Public Finance

Paresh Kr. Sarma

HoD, Department of Economics
Mangaldai College
 CONTENTS

• Public Finance
• Public Revenue
• Taxation
• Objectives of taxation
• Canons of taxation
• Classification of taxation
• Taxable capacity
• Significance of taxable capacity
• Factors determining taxable capacity
 What is Public Finance?
According to Dalton,’ Public finance is the branch of knowledge
which is concerned with the income and expenditure of public
authorities and with the adjustment of one to another.’ It deals
with the study of revenue and expenditure of the government
at the centre, state and local bodies.

The public authorities have to perform various functions such

as maintenance of law an order, provision of defence,
production for bringing in economic development. The
performance of these functions require large amount of funds
which is raised through taxes, fees, fines, commercial
revenues and loans.
 Public Revenue

This is one of the branches of public finance. It

deals with the various sources from which the state
might derive its income. These sources include
incomes from taxes, commercial revenues in the
form of prices of goods and services supplied by
public enterprises, administrative revenues in the
form of fees, fines etc and gifts and grants.
 Difference between Public revenue and
Public receipts

Public revenue includes that income which is not

subject to repayment by the government. Public
receipts include all the income of the government
including public borrowing and issue of new
currency. In this way public revenue is a part of
public receipts.

Public Receipts = Public revenue + Public

borrowing + issue of new currency
 Sources of Public Revenue

Public revenue can be categorized into

1.Tax revenue and

2.Non-tax revenue
 Taxation
•The most important source of revenue of the
government is taxes. The act of levying taxes is
called taxation.
•A tax is a compulsory charge or payment
imposed by government on individuals or
corporations.
•The persons who are taxed have to pay the
taxes irrespective of any corresponding return
from the goods or services by the government.
 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
 Canons of Taxation

•A good tax system is should 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.
 Adam Smith’s four canons of
taxation
• Canon of Equality
• Canon of Certainty
• Canon of Convenience
• Canon of Economy
 Canon of Equality
This states that persons should be taxed according to their
ability to pay taxes. That is why this principle is also known as
the canon of ability. Equality does not mean equal amount of
tax, but equality in tax burden. Canon of equality implies a
progressive tax system.

 Canon of Certainty
According to this canon, the tax which each individual is
required to pay should be certain and not arbitrary. The time
of payment, the manner of payment and the amount to be
paid should be clear to every tax payer. The application of
this principle is beneficial both to the government as well as to
the tax payer.
 Canon of Convenience

According to this canon, the mode and timings of tax

payment should be convenient to the 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 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 Economy
Every tax has a cost of collection. The canon of economy
implies that the cost of tax collection should be minimum.
 Types of Tax

Taxes can be classified into various types on the

basis of form,nature,aim and method of taxation.
the most common and traditional classification is
to classify into direct and indirect taxes .

• Direct Tax
• Indirect tax
 Direct taxes
A direct tax is that tax whose burden is borne by the same
person on whom it is levied. The ultimate burden of
taxation falls on the person on whom the tax is levied. It is
based on the income and property of a person. Thus
income tax, corporation tax on company’s profits, property
tax, capital gains tax, wealth tax etc are examples of direct
taxes.

 Indirect taxes
An indirect tax is that tax which is initially paid by one
individual, but the burden of which is passed over to some
other individual who ultimately bears it. It is levied on the
expenditure of a person. Excise duty, sales tax, custom
duties etc are examples of indirect taxes.
 Tax Rate Schedule

On the basis of degree of progression of tax,

it may be classified into:

• Proportional tax
• Progressive tax
• Regressive tax
• Degressive tax
 Proportional tax
A tax is called proportional when the rate of taxation remains
constant as the income of the tax payer increases. In this
system all incomes are taxed at a single uniform rate,
irrespective of whether tax payer’s income is high or low. The
tax liability increases in absolute terms, but the proportion of
income taxed remains the same.

 Progressive tax
When the rate of taxation increases as the tax payer’s income
increases, it is called a progressive tax. In this system, the
rate of tax goes on increasing with every increase in income.
 Regressive taxation
A regressive tax is one in which the rate of taxation decreases
as the tax payer’s income increases. Lower income is taxed at
a higher rate, whereas higher income is taxed at a lower rate.
However absolute tax liability may increase.

 Degressive taxation
A tax is called degressive when the rate of progression in
taxation does not increase in the same proportion as the
increase in income. In this case, the rate of tax increases upto
a certain limit, after that a uniform rate is charged. Thus
degressive tax is a combination of progressive and
proportional taxation. This type of taxation is often used in
case of income tax. This is the case of income tax in India as
well.
 Taxable Capacity

Taxable capacity means the maximum amount which

a nation can contribute towards the support of the
government without inflicting damage on the power
and will to produce.

In the words of Sir Josiah Stamp:

“Taxable capacity is that maximum amount which the

community is in a position to bear towards the
expenses of public authorities without having a really
unhappy and! down-trodden existence and without
dislocating the economic, organization too much".
 Taxable Capacity
Taxable capacity is normally used into two
senses;

1. Absolute Taxable Capacity and

2.Relative Taxable Capacity.

 ABSOLUTE TAXABLE CAPACITY

The absolute taxable capacity indicates the

amount of money or the proportion of national
income that can be taken away by the
government from people in the form of taxes
without producing unfavorable effects. The
concept of absolute taxable capacity is not to
be assumed as a constant entity.
 RELATIVE TAXABLE CAPACITY

Relative taxable capacity provides us a

comprehensive analysis of taxable capacities of
different taxpayers, groups of taxpayers or dif­
ferent nations. In a sense, it refers to the
taxable capacity of one community as compared
to that of another community.
 SIGNIFCANCE OF TAXABLE CAPACITY
• Knowledge of taxable capacity is of immense use to the
government and fiscal theorists for budget planning and
resource mobilization.
• idea about taxable capacity helps the government in
allocating tax burden rationally among dif­ferent sections of
the community, especially between rich and poor.
•The knowledge of taxable capacity is useful for mobilizing
economic resources needed for financing development
projects.
•The knowledge of taxable capacity is of immense use,
during extraordinary situation like war.
•Moreover, knowledge about the limit of taxable capacity
prevents the government from imposing necessary taxes
which will hamper productive system of the economy.
FACTORS DETERMINING TAXABLE
CAPACITY
SIZE OF THE NATIONAL INCOME

The taxable capacity of a country primarily

depends on its size of a national income which
in turn on the proper use of natural resources,
skill, technology, investment pattern.
FACTORS DETERMINING TAXABLE
CAPACITY
SIZE AND RATE OF GROWTH OF
POPULATION

Size and rate of population affects the taxable

capacity to a great extent. The larger the
population the lower the taxable capacity.
Countries like india
and china have a lower taxable capacity
because of high population.
FACTORS DETERMINING TAXABLE
CAPACITY
DISTRIBUTION OF INCOME AND WEALTH

The distribution of income and wealth also

influence the taxable capacity of the people. If
the wealth and income is unequally distributed,
taxable capacity is high because it will be easy
for the government to raise the bulk of revenue.
FACTORS DETERMINING TAXABLE
CAPACITY
STABILITY AND GROWTH OF INCOME

Taxable capacity of the country will be lower if

there are economic fluctuations with serious
ups and downs especially during the period of
depression.
FACTORS DETERMINING TAXABLE
CAPACITY
PATTERN OF TAXATION
Taxable capacity depends upon the pattern and
method of taxation. If the tax system is well planned
and broad based, it will bring more revenue, similarly if
it observes the canons of economy and convenience,
taxable capacity will certainly be greater.

PURPOSE OF TAXATION
The purpose of taxation has to do much with the
extent of taxable capacity.
FACTORS DETERMINING TAXABLE
CAPACITY
NATURE OF PUBLIC EXPENDITURE

The nature of public expenditure also

determines the extents of taxable capacity.
When it is used on productive projects, it
increases the wealth of the country which in turn
increases the taxable capacity.
FACTORS DETERMINING TAXABLE
CAPACITY
PSYCHOLOGY OF TAXPAYER

Psychology of taxpayer plays a vital role to

determine the taxable capacity of a country.
Incase the people are psychology depressed;
the taxable capacity will be reduced
automatically.