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Yamini Bhaskar
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Public finance... - January 14th, 2009

Public Finance –


Public Sector – State Controlled

Private Sector – Laissez faire

Capitalist Economy – the main task of providing goods and services is assigned to the private sector in which individual economic units are motivated by economic rationality and guided by the market mechanism in their decision making.

Socialist Economy – is dominated by the State Sector and the economic activities and decisions are expected to be guided not by commercial profitability but by totality of objectives of the society.

Mixed Economy – Both the private sector as well as the state sector are assigned significant roles, depending on the goods and services.


Role of Government –
- to protect the society against internal disruption.
- to protect the society against any foreign aggression.
- To create and run social overheads or infrastructural facilities for reasons of their commercial non-viability.

Public Revenue –
- tax revenues like direct and indirect taxes.
- Non-tax revenues like dividends and profits from public sector undertakings, grants, fees, fines, interest etc.,
- Debts
- Printing of notes.

Difference between Public Finances and Private Finances –
- Private economic units has to live within its means, that is it has its limitation as to overspending. Public finances can resort to deficit financing.
- State can borrow internally as well as externally. Private borrowings have limitations.
- State can create legal tender currency.




- Private finance follows market principle or on the principle of economic rationality. Public finance follows budget principle based on common social objectives.
- Private finance has short term view, Public finance has long term view.
- In private finance, first income is ascertained and then the expenditure. In public finances, the expenditure is ascertained first and then the sources of revenue are determnined.


Principle of Maximum Social Advantage –

Public expenditure is subject to diminishing marginal social benefit and taxes are subject to increasing marginal social dis-utility or cost. As the State increases its taxation and expenditure activities, the social benefit from each additional rupee spent falls while the dissatisfaction from each additional rupee taxed increases. This way a stage is reached when the rising dissatisfaction becomes equal to falling marginal benefit of expenditure. At this stage the State should stop expanding its activities.

LIMITATIONS of this theory –

1. There is no basis for the assumption that every tax is a burden upon the society and every State expenditure is a benefit for it.
2. The benefits and ill-effects of a public budget spill over beyond the period covered by the budget.
3. If we assume all taxes are harmful and all expenditure is beneficial, we arrive at absurd results.
4. Every State is committed to certain expenses – a liability from which it cannot free itself.
5. At times, an imbalanced budget is often an effective weapon affecting various remedial and welfare measures.


Tests of Maximum Social Advantage –
- Dalton’s Tests – Public finances are addiing to social advantage if it preserves the society and involves economic welfare of the community i.e. improvement in production and distribution of national income.



- Hicks Tests sets two criteria namely, the production optimum and the utility optimum. Production optimum is that reallocation of productive resources does not increase production of one commodity without reducing the production of some other commodity. Utility optimum is related to the composition of national output and relative importance of its components. Thus Utility optimum is achieved when the variation in the composition does not lead to increase in the Gross Domestic Product.

Tax Revenue –
A tax is a compulsory levy payable by an economic unit without any corresponding entitlement to receive a definite and direct quid pro quo from the government. This revenue may be in the form of any form of direct tax on an unit or indirect taxes on the goods, special assessment charge, fines, fees for certain services like registration etc. The base of a tax is the legal description of the object with reference to which the tax is payable. For example, the base of an excise duty is production of specific good. Certain taxes are one time charges whereas others are charged on annual basis. An increase in tax revenue on account of a growth of its base is termed its bouyancy. A bouyant tax has an inherent tendency to yield more tax revenue with the growth of its base. Thus Given the tax rates and the definition of taxable income, the yielkd from income tax increases as national income increases. Thus it is a bouyant tax. The elasticity of tax is reflected by the increase in yield due to extension of its coverage or a revision of its rates.

Deficit Financing –
Deficit financing means an excess of public expenditure over public revenue. This excess may be met by borrowings from the market, borrowings from abroad, or creation of currency. Deficit financing is a hidden tax. Some borrowings may come out of genuine savings and thus divert purchasing power into government hands, which it utilises to acquire goods and services, resulting in increase of prices and hence public is able to buy less for same money.





Principles of taxation

A tax system for achieving certain objectives, chooses and adheres to certain principles which are termed as its characteristics.

Canons of taxation –

a) Canon of Equality
b) Canon of Certainty
c) Canon of Convenience
d) Canon of Economy
e) Canon of productivity
f) Canon of Bouyancy
g) Canon of Flexibility
h) Canon of Simplicity
i) Canon of Diversity but multiplicity should be avoided.


Objectives of Taxation

Objectives will differ accordingly to the state of the Economy that is depending whether an economy is developed or under-developed.

Objectives of Taxation in a Under-Developed Country –
a) removal of poverty and inequality
b) correct regional disparities
c) address problem of chronic unemployment
d) accelerate rate of economic growth
e) curb unnecessary and conspicuous private consumption
f) yield increasing revenue to the government
g) Strengthen administrative machinery

Public Debt
It is possible to regulate the economy’s financial system through variations in the volume, composition and yield rates of public debt. A lenthening of the maturity composition of public debt is expected to reduce its overall liquidity shortening is expected to have the opposite effect.


Revenue and Capital Budgets


In many countries, the budget is divided into revenue and capital accounts. Revenue account covers those items which are of recurring nature while capital account covers those items which are in the nature of acquiring and disposing of capital assets. It is also maintained that through such division, the government can follow a good working rule namely, deciding that all the current or revenue expenses are met through taxation and the capital expenses are met through borrowings. In India Constitution demands that Revenue Budget consists of revenue receipts – both tax revenue and non-tax revenue like revenue from coinage and mint, currency, interest receipts, dividends etc. Capital Receipts include market loans, borrowings from RBI and others, sale of treasury bills, loans from foreign governments etc. Each oif the Budgets are then classified fuyrther into Plan and Non-Plan Components.



Zero Base Budgeting –

It is an innovative technique to guard against wastage in public expenditure. The technique works on examination of the very rationale of expenditure item under consideration and not through auditing which is a post operative check.
Each section is to start with the assumed position of its own non-existence. If a section is not able to justify its own existence, it would be closed down. If its existence is justified, the optimum level of its operations and the corresponding budgetary provisions have to be defended. No section is supposed to be essential. The justification as to why the money should be spent has to be proved by the spender. Every time this exercise has to start ab-initio.
First adopted in USA by Jimmy Carter in his State of Georgia. India also tried to adopt with caution. Implementation of ZBB is not an easy task as no ministry or department likes to admit that its usefulness has decreased or vanished. Actually the very mechanism of additional checks and justifications tend to add to the total public expenditure rather than bringing it down.
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