Nowhere in the world is a country''s budget as hyped up as in India. But then we Indians love a tamasha. Therefore, when the union budget is presented on February 28, be prepared for the media avalanche where mundane reporters ask mostly mundane people some very mundane questions.

So, in anticipation of being swamped with budget talk in the coming days, it will be in order to get a fix on what a budget is all about.

Every government needs money to spend for it''s various programmes and administration costs. The sources from which the money could be raised are the individuals, businessmen and companies. Thus the budget is a statement made to parliament revealing how the government proposes to raise resources and the manner in which they will be spent.

It is only after this statement — known as the Finance Bill — is passed that the government has the right to raise resources by way of taxes. The hitch here is that on budget day, the finance minister (FM) says that he will raise say, Rs1,50,000 crore in the next fiscal year and spend say, Rs1,30,000 crore in that year.

That sounds very good but, more often than not, governments end up raising R1,30,000 crore and spending Rs1,70,000 crore. This is what is called the fiscal / budgetary deficit, when spending outstrips revenues.

To come out this situation, the gap between expenditure and income the government has two options. One is to print fresh currency notes worth Rs40,000 crore, the shortfall amount or borrow Rs40,000 crore. This again, is a catch-22 situation. If the government prints fresh currency notes, it will lead to situation of too much money chasing too few goods and hence, inflation. On the other hand, if the government resorts to borrowings, the interest costs shoot up.

The FM, therefore, apart from being a master in taxation and public finance, needs to be an avid tightrope walker.

Taxes are of two types, direct and indirect tax. These two types of taxes are differentiated by the concept of impact and incidence. Impact is the burden of tax, which falls on a taxable entity immediately, while incidence is the tax burden, which falls on a taxable entity later.

To cite an example, in the case of excise duty, the government taxes the company first, but the company later passes on the burden of this tax to the consumer. Excise duty is, therefore, an indirect tax.

In the case of income tax, the government taxes the salaried employee and the employee cannot pass on the burden of this tax to some one else. Thus since both the impact and incidence of the tax is on the employee, income tax is a direct tax.

This explains what causes the salaried class anxiety-related stress about income tax in the weeks leading up to every annual budget.

This also explains why the FM needs to be an accomplished tightrope walker. If he raises the income tax rate, he will increase his revenues. However, the salaried class will have less money in its pocket and, consequently, less to spend. Less consumption will lead to the revenues from sales tax falling. If the FM lowers the income tax rate then worries of lower tax collection will continue to haunt him.

The FM, therefore, needs to follow a progressive approach. There are four canons of taxation, one of which is progression. This means that taxation should be fair and equitable. Here, a person who earns less pays less tax compared to the person who earns more - a fair deal and both segments of the population don''t mind paying up. This also helps in increasing the government''s coffers.

The second canon of taxation is that its effect should be as little as possible on production. If tax on companies and other indirect taxes are reduced, production will see more investment coming in which means more jobs. More jobs mean more purchasing power, more sales and higher indirect tax revenues.

The next canon is that tax should be certain. Try and fill any tax form or return and you know why this canon is important. The more complex the rules of taxation are, the more it can be subverted and evaded. The well-heeled can, under a complex tax regime, take advantage of various loopholes, leaving the revenue collectors exasperated.

Lastly and most importantly, tax should be easy to collect and administer.

These principles of taxation were first enunciated by noted economist, Adam Smith, in 1776 and have remained unchanged over the last 200 years. Governments, which have abided by these principles, have not only generated adequate revenues, but have fostered just and prosperous societies.

The FM should know. After all, he is a top class tax lawyer and he must have read Adam Smith.