002 Core 8 - Public Finance I - V Sem BA Economics

STUDY MATERIAL FOR B.
A ECONOMICA
PUBLIC FINANCE - I
SEMESTER - V, ACADEMIC YEAR 2020-21
UNIT CONTENT PAGE Nr
I INTRODUCTION 03
II PUBLIC EXPENDITURE 08
III PUBLIC REVENUE 15
IV TAXATION 24
V PUBLIC DEBT 39
STUDY MATERIAL FOR B.A ECONOMICA
PUBLIC FINANCE - I
UNIT-I
Meaning and Scope of Public Finance

Public finance is a field of economics concerned with how a government raises
money, how that money is spent and the effects of these activities on the
economy and society. It studies how governments at all levels—national, state
and local—provide the public with desired services and how they secure the
financial resources to pay for these services.
Public finance deals with the finances of public bodies – national, State or Local
– for the performance of their functions. The performance of these functions
leads to expenditure. The expenditure is incurred from funds raised through
taxes, fees, sale of goods and services and loans. The different sources
constitute the revenue of the public authorities. Public finance studies the
manner in which revenue is raised; the expenditure is incurred upon different
items etc. Thus, public finance deals with the income and expenditure of public
authorities and principles, problems and policies relating to these matters. We
can analyse some important definitions of public finance given by some leading
authorities in public finance.
Economists Publication Definition
For all States – whether crude or highly

Charles F. Public developed – some provisions of the kind
Bastable Finance – are necessary and there for supply and
1892 application of state resources constitute
the subject matter of a study which is
best entitled in English as Public
Finance
Principles One of those subjects which lies on the
Dalton of Public border line between Economics and
Finance- Politics. It is concerned with the
1922 income and expenditure of public
authorities and with the adjustment
of one to the other
Importance of Public Finance

 Provision of public goods: -For providing public goods like roads, military
services and street lightsetc. public finance is needed. Business firms will
have no incentive to produce such goods, as they get no payment from
private individuals.
 Public finance enables governments to tackle or offset undesirable
side effects of a market economy. The side effects are called spill overs
or externalities. For example, pollution. The governments can
introduce recycling programmes to lessen pollution or they can make
laws to restrict pollution or impose pollution charges or taxes on
activities that bring about pollution.
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 Public finance helps governments to redistribute income. To reduce the

inequality in the economy, the governments can impose taxes on the
richer people and provide goods and services for the needy ones.
 Public finance provides many a programme for moderating the incomes
of the rich and the poor. Such programmes include social security,
welfare and other social programmes.
 The acceptance of the principle of welfare state, the role of public
finance has been increasing. Modern governments are no more police
states as the classical economists viewed.
 As the scope of state participation in the economic activity is widening,
the scope of public finance has also been increasing. Generation of
employment opportunities, control of economic fluctuations like boom
and depression, maintaining economic stability etc. are some of the
thrust areas of the governments through fiscal operations.
Nature of Public Finance

The Nature And Scope Of Public Finance : Public finance is a science as well as an
art. It is a science because we study in it the various principles, problems and policies
underlying the spending and raising of funds by the public authorities. It teaches how to
collect taxes in the best way and how to maintain them economically and how to spend
them properly.
As an art, public finance enables the concerned personnel to adopt the principles
and policies in solving the financial problems of the Government in the best possible way
to the maximum benefit of the society. The way to be adopted should be logical, suitable
and proper according to the time. Application of various principles and policies depends
much on the ability of the personnel in the Government how best he can extract from it in
the public interest.
Scope of Public Finance

The scope of Public Finance can be broadly classified in to five categories
a) Public revenue b) Public expenditure c) Public debt d) Financial
administration e) Economic stabilization and f) Federal Finance.
Public Revenue:
The income of the states is referred to as Public Revenue. In this branch,
we study the various ways of raising revenue by the public bodies. We also
study the principles and effects of taxation and how the burden of taxation is
shared among the various classes of society etc.
Public Expenditure
It deals with the principles and problems relating to the allocation of
public spending. We study the fundamental principles governing the flow of
public funds in to different channels, classification and justification of public
expenditure; expenditure policies of governments and the measures adopted
for welfare state etc.
Public Debt
The governments borrow when its revenue falls short of its
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expenditure.Public debts is a study of various principles and methods of raising

debts and their economic effects. It also deals with the methods of repayments
and managements of public debts.
Financial Administration
It deals with the methods of Budget preparation, various types of
Budgets, war Finance, Development Finance etc. Thus, financial administration
refers to the mechanism by which the financial functions are carried on. In
other words, financial administration studies the organizing and disbursing of
the finances of the State.
Economic stabilization and Growth

The use of Public revenue and Public expenditure to secure stability in
levels of prices by controlling inflationary as well as deflationary pressures is
studied. Similarly the income and expenditure policies adopted by the
government so as to attain full employment, optimum use of resources,
equitable distribution of income etc. are also studied.
Federal Finance
Under federal finance we study the principles and policies governing the
distribution of functions and funds among the public authorities in a federal
set up. In a federal set up there are different levels of governments-centre,
state and local.
Public Finance and Private Finance

The understanding and the study of public finance is facilitated by a
comparison of the public or government finance with private or individual
finance. Such a comparison will help us to know how the aims and objectives
and methods of public Finance operation are similar or differed from the
financial operations of the individual.
Similarities
1. Both the State as well as individual aim at the satisfaction of human
wants through their financial operations. The individuals spend their
income to satisfy their personal wants whereas the state spends for
the satisfaction of communal or social wants.
2. Both the States and Individual at times have to depend on
borrowing, when their expenditures are greater than incomes
3. Both Public Finance and Private Finance have income and expenditure.
The ultimate aim of both is to balance their income and expenditure.
4. For both kinds of finances, the guiding principle is rationality.
Rationality is in the sense that maximization of personal benefits and
social benefits through corresponding expenditure.
5. Both are concerned with the problem of economic choice, that is, they
try to satisfy unlimited ends with scarce resources having alternative
uses.
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Dissimilarities
The private individual has to adjust his expenditure to his income.
i.e., his expenditure is being determined by his income. But on the other hand
the government first determines its expenditure and then the ways and
means to raise the necessary revenue to meet the expenditure.
The government has large sources of revenue than private individuals.

Thus at the time of financial difficulties the state can raise internal loans from
its citizens as well as external loans from foreign countries. In the case of
private individual, all borrowings are external in nature.
The state, when hard pressed, can resort to printing of currency, as an

additional source of revenue. In fact, during emergencies like war, it meets its
increased financial obligations by printing new currency. But an individual
cannot raise income by creating money.
The state prepares its budget or estimates its income and

expenditure annually. But, there is no such limitation for an individual. It
may be for weekly, monthly, or annually.
A surplus budget is always good for a private individual. But surplus

budgets may not be good for the government. It implies two things. a) The
government is levying more taxes on the people than is necessary and b) the
government is not spending as much as the welfare of the people as it should.
The individual and state also differ in their motives regarding

expenditure. The individuals hanker after profit. Their business operations
are guided by private profit motive. But the states expenditure is guided by
the welfare motive.
The private individual spends his income on various items in such a

manner as to secure equi-marginal utilities from them. The government on the
contrary does not give as much importance to this law as a private individual
does. Modern government sometimes incur cretin types of expenditure from
which there do not derive any advantage but they do incur this expenditure to
satisfy cretin sections of the community.
Individuals always seek quick returns they save only a small amount
for future and spend more to satisfy their current needs. Individual tend to
think more on the present as they are dead in the long run. Similarly they
seldom spend if it does not yield any money income. On the other hand,
State has a long term perspective of its expenditure. It does not care only
for immediate benefit. State spends on projects having long gestation
period. The burden of taxation is borne by the present generation in the
interest of long run welfare of the community. Similarly sometimes
government may have to spend on schemes which may not yield any money
income at all (e.g. Public Health).
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An individual’s spending policy has very little impact on the society as a

whole. But the state can change the nature of an economy through its fiscal
policies.
The pattern of expenditure in the case of private finance is often

influence by customs, habits social status etc. The pattern of government
expenditures is guided by the general economic policy followed by the
government.
Private Finance is always a secret affair. Individual need not reveal

their financial transactions to anyone except for filing tax returns. But Public
Finance is an open affair. Government budget is widely discussed in the
parliament and out sides. Public accountability is an important feature of
public finance.
Individuals can plan to postpone their private expenditure. But

the state cannot afford to put off vital expenditure like defence, famine
relief etc. Findlay Shiraz says that compulsory character is an important
future of public finance.
Role of public finance in Developing Economics?

Most developing countries often implement policies that have aggravated rather
than corrected the free market failures. So, it is argued that market failures ought to be
corrected by the government such as through the provision of goods and services and
through taxes and subsidies to caution the vulnerable. Experience has shown that public
finance policy reforms in most developing economies have not the corrected the free
market failures. In real terms, public finance policies should be designed on the basis of
promoting a stable economic growth and development. It can be argued that there is a
greater desire among the developing countries to increase their productivity so that the
people can attain substantially a better quality of life. Public finance affects developing
economies in many different ways. However, also public finance policies do affect key
sectors of the economy in many different ways. This is true especially that the economic
problems facing the developing countries are extremely difficult to address due to the
declining fiscal capacity.
Governments of developing economies through its public finance policies should be
able to increase rate of investment and also alter the pattern of investment. It follows to
emphasize the fact that the main role of public finance policy in developing countries is to
expand productive capacity by raising the level of real capital including skills as well as
plants and equipment and to check the demand generating effect of expanding
investment. In developed countries its role is to expand both production capacity as well
as the level of aggregate monetary demand in relation to their economic growth. In
practice, public finance policies through its different measures such as taxation policy,
budgetary policy, public debt policy and a co-ordination with monetary policy can direct
the economic destiny of a nation. For example, fiscal policy can be used to mitigate the
effects of trade cycles such as inflation and depression in an economy.
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PUBLIC FINANCE - I
UNIT - II
Public Expenditure
Public Expenditure:
Meaning and Importance
The expenses incurred by the governments for its own maintenance,
preservation and welfare of the economy as a whole is referred to as public
expenditure. In other words, it refers to the expenses of public authorities-
central, state and local governments in a federation-for the satisfaction of
collective needs of the citizens or for promotion of economic and social
welfare. The development functions include education, public health, social
security, irrigation, canal, drainage, roads, buildings, etc. The major cause of
increase in the public expenditure is nothing but, these developmental
functions. Hence, the study of public expenditure has become very
significant in the study of public finance.
The two major reasons for the same are: a) the economic activities of the state
has increased manifold and b) nature and volume of public expenditure have
greatly affected the economic life of the country in a different manner. i.e., it
has affected production and distribution and general level of economic
activities.
Prof. RA Musgrave, the twentieth century economist, advocated public

expenditure since a government is forced to do many activities such as 1)
activities to secure a reallocation of resources 2) redistribution activities, 3)
stabilizing activities and 4) commercial activities.
Causes for the Increase in Public Expenditure:

OR Need for Public Expenditure
One of the most important features of the present century is the
phenomenal growth of public expenditure. Some of the important reasons for
the growth of public expenditure are the following.
Welfare state:
Modern states are no more police states. They have to look in to the
welfare of the masses for which the state has to perform a number of
functions. They have to create and undertake employment opportunities,
social security measures and other welfare activities. All these require
enormous expenditure.
Defence expenditure:
Modern warfare is very expensive. Wars and possibilities of wars have
forced the nation to be always equipped with arms. This causes great amount
of public expenditure.
Growth of democracy:
The form of democratic government is highly expensive. Theconduct of
elections, maintenance of democratic institutions like legislatures etc. cause
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great expenditure.
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Growth of population:
Tremendous growth of population necessitates enormous spending on
the part of the modern governments. For meeting the needs of the growing
population more educational institutions, food materials, hospitals, roads and
other amenities of life are to be provided.
Rise in price level:

Rises in prices have considerably enhanced public expenditure in recent
years. Higher prices mean higher spending on the part of the govt. on items
like payment of salaries, purchase of goods and services and so on.
Expansion public sector:

Counties aiming at socialistic pattern of society have to give more
importance to public sector. Consequent development of public sector
enhances public expenditure.
Development expenditure:
For implementing developmental programs like Five Year Plans, Modern
governments are incurring huge expenditure.
Public debt:
Along with debt rises the problem like payment of interest and
repayment of the principal amount. This results in an increase in public
expenditure.
Grants and loans to state governments and UTs:

It is an important feature of public expenditure of the central
government of India. The government provides assistance in the forms of
grants-in-aid and loans to the states and to the UTs.
Poverty alleviation programs:

As poverty ratio is high, huge amount of expenditure is required for
implementing alleviation programmes.
Canons of Public Expenditure

Or Principles of Public Expenditure
The canons or principles of public expenditure are the fundamental rules
which govern the public expenditure policy of the governments. The method
and direction in which the public expenditure utilized is of paramount
importance
Professor Alfred G.Buchler made some guidelines for the utilization of
expenditure by the public authorities. They are as follows: -
a) Public expenditure should promote the welfare of the society.
b) Careful judgement should be exercised by the public authority
and the electorate to ensure that the advantages of the public
expenditure should exceed the costs and that the fund utilized
by the governments will be more conducive to social welfare than
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the same funds would, if privately utilized.

c) Public expenditure should be utilized in the order of priority of
welfare. That is, the services which will bring about maximum
welfare should be undertaken first.
Prof. Findlay Shirras has explained four canons of public expenditure.

They are canon of benefit, canon of sanction, canon of economy and canon of
surplus.
Canon of Benefit
The ideal of this is maximum social advantage. That is, public
expenditure should be planned so as to yield maximum social advantage
and social welfare of the community as a whole and not of a particular
group. Public expenditure must be spent in those directions which will
maximise utility. It is possible only when the marginal utility from different
uses is equal. The public authorities should distribute resources so as to
increase production, reduce inequalities of income distribution, preserve
social life of the people, and improve the quality of social life etc
Canon of Economy
This implies that the state should be economical in spending money.It
should not spend more than the necessary amount on items of expenditure.
The sole aim is to avoid extravagance and corruption. Social benefit can be
maximised when resources are not wasted. While incurring public
expenditure social costs are to be minimised. To satisfy this canon Project
Appraisal and Cost Benefit Analysis are to be adopted. “Economy means
protecting the interests of the tax payers not merely in effecting economies
in expenditure, but in developing revenue.”—Shirras.
Canon of Sanction
According to this canon, no expenditure should be incurred without the
proper approval of the sanctioning authority. It also implies that the spending
authorities should spend the amount for which it has been sanctioned and to
see that the sanctioned amount is properly utilized. Public accounts are to be
audited at the end of financial year. This canon acts as check on arbitrary,
unwise and reckless spending of public funds.
Canon of Surplus
This canon believes in the avoidance of deficit in public expenditure.
According to Findlay Shirras,”Public authorities must earn their living and
pay their way like ordinary citizens. Balanced budget must, as in the private
expenditure; the order of the day. Annual expenditure must be balanced
without the creation of fresh credits unrepresented by the new assets.”
Modern governments does not consider balanced budget a virtue always.
In an inflationary condition a surplus budget is desirable as it reduces
purchasing power of the individuals. Similarly, in the time of depression a
deficit budget is recommended in order to enhance the purchasing power of
the people.The canon of surplus is not relevant in modern public finance.
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Other Canons of Public Expenditure Canon of Productivity

Public expenditure should promote production and increase the working
efficiency of the people. Major part of public expenditure should be incurred
on developmental activities. The aim of public expenditure should be
maximum production, employment and income.
Canon of Elasticity
There should be flexibility in government expenditure. That is, the
government may be able to change its public expenditure policy with changing
conditions. It means that public expenditure should increase during periods of
emergency and reduce during normalcy.
Canon of Equality
This implies that public expenditure should be incurred in such a way that
inequality in the distribution of income should be reduced. For achieving this
canon the benefit of public expenditure should conferred more on the poorer
section of the society.
Canon of Neutrality
Public expenditure should not worsen the production-distribution-
exchange relationship instead of improving it. Public expenditure should result
in increased production and productivity, reduced inequality of income and
wealth and increased economic activity and exchange relationship.
Canon of Certainty
The public authorities should clearly know the purposes and extent of
public expenditure to be incurred. This anon explains the preparation of
public budgets.
Effects of Public Expenditure

The traditional economists held the view that the state should least
interfere in economic activities and the government is merely an agent for the
people to keep political organization intact. During the time of Adam Smith the
government that interfered least in the economic activities of the state was
considered the bestgovernment. Till the beginning of the 20th century, state
performed only limited functions-the maintenance of law and order and
protection of the country from the external attack. Therefore, the state had to
collect only small revenue andspend little. Recently, in almost all countries of
the world there has been a phenomenal increase in the magnitude and the
variety of governmental activities. The acceptance the principle of welfare
state, the necessity of maintaining full employment and economic
development etc. the significant role of the government has been increased.
All these show the need for an ever increasing public expenditure. In the
following few paragraphs we can explain the important effects of public
expenditure.
Effects of Public Expenditure on Production
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“Just as taxation, other things being equal, should reduce production

as little as possible so the public expenditure should increase it as much as
possible.”---Prof.Dalton. The effects of public expenditure on production can
be evaluated by examining its effects on the following.
a) Effects upon ability to work, save and invest.
b) Effects upon willingness to work, save and invest.
c) Effects upon diversion of economic resources as between
different uses and localities.
Ability to work, save and invest

Public expenditure may tend to influence the ability of the people to
work, save and invest. This is described as ‘efficiency effect’. Public
expenditure designed to increase the efficiency of the people will certainly
improve their ability to work. When a person’s ability to work is increased, his
earnings will also increase. As a consequence his ability to save also improves.
For example, expenditure on education, health services, and cheap housing
facilities, subsidised food, free education means of transportation,
communication etc. will increase the efficiency of the people to work.
Similarly, public expenditure incurred for maintaining law and order build up
the confidence in the minds of the people which will in turn encourages them
to invest in production activities. Public expenditure may have adverse effects
also. If public expenditure is spent on wasteful social functions or on the
production of intoxicants and drugs which are detrimental to health, the ability
to work, save and invest of the people may adversely be affected. Hence,
public expenditure should be incurred in such a way that it is most beneficial to
entire society
Willingness to Work Save and Invest

Public expenditure may tend to affect the willingness of the people to
work, save and invest which is described as ‘incentive effect’.As far as the will
to, save and invest is concerned, it depends to great extent on the character of
public expenditure and public policy of the governments. For example, old age
pension, provident fund benefit, insurance against sickness and
unemployment allowances etc., have an adverse effect on the willingness of
the people to work, save and invest. This is because people will have a feeling
that the governments will look after them, when they are unable to earn an
income. Therefore, public expenditure should be incurred in such a way that it
may not adversely affect the incentive to work of the people. If, however, the
benefit increases with the increase in work and the volume of savings, the
willingness to work, save and invest will increase and vice-versa. Similarly,
the willingness to work can be increased by making the benefits conditional,
i.e., the people may be required to contribute something in order to avail the
benefits of social security measures. In brief, public expenditure should be
incurred systematically and in a planned manner in order to provide social
security measures to the maximum extent. Public expenditure should also
provide opportunities under which savings and investments are properly
rewarded and do not enlarge inequalities.
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Diversion of Resources between Different Uses and Areas

Public expenditure can significantly influence the level and pattern of
production through the diversion of economic resources between different
uses and areas. Therefore, the government has to incur public expenditure in
those areas and regions which would secure maximum national production
and maximum social advantage.
For example, the public expenditure on projects like roads, railways, irrigation
energy etc. helps in accelerating the tempo of economic development.
Creation of such essential projects through diversion of economic resources
from private use to public use is very essential in developing countries.
Similarly, concessions and subsidies by governmentsmay help many industries
and agricultural activities. According to Dalton the role of public expenditure
in the diversion of economic resources from private use to government use
and as among different regions is important only when the area of economic
activities of the government is limited i.e. in a capitalistic economy.
The forms of public expenditure which increase the productive power

and are socially very much desirable for the transfer of resources are generally
of the following nature. a) Debt redemption b) Developmental projects like
irrigation, power and transport, roads, railways etc. c) Promotion of education,
research, inventions training etc. d) Provision of public health and e) Social
security etc.
Public expenditure also results in the diversion of resources among
different regions. This will reduce the regional inequality- one of the important
objectives of Indian economic panning. In order to bring about regional
balanced growth the government has to provide special expenditure
programmes to economically backward regions. Such diversion of resources
among regions is made possible by setting up a federal system of government.
Grants-in-aid from Central government to state governments and from state
governments to local governments are examples of diversion of resources.
In short, the public expenditure does have many favourable effects on

production. To conclude the effect of public expenditure on production we can
quote Dalton once again.“Whereas taxation, taken alone, may check
production, public expenditure, taken alone, should almost certainly increase
it.
Effects of Public Expenditure on Distribution

One of the important modern state policies, especially in developing
countries and socialistic countries, is reduction of inequalities in the
distribution of income and wealth. Public expenditure plays vital role in
realising this objective. According to Dalton, “The system of public
expenditure is the best, which has the strongest tendency to reduce
inequality of income.” Public expenditure which is in the form of money
grants, supply of social goods and services, social security measures, subsidies
etc. certainly affects the distribution of income in a country in socially desirable
way. Expenditures carried out for benefiting the poor people such as those on
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social services like free medical treatment, free education, unemployment

benefit etc. will enhance the benefit of the poor section than the rich. This will
help in reducing the gulf between the rich and the poor in the distribution of
income and wealth, thus bringing about justice in the economy.
Public Expenditure and Stability

Economic stability refers to a fairly stable level of national income,
employment, prices, savings and investments in the economy. The economy
may face cyclical fluctuations on account of imperfections in the market
(Depression and Inflation). Public expenditure can be used to check the
fluctuations. According to Lord J.M.Keynes economic instability implies
departure from full employment at stable price level. It is the deficiency of the
effective demand caused by a low marginal propensity to consume coupled
with low marginal efficiency of investment in developed countries. (“The
General Theory of Employment, Interest and Money-1936”)
During depression the effective demand falls short of what is required.

Deficiency in effective demand leads tounemployment which in turn reduces
consumption and finally to fall in production.In order to solve the situation
public expenditure is to be enhanced to compensate the deficiency in effective
demand. The increased public expenditure during the time of depression is
described as compensatory public expenditure. In a period of depression the
suitable public expenditure policy will be Deficit Budgeting. (i.e., Current
expenditure should be inexcess of current revenue.)
Similarly, during the time of inflation-rising prices- the public expenditure has
an entirely different role to play. The government has to adopt Surplus
Budgeting policy. That is, the government should spend less than its
revenue.During inflation that part of the public expenditure which reduces the
funds going to the people with higher propensity to consume is reduces. After
full employment, public expenditure is likely to add to inflationary pressure, for
public expenditure will further increase the purchasing power of the people
without any corresponding increase in production.
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UNIT - III
Public Revenue
Public Revenue
In the last module we have seen that in recent time, public expenditure
has been increased enormously. The main reason is that the functions of
governments have been increased manifold. The modern states are no more
police states but welfare states. Adolph Wagner, a German economist
presented his famous ‘Law of Increase of State Activities.’ He states that
‘comprehensive comparison of different countries and different times show
that among progressive people with which alone we are concerned, an
increase regularly takes place in the activity of both central and local
governments.’ This increase is both intensive and extensive.
Professor R.A Musgrave, the twentieth century economist, advocated

public expenditure since a government is forced to do many activities such as
1) activities to secure a reallocation of resources 2) redistribution activities, 3)
stabilizing activities and 4) commercial activities.
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.
The income of government through all sources is known as public

revenue or public income. Prof. Dalton defined public revenue in two senses –
Narrow sense and broader sense.
Narrow sense:
In the narrow sense, it includes income from taxes, prices of goods and
services supplied by public sector under takings, revenue from administrative
activities, such as fees, finesetc.
Wider sense:
It includes all the incomes of the governments during a given period of
time, including public borrowing from individuals and banks and income from
public enterprise it is known as public receipts.
Sources of Public Revenue

The sources of public revenue can be broadly classified in to two – Tax -
source and non- tax source.
Taxes:
Taxes are imposed by the government on the people and it is
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compulsory on the part of the citizens to pay taxes, without expecting a return.
Some definitions
Economists Definitions
Tax is compulsory contribution from a person to

Professor the government to defray the expenses incurred in the
Seligman common interests of all without reference to special
benefits conferred
Taxes are compulsory payments to the governments
Professor Taylor without expectation of direct return to or benefit to the
tax payer
The revenue from taxes came from three main sources. viz; a) Taxes on
income b) Taxes on wealth and property and c) Taxes on commodities.
What is Public Revenue?

The study of public finance is the deep study of all finance operations, related to the
state which is therefore concerned with complete income and expenditure of public authorities
and administrative structures, that are adjusted with one another.
Public finance is a concept that includes Public expenditure, public debt and public
revenue and income.
Public revenue is exactly income generated from sources of government in order to
meet requirements of expenses of public.
Meaning of Public Revenue

Public revenue generally refers to government revenue. 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
Sources of Public Revenue
A) Tax Revenue:
The chief source of public revenue is Tax. To define tax, it is said that tax is a
mandatory imposition of duty on public authority by government organizations to meet
requirements of general public as a whole.
Therefore, with the above defined term, some points are highlighted as below:
I. A Tax is a compulsory duty levied by the government. If any individual refuses
to comply with tax payments, he can be punished or penalized
II. Tax basically involves some understanding and sacrifice on the basis of a tax
payer
III. Tax is a duty and not a penalty
IV. Most part of revenue income is generated from tax by the central government.
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Broad classification of taxes is: Direct and Indirect Taxes

Direct taxes:
Direct taxes are levied on wealth and income of individuals or organizations. These
taxes are personal income tax, corporate tax, and gift or wealth tax. The impact of direct
taxes is on the same person.
Direct taxes are developing in nature and the tax rate increases along with the tax
base. Progressive direct taxes are involved in falling income discrimination especially in
rising countries.
Following major direct taxes are stated:

Personal Income Tax:
Personal income tax is duty imposed on an individual or group of individuals after specific
permissible deductions. Personal income taxes are planned as stated below:
Income (rs) Rate

0-1, 60,000 0%
1, 60,000 – 5, 00,000 10%
5, 00,000 – 8, 00,000 20%
8, 00,000 and above 30%
Senior citizens are exempted from payment of tax on income up to Rs: 2,40,000.
Females are exempted from payment of tax on income up to Rs: 1, 90,000
Corporate Tax:
Corporate tax is a duty that has to be paid on the profits registered corporate firms.
Corporate tax is direct tax because the company is given legal entity.
Present corporate tax rates are:

1. For Indian Organization – 30% + 7.5% surcharge.
2. For Foreign organization – 40% + 2.5% surcharge.
In the year 2009-2010, Corporate Tax added to 40% of the Total Tax Revenue
Other Direct Taxes

1. List of other direct taxes include, Wealth tax, Interest tax, gift tax, Expenditure tax,
etc
2. The share of these taxes is unimportant.
3. Indirect taxes
4. Indirect taxes are imposed on goods & commodities.
5. These taxes include sales tax, excise duty, service tax, customs duty, VAT, etc.
6. The impact of indirect taxes may be implied on different people.
7. In direct taxes are not progressive but regressive in nature. Here, the burden to pay
duties is indirectly or directly bearded by the consumer irrespective of their income
level.
8. Indirect taxes are of utmost importance for countries that are developing and face
low income levels.
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Major Indirect Taxes:

a) Excise Duty :
These taxes are levied on manufactured goods and consumable goods in India
Excise duty is the chief and single largest source to generate revenue income Rates of
excise duty faces a declining trend
b) Customs Duty:
This duty is imposed on exports of selective range and imports With revenue point
of view, Custom duty has less importance Peak rate of custom levy is 10%
c) Service Tax:
This tax is imposed by specific category of firms, agencies or persons Rate of service
taxes have been increased progressively
d) Goods and Service Tax

1. Goods and service tax includes range of all taxes like excise duty, service tax,
goods tax, VAT, etc
2. It covers goods and service charges in mostly all sectors
3. It generally simplifies the complexity of charges on good and services Non
tax revenues
4. Non Tax Revenue comprises all revenues apart from taxes accumulated to
the Government.
5. Non tax revenues are funds that are generated from internal sources
The sources of revenue are:

 Administrative revenues
 Commercial revenues
 Grants and gifts
Important sources of Non tax revenues include
a) Special Assessment:
 This can be called as betterment charge
 This tax is imposed to a certain category of members of a community who
are generally benefited from governmental activities or public functions like
constructions of road, railways, parks, etc
 Therefore, government imposes special charges on such properties
b) Surplus of Public Enterprises

The government has arranged public sector enterprises that are concerned in
commercial activities.
The surpluses generated of these enterprises are a significant source of non-tax
revenue.
These incomes are in the form of profits that are known as commercial revenues.
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c) Fees:
 A fee is a significant source of managerial non-tax revenue charged by
Government authorities for depiction services to the members of the public.
 There is no compulsion to pay fees. All those utilize services may pay fees.
 Fees may be charged for getting licenses, passports or registrations, filing of
court cases, etc.
d) Fine and Penalties

 These are general sources of administrative non tax revenues.
 These may be applied on public for non compliance with certain rules and
regulations.
 These are not considered as the major source of revenue for the
government
e) Grants and Gifts

 Grants are financial support
 These are provided to public authority to perform certain social activities
 These are generated by higher public authority to lower ones e.g. World bank gives
grants to State bank
 There is no repayment compulsion
 Gifts and donations are voluntarily made by individuals, organizations or foreign
governments to the Central Government.
 These gifts are made by natural feeling in case of disasters or natural calamities
 Gifts are not considered as a source of income
 Therefore, tax plays an important part in generating government revenue. Non tax is
important in developing revenue.
Changing trends in Tax and Non tax revenue in India

The Government elevates economics to meet its expenses from tax and non-tax
revenue sources.
As a matter of fact, Government expenditure goes beyond government revenue,
consequential in Government discrepancy.
Changing trends
a) Tax revenue
Tax structure is developed and divided as follows:
Central Government:
It levy taxes on income excluding agricultural income customs duty, central excise
duty and service tax.
State Government:
It levies taxes on state excise duty, agricultural income, Stamp Duty, Value Added
Tax (VAT), land revenue tax and professional tax.
Local Government Bodies:
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They levy Octroi, property tax, and tax for utilities like water supply, Sanitation etc.
Since Indian tax structure and system have faced certain reforms. These reforms include
decrease in rate of all major tax that simplifies laws and rules & procedure, modernization
of administration and enforcement machineries.
Main land tax revenue is:

 Trends in tax revenue
 Collection of tax rate has risen with reduction of tax rate, simple procedures and
high growth rate GDP.
 The share of Gross tax revenue of the Central Government as 1% of GDP has which
lies constant 9% to 10%.
 This is a low rate compared to developing or developed nations
Year Tax Revenue Rate

1990-1991 57,576 10%
2002-2003 216266 8.8%
2009-2010 641979 10.4%
Trends in direct and indirect taxes

Before liberalization revenue taxes were more than 70% income Since 1990-91
(post-liberalization), this trend got overturned due to economic development. The direct
taxes donated significantly due to raise in corporate tax and personal income tax.
Year Direct taxes Indirect taxes

1990-1991 19.1 80.9
2004-2005 43.3 56.1
2009-2010 57.7 42.0
Trends in Direct taxes

Share of direct taxes is raised. The Direct Tax Code will replace the Income and
Wealth Tax Laws and will be affective from April 1, 2011.
Main direct taxes:

Corporate Income Tax
This is the most important direct tax in order to collect revenues and contribution
to total tax revenue.
Contribution of direct tax has been increased after liberalization:
Year % Of Total Tax Revenue Rs. Crores

1990-1991 9.3 5335
2004-2005 27.1 82680
2009-2010 40.0 256725
Personal Income Tax:
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From 1990-1991, Collection of direct income tax has increased rapidly. Contribution of
personal income tax has also increased.
Year % Of Total Tax Revenue Rs. Crores
1990-1991 9.3 5371
2004-2005 16.2 49268
2009-2010 17.6 112850
Trends in Direct taxes

Total share of indirect taxes related to central government has fallen
There are 3 main indirect tax generating revenues

Excise duty
YEAR Rs. CRORES % OF TOTAL TAX REVENUE
1990-1991 24,514 42.6
2004-2005 99,125 32.5
2009-2010 1,06,477 16.6
Customs Duty:
1990-1991 20,644 35.9
2004-2005 57,611 18.9
2009-2010 98,000 15.3
Service tax (introduced in 1994-95)

1990-1991 862 0.8
2004-2005 14,200 4.7
2009-2010 65,000 10.1
Characteristics of a Tax
It is compulsory payments to the government from the citizen. Each
individual irrespective of caste, colour or creed, of age or sex has to pay it.
Refusal to pay it or delay in payment brings punishment.
It is imposes a personal obligation. It means that it is duty of tax

payer to pay it and he should in no case think to evade it.
Absence of direct benefit or quid pro quo between the State and
people. The tax payer do get many advantages from the public authorities
but no tax payer can claim direct benefit as a matter of right on the ground
that he is paying a tax.
It is payments for meeting the expenses in the common interest of all

citizens. The governments have to provide public utility goods. For this the
governments have to incur huge amounts of expenditure. Therefore, taxes are
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imposed on all citizens so that all may share a common burden.
Certain taxes are imposed on specific objectives for example, tax on

petrol to reduce consumption and tax on luxuries so as to divert resources for
the production of essential commodities.
There is no tax without representation. This means that proposals

regarding taxes are to be sanctioned in respective assembly of elected
representatives.
Non - Tax Revenue

a) Commercial Revenue. (Income from public property and
enterprises)
b) Administrative Revenue (Fee, Fine, Special assessment)
c) Gifts and grants and
d) Others
Commercial Revenue:
Income earned by public enterprises by selling their goods and services.
For example, Payments for postage, tolls, interest on borrowed funds etc. They
are also known as prices because they come in the form of prices and goods
and services provided by government.
Administrative Revenue
The receipts of incomes accrued on account of performing
administrative functions by the government are called administrative revenue.
The important items of administrative revenue are listed below.
Fees:
“Fee is a payment to defray the cost of each recurring service under
taken by the government in the public interest” – Prof.Seligman. Fees are
payments imposed by the government. For Example, Court Fee, License
Fee, Passport, Fee etc.
Fines and Penalties:

Fines penalties are imposed on persons as a punishment for
infringement of laws. They are imposed to prevent crime. Fines and penalties
are arbitrarily determined.
Special assessments:
According to Prof. Seligman “A special assessment is a compulsory
contribution levied in proportion to the special benefit derived to defray
the cost of specific improvement to property under taken in the public
interest”. For example, when the government constructs a highway, the
prices of plots on either side of it will naturally go up. There for, the land
owners may be required to bear a part of expenses incurred by the
government. Such charges are called as special assessments.
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Gifts and grants:

In general gifts and grants are the payments made by one government
to another for some specific functions for example, central grant to state
government. Gifts are voluntary contribution made by the people to the
government for some special purposes.
Other sources of Revenue:

Other sources of revenue are Forfeitures, Escheat, Issuing of currency
and Borrowings
Forfeitures:
It is penalty imposed by the court for failure of individual to appear in
the court to complete certain contract as stipulated.
Escheat:
Properties having no legal heirs or without will, that go to government
are called Escheats.
Issue of Currency:
The printing of paper money yields income to the government. It is
mean to create extra resources by the printing of paper money. It is
normally avoided because if once this method of financing is started it
becomes difficult to stop it. This further leads to inflation.
Borrowings:
This is another source of public revenue. That is through borrowings
from the public in the shape of deposits bonds etc. It also includes external
borrowings.
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UNIT - IV
Taxation
Classification Taxation
Taxes are classified on different bases. Different bases adopted by the
economists to classify taxes are the forms, nature, aims and methods of
taxation. The various taxes may be classified under following major heads.
Classification of Taxes
Direct Taxes and Indirect Taxes
According to Dalton ‘ A direct Tax is really paid by a person on whom
it is legally imposed, while an indirect tax is imposed on one person, but
paid partially or wholly by another, owing to consequential change in the
terms of some contract or bargaining between them.’
According to J.S. Mill, ‘A direct tax is one, demanded from the very person
who is intended or desired should pay it. Indirect taxes are those which are
demanded from the one person in the expectation and intention that we
shall identify him at the expenses of another’.
According to Prest, “The distinction between direct and indirect taxes

is more commonly drawn by reference to the basis of assessment rather
than the point of assessment.”
Professor Antonio defines direct taxes as, “Direct taxes strikes a

citizen’s income at the moment of its production.”
In the words of Gladstone, “The direct and indirect taxes are like two
attractive sisters between whom an exchequer should be perfectly
impartial.”
According to P.E. Taylor, an authority on public finance, distinguished

direct taxes and indirect taxes as follows,” The terms direct and indirect
taxes are finally distinguishable in meaning only in terms of shiftability.
Direct taxes are not shifted while indirect taxes are.”
From the above we can reach in a conclusion that direct taxes are
those which are paid by persons on whom these are imposed and the real
burden is also borne by them. The burden of such taxes cannot be
transferred or shifted to some other persons. That is, in the case of direct
taxes both impact and incidence fall upon the same person.
Indirect taxes are imposed on one person but, are paid either partly
or wholly by another. The person who pays the tax in the first instance,
transfers its burden on the shoulders of another person. In other words, an
in the case of indirect tax, the impact and incidence of the tax fall on
different persons.
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Examples of direct taxes are income tax, wealth tax, corporation tax, gift
tax etc. And examples of Indirect taxes are Sales tax, excise duty, VAT etc.
Merits of Direct Taxes:
Following are the main merits of direct taxes.
Equity:
Direct taxes such as income taxes, taxes on property, capital gain taxes
etc. are progressive in their nature. That is, higher incomes are taxed heavily
and lower incomes are taxed lightly. Hence, direct taxes are based on ability to
pay of the tax payer and they ensure the canon of equity.
Economy:
The administrative cost of collecting the direct taxes is low. The tax
payers directly pay the tax to the state. So there is not much waste of
resources and time. That is, direct taxes satisfy the canon of economy.
Certainty:
Another merit of direct tax is that it is certain. The tax payers know how
much tax is to be paid, on what basis tax is paid to the government etc.
Thus, the tax payer is able to make adequate provision the payment of tax in
advance. The government can also plan development activities since they can
estimate the amount of revenue they receives in the form of taxes.
Elasticity and revenue generation:

The yield from direct taxes increases as the country economically
advances. The government gets more revenue through direct taxes
automatically at higher rates.
Distributive justice:
Since direct taxes are progressive in rates, tax rate increases as the
income of individuals rises. The tax burden will heavily be on the richer
sections of the society. The increased revenue through taxes is allocated for
providing subsidized food, clothing and housing to the poor and needy people.
This will bring about distributive justice in the country.
Civic consciousness:
Direct taxes create civic consciousness among the tax payers. The tax
payers will be vigilant in the utilization of the tax revenue and will see
whether the resources are efficiently used and wastage is avoided.
Absence of leakages:
Since there is direct payment of taxes by tax payers to the government,
there is no room for any wastage. The whole amount of direct taxes such as
income taxes, property taxes, and taxes on capital gains etc., reaches the
treasury without any middlemen.
Demerits of Direct Taxes

The important demerits of the direct taxes are explained below.
Uncertainty:
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The precise degree on needed progression cannot be estimated on

account of the difficulties of measuring the ability to pay and the subjective
nature of the marginal utility of income.
Unpopularity:
The direct taxes are directly imposed on individuals. They have to bear
both the impact and incidence of these taxes. Thus they experience their pinch
directly. Consequently, direct taxes are not as popular as indirect taxes.
Violation of the principle of equity:

The burden of direct taxes falls almost exclusively on the richer sections
of the society while the poorer section are totally exempted from these taxes.
This is unjustified and improper because the burden of state expenditure
should be borne by individuals at all levels of society according to their ability
to pay.
Large scale evasion:

Direct tax is based on honesty. The tax is not evaded only when the tax
payer is honest. It is a fact that the people in the higher income groups do
not reveal their full income. It is remarked that “direct taxes are a premium
on honesty.”
Merits of Indirect Taxes

The following are the important merits of indirect taxes.
Convenience:
Indirect taxes are more convenient to pay. It is paid at the time of
purchase of a commodity. Hence, the tax payer does not feel the burden of
tax. The tax is hidden in the price of the commodity bought. It is paid in small
amount. The government can also collect it conveniently.
Indirect taxes lead to social welfare:

Indirect taxes on narcotics and intoxicants reduce the consumption of
them which are harmful to health. Reduction in the consumption of such goods
will indirectly increase the welfare of the people.
Indirect taxes are justified:

Indirect taxes are justifiable and equitable. They are paid by all the
individuals and when they purchase goods and services.
Indirect taxes help production and investment:

Another advantage of indirect taxes is that they perform as powerful
tool in moulding the production and investment activities of the economy.
No evasion:
Indirect taxes are generally difficult to be evaded as they are included in
the price of the commodity. A person can evade an indirect tax only when he
decides not to purchase the taxed commodity.
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Highly revenue yielding in developing countries:

Direct taxes do not yield much income in developing countries, as the
income of the people is very less. Since indirect taxes cover a large number of
essential commodities to be consumed by both the rich and the poor in the
country, large revenue could be collected.
Demerits of Indirect Taxes

Indirect taxes promote inequality:
Indirect taxes are generally imposed on the consumption goods. The
poor people have to pay as much by way of indirect taxes on commodities as
the rich people. This is unjust and equitable. They are regressive in nature
which will promote economic inequality in society by imposing larger burden
of taxes on the poor people.
Uneconomical:
Indirect taxes involve high costs of collecting them. To raise desired
levels of public revenue, taxes should be collected from millions of people.
Element of uncertainty:
Indirect taxes are extremely uncertain. The revenue accrued to the
government from indirect taxes cannot be estimated accurately. As soon as
the tax is imposed, the price of the commodity is raised. This will in turn
reduce the demand for the commodity. It cannot be estimated with
certainty as to what extent the demand falls.
Lack of civic consciousness:

Indirect taxes do not create civic consciousness as the tax payers in most
cases do not feel the burden of the tax they pay.
Indirect taxes promote inflation:

Another demerit of indirect taxes is that it promotes inflationary
tendency in the economy, as they would increase the prices of the taxed
goods.
Discourage saving:
Indirect taxes discourage savings because they are included in the prices
of commodities. Therefore, people have to spend more on the purchase of
commodities. This will reduces the disposable income of the people and hence
the savings.
Progressive, Proportional, Regressive and Degressive Taxes

A tax may be progressive, proportional, regressive or degressive
according to the relationship between tax rate structure and tax revenue.
Progressive Tax:
A progressive tax is that in which the rate of the tax depends on change
in income. That is, the rate of tax increases with the increase in the income.
The higher the level of income, the higher the tax will be and vice- versa.
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(Table-1)
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Table1. Progressive Tax Rates
Taxable Tax Rate% Amount of tax

income
3000 10 300
4000 15 600
5000 20 1000
6000 25 1500
Proportional Taxes
A proportional tax is one in which the rate of tax remains the same
irrespective of the level of income. Here, the same percentage of tax is levied
on all income groups. The tax amount is simply calculated by multiplying the
tax base with the tax rate. This is illustrated in Table 2.
Table 2 Proportional Tax Rate
Tax Base Tax Rate Amount of

% tax
1000 10 100
2000 10 200
Regressive Taxes3000 10 300
In regressive taxation, the higher the income of the tax payer, the
smaller is the proportion of income he contributes to the government in the
form of taxes. That is, in the regressive taxation, the tax rate declines as
income increases. This type of taxation is against the objective of welfare
state in modern time. (Table 3)
Table 3.Regressive Tax Rates

Tax Base Tax Rate Amount of tax in
in Rs. % Rs.
1000 10 100
2000 8 160
3000 6 180
Degressive Taxes
Under this tax system, the tax is mildly progressive up to a certain limit.
After that the tax may be charged at a flat rate. In other words, degressive tax
system is a mixture of proportional as well as progressive tax system. In this,
the higher income group people have to make little sacrifice in comparison
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with lower income group. (Table 4)

Table 4Degressive Tax Rates
Tax Base in Rs. Tax Rate % Amount of Tax in
Rs.
1000 10 100
2000 12 240
3000 13 390
4000 13 520
Single and Multiple Taxation

Single tax refers to a system in which the taxes are levied only on one
item or head of tax. It is only one kind of tax. It implies a tax on one thing. That
is, one class of things or one class of people. This type of tax was advocated by
th th
economists from 17 to 19 century. Such a tax is collected at regular
intervals, may be monthly or annually or any other shorter or longer duration.
A single tax may be progressive, proportional or regressive.
th
First of all, thephysiocrats during the 17 and 18th century strongly
advocated a single tax on land, for according to them agriculture was the
only productive sector yielding surplus. Issac Sherman proposed a single tax
on all real estates—on land— because it was convenient in administration
and payments. Henry George also advocated a single tax on land mainly
because he thought that it was not possible to shift the tax.
Merits of Single tax System

1) It is a very simple tax as it simplifies the work of the government.
2) It is less costly as lesser amount is spent to collect the revenue.
3) It is based social justice.
4) It does not discriminate against any particular work or industry.
Demerits
1) It Cannot bring adequate revenue to meet the needs of
the modern governments.
2) Single tax system violates the principle of ability to pay.
3) The burden of taxation is not equally distributed.
4) The tax system is not effective during the period of emergency or
crisis.
5) Tax evasion is much possible.
6) It lacks elasticity.
Multiple Taxation
The multiple taxes imply that there should be all types of taxes so that
every citizen can contribute to the state revenue. Similarly, modern economy
has to fulfil many objectives like those of economic growth, equitable
distribution of income and wealth, economic stability, full employment and so
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on. Since no single tax can realise all these objectives simultaneously, a
multiple tax system is preferred. But at the same time, too many taxes will
yield only a small amount of revenue. The cost of collection will be very high.
According to Dalton, “It is better to rely on few substantial taxes for the bulk of
revenue.” Thus, the burden of taxation should be widely distributed. Multiple
tax system is a mixture of proportional, progressive, direct and indirect taxes.
Merits
1) It leads to equitable distribution of tax burden as it includes
proportional, progressive, direct, and indirect taxes.
2) Tax evasion is very difficult under this system.
3) It is more flexible than single tax system.
4) It is based on the principle of equity.
5) It enhances the income of the governments.
Demerits
1) It is more complicated than single tax system.
2) Too much multiplicity leads to inconvenience to both the taxing
authority and the tax payer.
3) It is not based on the principle of ability to pay.
4) It checks the productive process of the economy.
Specific and Ad Valorem Taxes

According to the assessment, taxes on commodities can be divided in to
two types—Specific tax and Ad Valorem tax.
Specific Tax
Taxes which are based on specific qualities or attributes of goods are
called Specific tax. This tax is imposed on commodities according to their
weights, size or volume. It is a per unit tax on commodity. For example, specific
excise duty may be levied on the cloth in the length units and tax on sugar is
based according to the units of weight.
Advantages
1) It is quite easy to calculate and administer.
2) The collection of the tax is very convenient.
3) It does not add to inflation, since it is fixed in amount.
4) It confirms to the canon of certainty.
5) It is difficult to evade as the tax is imposed on the basis of weight,
size or measure.
Disadvantages
1) It is regressive in nature. It falls heavily on the cheaper varieties of
products which the lower income groups consume.
2) It is less equitable as compared to the ad valorem tax.
3) They are less productive and less elastic.
4) They are also less economical during the period of inflation.
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AD VALOREM TAX
When a tax is imposed on a commodity on the basis of its value, it is
called ad valorem tax. This type of tax is levied after assessing the value of the
taxable possession of a person. For example, several imported articles are
taxed in terms of value and they have nothing to do with the weight, length,
and size of the commodity.
Advantages
1) It imposes greater burden on the rich section of the society.
2) It is more equitable as it is imposed on the value of goods and
thus the canon of ability to pay is fulfilled.
3) It is highly productive and elastic.
4) It is economical.
Disadvantages
1) It is quite difficult to administer as it is difficult to assess the value
of commodities.
2) It increases inflationary pressures when there is rise in price level
3) There is wide scope for tax evasion as people may show smaller
value of a particular commodity only for the sake of saving the tax
amount.
Canons of taxation
Canons of taxation refer to the administrative aspect of the tax. They
relate to the rate, amount method of levy, and collection of a tax. In other
words, the qualities or attributes of a good tax are called canons of taxation. It
was none other than Adam Smith who gave first a detailed and comprehensive
statement of the principles of taxation. According to Findlay Shirras, “No
genius, however, has succeeded in condensing the principles into such clear
and simple canons as has Adam Smith.”
Adam Smith has given the following four canons of taxation.

 Canon of Equality
 Canon of Economy
 Canon of Certainty
 Canon of Convenience. (2 Es & 2Cs).
Canon of Equality
Canon of equity or equality is the most important and basic Canon of
taxation. It is based on the principle of social justice and ability to pay. Tax
burden should be equally distributed among the tax payers according to
their ability to pay. That is, the rich people should bear a heavy burden and
the poor a less burden. Hence, the tax system should be progressive.
According to Adam Smith, “The subject of every state ought to contribute
towards the support of the government, as nearly as possible, in
proportion to their respective abilities, that is, in proportion to the
revenue which they respectively enjoy under the protection of the state.”
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Canon of Economy
Canon of economy explains that taxes should be collected at minimum
cost. The tax laws and procedures should be simple. The administrative
machinery should not be elaborate and costly. According to Adam Smith,
“Every tax ought to be so contrived as little to take out and to keep out of
the pockets of the people as possible over and above what it brings in to
public treasury of the state.”
Adam Smith argued that lack of economy would result when:

 Tax administration is costly on account of complicated taxes.
 Taxes are unduly heavy which would discourage investment, so that the
income level reduces, hence the relative tax yields.
 Taxes are having elaborate and complicated administrative
supervision and
 Taxes are unproductive in yielding sufficient revenue.
Canon of Certainty
Taxation must have an element of certainty. That is, there must be
certainty about the tax which an individual has to pay. Things like the time
of payment, the manner of payment, and the quantity to be paid etc.
should be plain and clear to the tax payer. It should not be arbitrary.
According to Adam Smith, “The tax which each individual is bound to pay
ought to be certain, and not arbitrary. The time of payment, the manner of
payment, the quantity to be paid ought to be clear and plain to the
contributor and to every other person.”
Canon of Convenience
It explains that a tax should be levied in such manneror in such a time
that it is convenient for the tax payer to pay it. In the words of Adam Smith,
“Every tax ought to be levied at the time or in the manner in which it is
most likely to be convenient for the contributor to pay it.”
Other Canons of Taxation

Besides the four canons put forward by Adam Smith, there are some
other canons given by writers like Charles F.Bastable. They are canon of
productivity, canon of elasticity or flexibility, canon of simplicity, canon of
diversity, canon of co- ordination etc.
Canon of Productivity
Tax should be productive of large revenue. According to this canon it is
desirable to have a few taxes yielding large revenue rather than having a large
number of taxes yielding small revenue. It also implies that instead of imposing
large number of unproductive taxes, it is advisable to have a few productive
taxes.
Canon of Elasticity
It means that taxation should be flexible or elastic. That is, it should be
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capable of increasing or decreasing the tax revenue depending on the need of

the government. In other words, the tax revenue may increase automatically
whenever needed by an upward revision of tax rates or by extension of its
coverage.
Canon of Diversity
This implies that there should be a number of different taxes in the
country. This will make every citizen of a country to pay something to the
national exchequer. As the number of taxes increases it will increase the
administrative costs, reducing the revenue. Hence, too many taxes are to be
avoided.
Canon of Simplicity
This canon implies that the tax should be simple to understand even to a
layman. It should be free from all ambiguities and provisions to avoid
differences in interpretation and legal disputes.
Canon of Co-ordination
There should be co-ordination among different layers of governments in
imposing taxes. Especially, in a federal country like India there should be co-
ordination among the central, state and local governments regarding taxes,
since each of these is having legal right to impose taxes.
Impact, Incidence, and Shifting of Taxation

In modern time there is large number of taxes. In order to understand
the various social and economic effects of taxes it is very essential to discuss
terms like impact, incidence and shifting.
When government imposes taxes, the amount should be paid by
someone. In all the cases the tax burden should not be borne by the same
persons on whom the taxes are imposed. To understand this in a better way
we have to know two things—a) who pays the tax initially and b) who actually
bears the tax burden. In short, a tax may be imposed on one person; the
burden of the same may be transferred to a second person or transferred to
others who ultimately bear the burden. This is explained in the theory of
incidence. In order to understand the theory of incidence, it is very much
essential to distinguish between impact, shifting and incidence.
Impact
According to Professor Seligman, “Impact is the initial phenomenon,
shifting is the intermediate process and incidence is the result.” Impact is
otherwise called statutory tax incidence. It implies the burden of a tax
borne by the person on whom it is imposed. (De jure tax payer- De Viti). In
other words, impact refers to the immediate burden of a tax or the person
who first bears the legal obligation of a tax.
Shifting
The process of transferring the burden of a tax from one person to
another is called shifting. The producer may shift the tax burden to the
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PUBLIC FINANCE - I
wholesaler, the wholesaler to the retailers, and the retailers to the consumers
etc. This is done through the changes in prices. This is a case of forward
shifting. Forward shifting may be multi point or single point. The case
explained above is an example of multi point shifting. When the tax burden is
shifted by a producer to consumers directly it is a case of single point shifting.
Shifting may also be backward. Backward shifting refers to shifting of tax
burden to sellers by buyers. Tax capitalization is a particular case of backward
shifting.
Incidence
The final or ultimate money burden of a tax is called incidence. It is the
money burden of a tax which is borne by the last person. That is, the incidence
of a tax is the final resting place of it (De Facto tax payer- Di viti).
Distinction between Impact and Incidence

 Impact refers to the initial burden of the tax, while the incidence
is the ultimate burden of the tax.
 Impact is at the point of imposition, while incidence is at the point
of settlement.
 The impact of a tax falls upon the person from whom the tax is
collected and the incidence rests on the person who pays it
eventually.
 The impact may be shifted but the incidence cannot be shifted.
Effects and Incidence of Taxation

In economic analysis, incidence and effects are used to denote different
connotations. As we have already discussed, incidence is the final money
burden of a tax whereas effects of tax refer to the economic consequences of a
tax on production, consumption, distribution, and exchange. The study of
effects is broader than the study of incidence as taxes affect production,
consumption, savings, investments, growth, regional balance, distribution of
income and wealth and so on.
GST:
GST is an Indirect Tax which has replaced many Indirect Taxes in India. The Goods
and Service Tax Act was passed in the Parliament on 29th March 2017. The Act came into
effect on 1st July 2017; Goods & Services Tax Law in India is a comprehensive, multi-stage,
destination-based tax that is levied on every value addition.
In simple words, Goods and Service Tax (GST) is an indirect tax levied on the supply
of goods and services. This law has replaced many indirect tax laws that previously existed
in India.
GST is one indirect tax for the entire country.
So, before Goods and Service Tax, the pattern of tax levy was as follows:
Under the GST regime, the tax is levied at every point of sale. In the case of intra-state
sales, Central GST and State GST are charged. Inter-state sales are chargeable to Integrated
GST.
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PUBLIC FINANCE - I
Now let us try to understand the definition of Goods and Service Tax – “GST is a
comprehensive, multi-stage, destination-based tax that is levied on every value addition.”
Multi-stage
There are multiple change-of-hands an item goes through along its supply chain: from
manufacture to final sale to the consumer.
Let us consider the following case:

 Purchase of raw materials
 Production or manufacture
 Warehousing of finished goods
 Sale to wholesaler
 Sale of the product to the retailer
 Sale to the end consumer Goods and Services Tax is levied on each of these stages
which makes it a multi-stage tax.
Value Addition
The manufacturer who makes biscuits buys flour, sugar and other material. The
value of the inputs increases when the sugar and flour are mixed and baked into biscuits.
The manufacturer then sells the biscuits to the warehousing agent who packs large
quantities of biscuits and labels it. That is another addition of value after which the
warehouse sells it to the retailer.
The retailer packages the biscuits in smaller quantities and invests in the marketing of the
biscuits thus increasing its value.
GST is levied on these value additions i.e. the monetary value added at each stage to
achieve the final sale to the end customer.
Destination-Based
Consider goods manufactured in Maharashtra and are sold to the final consumer in
Karnataka. Since Goods & Service Tax is levied at the point of consumption. So, the entire
tax revenue will go to Karnataka and not Maharashtra.
Journey of GST in India
The GST journey began in the year 2000 when a committee was set up to draft law.
It took 17 years from then for the Law to evolve. In 2017 the GST Bill was passed in the Lok
Sabha and Rajya Sabha. On 1st July 2017 the GST Law came into force.
Advantages Of GST
GST has mainly removed the Cascading effect on the sale of goods and services.
Removal of cascading effect has impacted the cost of goods. Since the GST regime
eliminates the tax on tax, the cost of goods decreases. GST is also mainly technologically
driven. All activities like registration, return filing, application for refund and response to
notice needs to be done online on the GST Portal; this accelerates the processes.
What are the components of GST?

There are 3 taxes applicable under this system: CGST, SGST & IGST.
CGST:
Collected by the Central Government on an intra-state sale (Eg: transaction happening
within Maharashtra)
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PUBLIC FINANCE - I
SGST:
Collected by the State Government on an intra-state sale (Eg: transaction happening within
Maharashtra)
IGST:
Collected by the Central Government for inter-state sale (Eg: Maharashtra to Tamil Nadu)
In most cases, the tax structure under the new regime will be as follows:
New
Transaction Old Regime
Regime
VAT +
Sale within CGST + Central Revenue will be shared equally
the State SGST Excise / between the Centre and the State
Service tax
There will only be one type of tax
Central Sales (central) in case of inter-state sales.
Sale to
IGST Tax + Excise / The Centre will then share the IGST
another State
Service Tax revenue based on the destination of
goods.
Illustration:
Let us assume that a dealer in Gujarat had sold the goods to a dealer in Punjab
worth Rs. 50,000. The tax rate is 18% comprising of only IGST.
In such case, the dealer has to charge Rs. 9,000 as IGST. This revenue will go to the Central
Government.
The same dealer sells goods to a consumer in Gujarat worth Rs. 50,000. The GST
rate on the good is 12%. This rate comprises of CGST at 6% and SGST at 6%.
The dealer has to collect Rs. 6,000 as Goods and Service Tax. Rs. 3,000 will go to the
Central Government and Rs. 3,000 will go to the Gujarat government as the sale is within
the state.
Tax Laws before GST

In the earlier indirect tax regime, there were many indirect taxes levied by both
state and centre. States mainly collected taxes in the form of Value Added Tax (VAT). Every
state had a different set of rules and regulations. Interstate sale of goods was taxed by the
Centre. CST (Central State Tax) was applicable in case of interstate sale of goods. Other
than above there were many indirect taxes like entertainment tax, octroi and local tax that
was levied by state and centre. This led to a lot of overlapping of taxes levied by both state
and centre. For example, when goods were manufactured and sold, excise duty was
charged by the centre. Over and above Excise Duty, VAT was also charged by the State.
This lead to a tax on tax also known as the cascading effect of taxes.
The following is the list of indirect taxes in the pre-GST regime:

 Central Excise Duty
 Duties of Excise
 Additional Duties of Excise
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PUBLIC FINANCE - I
 Additional Duties of Customs

 Special Additional Duty of Customs
 Cess
 State VAT
 Central Sales Tax
 Purchase Tax
 Luxury Tax
 Entertainment Tax
 Entry Tax
 Taxes on advertisements
 Taxes on lotteries, betting, and gambling
CGST, SGST, and IGST has replaced all the above taxes. However, the chargeability of CST
for Inter-state purchase at a concessional rate of 2%, by issue and utilisation of c-Form is
still prevalent for certain Non-GST goods such as:
I. Petroleum crude;
II. High-speed diesel;
III. Motor spirit (commonly known as petrol);
IV. Natural gas;
V. Aviation turbine fuel;
VI. Alcoholic liquor for human consumption. in respect of following transactions only:
 Resale
 Use in manufacturing or processing
 Use in the telecommunication network or in mining or in the generation or
distribution of electricity or any other power
What changes has GST brought in?

In the pre-GST regime, every purchaser including the final consumer paid tax on
tax. This tax on tax is called Cascading Effect of Taxes.
GST has removed this cascading effect as the tax is calculated only on the value-
addition at each stage of the transfer of ownership. Understand what the cascading effect
is and how GST helps by watching this simple video:
This indirect tax system under GST has improved the collection of taxes as well as
boosted the development of Indian economy by removing the indirect tax barriers
between states and integrating the country through a uniform tax rate.
Illustration:
Based on the above example of biscuit manufacturer along with some numbers,
let’s see what happens to the cost of goods and the taxes in the earlier and GST regimes.
Tax calculations in earlier regime:

Action Cost 10% Tax Total
Manufacturer 1,000 100 1,100
Warehouse adds a label and repacks @ 300 1,400 140 1,540
Retailer advertises @ 500 2,040 204 2,244
Total 1,800 444 2,244
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PUBLIC FINANCE - I
Along the way, the tax liability was passed on at every stage of the transaction and the
final liability comes to rest with the customer. This is called the Cascading Effect of Taxes
where a tax is paid on tax and the value of the item keeps increasing every time this
happens.
Tax calculations in current regime:

10% Actual
Action Cost Total
Tax Liability
Manufacturer 1,000 100 100 1,100
Warehouse adds label
1,300 130 30 1,430
and repacks @ 300
Retailer advertises @
1,800 180 50 1,980
500
Total 1,800 180 1,980
In the case of Goods and Services Tax, there is a way to claim credit for tax paid in
acquiring input. What happens in this case is, the individual who has paid a tax already can
claim credit for this tax when he submits his taxes. In the end, every time an individual is
able to claim the input tax credit, the sale price is reduced and the cost price for the buyer
is reduced because of lower tax liability. The final value of the biscuits is therefore reduced
from Rs. 2,244 to Rs. 1,980, thus reducing the tax burden on the final customer. GST
regime also brought a centralised system of waybills by the introduction of “E-way bills”.
This system was launched on 1st April 2018 for Inter-state movement of goods and on
15th April 2018 for intra-state movement of goods in a staggered manner. Under the e-
way bill system, manufacturers, traders & transporters are now able to generate e-way
bills for the goods transported from the place of its origin to its destination on a common
portal with ease. Tax authorities are also benefitted as this system has reduced time at
check -posts and help reduce tax evasion.
For further reading and understanding, check out our articles:

 Know about gst.gov.in
 GST Council
 EWay Bill Guide for rules
 Guide on How to login to GSTN
 GST registration
 Best GST Software in India
 GST Return
Page 40 of 44
PUBLIC FINANCE - I
UNIT - V
Public debt
Public Debt and Budget

Among the non-tax sources, the major source of revenue of the
government is public debt. That is, borrowing. It may either be internal or
external debts. When the government raises revenue by borrowing from
within the country, it is called internal debt. Similarly, if the government is
borrowing from the rest of the world, it is a case of external debt. According
to Philip E. Taylor, “The debt is the form of promises by the treasury to pay
to the holders of these promises a principal sum and in most instances
interest on the principal. Borrowing is resorted to provide funds for
financing a current deficit.”
Causes for Public Debt

Till the beginning of the 20th century, state performed onlyvery limited
functions- maintenance of law and order, protection of the country from
external attack etc. Therefore, the state had to collect only small revenue and
little debt. Recently, in almost all countries of the world there has been a great
increase in the magnitude and variety of governmental activities. The
acceptance of the principle of the welfare state increases the role of state
participation in economic activity. This has necessitated the need to find out
additional sources of finance. Hence, modern governments have come to rely
on public borrowings.
Objectives of public debt:

The objectives of public debt are the following. To bridge the budget deficit
(Deficit Financing)
 To fight against depression.
 To check inflation.
 To finance economic development.
 To meet unforeseen contingencies.
An alternate source of income when taxable capacity is reached

 To finance wars.
 To finance public enterprises.
 To carry out welfare programmes.
 To create infrastructure.
 For creation of productive assets.
 For creation of essential non-income yielding assets (provision of
public goods) etc.
Important Sources of Public Debt

Every government has two major sources of borrowing—internal and
external. Internally the government can borrow from individuals, financial
institutions, commercial banks and from the central bank. Externally, the
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PUBLIC FINANCE - I
governments borrow from individuals and banks, international institutions like

IMF, IBRD, ADB etc. and from foreign governments.
They can be briefly summarized as follows.

 Borrowing from individuals.
 Borrowing from Non-Banking Financial Institutions (Insurance
companies, investment trusts, mutual funds etc.)
 Borrowing from commercial banks.
 Borrowing from central banks.
 Borrowing from External sources (IMF, IBRD, ADB, Foreign
Governments or countries)
Classification of Public Debt

Voluntary and compulsory (On the basis of legal enhancement):
Voluntary debt is the debt which is paid any legal enforcement. Whereas
compulsory debt is legally forced in nature. Here people have no option but
repay the debt.
Funded and unfunded debt (Provision for repayment):

Funded debt is long term or ‘definite period’ debt. A proper
agreement and terms and conditions of repayment with the percentage of
interest payable are declared. They are used for creation of permanent assets.
Unfunded debt is for a short term and for indefinite period. It is paid through
the income received from other sources. These are used for meeting current
needs.
Internal and external debt:

When the government raises revenue by borrowing from within the
country, it is call internal debt. Whereas if the government is borrowing from
the rest of the world, it is case of external debt.
Productive and Unproductive(Purpose of loans):

Loans on Projects yielding income (Construction of plants, railways,
power schemes etc.) are called productive debt. Loans on loan non income
yielding projects are called unproductive loans (war, famine relief etc.)
Redeemable and Irredeemable loans (Promise to repay):

Redeemable debts refer to the loan which the government promises
to pay off at some future date. (principal plus interest) Irredeemable debts
are those, principal amount of which are never returned by the government
but pays interest regularly.
Short / Medium / Long term loans (Time duration):

Short term loans are usually incurred for a period varying from three
months to one year. Usually governments get such loans from the central bank
by using treasury bills. These loans are calls ‘ways and means advances.’
Medium Term loans are those which are obtain for more than one year
but less than ten years. Long term loans are those which are obtain for more
Page 42 of 44
PUBLIC FINANCE - I
than ten years. These are used to finance developmental activities.
Redemption of Public Debt

Redemption of public debt means repayment of a loan and it is an
important responsibility of the government. All government loans should be
repaid promptly. It is, therefore, necessary that the provision of repayment
should be inherent in the scheme itself.
Advantages of debt redemption

 It saves the government from going into bankruptcy.
 It checks extravagance on the part of the governments.
 It preserves the confidence of the lenders.
 It makes easy for the government to float future loans.
 It reduces the cost of management of public debt.
 It saves the future generations from the pressure of public debt.
 The resources obtained after redemption of the debt would be diverted
towards private investments and therefore a favorable climate for
investment could be created.
 Redemption of debt may act as a useful tool to curb deflation.
Methods of Repayment of Debt

Repudiation:
It means refusal to pay a debt by governments. This method was
followed by the USA after the civil war and by the USSR after the 1917
Revolution. This method is undesirable and has not been used recently
anywhere in the world. Repudiation shakes the confidence of the people in
public debt and many provoke retaliation from creditor countries.
Refunding:
Refunding is the process of replacing maturing securities with new
securities. In some cases the bonds may be redeemed before the maturing
date when the government intends to rearrange the maturity of outstanding
debts or when current rate of interest is low. Generally, short-term borrowings
are made in anticipation of tax collections for meeting current expenditure.
However, excessive burden of new expenditure does not permit the
retirement of the debt by means of revenue newly raised or by means of long
term borrowing. Thus, there is necessity of refunding the loans by old lenders
and renewing the loans at lower rate of interest for future period. The
drawback of this method is that government is tempted to postpone its
obligation of debt redemption. This leads to a continuous increase in the
burden of public debt in future.
Conversion of Loans:
It is a special type of refunding. Conversion of existing securities into
new securities before maturity It is generally resorted to reduce the burden of
debt by converting high interest loans into low interest loans. According to
Professor Dalton, the conversion does not reduce the burden of public debt on
the state; because a reduction in interest rates reduces the ability of the
Page 43 of 44
PUBLIC FINANCE - I
creditors to pay taxes which may mean a loss of income to the governments
there by reducing its capacity to repay loans.
Sinking Fund:
Sinking fund is a special fund created for the repayment of public debt.
There is a theoretical justification for creating this fund because it imposes a
requirement on the government to pay the old debts regularly. According to
this method, the government sets aside a certain amount out of the budget
every year for this fund. The balances in the funds are also invested and the
interest accruing on them is also credited in the fund.
Sinking fund is of twotypes:

certain sinking fund - here, the governments credit
a fixed sum of money annually.
Uncertain sinking fund - the amount is credited when government
secures a surplus in the budget.The one danger of this method is that the
government may not wait till the end of the period of maturity and utilize the
fund for some other purpose than the one for which the fund was created
originally.
The practice of sinking fund inspires confidence among the lenders and
the enhancement of the creditworthiness of governments.
Capital levy:
Capital levy is a special type of “once for all” tax on capital imposed to
repay war debts. All capital goods are taxed above a minimum level of assets
possessed by residents of the country. Simply, capital levy refers to a very
heavy tax on property and wealth. This tax was levied immediately after the
First World War. This method has been advocated by economists like David
Ricardo, Pigou and Dalton.Professor Dalton has suggested that capital levy as a
method of debt redemption with least real burden on the society. It is useful
on account of its deflationary character.
Surplus budget:
Quite often, surplus budget may be used to clear public debt. But in
recent times due to the ever increasing public expenditure, surplus budget
is a rare phenomenon.
Buying up of Loans:
Governments redeem debt through buying up loans from the market.
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STUDY MATERIAL FOR B.

UNIT CONTENT PAGE Nr

III PUBLIC REVENUE 15

Meaning and Scope of Public Finance

Economists Publication Definition

For all States – whether crude or highly

Importance of Public Finance

 Public finance helps governments to redistribute income. To reduce the

Nature of Public Finance

Scope of Public Finance

expenditure.Public debts is a study of various principles and methods of raising

Economic stabilization and Growth

Public Finance and Private Finance

The government has large sources of revenue than private individuals.

The state, when hard pressed, can resort to printing of currency, as an

The state prepares its budget or estimates its income and

A surplus budget is always good for a private individual. But surplus

The individual and state also differ in their motives regarding

The private individual spends his income on various items in such a

An individual’s spending policy has very little impact on the society as a

The pattern of expenditure in the case of private finance is often

Private Finance is always a secret affair. Individual need not reveal

Individuals can plan to postpone their private expenditure. But

Role of public finance in Developing Economics?

Prof. RA Musgrave, the twentieth century economist, advocated public

Causes for the Increase in Public Expenditure:

Rise in price level:

Expansion public sector:

Grants and loans to state governments and UTs:

Poverty alleviation programs:

Canons of Public Expenditure

the same funds would, if privately utilized.

Prof. Findlay Shirras has explained four canons of public expenditure.

Other Canons of Public Expenditure Canon of Productivity

Effects of Public Expenditure

Effects of Public Expenditure on Production

“Just as taxation, other things being equal, should reduce production

Ability to work, save and invest

Willingness to Work Save and Invest

Diversion of Resources between Different Uses and Areas

The forms of public expenditure which increase the productive power

In short, the public expenditure does have many favourable effects on

Effects of Public Expenditure on Distribution

social services like free medical treatment, free education, unemployment

Public Expenditure and Stability

During depression the effective demand falls short of what is required.

Professor R.A Musgrave, the twentieth century economist, advocated

The income of government through all sources is known as public

Sources of Public Revenue

Tax is compulsory contribution from a person to

What is Public Revenue?

Meaning of Public Revenue

Broad classification of taxes is: Direct and Indirect Taxes

Following major direct taxes are stated:

Income (rs) Rate

Present corporate tax rates are:

Other Direct Taxes

Major Indirect Taxes:

d) Goods and Service Tax

The sources of revenue are: