2016 changes cannot apply to past transactions and struck down the 1988 penalty clause. Notice the link with India's fight against black money, alongside demonetisation and the Black Money Act, 2015.
Answer as per the official UPSC answer key.
What is/are the most likely advantages of implementing 'Goods and Services Tax (GST)'?
- 1. It will replace multiple taxes collected by multiple authorities and will thus create a single market in India.
- 2. It will drastically reduce the 'Current Account Deficit' of India and will enable it to increase its foreign exchange reserves.
- 3. It will enormously increase the growth and size of economy of India and will enable it to overtake China in the near future.
Select the correct answer using the code given below :
Answer (a) & explanation
Only statement 1 is correct (a). GST, launched on 1 July 2017 under the 101st Amendment, replaced central excise, service tax, State VAT, entry tax, octroi and other levies with one tax, collected at each stage on the value added. This created a single national market (1). Statements 2 and 3 are exaggerated. GST may help growth a little through efficiency, but "drastically" cutting the current account deficit or helping India overtake China are not results any tax reform can promise.
The GST Council (Article 279A) is chaired by the Union Finance Minister. In September 2025, the "GST 2.0" reform cut the rates to two main slabs, 5% and 18%, plus a 40% rate on sin and luxury goods. Notice the key Supreme Court case: in Mohit Minerals (2022), it said the Council's recommendations are not binding.
words like "drastically", "enormously" and "overtake China". Exaggerated claims are rarely the right answer.
Answer as per the official UPSC answer key.
Consider the following statements :
- 1. Tax revenue as a percent of GDP of India has steadily increased in the last decade.
- 2. Fiscal deficit as a percent of GDP of India has steadily increased in the last decade.
Which of the statements given above is/are correct ?
Answer (d) & explanation
Neither statement is correct (d). Between about 2007 and 2017, India's tax-to-GDP ratio fell after the 2008 global crisis, when stimulus tax cuts were made, and recovered only later, so it did not rise steadily (1). The fiscal deficit jumped from about 2.5% of GDP in 2007-08 to about 6.5% in 2009-10. It then came down to about 3.5% by 2016-17 under the FRBM path (2). Neither figure moved "steadily" in one direction.
The word "steadily" is the trap here. Notice the current numbers: the fiscal deficit target was 4.4% for 2025-26. From 2026-27, the government moved to a debt-to-GDP anchor of about 50% by 2031, under the revised FRBM approach.
"steadily" in both statements. In a decade with a world crisis, few numbers move in a straight line.
Answer as per the official UPSC answer key.