Deficit Reduction: Government deficit can be reduced by an increase in taxes or reduction in expenditure. In India, government has been trying to increase tax revenue with greater reliance on direct taxes (indirect taxes are regressive in nature - they impact all income groups equally). There has also been an attempt to raise receipts through the sale of shares in PSUs. However, the major thrust has been towards reduction in government expenditure. This could be achieved through making government activities more efficient through better planning of programmes and better administration. A recent study by the Planning Commission has estimated that to transfer Rel to the poor, government spends ₹ 3.65 in the form of food subsidy, showing that cash transfers would lead to increase in welfare. The other way is to change the scope of the government by withdrawing from some of the areas where it operated before. Cutting back government programmes in vital areas like agriculture, education, health, poverty alleviation, etc. would adversely affect the economy. Governments in many countries run huge deficits forcing them to eventually put in place self-imposed constraints of not increasing expenditure over pre-determined level. These will have to be examined keeping in view the above factors. 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.

An economy is experiencing the recession and the government has presented a deficit Budget. GDP and Tax revenue falls, as household and firm have to ______________.

Pay lower tax

During a recession, households and firms typically experience a decline in income and economic activity. As a result, their ability to generate taxable income decreases, leading to lower tax revenues for the government. In response to the economic downturn, governments may implement measures such as tax cuts to stimulate economic activity and support households and businesses. Therefore, Option 2, "Pay lower tax," aligns with the economic dynamics described in the given scenario.