Principle of Maximum Social Advantages: Meaning, Assumptions and Criticism together with diagram

Principle of Maximum Social Advantages
Meaning, Assumptions and Criticism
Test of Social Advantages

THE PRINCIPLE OF MAXIMUM SOCIAL ADVANTAGE

One of the important principles of public finance is the so – called Principle of Maximum Social Advantage explained by Professor Hugh Dalton. Just like an individual seeks to maximize his satisfaction or welfare by the use of his resources, the state ought to maximize social advantage or benefit from the resources at its command.

The principles of maximum social advantage are applied to determine whether the tax or the expenditure has proved to be of the optimum benefit. Hence, the principle is called the principle of public finance. According to Dalton, “This (Principle) lies at the very root of public finance” He again says “The best system of public finance is that which secures the maximum social advantage from the operations which it conducts.” It may be also called the principle of maximum social benefit. A.C. Pigou has called it the principle of maximum aggregate welfare.

Public expenditure creates utility for those people on whom the amount is spent. When the volume of expenditure is small with a slighter increase in it, the additional utility is very high. As the total public expenditure goes on increasing in course of time, the law of diminishing marginal utility operates. People derive less of satisfaction from additional unit of public expenditure as the government spends more and more. That is, after a stage, every increase in public expenditure creates less and less benefit for the people. Taxation, on the other hand, imposes burden on the people.

So, when the volume of taxation becomes high, every further increase in taxation increases the burden of it more and more. People under go greater scarifies for every additional unit of taxation. The best policy of the government is to balance both sides of fiscal operations by comparing “the burden of tax” and “the benefits of public expenditure”. The State should balance the social burden of taxation and social benefits of Public expenditure in order to have maximum social advantage.

Attainment of maximum social advantage requires that;

a) Both public expenditure and taxation should be carried out up to certain limits and no more.

b) Public expenditure should be utilized among the various uses in an optimum manner, and

c) The different sources of taxation should be so tapped that the aggregate scarifies entailed is the minimum.

Assumptions of this theory:

1.All taxes result in sacrifice and all public expenditures lead to benefit.

2. Public revenue consists of only taxes and there is no other source of income to the government.

3. The govt. has no surplus or deficit budget but only a balanced budget. 

Diagrammatical Explanation of the theory of maximum social advantages

In the above diagram, MSS is the marginal social sacrifice curve sloping upward from left to right. This rising curve indicates that the marginal social sacrifice goes on increasing with every additional dose of taxation.   MSB is the marginal social benefit curve sloping downwards from the left to right. This falling curve indicates that the marginal social benefit diminishes with every additional dose of public expenditure. The two curves MSS and MSB intersect each other at the point P. PM represent both marginal social sacrifice as well as marginal social benefit. Both are equal at OM which represents the maximum social advantage.

Criticism of the theory of Maximum Social Advantages

1. Non measurability of social sacrifice and social benefit: The major drawback of this principle is that it is not possible in actual practice to measure the MSS and MSB involved in the fiscal operation of the state.

2. Non applicability of the low of equimarginal utility in public expenditure: The low of equimarginal utility may be applicable to private expenditure but certainly not to public expenditure.

3. Neglect non-tax revenue: The principle says that the entire public expenditure is financed by taxation. But, in practice, a significant portion of public expenditure is also financed by other sources like public borrowing, profits from public sector enterprises, imposition of fees, penalties etc.

4. Lack of divisibility: The marginal benefit from public expenditure and marginal sacrifice from taxation can be equated only when public expenditure and taxation are divided into smaller units. But this is not possible practically.

5. Assumption of static condition: Conditions in an economy are not static and are continuously changing. What might be considered as the point of maximum social advantage under some conditions may not be so under some other.

6. Misuse of government funds: The principle of Maximum social advantage is based on the assumption that the government funds are utilized in the most effective manner to generate marginal social benefit. However, quite often a large share of government funds is misused for unproductive purposes

7. "The govt. has no surplus or deficit budget but only a balanced budget."- is an invalid assumption.

Economic tests of social advantage as suggested by Dr. Dalton

In view of some difficulties in the way of subjective measurement of social advantage, Dr. Dalton has suggested certain tests which enhance social advantage of the community as a whole. They are objective basis tests which are follows:

1)      Expenditure on Defence, Law and Order: It is the primary duty of the state to safeguard the country and the community from external attack and internal disorders. Internal peace and external security create confidence and promote economic life of the community and, thus enhance social advantage. It is, therefore, essential to maintain army, police, judiciary, prisons etc. so as to meet internal and external threats to the country and the community. Although it is an unproductive expenditure, it is to be incurred by all means. However, Dr. Dalton has suggested that the state should adopt a policy of peace and co-existence for home and abroad otherwise unproductive expenditure on army, police, judiciary, prisons etc. would increase and this may have an adverse effect upon the economic life of the country as well as the community.

2)      Increase in Economic Welfare: Second objective of public finance should be to increase economic welfare. Increase in economic welfare depends upon the following two things:

a)      Increase in Production: The operation of public finance should be in such a way that there is increase in production in the community. Increase in production implies (a) maximum increase in production power with minimum efforts; (b) improvement in the organization of production so as to reduce a minimum wastage of economic resources through unemployment and other causes; and (c) improvement in the composition or pattern of production so as to best serve the needs of the community.

Hence the operation of public finance should aim at securing all these objectives so at to increase production and economic welfare of the community.

b)      Improvement in the Distribution of Income and Welfare: Increase in production is insufficient and ineffective unless it is accompanied with an improvement in the distribution of income and wealth in order to achieve economic welfare in the society. Hence, it is the duty of every state to see that what is produced should be properly distributed among the different sections of the community, i.e. it should reduce the inequalities and fluctuations of income in the community. In the words of Dr. Dalton, “Improvement in distribution resolves itself into (a) reduction in the great inequality in the incomes of different individuals and families; (b) reduction in the great fluctuations between different periods of time, in the income of particular individuals and families, especially among the poor sections of the community.” Thus, proper distribution of income and wealth is also essential for increasing economic welfare.

3)      Economic Stability and Full Employment: Economic instability in the country is the characteristic of free economies and is also the cause of so many evils, such as unemployment, heavy booms and depressions, overproduction, underproduction etc. in the community. If economic stability is maintained in the country, it will provide employment to maximum persons, increase production and promote greater equality of income. Hence fiscal operations should be enforced in such a way so that the undue boom and undue depressions are controlled and employment is provided to maximum persons. For example, fiscal operations can reduce the effects of depression by increasing public expenditure on public works. Similarly, effects of inflation can be reduced by public borrowings, heavy taxation etc.

4)      Provisions of Future: The state has double responsibility of looking after the interests of present generation as well as of future generations. The state should choose a greater advantage of future generations and that of a small advantage to present generation.

According to Dr. Dalton, “The statesman is a trustee for the future, no less than for present. Individuals die, but the community, which they form, lives on. The statesman, therefore, should prefer a larger social advantage in the future to a smaller one of today.” From this point of view, soil conservation, protection of limited and scarce natural resources and expenditure on long-term plans (such as India’s Five Year Plan) is desirable. 

To conclude, it is not absolutely wrong to condemn all taxes, nor is it correct to justify all government expenditure. It is necessary to test all fiscal operations on the basis of maximum social advantage. The principle of maximum social advantage is the fundamental principle of public finance.