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Sunday, November 05, 2017

Public Finance Solved Papers: Nov' 2014

2014 (November)
The figures in the margin indicate full marks for the questions.
1. Answer the following questions:                                                                                          1x8=8
(a)    Give an example of social goods.   Examples of social goods are clean air, clean water.
(b)   Mention one cannon of taxation.     Canon of certainty
(c)    Mention any one source of public debt of Government of India.  Loans from bank and financial institution.
(d)   State the year in which the Income-tax Act of India was passed.                        1961
(e)   Mention one example of developmental expenditure of a State in India.      Expenditure on education, health, employment, industry etc.                         
(f)     Write the full form of ‘VAT’.                                Value added tax
(g)    Mention a tax levied by Municipal Corporation.                         Property tax
(h)   Name the Chairperson of the Thirteenth Finance Commission of India.          Dr. Vijay L Kelkar, 14th finance commission – Dr. Y. V. Reddy

2. Write short notes on:                                                                                                4x4=16
(a)    Private and Public finance
Ans: Public Finance and Private Finance

Generally, the word ‘finance’ is loosely used for both the public and private finance. By private finance, we mean the study of the income, debt and expenditure of an individual or a private company or business venture. On the other hand public finance deals with income, expenditure and borrowings of the government. There are both similarities and dissimilarities in governmental financial operations as compared to the monetary operations of private businessman. An individual is interested in the utilisation of labour and capital at his disposal to satisfy social wants. In short, both private finance and public finance have almost the same objective of satisfaction of human wants. Again, private finance stresses individual gains whereas public finance attempts at promoting social welfare of the whole community. These two view points are correct to greater extent only because of their similarities as well as dissimilarities between both.
Similarities between Public and Private Finance
a)      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.
b)      Both the States and Individual at times have to depend on borrowing, when their expenditures are greater than incomes.
c)       Both Public Finance and Private Finance have income and expenditure. The ultimate aim of both is to balance their income and expenditure.
Dissimilarities between Public and Private Finance
a)      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.
b)      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.
c)       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.

(b)   Techniques of budgeting.
Ans: Techniques of Budgetary Control
a)      Zero Based Budgeting
b)      Performance Budgeting
Zero Based Budgeting
Zero Base Budgeting is a new technique for the preparation of budgets. It involves fresh evaluation of every item of expenditure as if it were a new item. It is reconsideration of each item of expenditure from the very beginning. It is like assuming that a zero expenditure has been incurred on a project at the time of its review, although the project may be in existence from a long time and may have involved some expenditure also. The review is meant to provide a justification or otherwise of the project as a whole in the light of objectives set for it and priorities of the society. The procedure is altogether different from the usual procedure followed in India.

Peter A. Phyrr describes, the concept of zero base budgeting as an operating, planning and budgeting process that requires each manager to justify a budget request in detail from scratch…….” It means, the budget as a whole is considered rather than to examine incremental change only.
According to Prof. R. A. Musgrave, “the idea of zero base budgeting is to consider the budget as a whole, rather than to examine incremental changes only.”
Performance Budgeting
Performance budgeting is generally understood as a system or technique of presentation of public expenditure in terms of functions, programmes, performance units, i.e. activities, projects etc, reflecting primarily the government output and its cost. The focus in a performance budgeting is basically different from that in the conventional budgets. The two approaches differ in their scope and context. Under the performance budgeting, emphasis is shifted from the budget as a means of accomplishment to the accomplishment itself. If concerns itself primarily with the objectives aimed at by the government rather than with the outlays incurred on several projects. According to U. S. Bureau of Budget, “A performance is one which presents the purpose the objectives for which funds are required, the cost of the programmes proposed for achieving those objectives and quantitative data measuring the accomplishment and work performed under each programme.”
(c)    Taxable capacity
Ans: Taxable capacity refers to the maximum capacity that a country can contribute by way of taxation both in the ordinary and extraordinary circumstances. It represents maximum limit to which the government can tax the people of the country. If the government exceeds this limit, it shall result in over taxation, which, besides being injurious to the long-term interests of the community, may pose a serious threat, to the political stability of the country concerned. The concept of taxable capacity, thus, indicates the limit to which the government can tax the citizens.
Taxation Inquiry Commission defined it as, Taxation capacity of different sections of the community may be said to refer to the degree of taxation, broadly speaking, beyond which productive effort and efficiency as a whole begin to suffer. The concept of taxable capacity has been interpreted by the economists in the following two senses: (i) the absolute taxable capacity of one single community, and (ii) the relative taxable capacity of two or more communities.
(d)   Deficit financing
Ans: Deficit Financing: Deficit means an excess of public expenditure over public revenue. This excess may be met by borrowings from the market, borrowings from abroad, by the central bank creating currency. In case of borrowing from abroad, there cannot be compulsion for the lenders, but in case of internal borrowings there may be compulsion.

3. (a) What is ‘Public Finance’? Discuss the nature and scope of public finance.                                     2+5+5=12
Ans: Meaning and Definition of Public Finance
Public finance is a study of income and expenditure or receipt and payment of government. It deals the income raised through revenue and expenditure spend on the activities of the community and the terms ‘finance’ is money resource i.e. coins. But public is collected name for individual within an administrative territory and finance. On the other hand, it refers to income and expenditure. Thus public finance in this manner can be said the science of the income and expenditure of the government.
Different economists have defined public finance differently. Some of the definitions are given below. 
According to prof. Dalton “public finance is one of those subjects that lie on the border lie between economics and politics. It is concerned with income and expenditure of public authorities and with the mutual adjustment of one another. The principal of public finance are the general principles, which may be laid down with regard to these matters.
According to Adam Smith “public finance is an investigation into the nature and principles of the state revenue and expenditure”
To sum up, public finance is the subject, which studies the income and expenditure of the government. In simpler manner, public finance embodies the study of collection of revenue and expenditure in the public interest for the welfare of the country
Nature of Public Finance
Nature of Public finance implies whether it is a science or art or both.
a)      Public Finance is a science: Science is a systematic study of any subject which studies casual relationship between facts. Public finance is a systematically study relating to revenue and expenditure of the government. It also studies the casual relationship between facts relating to revenue and expenditure of the government. Prot. Plehn has advanced the following arguments in favour of public finance being science.
1)      Public finance is not a complete knowledge about human rather it is concerned with definite and limited field of human knowledge.
2)      Public finance is a systematic study of the facts and principles relating to government revenue and expenditure.
3)      Scientific methods are used to study public finance.
4)      Principles of public finance are empirical.
Science is of two types: (1) Positive science and (2) Normative science. In positive science one knows about factual situation or facts as they are. It describes “what is”. As against it, normative science presents norms or ideals. It describes “what ought to be” or what is right or wrong i.e. value judgement. By the study of public finance one gets factual information about the problems of government’s revenue and expenditure. Public finance is therefore, a positive science. Study of public finance also reveals what should be the quantum of taxes. Which taxes, direct or indirect, should be imposed. On what items more or on what items less of public expenditure is incurred. Public finance is therefore a normative science. Thus, study of public finance offers suggestions regarding revenue and expenditure of the government as also apprises of their factual position.
b)      Public Finance is an art: In the words of J.N. Keynes, ”Art is the application of knowledge for achieving definite objectives.” Fiscal policy which is an important instrument of public finance makes use of the knowledge of the government’s revenue and expenditure to achieve the objectives of full employment, economic equality , economic development and price stability, etc. To achieve the objective of economic equality taxes are levied at progressive rate. Since every tax is likely to be opposed, it becomes essential to plan their timing and volume. The process of levying tax is certainly an art. Budget making is an art in itself. Study of public finance is helpful in solving many practical problems. Public finance is therefore an art also.
In sort, public finance is both science and art. It is a positive science as well as normative science.
Scope of Public Finance (Subject Matter of Public Finance)
The scope of public finance may be summarised as under:
1.       Public Revenue
2.       Public Expenditure
3.       Public Debt
4.       Financial Administration
5.       Economic Stabilisation
1.       Public Revenue: Public revenue concentrates on the methods of raising public revenue, the principles of taxation and its problems. In other words, all kinds of income from taxes and receipts from public deposit are included in public revenue. It also includes the methods of raising funds. It further studies the classification of various resources of public revenue into taxes, fees and assessment etc.
2.       Public Expenditure: In this part of public finance we study the principles and problems relating to the expenditure of public funds. This part studies the fundamental principles that govern the flow of Government funds into various streams.
3.       Public Debt: In this section of public finance, we study the problem of raising loans. Public authority or any Government can raise income through loans to meet the short-fall in its traditional income. The loan raised by the government in a particular year is the part of receipts of the public authority.

4.       Financial Administration: Now comes the problem of organisation and administration of the financial mechanism of the Government. In other words, under financial or fiscal administration, we are concerned with the Government machinery which is responsible for performing various functions of the state.
5.       Economic Stabilization: Now –a-day’s economic stabilization and growth are the two aspects of the Government economic policy which got a significant place in the discussion on public finance theory. This part describes the various economic polices and other measures of the government to bring about economic stability in the country.
From the above discussion, we can say that the subject-matter of public finance is not static, but dynamic which is continuously widening with the change in the concept of state and functions of the state. As the economic and social responsibilities of the state are increasing day by day, the methods and techniques of raising public income, public expenditure and public borrowings are also changing. In view of the changed circumstances, it has given more responsibilities in the social and economic field.
(b) “The study of Public Finance has assumed increasing significance in the field of economic analysis in recent years.” Explain the statement.                                        12
Ans: Importance (Significance) of Public Finance
There is great socio-economic significance of public finance, both in developed and developing countries. In developed country countries, price-stability and full employment are the main economic goals of public finance. In developing countries, rapid economic development through capital formulation and creation of infrastructure art the important goals of public finance operations. Socially equitable distributions of income, reduction of inequalities in income are some important functions of public finance operations. The importance of public finance can be clarified from the following functions.
1. TO INCREASE THE RATE OF SAVING AND INVESTMENT: Most of the people spend their income on consumption. Saving is very low so the investment is also low. The government can encourage the saving and investment.
2. TO SECURE EQUAL DISTRIBUTION OF INCOME AND WEALTH: Unequal distribution of income and wealth is the basic problem of the under developed countries. The rich are getting richer and richer while the poor are becoming poorer and poorer. So for the equal distribution of income and wealth there is need of government.
3. OPTIMUM ALLOCATION OF RESOURCES: Fiscal measures like taxation and public expenditure programmers can greatly affect the allocation of resources in various occupation and sectors.
4. CAPITAL FORMULATION AND GROWTH: Fiscal policy will be designed in a manner to perform two functions as of expanding investment in public and private enterprises and by diverting resources from socially less desirable to more desirable investment channels.
5. PROMOTING ECONOMIC DEVELOPMENT: The state can play a prominent role in promoting economic development especially through control and regulation of economic activities. It is fiscal policy which can promote economic development.
6. IMPLEMENTATION OF PLANNING: Under democratic planning fiscal policy plays crucial role as financial plan is as much important as physical plan and the implementation of the financial will obviously depend upon the uses of fiscal measures.
7. INFRASTRUCTURE BUILDING: Public finance helps to build up well-development physical and institutional infrastructure.
8. TO CONTROL INFLATION: The imbalance between demand for and supply of real resources may lead to inflations to under-development countries inflation ruins the entire economic structure of the national and the process of economic development in these countries comes to stand still. So to check inflation, budgetary policies can be used by the government.
Role of public finance in an underdeveloped country
Public Finance occupies great significance in an underdeveloped or developing country. According to R. J. Chelliah, “Public finance has a positive and significant role in the context of economic development.” The importance of public finance in an underdeveloped/developing country like India may be summarized as under:
a)      Capital Formation: Since development entirely depends on the rate of capital formation in the country, the first and foremost aim of public finance is to promote capital formation. Students of commerce and economics are well aware of the fact that the burning problem of an underdeveloped or developing country is the low capital formation. In the words of Dr. Baljit Singh, “For an undeveloped country all economic policies and measures in the initial stages must concentrate on production and fiscal policy should act as a tool of capital formation.” Capital formation can be increased through an effective and well-planned taxation policy. In the words of R. Nurkse, “For economic development, it is not the aim of public finance to bring about reduction in inequalities of incomes but its aim is to increase that proportion of the income which goes into capital formation.”
b)      Unemployment Problem: Another major problem of an underdeveloped/developing country is the unemployment problem. Increased income may be eaten up by a large mass of unemployed people. This problem of unemployment leads again to low standard of living, poverty, backwardness, ignorance and above all starvation. It is the function of public finance to provide employment opportunity. In the connection must be remembered that fiscal policies (public finance policies) are most effective tools for tackling of the problem of unemployment.
c)       Planned Economic Development: In underdeveloped/developing countries the productive resources are limited in quantity as well as quality. Public finance renders valuable help in the planned economic development of the country. The entire machinery of planning works through the mechanism of public finance. The principles of public finance have paramount importance in the sphere of rapid economic planning because both of these are the closely related activities of the state. For example, the Government of India is raising necessary funds through taxation etc. for formulation and implementation of its five year plans.
d)      Increase in Income: Capital formation is not an end in itself but only a means of achieving another important end, i.e. increase in income. The object of public expenditure is to increase the income in underdeveloped countries so at to invest funds in such industries and in such an economical and efficient manner that least amount of money fetches the greatest possible output. The Government gives subsidies and grants to industries to enable them to increase production at cheaper rates. This will lead to prosperity and development with an overall increase in the income of the masses.
e)      Reduction in Economic Inequalities: Another problem of underdeveloped or developing countries is the unequal distribution of income and wealth to the public. Public finance has an important role to play in this context. For example, the Government can impose heavy taxes (such as income tax) on the richer sections of the society and spend the income so received on providing cheap food, cheap housing, employment, free medical aid etc. for poorer sections of the society.
f)       Optimum Utilization of Resources: Another major problem of underdeveloped or developing countries is the problem of non-utilization or even destruction of the scarce and limited resources. The solution of this basic problem lies in the optimum utilization of these available resources by means of adopting planned monetary and public finance policies. The state can direct the flow of consumption, production and distribution in the right direction by adopting balanced budget policy.
g)      Problem of Economic Stabilization: Another problem of an underdeveloped and developing country is the economic instability. After 1929-30 worldwide depression, it has been emphasised that public finance (revenue and expenditure process of the Government) may be used to secure economic stability or to remove economic fluctuations and distortion in the economy.
h)      Increase to Savings: The major problem of developing and underdeveloped countries is that savings are very nominal which hinder their economic development. Public finance encourages the accumulation of savings.
4. (a)      What do you mean by ‘Financial Administration’? Briefly analyze the various instruments of Financial Administration.                                3+8=11
Ans: Meaning of Financial Administration
In simple words, financial refers to such a system or method by which one can analyse the financial working of the public authority. Thus the focuses on the procedure which ensure the lawful use of public funds. However the concept has been differently defined as under:
Prof .M.S Kenderic, “The financial administration refers to the financial measurement of govt. including the preparation of budget method of administering the various revenue resources the custody of the public fund, procedures in expending money, keeping the financial records and the like. These functions are important to the effective conduct of operation of public finance”
Prof. Dimock, “Financial administration consists of a series of steps whereby funds and made available certain official under procedures which will ensure their lawful and efficient use. The main ingredients are budgeting, accounting, auditing and purchase and supply.”
From these definitions one can easily find four ingredients (Methods/Process) of financial administration:

For the success of financial administration of the Government, different constitution play imperative role. These agencies can be grouped as:
a)      Executive
b)      Legislature
c)       Financial Department of Financial Ministry
d)      Auditing Department
a)      Executive. According to Prof. H. M. Grover, “The executive is the best position to the view the financial problem as a whole ant to assume the responsibilities for the success and failure of a financial programme.” Executive is responsible for running the administration, thus it is in the best position to say what funds are required for it. No tax or expenditure can be made without the permission of the executive. It is therefore, the responsibility of the executive to prepare the budget which is stupendous task.
In Parliamentary Government, there is a principle that no demands for grants can be made except on recommendation of the executive. It is therefore In India; executive refers to the Central Government. Since, Finance Ministry is responsible for the administration of the finance of the Central Government, even then it performs the policy making function and tries its best to get the final approval of the legislature.
b)      Legislature. In democratic parliamentary system, it is the legislature or parliament which is the time representation of the people. In India, under the constitution there is special provision to control the finances:
1.       Controller over Taxation. Indian constitution under Article 265 provides that no tax shall be levied or collected except the permission of law. Thus, The Government has to present all tax proposals before parliament in the form of a Bill to be passed into law and unless no art is passed, no tax can be levied. Similarly U.S.A constitution under article one mentions, “The congress shall have to levy and collect tax.”Therefore under, we can conclude that the power of taxation always vests with literature.
2.       Control over Public Expenditure. In Indian constitution states. “All revenues received of all loans by the union or state shall be paid into in the consolidated funds of the union or state, as case may be ad that no money can be written out of  the fund except in accordance with the law and for the purpose and in the manner provided for in the constitution.”
3.       Enforcement of Financial Accountability. Every Government is bound to spend the money granted by the parliament for no purpose other than it was sanctioned by the legislature or parliament. This function is performed by the Comptroller and Audit-General of India. In this way, one can say that Parliament is the supreme in Finance matters.
c)       Financial Ministry: This Finance Ministry plays significant role in financial administration as it ensure that proper use of public funds. It controls the both before the presentation of budget to parliament to and in it executive after approval by the parliament. The Finance Ministry possesses the expert knowledge in financial matters. It considers all proposals to each ministry in the perspective of the government as whole.
The various scheme and proposals of the different ministries are included in the budget after consultations and discussions with the finance ministry. After the final approval of the budget by the parliament, it seeks to ensure that the amounts are properly spent in accordance with the provision of budget. Therefore, it is the finance ministry which frames rules and regulations about the preparation and executive of the budget. The ministry of finance has been divided into four departments, viz
1.       Department of Economic Affairs.
2.       Department of Revenue and Insurance.
3.       Department of Expenditure.
4.       Department of Co-ordination.
d)      Auditing. Auditing is the most important ingredients of parliamentary control over the finances of country as a hole. In a democratic form of government, the supreme authority with the regard to financial policy is vested in legislature. This is ensured by the provision of audit of public expenditure by an independent statutory authority i.e. Comptroller and Audit-General. Therefore, audit supplies an essential link between the executive and parliament and helps in interpreting the action in so as the have a finance bearing of the former on the latter.
(b) What is ‘zero-base budgeting’? Explain its need and pre-conditions.                    3+4+4=11
Ans: Zero Based Budgeting
Zero Base Budgeting is a new technique for the preparation of budgets. It involves fresh evaluation of every item of expenditure as if it were a new item. It is reconsideration of each item of expenditure from the very beginning. It is like assuming that a zero expenditure has been incurred on a project at the time of its review, although the project may be in existence from a long time and may have involved some expenditure also. The review is meant to provide a justification or otherwise of the project as a whole in the light of objectives set for it and priorities of the society. The procedure is altogether different from the usual procedure followed in India.
Peter A. Phyrr describes, the concept of zero base budgeting as an operating, planning and budgeting process that requires each manager to justify a budget request in detail from scratch…….” It means, the budget as a whole is considered rather than to examine incremental change only.
According to Prof. R. A. Musgrave, “the idea of zero base budgeting is to consider the budget as a whole, rather than to examine incremental changes only.”
Essentially, the concept of zero base budgeting is that all the financial requirements of a budget unit are analyzed, evaluated and justifies annually and not just the increased or additional requirements. In more practical way, zero base budgeting means the evaluation and prioritization of all programmes at different levels of effects. To be simpler, under zero base budgeting, each department ministry is required to justify its budget requests from the bottom up, evaluating alternative programme packages and ranking programmes so as to select the best alternative and allocate resources accordingly. The budget is considered as a whole and a fresh one, i.e. from zero base.
Need of Zero-base budgeting
Zero-base budgeting is revolutionary concept and is relatively a new management tool for planning and control of activities. It involves people at all levels in the organization and promotes team sprit. The plans and budgets based upon ZBB are much improved than shoes based upon traditional budgeting. There are a number of benefits that arise from zero-base budgeting. Some of the important advantages of ZBB are enumerated below:
1.       Proper Allocation of Funds: It enables management to allocate funds according to the jurisdictions of the programme. The priority can be fixed for various activities and their implementation will be in the same order.
2.       It improves Efficiency: Zero-base budgeting improves efficiency of the management. Every manager will have to justify the demand for resources. Only those activities will be undertaken which will have justification and will be essential for the business.
3.       Identification of Economical Areas: Zero-base budgeting will help in identifying economical and wasteful areas. Emphasis will be given to economical activities and alternative courses of action will also be studies.
4.       Optimum use of Resources: The management will be able to make optimum use of resources. The expenditures will be undertaken only when it will have justification. A list of priorities is prepared and cost-benefit analysis will be the guiding principle in fixing the priority.
5.       Determining of Utility: Zero-base budgeting will be appropriate for those areas whose output is not related to production. It becomes difficult to evaluate the performance of those sides which are not directly related to production but undertaken other activities. This technique will be helpful in determining the utility of each and every activity of the business.
6.       Useful of Attain organizational Goals: Budgeting will be related to organizational goals. Something will not be allowed the plea that it was done in the past. Only those things will be allowed which will help in realizing organizational goals.
7.       Job Satisfaction: ZBB ensures greater participation of personnel in formulation and ranking processes. This helps in promoting level of job satisfaction and thus resulting in better control and operational efficiency in the organisation. 
8.       Applied to priority areas: Zero base budgeting is a flexible tool that can be applied on a selective basis. It does not have to be applied throughout the entire organisation or even in all the service departments. Keeping in view the limitations of time, money and persons available to install, operate and monitor it the management thus can select priority areas to which zero base budgeting may be applied. 
The introduction of Zero Base Budgeting (ZBB) is not as easy as it appears. It requires a tremendous paper-work and detailed analysis. Thus, the organization should be able to provide all information including the cost data necessary for introducing ZBB. Moreover, the successful implementation of the zero base budgeting also depends upon the availability acceptability of the concept in letter and spirit. Obviously, this acceptance would be associated with the organization where the new system has to be implemented. It is so because any apathy on the part of the people could lead to a situation in which priorities relating to the existing schemes may not be assessed accurately. In short, it requires the following pre-conditions:
1. Committed Management: The top management must be committed as well as have a participatory role.
2. Fixed goals: Organisational goals must be fixed. As ZBB is not an end product itself but a means to achieve targets, goal setting must not be vague and ambiguous.
3. Identification of weakness: Weakness of an organisation must be perceived and strengths enumerated so that identified weak areas can be worked upon.
4. Trained staff: ZBB requires staff to be trained for its procedures to be implemented properly.
5. Elimination of doubts: All levels of management must cooperate with each other by eliminating all doubts regarding the ZBB procedure.
6. Review: Decision packages must be reviewed periodically.
7. Brainstorming Session: There must be brainstorming sessions at all hierarchical levels to get proper and timely feedback.
5. (a) Define taxation. Mention the effects of taxation on production and distribution.                                3+8=11
Ans: Meaning and Definition of Tax
In simple words, it is a compulsory payment by the people. If a person defies the tax payment, he may be punished in the court of law. However, different economists tried to define taxation in a different style as stated below :
Adam Smith : “A tax is a contribution from citizens for the support of the state.”
Saligman: “A tax is compulsory payment from a person to govt. to defray the expenses incurred in the common interests of all without reference to special benefits conferred.”
Bastable : “Tax is a compulsory contribution of the wealth of a person or body of persons for the service of the public powers.”
Taussig : “The essence of a tax is distinguished from other charges by govt. in the absence of direct quid pro quo between the tax-payer and public authority.”
Dalton : “A tax is a compulsory contribution imposed by a public authority irrespective of the exact amount of service rendered to the tax-payer in return and not imposed as penalty for any legal offence.”
From these mentioned definitions, it is clear that the taxes are not a voluntary contribution by the tax-payer but it is compulsory in nature. Therefore, one can say that every payment by individuals to the state is not a tax. It is just like withdrawal from the people’s income which reduces their purchasing power. It should be noted here that tax checks production where as public expenditure may spurt the productive process. In the opinion of Dr. R.N. Bhargava, taxes are as much compulsory as other payment, like fees etc. In this context, Dalton says, “Where taxation, taken alone, may check production, public expenditure taken alone, should almost certainly increase it.” So, tax is a necessary contribution by the tax-payer to social objectives like reducing inequalities in income and wealth, securing high level of employment as well as promoting economic stability with growth.
Dalton discusses the economic effect of taxation under the following heads: 1. Effect of Taxation on Production, 2. Effect of Taxation on Distribution:
1. Effect of Taxation on Production: According to Dalton effect of taxation on production can be in the following three ways:
(a) Effect on ability to work, save and invest.
(b) Effect upon willingness to work, save and invest.
(c) Effect of taxation on composition or pattern of production, i.e., on allocation of resources as between different uses.
(a) Effect of Taxation on Ability to Work, Save and Invest: Any person’s ability to work will be reduced by taxation, which in turn reduces his efficiency. Taxation leads to reduction of purchas­ing power of taxpayers, thereby reduced income and consumption. Ultimately it leads to reduced ability to acquire the necessaries of life.
(b) Effect of Taxation on Willingness to Work, Save and Investment: Taxation affects the willingness to work, save and invest and thereby the productive process in an economy.
(ii) Psychological Reaction of Taxpayer: Prof. A.C. Pigou refer this as the announcement effect of taxation when a tax is imposed, the taxpayer feels that his income is re­duced immediately. This psychology of the taxpayer will affect his desire to work, save and invest. This disincentive effect of a tax on the taxpayer’s willingness to work, save and invest is called the an­nouncement effect of taxation.
However, this differs from person to person depending upon the elasticity of demand for income. The demand for income may be elastic, inelastic or unity. The demand for income is elastic if a person is not willing to work hard to maintain the same level of income, which has been reduced due to the impo­sition of tax.

In such case his desire to work and save will be re­duced by the imposition of a tax. On the other hand, taxpayers demand for income is regarded as inelastic, his desire to maintain a given level of income is high, and he is willing to work more to main­tain the level of income, which has been reduced by the imposition of tax.
2. Effect of Taxation on Distribution: In modern welfare state, tax is considered as the most important fiscal tool to achieve social justice by reducing glaring inequality existing in the distribution of income. The German economist Adolf Wagner, insisted that taxation should be used as an instrument to reduce inequalities in the distribution of income.
In this context Prof. Dalton observed “other things being equal, one tax system is prefer­able to another, if it has a stronger tendency to check inequality”. The effect of taxation on distribution of income and wealth, among different sections of society depends upon nature of taxation or rate of taxation and kinds of tax.
(a) Nature of Taxes or Tax Rate and Distribution: Nature of taxation implies the distribution of tax burden among differ­ent sections of the community. By nature of taxation we mean whether It is proportional, progressive or regressive taxation. A regressive tax falls more heavily upon the poor community. It widens the gap be­tween rich and poor. Hence, if regressive taxation is followed, in­equalities in the distribution of income will increase.
On the other hand, progressive taxation helps to reduce inequalities in the distri­bution of income. Under progressive taxation, the burden of taxation falls more heavily upon the richer sections of the community. Hence, progressive taxation is desirable to attain distributional justice. How­ever, progressive taxation should be based upon the principle of abil­ity to pay. Under proportional taxation inequalities will remain as such, if income remains the same. But if income increases in un­equal proportion, inequality will increase.
The above analysis clearly shows that, equitable distribution of income and wealth, necessitate a sharply progressive taxation. Logi­cally, equitable distribution aims at taxing the largest income and all incomes above certain level, should be brought under taxation.
(b) Kinds of Taxes and Distribution: The composition of the tax system affects the distribution of income and wealth. Different taxes produce different effect upon distribution process. Indirect tax on commodities generates more burdens upon the poor class. Taxes on mass consumption goods, consumed by the poor class, have regressive effect upon income distribution.
Hence, if possible mass consumption goods like food stuffs should be avoided from taxation. However, commodity taxation can be made progres­sive by imposing higher rate of articles of luxury consumption and leaving mass consumption good un-taxed or little taxed. Import du­ties can produce favourable distribution effect.
Direct taxes which fall on richer income group can also produce good distributional effect. Progressive income tax rates, while ex­empting a minimum level of income, have positive distributional ef­fect. Likewise, property tax, inheritance tax, etc. also can make favourable effect on distribution of income and wealth.
(b) Describe various sources of public revenue. Discuss the importance of public revenue in the economic development of a country.                                                      4+7=11
A government needs income for the performance of a variety of functions and meeting its expenditure. Thus, the income of the government through all sources like taxes, borrowings, fees, and donations etc. is called public revenue or public income.
However, Prof. Dalton has defined the term in two senses – broader and narrow sense. In broad sense, it includes all the income and receipts, irrespective of their sources and nature, which the government happens to obtain during any period of time. In the narrow sense, it includes only those sources of income of the government which are described as revenue resources. In broader view of the concept is that is includes all loans which the government raises under the term ‘public revenue’ or public income. The distinction in both can also be explained as the term ‘public revenue’ used in public finance. It includes only those sources of government income which are not subject to repayment. In a broad sense, it means all receipts of the government irrespective of the fact whether they are subject to repayment or not.
In a modern welfare state, public revenue is of two types:
(a)    Tax revenue and
(b)   Non-tax revenue.
(a) Tax Revenue: A fund raised through the various taxes is referred to as tax revenue. Taxes are compulsory contributions imposed by the government on its citizens to meet its general expenses incurred for the common good, without any corresponding benefits to the tax payer. Seligman defines a tax thus: “A tax is a compulsory contribution from a person to the government to defray the expenses incurred in the common interest of all, without reference to specific benefits conferred.
Examples of Tax Revenue 
Ø  Income Tax(on income of the individual as well as joint Hindu families) 
Ø  Corporation Tax (on income of the companies both domestic and foreign companies operating in India ) 
Ø  Interest Tax (on the gross interest income of the financial institutions like Bank) 
Ø  Expenditure Tax(expenditure incurred in luxury hotels and restaurants) 
Ø  Wealth Tax(total wealth of individuals and Hindu undivided families) 
Ø  Custom Duty.(import and export duty) 
Ø  Central excusive Duty.(duties on industrial products) 
Ø  Service Tax.(on services provided by hotels,telephones,port services etc.) 
(b) Non Tax Revenue: The revenue obtained by the government from sources other then tax is called Non-Tax Revenue. The sources of non-tax revenue are:
1. Fees: Fees are another important source of revenue for the government. A fee is charged by public authorities for rendering a service to the citizens. The government provides certain services and charges certain fees for them. For example, fees are charged for issuing of passports, driving licenses, etc.
2. Fines or Penalties: Fines or penalties are imposed as a form of punishment for breach of law or non fulfillment or certain conditions or for failure to observe some regulations. Like taxes, fines are compulsory payments without quid pro quo. But while taxes are generally imposed to collect revenue. Fines are imposed as a form of punishment or to prevent people from breaking the law.
3. Surplus from Public Enterprises: The Government also gets revenue by way of surplus from public enterprises. In India, the Government has set up several public sector enterprises to provide public goods and services. Some of the public sector enterprises do make a good amount of profits. The profits or dividends which the government gets can be utilized for public expenditure.
4. Special assessment of betterment levy: It is a kind of special charge levied on certain members of the community who are beneficiaries of certain government activities or public projects. For example, due to a public park in a locality or due to the construction of a road, people in that locality may experience an appreciation in the value of their property or land. Thus, due to public expenditure, some people may experience 'unearned increments' in their asset holding.
5. Grants and Gifts: Gifts are Voluntary contributions by individuals or institutions to the government. Gifts are significant source of revenue during war and emergency. A grant from one government to another is an important sources of revenue in the modern days. The government at the Centre provides grants to State governments and the State governments provide grants to the local government to carry out their functions.
6. Deficit Financing: Deficit means an excess of public expenditure over public revenue. This excess may be met by borrowings from the market, borrowings from abroad, by the central bank creating currency. In case of borrowing from abroad, there cannot be compulsion for the lenders, but in case of internal borrowings there may be compulsion.
The public revenue of one country differs in amount from that of another country. The difference is due partly to the size of country and partly to other causes. India is not a small country. It is sub-continental in itself. Its stages are as big as some counties of the west. But its public revenue is not very big in size. What does the size of public revenue then indicate. It depends on the following aspects.
1. Sign of Prosperity: A man who has a big income is in general respected more than the other who has a smaller income. It is only rarely that people with small income are held in high esteem by society. And in the same way a country that has a small volume of public revenue is not regarded as a big power and consequently not respected by other counties. A State that has a big volume of public revenue considered as a power to be reckoned with. America and United Kingdom have public revenue that is several times higher than that of our country. And we knows they do, that they can afford to do things that require much money.
2. Welfare of Country: Other things being equal, however, the welfare of a country can be judged from the size of its public revenue. A country whose resources, both natural and human, are not fully developed is a poor and backward country. And the government of such a country must necessarily be poor also. And with poverty of wealth goes also the poverty of welfare unless other things are not the same.
3. Composition of Public Revenue: Yet, it is not merely the size of public revenue the one should look to in order to form some idea of the prosperity or otherwise of a country. The composition of public revenue is as much important as its size. If a large part of the wealth of the government comes from the poor it is not a sign of a healthy state of affairs.
4. Mere Availability of Means: Public revenue is only, a means and the mere availability of means indicates nothing. All depends on how the means are utilized. It is not safe, therefore, to reckon with merely the size of revenue. Some countries of the world have public revenue in thousands of millions. The tendency today is on the one hand to spend an increasing percentage of public revenue on social services and social security. On the other hand, everywhere more and more money is being diverted to the building up of strong defensive and offensive force.
5. Manner of Public Revenue: A word may again be said about the manner in which revenue is obtained from the people. Every government tries to get more money from the rich that from the poor. But not all succeed in so doing. Some fail because they are ignorant and some fail because they are careless. And we have to say also that some fail because they are mischievous.
6. (a) Explain the factors responsible for the growth of public expenditure in case of a modern State.           11
Ans: Causes for increase in Public Expenditure
There has been a persistent and continuous increase in public expenditure in counties all over the world. It is due to the continuous expansion in the activities of the state and other public bodies on several fronts. The modern governments not only perform such primary functions as the civil administration as well as defence of the country, but also take considerable interest in promoting economic development of their countries. Today, the state is taking active part in social and economic matters, such as education, public health, removal of poverty and in commercial and industrial development. The public expenditure has increased enormously in recent years mostly due to the development activities of the state. Hence, the increase in public expenditure is fully justified.
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.
1) 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.
2) 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.
3) Growth of democracy: The form of democratic government is highly expensive. The conduct of elections, maintenance of democratic institutions like legislatures etc. cause great expenditure.
4) 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.
5) 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.
6) 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.
7) Development expenditure: for implementing developmental programs like Five Year Plans, Modern governments are incurring huge expenditure.
8) 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.
9) 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.
10) Poverty alleviation programs: As poverty ratio is high, huge amount of expenditure is required for implementing alleviation programmes.
Justification for increase in Public Expenditure
Increase in public expenditure can be justified on the following grounds :
a)      Assists in increasing state activities,
b)      Increase in welfare activities,
c)       Reduces disparities between rich and poor,
d)      Boom for rapid economic development specially in underdeveloped and backward economy,
e)      Provides economic stability, and
f)       Brings prosperity etc.
(b) Explain the significance of public expenditure on the economic development and economic stability of our country.                11
Ans: Importance of Public Expenditure
Gone are the days when any kind of state intervention in the socio-economic affairs of a country was considered as a positive hindrance in the smooth working of the economy. The state was to act as passive spectator and the countries were left to the free working of the economic forces. It was Prof. J. M. Keynes in the twentieth century, who realised that state interference is necessary to keep the economy of a country in a stable equilibrium and the road leading to the destination of full employment. At a time when there was world-wide depression (1929-30), the economies of the world were facing the acute problems of overproduction and mass unemployment, private investment was showing a chronic deficiency, the emphasis was shifted from private spending to public spending. The doses of public spending served to uplift the economic system of the world through the interaction of multiplier principle, from the cruel hands of worldwide depression. The importance/significance/role of public expenditure may be studied under the following heads:
1)      Economic Development and Planning: Public expenditure plays a crucial role in the economic development and planning. The success of economic planning depends on the public expenditure because: (i) Economic planning itself requires heavy public expenditure; (ii) For the success of economic planning proper allocation of public expenditure is to be done on different items, such as, roads, transport, irrigation, electricity and power, industries, agriculture etc; (iii) the government is required to establish and manage the working of several government undertakings including public utility undertakings; (iv) Speedy capital formation is to be undertaken, and (v) balanced economic development. All these require heavy public expenditure. Planned development programmes cannot be undertaken without increasing public expenditure.
2)      Reduction in Disparities of Income and Wealth: Today, great emphasis is being given in almost all countries of the world to the reduction of disparities of income and wealth. Public expenditure has a vital importance in the attainment of this vital objective. Programmes for the uplift of the poor and backward classes may be undertaken by adopting a suitable policy of public expenditure.
3)      Economic Stability: Economic stability of a country depends on the public expenditure. In case of depression, heavy public expenditure is to be incurred for increasing investment, capital formation and employment and also for saving the economy from adverse effects of depression. On the contrary, in case of boom period public expenditure is incurred in such a way as to increase production and control the rising price-level.
4)      Economic-Social Welfare: Economic-social welfare in a country depends on the amount of public expenditure incurred on them. Economic and social welfare programmes like labour welfare, child welfare, women welfare, welfare of physically and mentally handicapped persons, welfare of scheduled castes, scheduled tribes, backward classes and backward areas, welfare of economically and socially weaker sections of the society etc. all these require huge public expenditure.
5)      Economic Development of Underdeveloped Countries: It is now unanimously agreed that public expenditure plays a positive role especially in the economic development of an underdeveloped country. The problems of underdeveloped countries are in such a magnitude that they cannot be left at the mercy of the old laissez-faire policy. Private sector cannot undertake the development projects, where the large amount of risk and capital investment is involved. The only available solution lies in the rapid increase of public expenditure.
6)      Increase in State Activities: Formerly, the activities of the state were limited, i.e. internal administration, maintenance of peace and order, judiciary and defence of the countries. Now-a-days the state is required to perform several functions over and above the basic functions, such as education, providing basic necessities like water and electricity, transport, establishment of basic industries in particular, labour welfare, banking including issue of currency, agricultural development, socio-economic welfare, medical assistance to industries and trade, entertainment etc. All these require huge public expenditure.
7. (a) Discuss the impact of public debt on a developing country. Describe the various methods of repayment of public debt.                     5+6=11

(b) Discuss the role and functions of the ‘Finance Commission’ in India in the context of maintaining and promoting Centre-State financial relations.                                5+6=11