Study the table about a country’s budget.
| Year | State of the economy | Tax rates and spending programmes | Fiscal deficit (per cent of GDP) |
|---|---|---|---|
| Year 1 | Boom | No change | 3.0 |
| Year 2 | Recession | No change | 4.5 |
Which of the following best explains the rise in the fiscal deficit in Year 2?
Answer & explanation
Correct answer: option 4
The correct answer is Option (4) → In a recession, firms and households earn less and so pay lower taxes
Tax rates and spending did not change, yet the deficit rose. In a recession GDP falls, people earn less and pay lower taxes, so tax revenue falls and the deficit grows.
So a larger deficit does not always mean a more expansionary fiscal policy. Tax revenues fall in a recession, they do not rise.
NCERT (2026-27): “Deficit Reduction: … We must note that larger deficits do not always signify a more expansionary fiscal policy. The same fiscal measures can give rise to a large or small deficit, depending on the state of the economy. For example, if an economy experiences a recession and GDP falls, tax revenues fall because firms and households pay lower taxes when they earn less. This means that the deficit increases in a recession and falls in a boom, even with no change in fiscal policy.” |