Public Finance Solved Question Papers: Nov' 2013 | Dibrugarh University | B.Com 5th Sem

1. Answer the following questions as directed:                  1x8=8

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.

2. Write notes on any four of the following:         4x4=16

Ans: The scope of public finance may be summarised as under:

Ans: Objectives of Budgetary Control: The main objectives of budgetary control are as under:

Ans: Evils of Deficit Financing

Deficit financing is not free from its defects. It has its adverse effect on economy. Important evil effects of deficit financing are given below:

1. Leads to inflation: Deficit financing may lead to inflation. Due to deficit financing money supply increases & the purchasing power of the people also increase which increases the aggregate demand and the prices also increase.

2. Adverse effect on saving: Deficit financing leads to inflation and inflation affects the habit of voluntary saving adversely. Infect it is not possible for the people to maintain the previous rate of saving in the state of rising prices.

3. Adverse effect on Investment: Deficit financing effects investment adversely when there is inflation in the economy trade unions make demand for higher wages for that they go for strikes and lock outs which decreases the efficiency of Labour and creates uncertainty in the business which a decreases the level of investment of the country. 

4. Inequality: In case of deficit financing income distribution becomes unequal. During deficit financing deflationary pressure can be seen on the economy which make the rich richer and the poor, poorer. The fix wage earners are badly effected and their standard of living reduced thus gap between rich & poor increases. 

Ans: 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 

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. 

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.

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.

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Ans: Keynes’ Theory of Public Finance: Functional Finance Keynes and Hansen have given us the ‘new economics’ which is primarily a new concept of public finance. They assume that a capitalist economy by itself cannot function and thereby the government will have to come to the rescue of the economy at certain times. They emphasize compensatory action through fiscal policy to stabilize and regulate the economic system of a country. The Keynesian concept of public finance has been called functional finance by Abba P. Lerner. Functional finance is the system of judging fiscal measures by the way they function in the economy. Functional finance reduces fiscal operation of taxation, public expenditure and the public debt to operations of policy so as to reduce the volume of money and the aggregate demand in the country. For example, according to functional finance, the main function of taxation is not to secure funds for the state but to be an effective weapon in the hands of the state so as to reduce the purchasing power of the people. In the same way, the main function of public expenditure is to influence the volume of aggregate demand to equal aggregate supply.

Thus, the old precepts vanished, economists began to visualize the instrument of fiscal policy as a means of promoting a healing to their economy. Public finance became Functional Finance signifying a study of the fiscal functions of the government that could eliminate unwanted distortions and fluctuations in the economic activity.

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.”

For the success of financial administration of the Government, different constitution play imperative role. These agencies can be grouped as:

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

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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.

Ans: CANONS OF TAXATION

In the modern age, tax is the main source of Income. Every tax is an additional burden on the tax-payer. Thus, it is essential that the burden of a tax should be divided in equitable manner. Every govt. bears the responsibility to provide certain facilities to its subject. For this purpose, the govt. has to adopt a definite principle. Further, it needs a definite machinery for imposing, collecting and utilizing the money. Therefore, a better taxation system speaks of the better taxing capacity and efficient economic administration of the governments.

It is an important question as to how the taxes can be levied and what should be pattern of distribution of the taxes. Moreover, taxation does not have only economic but also social and political implications. For every new tax, it is correct to note the ‘motive’ behind such proposals. In short, it carries the motives of capacity to pay, no discrimination and positive effect on the balance of payment.

However, these motives cannot be achieved unless a clear cut policy regarding the imposition of taxation is followed. Economists have suggested various principles regarding taxation. But none of had given the exact canons of taxation. The canons or principles given from time to time bear the testimony of a good taxation policy.

Adam Smith was the first writer to give a detailed and comprehensive statement of the principles of taxation. Basically, he laid stress on the ways in which an economy could increase its productive capacity and ultimately achieve a higher rate of economic growth. According to him, if the principles enunciated by him, were adopted in a full spirit, the govt. would have a very sound taxation policy. Findlay Shirras has strongly commented on the contribution made by Adam Smith, “No genius, however, has succeeded in condensing the principles into such clear and simple canons as has Adam Smith.” Adam Smith has enumerated the following four canons of taxation which are accepted universally:

In other words, the principle of benefit states that the burden of taxation should be fair and just. Thus, rich people must be subjected to higher taxation in comparison to poor. The higher the income and higher the tax, the lower the income of lower the tax.

With this, a tax-payer will be able to keep equilibrium between his income and expenditure. There should not be any embarrassment and confusion about the payment of tax. Every tax-payer must know the time of payment, manner and mode of payment, so that he may adjust his expenditures accordingly. In the words of Adam Smith, “The tax which each individual is bound to pay ought to be certain the not arbitrary. The time of payment, the manner of payment, the quantity to be paid, all ought to be clear and plain to the contributor and to every other person.” This certainty creates confidence in the contributor of the tax.

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Ans: Incidence of Tax

Incidence of tax or taxation is the burden of paying tax ultimately. In other words, when the money burden of a tax finally settles or comes to rest on the ultimate tax payer, it is called the incidence of a tax. The incidence of tax remains upon that person who cannot shift its burden to any other person, i.e. who ultimately bears it. The burden of a tax falls either on the buyer or on the seller. If the price of a commodity rises by the full amount of the tax, the incidence is wholly on the buyer. On the contrary, if the price of the commodity does not rise at all, the incidence is wholly on the seller. In case the prices rise by less than the full amount of the tax, the incidence is partly on the buyer and partly on the seller.

The concept of incidence of tax or taxation has been variously defined by different economists. According to Dalton, we may say that the incidence is upon those who bear the direct money burden of the tax. For example, when a sales tax is imposed on Tata Steel, but the company’s shop recovers it from the buyers, so the incidence of this tax lies on the buyers since they ultimately bear its money burden. Mrs. Ursula Hicks, however, classified incidence of taxation into two categories: formal incidence and effective incidence of taxation. The Taxation Enquiry Committee also adopted the definition as given by Mrs. Hicks while studying the problem of incidence of taxation in India. The Taxation Enquiry Commission defined the formal and effective incidence of taxation as Formal incidence is the money burden of taxes resting with the subject on whom the burden is intended by taxing authority to fall, and effective incidence is the real or final distribution of tax burden after its shifting in consequences of changing demand and supply condition of taxed commodity or services. In this sense, formal incidence refers to the concept or incidence of taxation and effective incidence to the effects of taxations.

Factors Influencing the Incidence of Taxation: The following are the factors influencing the incidence of taxation are as follows:

Ans: Effects of Public Expenditure

Public expenditure incurred according to the sound principles of public finance, exerts healthy effects on the entire economy of a nation. The ultimate effects of public expenditure, in the form of greater production, more equitable distribution of wealth and all-round economic development of a country, are always expected to be present, if the expenditure is incurred after considerable thought and utmost rationality.

Gone are the days when it was advocated that the state should interfere the least in economic activities and the government is merely an agent for the people – responsible for the maintenance of justice, police and army. In those days public expenditure on economic activities was normally considered a waste. Contrary to this, a new concept of public expenditure has been developed by the modern economists. Today, public expenditure is regarded as a means of securing social ends rather than just being a mere financial mechanism. In present times, Wagner’s Law of Increasing Public Expenditure – both extensively and intensively, is considered universally true. The trend of rising public expenditure is not confined to any particular country, but it is found in almost all countries of the world, irrespective of its socio-economic and political set-up. Every public expenditure is considered desirable, when it is not wasteful, but has a positive effect on production, distribution, consumption and thus maximizes economic and social welfare of the country as a whole.

Effects of public expenditure can be studied under the following heads:

Effects of Public Expenditure on Production: While analyzing the effects of public expenditure, Dalton very correctly said that 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. He further added that the level of production and employment in any country depends upon the following three factors:

Effects of Public Expenditure on distribution: Public expenditure has its effects not only on production but is also a most powerful weapon in the hands of the government for bringing about an equitable distribution of wealth. For bringing about an equitable and just distribution of wealth the government can use not only its taxation policy but public expenditure policy can also help to a great extent in achieving this very objective. In fact, the role of taxation and public expenditure in removing inequalities of income is complementary and supplementary. If the government intends to minimize the economic inequalities that existed in the society, it should levy maximum about of taxation on richer sections of the community, because their taxable capacity is undoubtedly high. The income so earned through taxation should be spent on providing various types of facilities, subsidies and amenities to the poorer section of the community. For example, the state can extend to the poor benefits of old age pensions, social insurance, free medical aid, cheap housing, interest-free loans, subsidized food etc. This will automatically bring redistribution of wealth (national income) in favour of the poorer section of the community. On the contrary, public expenditure which confers larger benefits to the richer sections of the community, e.g., subsidies on luxury goods, provision of subsidized milk, other foodstuff etc. tends to widen the gap of inequalities. As Dalton puts, “That system of public expenditure is best which has the strongest tendency to reduce inequalities of income”. Public expenditure has, thus, an important rule in reducing economic inequalities in the community.

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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.

Increase in public expenditure can be justified on the following grounds :