THEORY AND PRACTICE

Unit 3: PUBLIC BUDGETS

By Nadya Narsidani
BUDGETS
A Budget is a financial document or an action
plan which is prepared and used to project
future income and expenses.

It is a financial plan of a nation that serves as the

basis for expenditure decision-making and
subsequent control of expenditures. It is a
financial statement of the government’s planned
revenues and expenditures for the fiscal year.

To facilitate annual decision-making on expenditures, government prepares a

budget. The Government budget is a financial plan covering outlays and
receipt of the government. It is the outcome of a process that includes
preparation of financial plan, review of the plan by the legislature where there
is one, execution of the plan and (ideally) evolution and public reporting of the
results.
A budget may be defined as a financial plan of a nation that serves
as the basis for expenditure decision-making and subsequent
control of expenditures. It is a financial statement of the
government’s planned revenues and expenditures for the fiscal year
(April-March).

Need for Budgets:

1. It forms the basis of the government’s long-term financial
planning of its own economic and social commitments.

2. Budget is an instrument of fiscal policy in regulating the

aggregate demand in an economy. To tackle inflation,
government imposes new taxes and/or raises existing tax rates
and curtails its expenditure programmes. To tackle deflation,
tax rates are lowered down and more expenditure are made in
the budget. Thus, a budget helps the financial administration to
control and coordinate the activities in a given year.
3. It helps in attaining greater efficiency in the use of governmental
resources.

4. It is an instrument through which savings and investments are

encouraged.
COMPONENTS OF BUDGET
Balanced Budget is that budget in which Government receipts are
equal to Government expenditure.

Merits of the Balanced Budget:

1. The Government does not indulge in wasteful expenditure.
2. Interference in economic functioning of the system is totally
avoided by the government generally.
3. Financial stability is ensured with balanced budget.
4. Balanced budget is not an achievement of the government
when economy is in a state of depression for at that time,
government is expected to increase its expenditure with a view
to increasing aggregate demand.

Demerits of a Balanced Budget:

1. Balanced budget does not offer any solution to the problem of
unemployment during depression.
2. Balanced budget is not helpful to the growth and development
programmes of the less developed countries.
Deficit Budget is that budget in which government expenditures
are greater than government receipts.

Merits of a Deficit Budget:

(i) It helps in addressing the problem of unemployment during

depressions.
(ii) It is conducive for growth and development in less developed
countries
(iii) It works towards social welfare of the people.

Demerits of Deficit Budget

(i) It shows wasteful expenditure by the government.

(ii) It shows less revenue realization in comparison with the
expenditure.
(iii) It increases debt burden of the government.
Surplus Budget When estimated government receipts are more
than the estimated government expenditure it is termed as surplus
budget. When the government spends less than the receipts the
budget becomes surplus that is.

Estimated government receipts > anticipated government

expenditure.

A surplus budget is used either to reduce government public debt

or increase its savings.

A surplus budget may prove useful during the period of inflation.

In periods of inflation, although there is greater employment there
is also a tendency for prices to rise rapidly. This has to be checked
particularly in the interest of those who have more or less fixed
income. This inflationary gap can be corrected by lowering the
level of effective demand in the economy.
It can be corrected by increasing taxes. This would increase the
revenue of the government but reduce the purchasing power of the
people. As a result, the aggregate demand will fall. This inflation
gap can be corrected by lowering the level of public expenditure.
The surplus budget should not be used in a situation other than
the inflationary gap as it may lead to unemployment and low levels
of output as an economy.
ZERO BASED BUDGETING
Zero-based budgeting (ZBB) is a method of budgeting in which all
expenses must be justified for each new period. The process of zero-
based budgeting starts from a "zero base," and every function within an
organization is analyzed for its needs and costs.

For example, if you hire one new employee, you would increase
your budget since you would add new wages to your payroll
expenses. Zero-based budgeting is more time-consuming than the
traditional approach because you need to start from scratch and strategize
where your expenses can be cut.

The major advantages are flexible budgets, focused operations, lower

costs, and more disciplined execution.

The disadvantages include the possibilities of resource intensiveness,

being manipulated by savvy managers, and bias toward short-term
planning.
Benefits of Zero Based Budgeting (ZBB)
•Cuts budget more rationally leading to improvement in efficiency &
profitability.
•Provides coherency and better coordination between planning and
budgeting
•Better insight into detailed working of organization
•Better evaluation of subordinate managers by top management
•Remove duplication/multiplication of expenditure
•Manage overheads better
•Enable the top management to reallocate resources with greater
flexibility
•Enable better coordination between different departments of an
organization
•Provides a tremendously effective information systems
•Enable managerial analysis at all levels
Limitations of Zero Based Budgeting (ZBB)
•High costs
•More information requirements
•Takes up more time than traditional budgeting
•Attitudinal resistance from unions/Bureaucrats/Operational people,
Lack of orientation/skills of prioritization
•New innovative decision packages are to be conceived, evaluated and
compared which is difficult task
•Multi-level decision making procedures are required; this is difficult
•Information data retrieval is not necessary
 What is a tax?
Taxes are levied by governments on their citizens
to generate income for undertaking projects to
boost the economy of the country and to raise the
standard of living of its citizens. The authority of
the government to levy tax in India is derived from
the Constitution of India, which allocates the
power to levy taxes to the Central and State
governments. All taxes levied within India need to
be backed by an accompanying law passed by the
Parliament or the State Legislature.
Definition of Tax
 In every country major part of the revenue is raised through taxation.
According to Prof. Taylor “Taxes are compulsory payments to
governments without expectations of direct return or benefit to the tax
payer”.

 Dr. Dalton opines that “a tax is a compulsory contribution imposed by

the public authority irrespective of the exact amount of service to the
tax payer in return and not imposed as a penalty for any legal offence”.

 Another acceptable definition was given by Prof. Seligman; “tax is a

compulsory contribution from the person to the government, to defray
the expenses incurred in the common interest of all without reference
to special benefit conferred”.
Characteristics of Tax
 Tax is a compulsory contribution to the State from the citizens
and this contribution is for general or common use.

 Tax imposes a personal obligation on the tax payer. It means

that it is the duty of taxpayer to pay the tax if he is liable to pay it
and should in no case think to evade it.

 The contribution received from the tax payers may not be

incurred for their benefit alone, but for general or common
benefit.
OBJECTIVES OF TAXES

• Raising Revenue
• Regulation of Consumption and Production
• Encouraging Domestic Industries
• Stimulating Investment
• Reducing Income Inequalities
• Promoting Economic Growth
• Development of Backward Regions
• Ensuring Price Stability
TYPES OF TAXES
TYPES OF TAXES
 Direct and Indirect Taxes

Direct tax is paid by a person on whom it is legally imposed while an indirect tax is paid
partly or wholly by another person owing to consequential change in terms of some
contract or bargaining.

Direct tax, are taxes that you pay directly. These taxes are imposed specifically on a
substance or an individual and can’t be transferred to any other person. One of the
bodies that manage these direct taxes is the Central Board of Direct Taxes (CBDT) which
is a part of the Revenue Department.
Indirect taxes are those taxes that are levied on merchandise or administrations. They
vary from direct taxes since they are not imposed on a man who pays them directly to the
government; they are rather imposed on items and are gathered by an intermediary, the
individual selling the item.

Impact and incidence of the tax i.e. initial burden and final burden of a tax lies on the
same person in case of direct tax.
Impact can be shifted in case of indirect tax.

Examples of Direct taxes: Personal income tax, Corporation tax, property tax etc
Examples of Indirect Taxes: GST, Import duties etc.
 Merits of Direct Taxes

1. Equity: A direct tax is equitable in the sense that it is levied according to

the taxable capacity of the people. The rates of direct taxes, like the
income tax, can be fixed in such a way that the higher the income of a
man, the greater is the rate at which he has to pay the tax. Such a
system is known as progressive taxation.

2. Certainty: a person liable to pay income tax knows how much he will be
required to pay; for that purpose he can appropriate steps beforehand.

3. Elasticity: It can be varied according to the needs of the government

and changes in the income of the people. When the income of the
people goes up, the rate of income tax can also be increased. If the
income of the people falls, the rate of income tax can also be lowered.
 Merits of Direct Taxes

4. Productivity: Direct taxes constitute an important source of

government revenue. Their collection charges are also low. Therefore,
direct taxes are productive.

5. Civic Consciousness: A direct tax increases the civic sense of the

people. When the people are fully aware of the payment of taxes, they
are also conscious of the way the government spends the money. They
resent unproductive or wasteful expenditure. As a result, the
government becomes careful in its expenditure.
 Demerits of Direct Tax:

1. Lack of Popularity: such taxes are not very popular, because the people
have to bear the burden of such taxes directly. That is why, when the
rate of a direct tax is raised, most people express their resentment
against the government.

2. Possibility of Evasion: direct tax is liable to be evaded by submitting

false returns.

3. People’s Indifference: it does not develop the civic sense of those who
do not pay such taxes. Those who are not directly affected by the
burden of taxation remain indifferent as to the way the public
expenditure is incurred.

4. Disincentive to Work and Save: Direct taxes reduce the desire to work
and save.
 Merits of Indirect Tax:

1. Convenient to Pay and Less Cumbersome as compared to direct taxes as

people have to pay these taxes bit by bit when they produce, sell and
buy these commodities.

2. Large Revenue Potential/ Wide Coverage: Through indirect taxes even

the poor and low- income people can be brought in the tax net.
Whoever, rich or poor, buys commodities ultimately bears the burden
of indirect taxes.

3. Important Instrument for Influencing Pattern of Production and

Investment: The government can use it to discourage certain types of
consumption. A high rate of tax on tobacco can, for example, affect
smoking habits.

4. Indirect taxation is a good way of raising revenue when levied on goods

with an inelastic demand, such as necessities.
 5. There is less possibility of tax evasion

Demerits of Indirect Tax:

1. Regressive nature: Indirect taxes are, regressive. For instance, the tax
incidence of the price of a new television set would be the same for the
poor and the rich person, but, as a percentage of the poor person’s
income, it is far greater.

2. Inflationary: The imposition of an indirect tax on an item will in-crease

its price, which is, in itself, inflationary.

3. High cost of administration

4. Discourage savings
PRINCIPLES OF TAXATION
• A good tax system should adhere to certain principles which
become its characteristics.

• A good tax system is therefore based on some principles.

• Adam Smith has formulated four important principles of

taxation.

• A few more have been suggested by various other economists.

• These principles which a good tax system should follow are

called canons of taxation.
 PRINCIPLES OF TAXATION
Adam Smith’s four canons of taxation
This states that persons should be taxed according to
their ability to pay taxes. That is why this principle is
Canon of also known as the canon of ability. Equality does not
Equality mean equal amount of tax, but equality in tax
burden. Canon of equality implies a progressive tax
system.
This canon is meant to protect tax payers from
Canon of unnecessary harassment by the tax officials. The
amount to be paid, the time and method of payment
Certainty should be clear and certain for the tax payers to adjust
his income and expenditure accordingly.

• According to this canon, the mode and timings of tax payment should
Canon of be convenient to tax payer. It means that the taxes should be imposed in
such a manner and at the time which is most convenient for the tax

Convenience payer. For example, government of India collects the income tax at the
time when they receive their salaries. So this principle is also known as
‘the pay as you earn method’.

Canon of • Every tax has a cost of collection. The canon of

economy implies that the cost of tax collection
Economy should be minimum.
Other canons of taxation:

5. Canon of Productivity:
Productivity or physical adequacy means that, the tax system should
sufficiently yield the revenue needed to meet the requirements of the
state.
6. Canon of Elasticity:
This canon implies that yield from taxation should grow along with
increase in population and tax base.
7. Canon of Diversity:
The tax system should be broad based. This canon requires that the tax
system should not rely on a few taxes. There should be a large number
and variety of taxes, so that it can touch all sections of the people in the
society
8. Canon of Simplicity:
The system of taxes and the laws governing them should be simple. A
complex tax system may even prompt an honest taxpayer, to indulge in
involuntary tax evasion.
Other canons of taxation:

9. Canon of Expediency:
It implies that the possibility of imposing a tax should be taken into
account from different angles i.e. its reaction upon tax payers.
Sometimes it is seen that the tax may be desirable and may have most
of characteristics of good tax but the government may not find it
expedient to impose it.

10. Canon of Coordination:

In democratic countries taxes are imposed by the Central, State and
Local governments. It is therefore very much desirable that there must
be coordination between different taxes that are imposed by different
taxing authorities.
Incidence of Tax
Incidence means the final resting place of a tax. The incidence is on the
man’ who ultimately bears the money burden of the tax.

We may distinguish between impact and incidence. The impact of the tax
is on the person who pays it in the first instance and the incidence is on
the one who finally bears it. The incidence is, therefore, on the final
consumer.

Incidence and Effects:

The effect of a tax refers to incidental results of the tax. There are several
consequences of the imposition of tax which are quite distinct from the
problem of incidence. The taxes reduces manufacturer’s profits, wages
may be reduced etc.
 Importance of incidence:

• The study of incidence is very-important. The tax system is not merely

aimed at raising a certain amount of revenue, but the aim is to raise it
from these sections of the people who can best bear the tax. The aim,
in short, is to secure a just distribution of the tax burden.

• This obviously cannot be done unless an effort is made to trace the

incidence of each tax levied by the State. We must know who pays it
ultimately in order to find out whether it is just to ask him to pay it, or
whether the burden imposed on him is according to the ability of the
tax-payer or not.
 Lindahl-Bowen model
This model is related to usage of Public Goods
A Lindahl tax is a form of taxation conceived by Erik Lindahl in which
individuals pay for public goods according to their marginal benefits. In
other words, they pay according to the amount of satisfaction or utility
they derive from the consumption of an additional unit of the public
good.
A concept that proposes that individuals pay for the provision of a public
good according to their marginal benefits in order to determine the
efficient level of provision for public goods. In the equilibrium state, all
individuals consume the same quantity of public goods but may face
different prices because some people may value a particular good more
than others. The Lindahl equilibrium price is the resulting amount paid by
an individual for his or her share of the public goods.

In Lindahl’s model, equilibrium requires each individual to pay a tax rate

just equal to the individual’s marginal utility from the good.
This can be shown for a two-person
community (consisting of A and B) in Fig. 1
which has quantity of public good along
horizontal axis and the share of tax paid by
A and B along vertical axis. A’s share of taxes
increases from the bottom to up and B’s
share of taxes increases from top to down.
The schedule DA indicates the amount of the good A will wish to demand at
different levels of his tax share. As his share of the cost goes down, his
desired level of provision increases. DB indicates B’s preferences—again, as
his share of the cost falls, his preferred quantity of the good increases. The
Lindahl equilibrium involves producing Q1 of the good with tax shares as
indicated at point S.
In the Lindahl model, public goods are provided in a manner which
ensures everyone gains from their provision i.e. The provision of goods is
always a Pareto improvement. Lindahl’s analysis adds the condition that
each individual consumes his most-preferred or ‘optimal’ amount of the
public good given his tax share.
Despite the appeal of the model, difficulties arise in its application. In
particular, the problems of reaching unanimous agreement and the
possibility that individuals will not indicate true preferences (i.e. they may
seek to be free riders) undermine the usefulness of the model.
Lindahl-Bowen model.
Bowen has explained in his model how A and B will pay different prices for a
social goods on the basis of ability to pay and benefit received. This model
attempts to present the Lindahl analysis in a simpler way.

In the Bowen Model, the volume of social good is measured on the horizontal
axis and the combined unit price, including the contributions of both A and B is
measured on the vertical axis. Line aa and bb shows the demand schedules for
social goods of tax payers A and B respectively. Line tt shows the aggregate
demand schedules. Since both must consume the same amount of social goods,
tt is obtained by vertical addition of individual schedules and not by horizontal
addition as in case of private wants where various individuals may consume
different amounts.

The aggregate demand schedule tt shows the combined price per unit of social
goods offered for various amounts of jointly consumed public services. SS is the
supply schedule of social goods that we assume are produced under conditions
of constant cost. The equilibrium output is determined where the tt and ss
schedules intersect. For this amount, the combined offers equal total cost.

Equilibrium output is established at OE. A and B will pay different prices for a
social goods on the basis of ability to pay and benefit received and cost of
supplying social goods is also covered from the two consumers.
 Theories of Equitable Distribution of Tax Burden
There are three theories

1) Cost of Service Principle :

This suggests that the cost incurred by the Government in providing Public
goods to satisfy social wants should be regarded as the basis of taxation, thus
the tax paid as per the cost of public goods enjoyed by the citizen. This means
that Government is just a producer of social goods and taxes are the prices for
the same.

This principle has lot of disadvantages such as :

1) the cost of Public goods cannot be linked to individuals directly.

2) It is not in conformity to the definition of Tax.
3) It goes against the norms of welfare.

2) Benefit Principle:

This suggests that the burden of taxes should be distributed amongst the tax
payers in relation to the benefit enjoyed by them for Government services, thus
those who receive more utility from Public goods should pay more than others,
The main merit of this principle is that it assumes the imposition of taxes
justified by the benefits involved in Public goods.

It has following draw backs:

1) There are certain public goods which satisfy collective wants and are not
subject to voluntary exchange principle.
2) Not in conformity with definition of Tax.
3) A blind application of this principle will cause great injustice to the poor
people.

3) Objective approach of ability to pay principle:

Realizing the practical difficulties of subjective principles above, Prof. Seligman,

has suggested objective approach, this approach considers money value of the
taxable capacity of each tax payer rather than his psychology of sacrifice and
feelings. Taxable capacity is connected to a persons ability to pay, it also refers to
the maximum capacity of a community to bear taxes without much hardship.
PUBLIC EXPENDITURE
What is Public Expenditure?

Public expenditure refers to Government expenditure i.e.

Government spending. It is incurred by Central, State and Local
governments of a country.

The expenditure incurred by public authorities like central,

state and local governments to satisfy the collective social
wants of the people is known as public expenditure.

In developing countries, public expenditure policy not only

accelerates economic growth & promotes employment
opportunities but also plays a useful role in reducing poverty and
inequalities in income distribution.
CLASSIFICATION OF PUBLIC EXPENDITURE
The classification is a based on different views of the economists.

1. Functional Classification: The government performs various functions like

defence, social welfare, agriculture, infrastructure and industrial development.
The expenditure incurred on such functions fall under this classification.

2. Revenue and Capital Expenditure: Revenue expenditure are current or

consumption expenditures incurred on civil administration, defence forces,
public health and education, maintenance of government machinery. capital
expenditures are incurred on building durable assets, like highways,
multipurpose dams, irrigation projects, buying machinery and equipment.

3. Transfer and Non-Transfer Expenditure: Transfer expenditure relates to the

expenditure against which there is no corresponding return but it adds to the
welfare of the people, especially belong to the weaker sections of the society.
Like public expenditure on National Old Age Pension Schemes, Interest
payments, subsidies, welfare benefits to weaker sections, etc.
 The non-transfer expenditure relates to expenditure which results in
creation of income or output. The non-transfer expenditure includes
development as well as non-development expenditure that results in
creation of output directly or indirectly. Economic infrastructure such as
power, transport, irrigation, etc. Social infrastructure such as education,
health and family welfare, internal law and order and defence, public
administration, etc. By incurring such expenditure, the government creates
a healthy conditions or environment for economic activities.

4. Productive and Unproductive Expenditure: Expenditure on

infrastructure development, public enterprises or development of
agriculture increase productive capacity in the economy and bring income
to the government. Expenditures in the nature of consumption such as
defence, interest payments, expenditure on law and order, public
administration, do not create any productive asset which can bring income
or returns to the government.

5. Development and Non-Development Expenditure: All

expenditures that promote economic growth and development are
termed as development expenditure. These are the same as productive
expenditure.
Unproductive expenditures are termed as non development expenditures.

6. Grants and Purchase Price: Grants are those payments made by a

public authority for which their may not be any receipt of goods or
services. Eg. old age pension, unemployment benefits, subsidies, social
insurance, etc. These are transfer expenditures. Purchase prices are
expenditures for which the government receives goods and services in
return. For example, salaries and wages to government employees and
purchase of consumption and capital goods.

Classification According to Benefits

Public expenditure can be classified on the basis of benefits they confer

on different groups of people.

 Common benefits to all : Expenditures that confer common benefits on

all the people. For example, expenditure on education, public health,
transport, defence, law and order, general administration.
 Special benefits to all : Expenditures that confer special benefits on all.
For example, administration of justice, social security measures,
community welfare.

 Special benefits to some : Expenditures that confer direct special

benefits on certain people and also add to general welfare. For example,
old age pension, subsidies to weaker section, unemployment benefits.
To promote rapid
To promote trade To promote rural
economic
& commerce development
development

To promote To build
To develop
balanced infrastructure like
industrial &
regional roads, railways,
agriculture sector hospitals etc.
development

To ensure
To ensure full
equitable
For Security employment &
distribution of
price stability
Income
 Objectives of Public Expenditure
Administration of law and order and justice.
Maintenance of police force.
Maintenance of army and provision for defence goods.
Maintenance of diplomats in foreign countries.
Public Administration.
Servicing of public debt.
Development of industries.
Development of transport and communication.
Provision for public health.
Creation of social goods.
FACTORS AFFECTING PUBLIC EXPENDITURE
 Tax policies: Government spending is affected by tax policies
indirectly. The amount of collected revenues increases when the
government increases taxes on certain services and products with an
aim of promoting economic growth.
 Monetary policy: When the monetary system is stable, the spending
environment is good. However, when the monetary system is poor, there
are crippled investment opportunities and the overall economic
confidence among the people and their government is ruined and this
reduces government spending.
 Trade policy: The economy of a country with a free trade grows at a
faster rate and this increases spending by the government. However, if
trade in a country is restricted through the imposition of policies that
cause economic inefficiency, government spending reduces.
 Politics: Politics have a significant impact on government spending.
EFFECTS OF PUBLIC EXPENDITURE
 Effects on Production: The effect of public expenditure on production
can be examined with reference to its effects on ability & willingness to
work, save & invest and on diversion of resources. Socially desirable
public expenditure increases community's productive capacity.
Expenditure on education, health, communication, increases people's
productivity at work and therefore their incomes.
Public expenditure, sometimes, brings adverse effects on people's
willingness to work and save. Government expenditure on social
security facilities may bring such unfavourable effects.
Many a times the government expenditure proves to be an effective
instrument to encourage investment on a particular industry.

 Effects on Distribution: The primary aim of the government is to

maximise social benefit through public expenditure. The objective of
maximum social welfare can be achieved only when the inequality of
income is removed or minimized .
 Government expenditure is very useful to fulfill this goal. Government
collects excess income of the rich through income tax and sales tax on
luxuries. The funds thus mobilised are directed towards welfare
programmes to promote the standard of poor and weaker section.
Public expenditure on education, communication, health has a positive
impact on productivity of the weaker section of society, thereby
increasing their income earning capacity.

 Effects on Consumption: Public expenditure enables redistribution of

income in favour of poor. It improves the capacity of the poor to
consume. Thus public expenditure promotes consumption and thereby
other economic activities. The government expenditure on welfare
programmes like free education, health care and housing certainly
improves the standard of the poor people. It also promotes their
capacity to consume and save.

 Effects on Economic Stability: Economic instability takes the form of

depression, recession and inflation. Public expenditure is used as a
mechanism to control instability.
 The modern economist Keynes advocated public expenditure as a better
device to raise effective demand & to get out of depression. Public
expenditure is also useful in controlling inflation & deflation.
Expansion of Public expenditure during deflation & reduction of public
expenditure during inflation control money supply & bring price
stability.

 Effects on Economic Growth: The goals of planning are effectively

realised only through government expenditure. The government
allocates funds for the growth of various sectors like agriculture,
industry, transport, communications, education, energy, health,
exports, imports, with a view to achieve impressive growth. Government
expenditure has been very helpful in maintaining balanced economic
growth.

Conclusion: It is absolutely necessary for governments to formulate

rational public expenditure policies in order to achieve the desired
effects on income, distribution, employment and growth.
MAIN CAUSES OF GROWTH OF PUBLIC EXPENDITURES

1. Income Elasticity and Increase in Per Capita Income

2. Welfare State Ideology
3. Effects of War and the Need for defence
4. Resource Mobilisation and Ability to Finance
5. Inflation
6. The Role of Democracy and Socialism
7. The Urbanisation Effect
8. The Rural Development Effect
9. The Population Effect
10. The Growth of Transport and Communication
11. The Planning Effect.
1. Income Elasticity and Increase in Per Capita Income: According to
Musgrave, a rising share of public expenditure in national income is
associated with a rise in per capita income.

2. Welfare State Ideology : The modern State is a welfare state. It aims at

promoting the economic, political, and social well-being of its citizens.
It makes every effort to improve the living standard of the common
people. In India, for instance, expenditure on social service is rising
fast.

3. Effects of War and the Need for Defence: The tremendous growth in
public expenditure may also be attributed to wars and threats of war in
modern times.

4. Resource Mobilisation and Ability to Finance: When the government

innovates more and more methods of taxation and resource
mobilisation, its ability to finance public expenditure increases and the
size of public expenditure grows.
5. Inflation: During inflation, the government has to pay additional DA to
its employees which obviously call for an extra burden on public
expenditure.

6. The Role of Democracy and Socialism: The recent growth of democracy

and socialism everywhere in the world has caused public expenditure
to increase very much.

7. The Urbanisation Effect: Expenses on water supply, electricity,

provision of transport, maintenance of roads, schools and colleges,
traffic controls, public health, parks and libraries, playgrounds, etc.
have increased enormously these days.

8. The Rural Development Effect: In an underdeveloped country, the

government has also to spend more and more for rural development. It
has to undertake schemes like community development projects and
other social measures.
9. The Population Effect: A high growth of population naturally calls for
increase in the expenses as all State functions are to be performed more
extensively. Rising population also poses various problems in poor
countries.

10. The Growth of Transport and Communication: With the expansion of

trade and commerce, the State has to provide and maintain a quick and
efficient transport system. Transport being a public utility, the State
has to provide it cheaply also. Hence, railway and passenger transport is
nationalised.

11. The Planning Effect: In a less developed economy, the government

adopts economic planning for the development of the country. In a
planned economy, thus, when the public sector is expanding its role,
public expenditure obviously shows an increasing trend.
PRINCIPLES / CANONS OF PUBLIC EXPENDITURES

1. Principle of Maximum Social Advantage: Public expenditure

should result in increased production, elimination of inequality and
promotion of welfare of all. It should secure internal peace and also
protection from external aggression.

2. Canon of Economy: Public money should not be misused and not

result in any wastage.

3. Canon of Sanction: Without the sanction of the public authority, no

money should be spent.

4. Canon of Elasticity: There should not be any rigidity in public

expenditure.

5. Canon of Surplus: the government expenditure should lead to

increased production, employment and income.
EVALUATION OF PUBLIC EXPENDITURE
Cost-Benefit Analysis is a valuable tool for evaluating the net benefits of
proposed government projects. It represents practical technique for
determining relative merits of alternative government projects over time.

Use of CBA can contribute to efficiency by making sure that new projects
for which marginal social cost exceeds marginal social benefit are not
considered for approval.

It helps to make choices among alternative government projects.

While applying cost benefit analysis, the economist tries to know whether
the society as a whole will become better off or not by undertaking of a
particular project. The aim of cost benefit analysis is to channel resources
into projects which will yield the greatest gain in the net benefit to the
society.
Control over Public Expenditure

In a parliamentary democracy, the political executive is responsible to the

Parliament. The control exercised by the Parliament over the executive is
its control on financial expenditure. This is exercised in two ways: a) the
executive cannot spend money without Parliament’s approval and b) post
expenditure control by audit.

The office of the Comptroller and Auditor-General of India (CAG) conducts a

detailed audit of all the Government departments. He sends his report to the
president, who lays it before the houses of the Parliament. He also submits report
about the commercial and industrial undertakings of the Government of India.

There are different Parliament Committees to control public expenditure: Public

Accounts Committee, Estimates Committee, Committee on Public Undertakings
and The Standing Committee. These are vested with the responsibilities of
scrutiny of public expenditure, economy in public spending and controlling the
irregularities and waste in the management of public enterprises
PUBLIC REVENUE
What is Public Revenue?

Governments need to perform various functions in the field of political,

social & economic activities to maximize social and economic welfare. In
order to perform these duties and functions, the government requires a
large number of resources. The revenues from different sources received
by the government are called public revenues.

Some important sources or concepts that are included in public

revenue consist of taxes, fees, sale of public goods and services, fines,
donations, etc. The main sources of public revenue are: Tax and Non-tax
revenue. Non-tax revenue: includes dividends from government-owned
corporations, central bank revenue and capital receipts in the form of
external loans and debts from international financial institutions.
Dalton has defined public income in a broad and a narrow sense i.e. in
terms of public receipts and public revenue. Public Revenue includes
income from taxes, prices of goods and services supplied by public
enterprises, revenue from administrative activities, such as fees, fines, etc
and gifts and grants, while Public receipts include all the income of the
government which may have received during a given period of time. Thus,
public receipt = public revenue + income from all other sources such as
public borrowing from individuals and banks and income from public
enterprises.

Sources of Public Revenue:

 Taxes
Commercial revenues
Administrative revenues
Grants and gifts
Sources of Public Revenue:
 Taxes:
Taxes are compulsory payments to the government without expecting
direct benefit or return by the taxpayer. Taxes collected by Government are
used to provide common benefits to all mostly in form of public welfare
services. Taxes do not guarantee any direct benefit for the person who pays
the tax. It is not based on a direct quid pro quo principle.

Characteristics of Tax

The following are the characteristics of a tax :-

 A tax is a compulsory payment made to the government. People on whom a
tax is imposed must pay the tax. Refusal to pay the tax is a punishable
offence.
 There is no quid pro quo between a taxpayer and public authorities. This
means that the tax payer cannot claim any specific benefit in return for the
payment of a tax.
 Every tax involves some sacrifice on part of the tax payer.
 A tax is not levied as a fine or penalty for breaking law.
 Commercial Revenues:
Revenues received in the form of prices paid for government produced
commodities and services are called commercial revenues. These are derived
by the government from public enterprises by selling their goods and services.
They include payments for postage, tolls, interest on funds borrowed from
government credit corporations, electricity distributed by the government,
railway services etc.

 Administrative Revenues:
These include fees, licenses, fines, forfeitures etc. They are characterised by
more or less as a free choice on part of tax payer as to whether or not he will
pay, and more or less on direct benefit (or penalty) conferred upon him.
These arise as a by product of the administrative function of the government
hence they are known as administrative revenues.

a) Fees: Prof. Seligman defined fee as a “payment to defray the cost of each
recurring service undertaken by the government, primarily in the public
interest nut conferring a measureable special advantage on the fee payer.”
Unlike tax, there is no compulsion involved in case of fees.
The government provides certain services and charges certain fees for them. For
example, fees are charged for issuing of passports, driving licenses, etc.

b) License Fees:
A license fee is paid in those instances in which the government authority is
invoked simply to confer a permission or a privilege rather to perform a service of
a more tangible and definite sort. Example: registration fee for motor vehicles,
payments for permits to operate automobiles etc.

c) Special assessments:
Prof. Seligman defined special assessments as “a compulsory contribution, levied
in proportion to the special benefit derived to defray the cost of a special
improvement to property undertaken in the public interest.” When the
government undertakes certain activities of public improvements like
construction of roads, provision of drainage, street lighting etc they may confer
the common benefit to the community as a whole and special benefit on those
whose properties are nearby. As a result of the improvements, the values or rents
of these properties may rise. The government therefore may impose some special
levy to recover a part of the expenses incurred. Such special assessment is levied
generally in proportion of the increase in the value of property. In this respect it
defers from tax.
Gifts and Grants:
Gifts are voluntary contribution from private individuals or non government
donors to the government fund for specific purpose, such as relief fund or
defence fund during a war or an emergency.
EFFECTS OF TAXATION
Effects of Taxation on Production:
 Effects on Ability to work: Taxes reduce disposable income. As such,
the buying capacity and consumption expenditure are
curtailed. Consequently, efficiency and ability to work is adversely
affected.
 Effect on the Ability to Save: Ability to save is adversely affected by
taxation as taxes fall on income and saving is the function of disposable
income. As disposable income declines, savings tend to decline.
 Effect on Ability to Invest: Ability to invest in the private sector
evidently falls on account of the reduced saving ability caused by the
tax imposition.

Effects of Taxation on Distribution depends on:

i. Nature of taxes or tax rates; and
ii. Kinds of taxes.
Progressive tax rates can reduce inequality as a larger amount of tax will
be collected from the high income groups.

Other Effects of Taxation

 Effect of taxation on employment: Tax money is spent by government
on social and welfare activities thereby increasing production and
employment.
Taxation and Inflation: Tax helps in reducing demand for goods and
services by restricting purchasing power of public thereby keeps check on
inflation.
Taxation and Depression: Reduction of taxation during depression may
have favourable effects on the level of economic activity and employment.
Regulatory effects of taxation: Taxation can be used as an instrument for
the purpose of regulation of consumption and production.