INTODUCTION TO PUBLIC FINANCE AND TAXATION THEORY

Public Finance is the term, which has traditionally been used or applied to the packages of those
policy problems, which involve the use of tax and expenditure measures. As a subject, public
finance is a study of public sector economics. It is about the revenue, expenditure and debt
operations of the government and the impact of these measures to the society. Public Finance is,
therefore, about fiscal institutions, that is the tax systems, expenditure programs, and budget
procedures, stabilization instruments, debt issues, level of government etc
Meaning & Scope of Public Finance
Meaning of Public Finance
The word public refers to general people and the word finance means resources.So public finance
means resources of the masses,how they are collected and utilized.Thus, Public Finance is the
branch of economics that studies the taxing and spending activities of government.The discipline
of public finance describes and analyses government services,subsidies and welfare payments,and
the methods by which the expenditures to these ends are covered through
taxation,borrowing,foreign aid and the creation of money.
Definition

Economists have defined public finance differently. The following are some of the popular
definitions:

According to Dalton, “Public finance is concerned with the income and expenditure of
public authorities and with the adjustment of the one with the other―.

Findlay Shirras says that, “Public finance is the study of the Principles underlying the
spending and raising of funds by public authorities―.

To quote Lutz, “Public finance deals with the provision, custody, and disbursement of
resources needed for the conduct of public or government functions―.

We may conclude from the above definitions that Public Finance or Fiscal Economics is
concerned with the principles and practices of obtaining funds and spending the same for achieving
the maximum social welfare and economic growth in the country.

Subject matter of public finance

The following subdivisions form the subject matter of public finance

1. Public expenditure

2. Public Revenue

3. Public debt
4. Financial administration and

5. Federal finance

1. Public expenditure

Since the modern government represents a welfare state, the responsibility of the government is to
bring about maximum social welfare. In addition to this, it has to perform various other functions,
which require heavy expenditures. We study in this sub-division, the fundamental principles
governing the flow of government funds into different spending streams and the methods of
incurring expenditure on the various activities.

2. Public Revenue

Public revenue means different sources of government’s income. It deals with the
methods of raising revenue for the government, principles of taxation and other related problems.
Raising of tax revenue and non-tax revenue is the subject matter of public revenue. Tax revenue
deals with the kinds of taxes and the impact and incidence of various taxes. Non-tax revenue
includes

i.) Commercial revenue (income earned through sale of goods and services and profits earned by
public sector enterprises),

ii.) Administrative revenues (Fees, license fees, special assessments),

iii) Gifts and grants.

3. Public debt

The problem relating to the raising and repayment of public loans is studied under this sub-
division. Borrowing by the government from the public is called public debt. In modern world, it
is not possible for the government to meet all its expenditure through tax and non-tax revenue.
Hence public revenue falls short of public expenditure. As a result, governments are forced to
borrow from internal and external sources. In the case of internal debt, Government borrows from
the people, commercial banks and the central bank. External debt includes borrowing from
international monetary institutions like IMF and World Bank and also from foreign countries. The
soundness of the borrowing policy of the governments and indication of the healthy direction of
spending are examined under this sub-division.

4. Financial administration

Financial administration is concerned with the organisation and functioning of the

government machinery that is responsible for performing various financial activities of the state.
Preparing the budget for the particular financial year is the master financial plan of the government.
The various works, starting with the objectives of designing a budget, the methods of preparing it,
presentation of the budget before the Parliament and State Assembly, passing or sanctioning by
the Parliament, execution, auditing, implementation etc., constitute the subject matter of financial
administration.

5. Federal finance

Federal finance is a part of the study of public finance. A federation is an association of two
or more states. In a federal form of government, there are: Central, State, and local governments.
The interrelationships between these forms of governments, and the problems related to them and
the financial functions of all these units are studied under federal finance.

According to Findlay Shirras

“Public finance is the study of principles underlying the spending and raising of funds by public
authorities”.
According to H.L Lutz
“Public finance deals with the provision,custody and discursement of resources needed for conduct
of public or government function.”
According to Hugh Dalton
“Public finance is concerned with the income and expenditure of public authorities,and with the
adjustment of the one to the other.
Nature of Public Finance
Nature of public finance implies whether it is a science or art or both.
Public Finance as Science
Science is the systematic study of any subject which studies relationship between facts. Public
finance has been held as science which deals with the income and expenditure of the government’s
finance.It studies the relationship between facts relating to revenue and expenditure of the
government.
Arguments in support of Public Finance as Science:
 Public finance is systematic study of the facts and principles relating to government
expenditure and revenue.
 Principles of Public finance are empirical.
 Public finance is studied by the use of scientific methods.
 Public finance is concerned with definite and limited field of human knowledge.
Public Finance as Art
Art is application of knowledge for achieving definite objectives. Fiscal Policy which is an
important instrument of public finance makes use of the knowledge of government’s revenue and
expenditure to achieve the objectives of full employment, economic development and equality.
Price stability etc. To achieve the goal of economic equality taxes are levied which are likely to be
opposed. Therefore it is important to plan their timing and volume. The process of levying tax is
therefore an art. Study of Public finance is helpful in solving many practical problems. Public
finance is therefore an art also.
From the above discussion it can be concluded that public finance is both science and art. It is
positive science as well as normative science.
It is a positive science as by the study of public finance factual information about the problems
of government’s revenue and expenditure can be known. It also offers suggestions in this respect.
It is also normative science as study of public finance presents norms or standards of the
government’s financial operations . It reveals what should be the quantum of taxes,kind of taxes
and on what items less of public expenditure can be incurred.
Scope of Public Finance
Public finance not only includes the income and expenditure of the government but also the sources
of income and the way of expenditure of various government corporations, public companies and
quasi government ventures. Thus the scope of public finance extends to the study of independent
bodies acting under the government’s direct and indirect control. The Scope of public finance
includes:
1. Public Revenue
Public finance deals with all those sources or methods through which a government earns revenue.
It studies the principles of taxation, methods of raising revenue, classification of revenue, deficit
financing etc.
2. Public Expenditure
Public expenditure studies how the government distributes the resources for the fulfillment of
various expenses. It also studies principles that the government should keep in view while
allocating resources to various sectors and effects of such expenditure.
3. Public debt
It deals with borrowing by the government from internal and external sources. AT any time
government may exceed its revenue. To meet the deficit, government raises loans. The study of
public fiancé focuses on the problems of raising loans and the methods of repayment of loans.
4. Financial/Fiscal administration
The scope of financial administration is wider. It covers all the financial functions of the
government. It includes drafting and sanctioning of the budget, auditing of the budget, etc.
Financial administration is concerned with the organization and functioning of the government
machinery responsible for performing the various financial functions of the state. The budget is
the master financial plan of the government.
5. Economic Stabilization and Growth
In the present times, public finance is mainly concerned with the economic stability and other
related problems of a country. For the attainment of these objectives, the government formulates
its fiscal policy comprising of various fiscal instruments directed towards the economic stability
of the nation.
6. Federal Finance
Distribution of the sources of income and expenditure between the central and the state
governments in the federal system of government is also studied as the subject matter of the public
finance. This branch of public finance is popularly known as Federal Finance.
It is a positive science as by the study of public finance factual information about the problems
of government’s revenue and expenditure can be known. It also offers suggestions in this respect.
It is also normative science as study of public finance presents norms or standards of the
government’s financial operations . It reveals what should be the quantum of taxes,kind of taxes
and on what items less of public expenditure can be incurred.
Meaning of Government Finance
Government finance is the deliberate manipulation of revenues and expenditures of the
government. It is the financial plan of the government. The government uses the different types of
revenues and expenditures as fiscal tools to achieve different objectives. The main objectives are
high economic growth, price stability, favorable balance of trade and payment, equitable
distribution of income and wealth, proper allocation of resources, balanced and stable economic
growth and so on. The government should avoid inflation and deflation, recession or depression.
Improper use of resources, price fluctuation, high inequality and so on. For all these things
revenues and expenditures are increased and decreased as per the situation of the country.
Government finance has two sides, they are
1. Government revenues
2. Government expenditures
In government revenues, the money received by the government in the form of royalties, taxes,
escheats, penalties, fines, cess etc are included. In the government expenditure we include
development expenditure, administrative expenditures, diplomatic expenditure, difference
expenditure, payments of public debts and interest and miscellaneous expenditure. They are used
as fiscal tools to solve different economic problems.
Importance of Public Finance
1. Steady state economic growth:
Government finance is important to achieve sustainable high economic growth rate. The
government uses the fiscal tools in order to bring increase in both aggregate demand and aggregate
supply. The tools are taxes, public debt, and public expenditure and so on.
2. Price stability:
The government uses the public finance in order to overcome form inflation and deflation. During
inflation it reduces the indirect taxes and genera expenditures but increases direct taxes and capital
expenditure. It collects internal public debt and mobilizes for investment. In case of deflation, the
policy is just reversed.
3. Economic stability:
The government uses the fiscal tools to stabilize the economy. During prosperity, the government
imposes more tax and raises the internal public debt. The amount is used to repay foreign debt and
invention. The internal expenditures are reduced. During recession, the case is just reversed.
4. Equitable distribution:
The government uses the revenues and expenditures of itself in order to reduce inequality. If there
is high disparity it imposes more taxes on income, profit and properties of rich people and on the
goods they consume. The money collected is used for the benefit of poor people through subsidies,
allowance, and other types of direct and indirect benefits to them.
5. Proper allocation of resources:
The government finance is important for proper utilization of natural, manmade and human
resources. For it, on the production and sales of less desirable goods, the government imposes
more taxes and provides subsidies or imposes taxes lightly on more desirable goods.
6. Balanced development:
The government uses the revenues and expenditures in order to erase the gap between urban and
rural and agricultural and industrial sectors. For it, the government allocates the budget for
infrastructural development in rural areas and direct economic benefits to the rural people.
7. Promotion of export:
The government promotes the export imposing less tax or exempting form the taxes or providing
subsidies to the export oriented goods. It may supply the inputs at the subsidized prices. It imposes
more taxes on imports and so on.
8. Infrastructural development:
The government collects revenues and spends for the construction of infrastructures. It has to keep
peace, justice and security too. It has to bring socio-economic reformation too. For all these things
it uses the revenues and expenditures as fiscal tools.
Public Revenues
The revenues from different sources received by the government are called public revenues. Some
are regularly collected whereas some are irregularly collected. Revenues are not repayable. Some
of them are obtained from the sale of public utilities whereas some are obligatory payments to the
government.
Types or sources of government (public) revenue
The public revenue can be classified into tax revenue and non tax revenue:
Tax revenue:
The tax is compulsory payment to the government without quid pro quo. The government does not
repay back it to the payers nor does it do anything for the personal benefit to the payers. It is very
effective fiscal tool essential for the achievement of different socio-economic objectives. There
are mainly two types of tax.
1. Direct tax:
The tax that is not shiftable in nature and paid by the payers who really take its burden is called
direct tax. The person or organization which faces the incident taxes the burden too. The taxes
imposed in income, profit, land, houses, vehicles etc are called direct taxes.
2. Indirect taxes:
It is the tax shiftable in nature. The person or organization which faces the incident of tax is
different from person or organization who really takes the burden of tax. The incident is faced by
the producers and traders but the burden is taken by the final consumers. The tax is imposed on
production, sales, export and imports etc. The taxes like excise duty, custom duty, entertainment
tax, octroi charges etc are indirect taxes. The VAT is also called indirect tax
Non tax revenue
1. Fees:
The government receives the money from the sale of different services like health, education etc.
Moreover it takes fees for registration, license etc. The examples of fees are education fee, health
fee, registration fee (birth, death, marriage, organization etc) license fee (driving, share broker,
export, import, pistols) etc.
2. Fines and penalties:
Against the violation of rules and regulations the government charges the fines but if there is
violation of law and order government charges penalties. Fines and penalties are not regular source
of government revenue.
3. Royalties:
The government receives the royalties its production right, copy right, public land and building,
capital equipment and plants for use to others. It obtains dividends from public enterprises, rents
from public properties etc. this is also regular source of public revenue.
4. Cess:
The government collects different types of cess like road cess, pool cess etc in order to recover he
construction cost and to reach the fund for maintenance of the construction.
5. Grants and donation:
The government receives the grants and donations from the people, business organization, NGOs,
within the country or outside the country. It obtains grants from foreign government too.
6. Escheats:
The nationalized properties of people after the death being unclaimed are called escheats. This is
irregular source of government revenue.
Difference Between Private and Public Finance
Private finance (individual) Public finance (government)
An individual adjusts his or her expenditure The public authority adjusts its income to its
according to his or her income. expenditure.
A private individual tries to have a surplus of A public authority will spend all that it gets
income over expenditure i.e. surplus budget.
An individual can borrow money from other A public authority esp. a state can raised loans from
individual only and externally both internally
Finances of individuals are limited Finances of government are flexible
Private individuals cannot use force to get their The government can use coercive method to realize
income; they cannot compel others to get income revenues
Not a single individual can print notes A state can print currency notes in order to meet its
expenditure in difficult times
Public Expenditures
Government revenue collected from different sources is allocated for different purposes. Generally
public expenditure is classified into development expenditure and administrative expenditure. The
government allocates resources through its ministries, departments and local authorities. These
types of expenditures are made either for their own maintenance or for the promotion of social
welfare of the people. In the government expenditure we include development expenditure,
administrative expenditures, diplomatic expenditure, difference expenditure, payments of public
debts and interest and miscellaneous expenditure.
Role or importance of public expenditure
1. To maintain law and order’
2. To maintain national security
3. To provide administrative services
4. To invest in social overheads like transportation, communication, irrigation, energy, education,
health, security, law and justice
5. To ensure economic equity in the society.
6. For development and promotion of basic and strategic industries
Classification of public expenditure:
1. Development expenditures:
Expenditures on the construction of infrastructures of transportation, communication, sanitation,
irrigation, education, health, power, energy etc is called development expenditure
2. Expenditure on public utilities:
After the construction of infrastructures the government spends the money to provide facilities of
education, sanitation, drinking water, communication, transportation etc. these expenditures are
expenditure on public utilities.
3. Defense expenditure:
The expenditure on arms and armaments to protect the country and the people from foreign
aggression is called defense expenditure
4. Expenditure on general administration:
For the good governance, to keep peace, security and justice in the country, the government makes
the expenditures through different ministries, departments and constitutional bodies etc. These
expenditures are called general administration expenditure
5. Conservation of resources:
To avoid depletion in the quantities and qualities of the resources and for their sustainability the
government makes expenditures on their conservation. it includes expenditure on forestry, soil
fertility management, irrigation, flora fauna management
6. Preservation and renovation of monuments:
For the preservation of culture, traditions, arts, skills of the people of the country the government
makes the expenditure. The government spends the money also to renovate the historical,
archaeological, religious monuments.
Concept of public enterprises
Public enterprise is an organization which is owned, managed and controlled by the government.
It is necessary for the active participation of government in individual and commercial level. It is
financed and operated by the government. It provides service to the public. It provides goods and
services to the public at reasonable price. It is guide by service motive but it can earn nominal
profit. It helps in maintaining the state of ownership and operation of industrial, agricultural,
financial and commercial undertaking. It is one autonomous body which is managed and owned
by government and which provide goods/ services for public.
Characteristics of public enterprises
Features
1. Government ownership: It is totally owned by government. Its majority shares are taken
up by the government. In this enterprise, sometimes 50% of share is owned by the
government.
2. Government management and control: It is one autonomous body which is managed
and owned by government. Government controls and manages organization by appointing
key personnel. It is like board of directors, managing directors, chairman and so on which
manage the appointing, transfer of members and so on.
3. Public accountability: They are operated by government fund. It is also accountable to
general public. It is carried out by the parliament and helps in providing goods and services
for public.
4. Service motive: It provides service to the public. It provides goods and services to the
public at reasonable price. It is guide by service motive but it can earn nominal profit.
5. Autonomous: It is one autonomous body which is managed and owned by government. It
receives fund from the government. But government doesn’t interfere in the day to day
activities of the organization.
6. Monopoly: Government has monopoly in this sector.
7. Separate legal entity: It is established under acts and is rum under a law. It can purchase
and sell securities, can enter into any contract, can sue and can be sued.
8. Stability: It is generally stable and perpetual in nature.
Types of public enterprises
Departmental undertaking:
It is a traditional form of operating and managing affairs of public enterprise. They are organized,
financed and controlled by the certain department of the government. Budget is prepared very year
Features
1. It is totally financed by treasury and all the revenues are paid into treasury.
2. The budgeting, accounting and audit procedures are controlled and managed by the rules
and regulations of the government
3. The civil servants are the permanent staff.
4. The recruitment, training, promotion, terms and conditions of employment are same for all
civil servants.
5. It is managed by the officials of the concerned department of the government.
6. The ministry is directly controlled by administrative staff.
7. The policy and performance are discussed in parliament.
8. It has no separate legal entity.
9. Nothing can be done without the permission of government.
THE NEED FOR PUBLIC SECTOR:
From the economic point of view government, intervention is necessary because of what is known
as Market failure in such functions as allocation of resources, distribution of income and
stabilization of the economy.

(a) Allocation Function:

The provision of social goods or the process by which total resources used is divided between
private and social goods and which chooses the mix of social goods. This provision of social goods
is what is known as the allocation function. Market failure in the provision of social goods is
chosen. This provision of social goods is what is known as the allocation function. Market failure
in the provision of social goods arises because of the presence of public goods. These are goods
we consume collectively and therefore one person who purchased the good can exclude no one
from the benefits arising from consumption of such goods. To put id differently the benefits
derived by anyone consuming a social good are ‘exterilised’ in that they become available to all
others. Incase of private goods the benefits of consumption are ‘internalized’ with a particular
consumer whose consumption excludes military defence, Law and Order (The Police), Judiciary,
Air clearing etc.

The market mechanism is well suited for the provision of private goods. It is based on exchange,
and exchange can occur only where there is an exclusive title to the property, which is to be
exchanged. Application of the exclusion principle tends to be inefficient solution. This is not the
case for social goods, as it will be inefficient to exclude anyone consumer from partaking in the
benefits, when such participation would not reduce consumption by anyone else. For instance, you
may cross the Salender Bridge as much as you can but this does not reduce the possibility available
to others to use the bridge.

However, incases where benefits are available to all, consumers will not voluntarily offer payments
to supplier of social goods. Hence, no voluntary payment is made especially where many
consumers are involved. The linkage between producer and consumer is broken and the
government must step in to provide for such goods.

 Distribution Function:
Again, the government has to intervene in order to adjust the distribution of income and wealth to
ensure conference with what society considers a ‘fair’ or just state of distribution of income and
wealth to ensure conformance with what society considers a ‘fair’ or just state of distribution. This
fair or just distribution of income cannot be achieved under the market mechanism. Under the
market mechanism, the distribution of income and wealth depends first of all on the distribution
of factor endowment and then determined by the process of factor endowment and then determined
by the process of factor pricing, which in a competitive market, sets factor returns equal to the
value of marginal product. The distribution of income among individuals thus depends on their
factor supplies and the prices which they fetch in the market.
Earning abilities differ, so does factor endowment, this distribution of income may or may not be
in line with what society considers fair and just. It involves a substantive degree of inequality
especially in the distribution of capital income, and through views on distributional income justice
differ, most would agree that some adjustments are required.
Among various fiscal devices, redistribution is implemented most directly by:
 A tax scheme which combines progressive income taxation of high income households
with a subsidy to low income households.
 Alternatively, redistribution may be implemented by progressive income taxes used to
finance public services especially those such as public housing scheme, hospitals and other
health care schemes, education schemes etc which particularly benefit low income
households.
 A combination of taxes on goods purchased largely by high income consumers with
subsidies to other goods, which are chiefly used by low-income earners.

1. Stabilization Function
Fiscal policy has to be designed by the government to maintain or achieve the goals of high
employment, a reasonable degree of price level stability, soundness of foreign accounts and an
acceptable rate of economic growth. Fiscal policy is needed for stabilization of the economy. Full
employment and stability do not come about automatically in a market economy but require public
policy guidance. Without it, the economy tends to be subject to substantial fluctuations, and it may
suffer firm sustained periods of unemployment or/and inflation.
Sources of Government Revenue
To perform the aforementioned functions efficiently the government must have resources or funds
to finance the said activities. The government raises much of its finance through taxation. Taxation
is the most preferred sources of revenue among governments’ worldwide. Apart from ensuring
constant and uninterrupted flow of revenue to government revenue, taxation serves other fiscal
policy objectives as well.
Other Sources of Government Revenue include:
 Borrowing:
The government may borrow funds from both internal and external sources. Internal sources
include all financial institutions such as Banks, Insurance companies and social Security
institutions.
External sources include bilateral (between governments) multilateral sources such as IMF, World
Bank etc.
 Grants and Aids:

Grants are funds given to the government for a specific purpose, e.g. construction of road, purchase
of rice etc. An aid is a general monetary assistance given to the government with a donor country
not specifying its particular use.

 Dividends from its corporations:

The government may own shares in various corporations from which it may receive cash dividend.

 User Charges:

These include port and airport services charges.

 Fines imposed as punishment or damages for contravening various Laws enacted by the
government. For instance driving a defective motor vehicle may attract payment of a
certain amount of money to the government as fine.

 Licenses and other fees.

 Sale of government bonds and securities.

None of these sources however can bypass taxation in terms of bringing much revenue to the
government. Most of these sources are infact unstable and unreliable as they are subject to
unpredictable fluctuations and willingness of certain individuals or credit worth-ness

WHAT IS TAXATION

As a subject, taxation is a study of how the government imposes on and collects taxes from, the
income and wealth of individuals and corporations to finance its social and regulatory activities.
The study of taxation usually covers the entire tax system which is made up of Tax policy, law and
administration.

The government, therefore, derives its revenue from taxes. A tax is compulsory and mandatory
contribution to the government from its subjects. It is mandatory in the sense that there is a legal
document giving the government the mandate to collect such contribution: However, if carefully
analysed this definition may include such payments as fines and penalties paid to the government.
The most dependable and reliable definition of what is a tax was given by Hugh Dalton who
defined a tax as “a compulsory contribution imposed by a public authority, irrespective of the exact
amount of services rendered to the taxpayer in return, and not imposed as a penalty for any legal
offence”.

Imposition of a tax, therefore, creates a tax liability upon those liable to pay the imposed tax. A
tax liability is always expressed in monetary terms, and it is worth noting here that any monetary
liability creates a burden. In other words imposition of a tax creates a tax burden on taxpayers.

EQUITY:

In taxation, equity refers to fairness in the distribution of the tax burden. For compliance purposes
and to fend off public outcry the tax burden should be apportioned in more equitable manner. Two
principals have long been developed as a guide to equity. These are:

 The Benefit Principle: This approach dictates that taxes are apportioned to individuals
according to the benefit they derive from government activities and spending. Taxes
 therefore should be treated as a payment for the goods and services provided by the
government.

 The ability to pay principle: This is concerned with the equitable distribution of taxes
according to the stated taxable capacity or ability to pay of an individual or group. The
emphasis in this approach is put on redistribution of income, that, those with higher
incomes should sacrifice more so that there can be proper and equitable redistribution of
income.

Both principles are calling for equality, no one then will quarrel with a saying that ‘those who are
essentially equal should be taxed equally’ (Horizontal Equity), and if equals are to be taxed equally
then the reverse is also true, that unequal to be taxed unequally (Vertical Equity)

To attain the much needed equally taxes are made to be proportional, progressive or regressive
depending upon whether they take from high income earners the same fraction of income as tax
than they take from low income people.

However the general philosophy of Benefit or ability to pay alone does not answer the question of
best tax formula and hence the need for political process. In practice all the principle are put into
use.
TAX BASE AND TAX YIELD

To clearly understand the concept of tax base, we need to classify taxes into two classes:

1. Direct Taxes
2. Indirect Taxes

Direct Taxes are levies directly on the income of individuals or corporations. This includes income
tax, Payroll levy, and other withholding taxes. A tax base for direct taxes therefore is income. In
other words, direct taxes are tax based income. The amount of tax revenue (tax yield) from direct
taxes will therefore depend on income of individuals and corporations.

Indirect Taxes are levied on goods or services. The tax base for indirect taxes is therefore the
goods produced and services rendered in a particular economy. Tax yield from indirect taxes will
therefore depend on goods produced and services rendered in the economy. The amount of tax
revenue collected from a particular tax will therefore depend on, among other how wide the tax
base or coverage of that particular tax is.

Some advantage of Direct Taxes:

 They don’t have inflationary tendencies. Increase or decrease in tax rates usually does not
affect the general price level.
 When made progressive direct taxes tend to be highly equitable.

Disadvantages:

 In a cash economy like ours where general level of education of taxpayers is low, it is
difficult to determine taxable income of taxpayers.
 Direct tax Laws are difficult to understand as a result the lead to disputes.
 Direct taxes are unpopular as they directly affect the disposable income.
 Progressiveness of direct taxes may be disincentive to hard work, and therefore discourage
savings and investment.
 They have a very narrow tax base
 Tax incidence cannot be shifted.

Advantages of Indirect Taxes:

 They are easy to collect
 They provide a wide tax base and hence revenue potential
 As taxes are included in the price of taxable goods and services, the tax incidence is shifted
to the last consumer.

Disadvantages:
 They tend to be regressive especially when imposed on goods and services consumed by
low income earners.
 They have inflationary tendencies. Increase in tax rates is likely to disturb the general price
level.
Principles of a Good Tax System:

Taxation being compulsory contributions from individuals, or business entities to the government
to defray the public expenditures by the government has some effects in the economy as well as in
the social life of the society. The effect might be constructive to the economy or might damage the
economy. In order then to avoid/minimize damage to the economy there are criteria/principles for
evaluating tax systems. These criteria are also called Canons of Taxations.

Canons of Taxation

Equity: Equity entails that taxes should be levied in such a way that they promote fairness. The
concept of from each according to his ability to pay or benefits received are really what the
principle of equity is all about a tax system that takes away proportionately more income from
higher income earners than from lower income earners is the termed as a progressive tax system.
In equity, a progressive rat structure and the minimum exemption policy should characterize the
tax system. Thus, equals should be treated equally and unequal to be treated unequally.

Simplicity: A tax system ought to be simple. Simplicity of the tax system means the taxpayer
should be able to understand the system and the tax base should be known clearly. The taxpayer
should be able to compute his/her liability and the penalties involved for any neglect or failure to
comply with tax law. The amount should not be the prerogative of the tax collector, as this will
put the taxpayer to disadvantage and at the mercy of the collector and may make tax system
arbitrary.
Economy: The administration of tax system should be least expensive in terms of both manpower
and material. The cost benefit analysis is emphasized, as it does not make sense to spend more
than the revenue collected. Optimization of collection costs is called for to judge whether a tax
system is uneconomic or not, both pecuniary and non-pecuniary costs should be taken into account.

Certain: The imposition of tax should yield the expected revenues in order to assist government
forward planning. Taxes on some commodities are certain while on others are fairly uncertain. On
the other hand, this criterion advocates that the taxpayer ought to know precisely and exactly as
regards the time of payment, the manner of payment and the amount to be paid.
Convenience: This calls for tax to be levied at the time and n the manner in which it is most likely
to be convenient to the taxpayer. The system that allows the payment of tax at month end,
immediately after crop harvest seasons or provides for the payment of tax through such devices as
PAYE or other withholding arrangement can be regarded as convenient to the tax-payers; while a
tax system that places heavy tax burden on tax-payers long after the income is exhausted is an
inconvenient one.

Elasticity of Tax to changes in the tax base: A good tax system should be elastic to changes in
the Tax base; the tax is elastic when the amount of revenue it yields increases as fast or faster than
the growth of income or the economic or the economic activities. The elastic tax system yields
adequate revenue for planned projects.

Public corporation:
They are the most widely use form of organization under public enterprise. Under public
corporation act 1961, statutory companies or public corporation are established. They are governed
by the special act of the parliament. It is managed and controlled by board of directors and boards
of directors are appointed by the government. It is established for service motive. Its main aim is
to maximize the social welfare. The employees are appointed under the terms and conditions of
the corporation. They are not civil servants. Some examples are; Nepal oil corporation, Nepal
Airlines Corporation.
Features
1. The act defines the objectives, functions, powers, rights and duties, privileges and
relationship with other department of the government
2. It is totally owned by the government
3. In some cases, public my hold the portion of share capital.
4. It is a separate legal entity.
5. It can purchase and sell securities, can enter into any contract, can sue and can be sued.
6. It has independent accounting, auditing and financial system.
7. It is established for service motive
8. Employees are not civil servants
9. Employees are appointed under the terms and conditions of the corporation
10. It is managed and controlled by board of directors and boards of directors are appointed by
the government
11. They are governed by the special act of the parliament.
12. Its main aim is to maximize the social welfare
13. Expenditure and revenues are not shown in the budget of department
Government companies
A public enterprise which is established under the prevailing law of the country is called a
government company. In this company, government owns at least 51% of total shares. This type
of company is a popular form of company because it is easy to organize and is considered to be
more efficient. It is incorporated under company law of the country. It doesn’t need any special
act for its incorporation. There are 2 types of Government Company. They are;
1. It is totally owned by government
2. At least 51% of its shares is taken up by government
Features
1. It is incorporated under company law of the country.
2. At least 7 promoters are required for incorporation
3. It has separate legal entity.
4. It can purchase and sell securities, can enter into any contract, can sue and can be sued.
5. It is totally owned by government or at least 51% of its shares is taken up by government.
6. It is managed and controlled by board of directors and boards of directors are appointed by
the government
7. It is financed by the government.
8. Expenditure and revenues are not shown in the budget of department
9. Employees are not civil servants
10. The policies are mentioned in memorandum and articles of association.
11. The budgeting, accounting and audit procedures are not controlled and managed by the
rules and regulations of the government
12. Activities of the company are accountable to the parliament.
Department board:
They are established in the form of development board. They are needed to contact different
ministry for the incorporation. Its main aim is to operate public welfare development work. It is
established under development board act 2013. For eg trade promotion center, cottage and small
industry development board etc.
Importance of public enterprises
1. Planned development: Its main aim is to promote economic and social development in
the weaker section. It helps to run all the works of development in an efficient manner. It
follows government plans and policies. It generally focuses on private sector. It also earns
profit. It provides planned development by setting up industries too.
2. Balanced development: Development works are done in planned and balanced way. It
also provides decentralization of industries. It tries to develop all regions in harmonious
ways. Balanced development is the main aim of public enterprise.
3. Accelerating the rate of economic growth: In developing countries, increasing the rate
of economic growth always gets the first priority. It tries to remove deficiency of economy.
It provides infrastructural facilities for economic development. It provides employment
opportunities. Government invests the money. Amount of capital, technical empowerment
and other facilities can be easily arranged by the government.
 4. Public utilities: Public enterprises provide the utility of transportation, water supply,
irrigation, electricity, communication, education, health facilities and so on to the general
public.
5. Supply essential goods and services: public enterprise provides goods and services to the
public at reasonable price. The government helps in manufacture and distribution of goods.
These types of services are not done for earning profit.
6. Provide job opportunities: They help to create the employment opportunities in the
society and work as the model employer. They help in uplifting the living standard of the
people.
7. Reducing economic inequality: It removes economic inequality. It helps to develop
different regions of the country. Therefore, it maintains living standard of the public.
8. Establishment of social welfare: They help in planned development and balanced
development of the country. They also try in accelerating the rate of economic growth.
They are also established for supply essential goods and services. They help in providing
job opportunities to many people. They further help in reducing economic inequality. Thus,
they establish social welfare.
Difference Between Public and Private Goods
Public goods have two distinct aspects: nonexcludability and nonrivalrous consumption. Non
rivalry means consuming good doesn’t reduce amount available to other people and Non
excludable means once provided you can’t stop anyone consuming it.Private good, a product or
service produced by a privately owned business and purchased to increase the utility, or
satisfaction, of the buyer. The majority of the goods and services consumed in a market economy
are private goods, and their prices are determined to some degree by the market forces of supply
and demand. Pure private goods are both excludable and rivalrous, where excludable means that
producers can prevent some people from consuming the good or service based on their ability or
willingness to pay and rivalrous means that one person’s consumption of a product reduces the
amount available for consumption by another.
Public Expenditure: Meaning & Nature,Canons/Principles of Public Expenditure
Public expenditure is spending made by the government of a country on collective needs and
wants such as pension, provision, infrastructure, etc. Throughout the 19th Century, most
governments followed laissez faire economic policies & their functions were only restricted to
defending aggression & maintaining law & order. The size of pubic expenditure was very
small.But now the expenditure of governments all over has significantly increased. In developing
countries, public expenditure policy not only accelerates economic growth & promotes
employment opportunities but also plays a useful role in reducing poverty and inequalities in
income distribution.
Definition
“Public expenditure refers to the expenditure incurred by the central,state or local government of
a country for its own administration,social welfare,economic development and for providing help
to other countries.”
Nature
The nature of public expenditure differs from country to country as per the needs and requirements
of the country.In developing country,like India,government has a unique role to play with a vision
of socio-economic makeover and attainment of higher rate of growth with social justice. Public
spending in developed countries is basically undertaken to check the fluctuation in effective
demand.In developing countries public expenditure has the objective of socio-economic
transformation and positioning a leading big emerging economy in the global setting in a
developed country status.Public expenditure has multiplier effect on level of output and
employment.As the public expenditure is made by the government for public goods,it also raises
the real income and quality of life.But on one hand it has potential to raise the standard of living
at the same time it also has the tendency to push up the price by injecting the purchasing power.So
cost of living also increases.
Canons of Public expenditure/Principles of Public Expenditure
There are several principles suggesting maximization of gains of public expenditure.These
principles are called canons of public expenditure.
1.Canon of Benefit
Findly Shirras states “ Other things being equal,public expenditure should be made in such a way
that society gets major benefits which, in turn,may increase production,protect against external
aggressions maintain the internal order,and may possibly reduce the economic inequalities. “
Achievement of these objectives can be possible only when public expenditure is made not for an
individual or a class,but for the whole society.By studying the effect of public expenditure on the
distribution of income and wealth production economic development etc. assessment can be made
regarding their benefits. A major canon of public expenditure is the canon of maximum social
benefit.
2. Canon of Economy
It implies that public expenditure should be incurred carefully and economically. Economy here
means avoidance of extravagance and wastages in public spending. Public expenditure must be
productive and efficient.
Hence, it must be incurred only on very essential items of common benefit, without duplication,
in a way that involves minimum cost. An efficient system of financial administration is, therefore,
very essential in any country.
3.Canon of Sanction
Another important principle of public expenditure is that before it is actually incurred, it should be
sanctioned by a competent authority. Unauthorised spending is bound to lead to extravagance and
over-spending. It also means that the amount must be spent on the purpose for which it was
sanctioned. As a rule, therefore, money must be spent on the purpose for which it is sanctioned by
the highest authority and accounts be properly audited.
4. Canon of Surplus
Findly Shirras states “ Other things being equal,public expenditure should be made in such a way
that society gets major benefits which, in turn,may increase production,protect against external
aggressions maintain the internal order,and may possibly reduce the economic inequalities.”
This canon suggests that saving is a virtue even for the government, so an ideal budget is one
which contains an element of surplus by keeping public expenditure below public revenue. In other
words, it means that the government should avoid deficit budgeting in the interest of its own
creditworthiness.
5. Canon of elasticity
Another principle is that it should be fairly elastic. It should be possible for public authorities to
vary the expenditure according to the needs. A rigid level of expenditure may prove a source of
trouble and embarrassment in bad times. Alteration in the upward direction is not difficult. But
elasticity is needed most in the downward direction. It is not so easy to cut down expenditure.
Retrenchment of a widespread character creates serious social discontent. Perfect elasticity is out
of question. But a fair degree of elasticity is essential if financial breakdown is to be avoided at
the time of shrinking revenue.
6.Canon of Productivity
Public expenditure should stimulate productivity. It should be made in such a way that it fosters
capital formation and generated employment opportunities alongwith increases levels of
productivity and employment opportunities.
7. Canon of Equitable Distribution
Public expenditure should help equitable distribution of wealth.The government should make
expenditure so as to provide more benefit to the backward section of the society.
8. Canon of Certainty
The areas in which public expenditure is to be made should be certain so that the development
works may be carried out properly.The government should determine with certainty the allocation
of public expenditure to various uses.
9. Canon of Co-ordination
The items and amounts on which public expenditure is to be made by central,state and local self
governments should be clearly demarcated.Their should be proper co-ordination among different
governments so that dual expenditure on same item can be avoided.
10. Miscellaneous
Some other canons are:
i. While making expenditure various works should be given priority according to their relative
importance.
ii. Mode of expenditure should also be kept in mind
iii. Both short term and long term effects of public expenditure should be kept in mind
iv. While making public expenditure,population of the country,its area,its physical resources etc.
should be kept in mind.
Effects of Public Expenditure on production, distribution and economic stability
Effects of Public Expenditure on Production
Public expenditure has a great bearing on economic development and social welfare of a
country.Following observations may be noted in this regard.
 Effect on Production
According to Dr.Dalton,public expenditure tends to affect the level of production in the following
manner:
1.Capacity to work and save
As a result of public expenditure,capacity to work and save tends to rise.Government expenditure
provides various kinds of social and economic facilities stimulating the capacity to work of the
people.Increased capacity implies increased efficiency and greater employment. Level of income
and saving tends to rise facilitating greater investment and adding to the pace of growth.
2. Desire to Work and save
Expenditure incurred by the government promotes the will to work and save.As a result,their
income and standard of living tent to rise.
3. Productive Utilization of Resources
Public expenditure restores a balance in the economy by focusing on those areas of production
which generate maximum linkages effect.Public expenditure acts as a pump-priming,attracting
idle resources to their productive utilization.Accordingly,production level tends to raise the
resources from unproductive activities to productive ones.This results in increase in production.
 Effect on Distribution
Public expenditure affects distribution in the following possible ways:
1. Regional Inequality
This is how public expenditure can promote equality across different regions of a country :
i. The government expenditure should focus on development of backward areas,increasing the
level of production and income of the people of those areas.Their standard of living will increase
to catch up with the living standards in developed regions of the country.
ii. Public expenditure should include financial help to the small-scale and cottage industries.These
industries have the merit of easy-diversification across different parts of the country.Accordingly
regional inequality is expected to improve.
2. Distribution of the Dividends of Industrial Development
As a result of public expenditure,public sector industries in the country.The workers employed in
these industries are paid higher wages.They get some facilities also,better than others.Following
the public sector industries,private sector industries also provide higher wages and other facilities
to the workers.Increase in the workers wages will lead to the reduction in economic inequality.
3. Benefit to the Weaker Section
If the government makes public expenditure on social services like education,medical
care,unemployment allowance,labour welfare etc. after collecting resources by way of taxes from
the rich class,it will result in the increase in real income of the poor people,thus tilting the
distribution further in their favour.
4. Increase in the Ability to work of the Poor
Distribution of income can also be influences by increasing the ability to work of the poor with
the help of public expenditure.This objective can be achieved in two ways:
i. Direct Help : The government can provide direct help to the poor people in the form of
cash,commodities and service.
ii. Indirect Help: The government can provide loans to the poor at a low rate of interest.It can
provide them food at fair price.It can provide more social services to them.As a result of it,their
efficiency will be increased.With rise in their income level their standard of living will improve.
 Public Expenditure and Economic Stability
Cyclical changes are an inherent character of a market economy.These changes are called Trade
Cycles,and are manifested as the state of recession,depression,recovery and boom.The states of
recession and depression are particularly dangerous for restricting the pace of growth.Inflation is
equally bad when it tends to be galloping or hyper.Note the following observations to understand
how public expenditure facilities economic stability:
1. Public Expenditure and depression
During depression,the prices of commodities tend to fall. Accordingly there is a fall in production
and employment.Unemployment increases.Both the producers and the consumers become
pessimistic.Producers reduce output because of the lack of demand.Consumers,hoping for a further
fall in prices,suspend their existing consumption needs.Accordingly,reduction in demand is
compounded.As a consequence,the vicious circle of reduced demand,reduced production,and
reduced employment sets in.Here comes the significance of public expenditure.According to
Keynes, in the state depression,the government should plan for a comprehensive increase in public
expenditure.It can be of twp types:
i. Compensatory Expenditure
It includes those spending which the government makes on public works so as to increase
employment and aggregate demand.Such spending generate multiplier effect on income.Income
rises in consonance with increased employment,acting as an anti-dote the situation of depression.
ii. Pump Priming Expenditure
During the depression periods,investment is low.If investment is made in public sector,it will
prompt private investment as well.Public expenditure thus made is called pump priming.Initial
expenditure by the government particularly on infra-structural facilities,tends to be conductive for
an all round growth of private investment.
Taylor categories public expenditure during depression as
(a)Home Relief
(b) Unemployment Compensation Plans, and
(c) Work Projects.
a) Home relief is provided to the poor so as to increase their consumption,without getting their
services.This is a kind of transfer payments expected to raise consumption expenditure.
b) Unemployment Compensation Fund is set with the help of the employers,employees and the
government.Help is provided to the workers during the period of unemployment out of this fund.
c) Work projects include public works like construction of roads,bridges and dams, etc.
Expenditure on such projects will projects will generate income to combat deflation through
increased demand.
2. Public Expenditure and Inflation
Public expenditure can be used as a policy instrument to curb inflation.It should focus on the
following areas:
i. Increase in Production
Public expenditure should be utilized for increasing production. Increase in production during
inflation implies increased flow of goods and services in the economy.In the backdrop of rising
prices,increased flow of goods and services will help strike a balance between demand and supply.
ii. Reduction in Consumption
In a state of price-rise,the government should reduce its consumption expenditure.This will reduce
the pressure of demand on the goods and services.Accordingly prices are expected to fall,or at
least their pace of rise will be arrested.
Principle of Maximum Social Advantage
The ‘Principle of Maximum Social Advantage’ was introduced by British economist Hugh
Dalton. Public Finance” is concerned with income & expenditure of public authorities and with
the adjustment of one with the other.
Budgetary activities of the government results in transfer of purchasing power from some
individuals to others. Taxation causes transfer of purchasing power from tax payers to the public
authorities, while public expenditure results in transfers back from the public authorities to some
individuals, therefore financial operations of the government cause ‘Sacrifice or Disutility’ on one
hand and ‘Benefits or Utility’ on the other.
This results in changes in pattern of production, consumption & distribution of income and wealth.
So it is important to know whether those changes are socially advantageous or not.
If they are socially advantageous, then the financial operations are justified otherwise not.
According to Dalton, the principle of maximum social advantage is the most fundamental principle
lying at the root of public finance. Hence, the best system of public finance is that which secures
the maximum social advantage from its fiscal operations.
Assumptions
The principle of social maximum advantage is based on the following assumptions.
1. Taxes are the major source of government revenue.
2. The law of diminishing marginal social advantage applies to the public expenditure.
3. The taxes are subject to increasing marginal social Disutility.
Conditions of Maximum Social Advantage
The main conditions of maximum Social Advantage are as follows:
1. The social benefit from the rupee spent(MSB) on public expenditure should be equal to the
sacrifice(MSS) from the last rupee collected by way of a tax.It implies that MSB=MSS.
2. Public expenditure should be so distributed among various schemes that benefit of last
rupee spent on every scheme should be equal.
3. Taxations should be levied in different directions such that scarify or disutility from last
rupee collected from every direction should be equal.
Explanation
Government collects revenue in the form of taxes and o transfers that revenue to the public in the
form of public expenditure.The sacrifice that society has to make by paying taxes,is called social
sacrifice.Similarly,the gains which society makes by government expenditure on healthcare
,education etc. is called social satisfaction or Benefit.The government should strike a balance
between the public revenue and public expenditure in such a way as could yield maximum
satisfaction.This depends upon the Diminishing Marginal Utility and Equi-Marginal Utility.The
maximum satisfaction is achieved when Marginal Social Sacrifice(MSS) due to taxation become
equal to Marginal Social Benefit(MSB) due to expenditure.Thus Maximum Social advantage is
obtained when,
MSS=MSB
MSS-Marginal Social Sacrifice
MSB-Marginal Social Benefit
i. Marginal Social Sacrifice
When a tax is levied,people have to part with their money to give a segment of their money in the
form of taxes.This causes monetary sacrifice.This results in reduction of purchasing power of
people.The MSS curve indicates the rising marginal social sacrifice with every increase in the
taxes.

ii. Diminishing Marginal Social Benefits (MSB)

When the government undertakes public expenditure,the society gets utility or benefits.But as
more and more benefits are provided to the people,its utility to them goes on diminishing.The MSB
curve shows diminishing marginal social benefit.When the public expenditure increases from OM
to OM1 the marginal social benefit decline from LM to L1M1.

iii. Maximum Social Advantage

Since,the marginal social benefit goes on diminishing and marginal social benefit goes on
diminishing and marginal social sacrifice goes on increasing with every additional change in
expenditure and taxes respectively,the government goes on comparing marginal social sacrifice
with marginal social benefit while it imposes taxes or make public expenditure.The conditions of
maximum social advantages have been stated differently by different economists.
 Dalton’s Conditions of Maximum Social Advantage
According to Dalton,”Public expenditure in every direction shall be carries out just so far that the
advantage to the community is just counter-balanced by the disadvantage of a corresponding small
increase in taxation.”
The doctrine of maximum social benefit can be explained with the help of following figure:
MSS curve is showing marginal social sacrifice.It slopes upwards from left to right side.This
means that as a result of every increase in government expenditure,an increase in marginal social
sacrifice takes place.In this diagram,point P is showing the position of maximum social
advantage.At this point,government expenditure becomes equal to the government revenue as
shown by ON.Further,MSS(Marginal Social Sacrifice) is equal to MSB(Marginal Social
Benefit),as shown by OM.Point P shows the positions of equilibrium.
If the government imposes the taxes which exceed ON,as shown by ON1 marginal social sacrifice
will be greater than marginal social benefit(MSS>MSB).It will result into less social
advantage.Similarly,if the government keeps its expenditure less than ON1 as shown by ON2
marginal social benefit will be greater than marginal social sacrifice,yet the aggregate welfare of
the society will be less.
Significance of Principle of Maximum Social Advantage
The practical significance of this doctrine depends upon how social welfare is to be measured.Only
after determining it,we can make an estimate about the system giving maximum social
benefit.Dalton has given following standards of measurement in this regard:
Increase in production
Maximum social benefit depends upon what effect public finance is making on the country’s
production.In order to maximise the social benefit,such changes in the revenue and expenditure of
the government should be made which could stimulate production and could increase employment
and exports.According to Dalton,increase in production depends on three factors:
1. Such improvements are made in the production technique as result of which production
per workers goes up
 2. Such improvements should be made in the production organisation by which the minimum
wastage of economic resources takes place.
3. The nature of production should be improved so as to yield maximum benefit to the society.
Equitable Distribution of Wealth
Maximum social benefit also depends upon the fact that there is a proper distribution of income in
society.For it, the taxation process should be changed in such a way that more and more wealth is
collected from the rich and the same is spent on providing more and more facilities to the poor.
Political stability
Social welfare and production efficiency are promoted when there is peace and order within and
the country is protected against any external aggression.
Economic Stability
By pursuing an appropriate Fiscal Policy,Government should avoid economic fluctuations which
is a pre-condition to achieve social welfare.
Full Employment
Every government aims at achieving the goal of full employment through its fiscal policy.Full
employment maximises production and social welfare.
Future Consideration
It is the bounden duty of the government to safeguard the interests of the future generation also
while utilizing the available natural resources in the present.
Limitations
1. Difficulty of Measuring Sacrifice and Benefits
Maximum advantage is determined by marginal social sacrifice and marginal social benefit or
satisfaction.But measurement of both of them is very difficult.Since society is a group of number
of people,so it is not easy to measure the sacrifice and satisfaction of every one. Besides it,utility
or satisfaction is subjective.It is not possible to measure it.
2. Future Advantage
The expenditure made on the development projects yields several benefits in future,but the public
is burdened with taxes in the present.Therefore,it becomes difficult to make an estimated of the
maximum social advantage on the basis of future advantages and present sacrifices.
3. Methodological inconsistency
To some economists,the disutility created by taxation to the taxpayer is a micro matter concerned
with individuals,while the utility of public expenditure available to the society as a whole is a
macro problem. Therefore,serious mythological inconsistency is involved in balancing
microeconomics matter with macroeconomic matter.
4. Unrealistic assumptions
It is unrealistic to assume that government expenditure is always beneficial and that every tax is a
burden to society. For example, taxes on cigarettes or alcohol can provide benefit to society,
whereas a tax on education of essential commodities may harm general interest of society,
similarly, expenditure on social overheads like health care will give rise to social benefit whereas
unnecessary increase in expenditure on defence may divert resource from productive activities
causing loss of welfare to society.
5. 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 which do not provide any
social benefit. Secondly, there is rampant corruption in government departments. The funds meant
for public expenditure are often misappropriated, and therefore, the funds generated by way of
taxation fails to generate social benefit.
6. Large budget size
The financial operations of the government involve collection of large sums of money from
taxation and other sources and the disbursement of large amounts by way of public expenditure.
The effects of small additional amounts of these on the community are difficult to measure.
Therefore, in practice, the public authorities are not in a position to estimate the marginal benefits
and the marginal sacrifices. It is almost impossible to determine the particular size of budget that
will maximise the welfare of the community.
7. 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. Dalton fails to take into
account all such other sources.
8. Difficult to assess the capacity of the people
It is very difficult to measure the capacity of the people of a state which they can afford to pay to
the government. What people of a country afford,depends upon:
1. The manner in which the money is raised
2. The manner in which the money is spent.
Economic functions of a Modern state
The modern slate is actively intervening in economic spheres. Though it recognizes the individual
rights in private property, it allows freedom of enterprise and contract. When it finds that its laws
are being violated, it immediately intervenes for regulating the economic affairs. If the state finds
that private capital is not forthcoming in certain industries, it assists private enterprise in
establishing and running the industries. Sometimes, the government itself takes initiative and sets
up industries. The modern economists justify state interference in the following cases:
(a) Where Business is of Monopolistic Nature: There are certain businesses like railways, post
and telegraph, canal, electricity, water supply, etc., which are extremely useful for the people. If
they are given into private hands, the consumers can be easily exploited. So the government, in
the interest of the people, takes control of these businesses and runs them almost on a non-profit
basis.
(b) Where Private Capital is not Attracted: If in a certain industry or industries, the private
capital is shy because of the inadequate return or there is no return at all, the state must step in and
provide the requisite capital. The cases where private capital is not attracted are public health,
libraries, museums afforestation, road construction schemes, parks, etc., etc.
(c) Protection of economically weak persons: In a competitive society, the factory workers are
often exploited by their employees. The State therefore, must take suitable steps for protecting the
legitimate rights of a class having very weak bargaining powers.
(d) Exploitation by Forming Monopolistic combination: Sometimes the businessmen form
cartel* and trust and exploit the consumers by charging very high prices. The state in such cases
must intervene and prohibit the formation of such combination.
(e) Protection of Consumers: The state must protect its citizens against adulteration of food, sale
of intoxicants, etc. The Consumer Councils are created to advise and assist the consumers in
seeking and enforcing their rights.Consumer Protection Councils are both at Centre level and State
level, that is one Central Council and many State Councils.
(f) Supply of Currency: The state must take full control of the supply of currency in the country.
This will help the government in securing stability of prices, suitable steps to reduce inequality of
the income in the country. For this purpose, it adopts progressive system of ‘taxation, levies death
duties on inherited property and provides social services among the poor section of the community.
(g) State and Economic Planning: The state in order be speed up the economic development in
a balanced manner, formulates programmes and policies to harness the human efforts and-physical
resources to the maximum possible extent. It fixes targets and priorities and then proceeds to
complete them within the specified period.
*In economics, a cartel is an agreement between competing firms to control prices or exclude
entry of a new competitor in a market. It is a formal organization of sellers or buyers that agree to
fix selling prices, purchase prices, or reduce production using a variety of tactics.
Tax revenue-Meaning,Definition,Features and Objectives

Meaning
Tax revenue is the income that is gained by governments through taxation.To meet the increasing
public expenditure public authorities raises resources through public revenue. There are several
sources of revenue and one among them is taxes.Tax is a compulsory payment by the citizens to
the government to meet the public expenditure. It is legally imposed by the government on the tax
payer and in no case tax payer can deny to pay taxes to the government.
Definition
“A Tax is a compulsory payment made by a person or a firm to a government without reference
to any benefit the payer may derive from the government.”
-
Anatol Murad
“A Tax is a compulsory contribution imposed by public authority,irrespective of the exact amount
of service rendered to the tax payer in return and not imposed as a penalty for any legal offence.”
-
Dalton
Features/Characteristics of a Tax
1.Compulsory payment
A tax is a compulsory payment to be paid by the citizens who are liable to pay it. Hence, refusal
to pay a tax is a punishable offence
2. Public Welfare
Tax revenue is spent for the general and common benefit e.g. the construction of a hospital and
railway line,supply of water and electricity, etc. It does not benefit any single individual in
particular,rather entire society is benefitted by it.
3. No direct Service
The tax payer does not get any direct service as quid-pro-quo. In other words,the tax is not in any
way related to the benefit received from the government expenditure and the tax payer cannot
expect any benefit from the government in proportion the tax paid by him But this is not true in
all cases as there are certain taxes from whom the collected revenue is spent on those persons from
whom these taxes have been collected.For example,the major portion of the revenue collected from
road tax or petrol tax is spent on the repair and upkeep of roads.
4. No proportionate relation between the tax and the benefit
It is also not necessary that a tax payer gets the benefits form the government proportionately to
the amount paid by him as tax.Thus taxes are not paid because an individual receives a benefit
from the government or are taken from him because the government has rendered any services to
him.But there are certain qualifications to its, e.g. a land tax is paid only by those individuals who
possess land or derive benefit from land.Similarly entertainment tax will be paid by only those
who receive the benefits.
5. Personal Responsibility of an Individual
Tax has to be paid by a person even though the basis of its imposition may be goods.In other
words a tax imposes personal obligation on the tax payer.
6. Legal Procedure
Taxes are imposed legally and properly.Taxes are levied according to legal procedure.
Objectives of Taxation
1. To get Income
The fundamental objective of taxation is to finance government expenditure. The government
requires carrying out various development and welfare activities in the country. For this, it needs
a huge amount of funds. The government collects funds by imposing taxes. So, raising more and
more revenues has been an important objective of tax.
2. To regulate and Control
Taxation also aims at regulating consumption,imports,exports,profit etc. For example,in order to
control or prohibit the consumption of liquor or other intoxicants government imposes heavy taxes
on these goods.Similarly goods whose imports are to be discouraged are burdened with heavy
import duties.
3. Prevent Concentration Of Wealth In A Few Hands
Tax is imposed on persons according to their income level. High earners are imposed on high tax
through progressive tax system. This prevents wealth being concentrated in a few hands of the
rich. So, narrowing the gap between rich and poor is another objective of tax.
4. Boost Up The Economy
Tax serves as an instrument for promoting economic growth, stability and efficiency. The
government controls or expands the economic activities of the country by providing various
concessions, rebates and other facilities. The effective tax system can boost up the economy.
Similarly, taxes can correct for externalities and other forms of market failure (such as monopoly).
Import taxes may control imports and therefore help the country’s international balance of
payments and protect industries from overseas competition.
5. Allocation of resources
Change in the allocation of resources is another objective of taxation.If government wants to
withdraw the resources from the production of luxuries and utilize the same for producing more
of necessities,it imposes heavy taxes on luxuries and remove taxes from necessaries.As a result of
more taxes on luxuries their prices rise and demand falls.Less demand means less production of
these goods and less use of resources.These resources can be used for the production of necessities.
6. Control over prices
Taxation alos increase the rise in prices.One of the causes of price rise is the expansion of the
supply of money.when there ismore money with the people there is more demand and hence rise
in prices. Through taxes,government reduces the voulume of money with the
people.Consequently,there is fall in demand and also fall in the price level.
Direct and Indirect Taxes
Direct and Indirect Taxes
Direct Taxes
As the name suggests, are taxes that are directly paid to the government by the taxpayer. It is a tax
applied on individuals and organizations directly by the government e.g. income tax, corporation
tax, wealth tax, Estate Duty, Gift tax etc.
Definition:
“A direct tax is really paid by the person on whom it is legally imposed.”
-
Dalton
“Direct Taxes are those taxes which cannot be shifted and which,therefore,fall directly on the
persons from whom the government extracts the payment.”
-
Anatol Murad
Types of Direct taxes
1.Income Tax
Income Tax is paid by an individual based on his/her taxable income in a given financial year.
Under the Income Tax Act, the term ‘individual’ also includes Hindu Undivided Families (HUFs),
Co-operative Societies, Trusts and any artificial judicial person. Taxable income refers to total
income minus applicable deductions and exemptions.Tax is payable if the taxable is above the
minimum taxable limit and is paid as per the differing rates announced for each tax slab for the
financial year.
2.Corporation Tax
Corporation Tax is paid by Companies and Businesses operating in India on the income earned
worldwide in a given financial year. The rates of taxation vary based on whether the company is
incorporated in India or abroad.
3. Wealth Tax
Wealth tax is applicable on individuals, HUFs or companies on the value of their assets in a given
financial year on the date of valuation. Wealth tax payable is 1% of the net value of taxable wealth
if it exceeds Rs 30 lakh as on valuation date for the financial year. The due date for filing wealth
tax return is the same as for income tax return.
‘Net wealth’ here includes, unproductive assets like cash in hand above Rs 50,000, second
residential property not rented out, cars, gold jewellery or bullion, boats, yachts, aircrafts or urban
land. It does not include productive assets like commercial property, stocks, bonds, fixed deposits,
mutual funds etc.
4. Capital Gains Tax
The profits made on sale of property are taxable under Capital Gains Tax. Property here includes
stocks, bonds, residential property, precious metals etc. It is taxed at two different rates based on
how long the property was owned by the taxpayer – Short Term Capital Gains Tax and Long Term
Capital Gains Tax. This deciding period of ownership varies greatly for different classes of
property.
Merits of Direct Taxes
1. The larger burden of the direct taxes falls on the rich people who have capacity to bear
these and the poor people with less ability to pay have to bear less burden.
2. Direct taxes are important instrument of reducing inequalities of income and wealth.
3. Unlike indirect taxes, direct taxes do not cause distortion in the allocation of resources. As
a result these leave the consumers better off as compared to indirect taxes.
4. Revenue elasticity of direct taxes, especially if they are of progressive type is quite high.
As the national income increases, the revenue on these taxes also rises a great deal.
5. Collection of these taxes are not expensive.The tax payer himself has to deposit these taxes
with the government.
6. These taxes are based on the principle of certainty. The tax payer knows how much
tax,when,where or how he has to pay.Even the government is certain to a large extent about
the revenue collected from these taxes.
Demerits of Direct Taxes
1. In the direct taxation, people are aware of their tax liability and therefore they would try to
avoid or even evade the taxes. The practice and possibility of tax evasion and avoidance is
more in direct taxes than in case of indirect taxes.
2. Direct taxes are generally payable in lump sum or even in advance and become quite
inconvenient.
3. Another demerit of direct taxes is their supposed effect on the will to work and save. It is
assessed that work (given Income) and leisure are two alternatives before any taxpayer. If
therefore, a tax is imposed say on income, the taxpayer will find that the return from work
has decreased as compared with return from leisure. He therefore tries to substitute leisure
for work.
4. Sometimes the collection of these taxes is very expensive.If there is a great number of
people who pay only small amounts as tax,the expenditure on the collection of the tax
revenue will be enormous.For example,land revenue in India is adirect tax.Since this tax is
collected from millions of farmers in small amounts of money,its collection is very
expensive.
5. Such type of taxes may discourage capital formation.If the rate of these taxes is very high,it
affects saving adversely reducing the rate of capital formation.
6. These taxes are not popular because the tax payer has to bear their burden directly.These
taxes seem to be more oppressive.A lot of amount has to be paid in the form of these taxes.
Indirect Taxes
These are applied on the manufacture or sale of goods and services. These are initially paid to the
government by an intermediary, who then adds the amount of the tax paid to the value of the goods
/ services and passes on the total amount to the end user.Examples of these are sales tax, service
tax, excise duty etc.
Definition:
“A indirect tax is imposed on one person,but paid partly or wholly by another’.
 -Dalton
“AN indirect tax is demanded from the person in the expectation and intention that he shall
indemnify himself at the expense of another”.
Direct and Indirect Taxes
Types of Indirect Taxes
1.Sales Tax
Sales Tax is charged on the sale of movable goods. It is collected by the Central Government in
case of inter-state sales (Central Sales Tax or CST) and by the State Government for intra-state
sales (Value Added Tax or VAT). The rates of taxation vary depending on the product type.
2. Service Tax
Service tax is applicable on all services provided in India except a specified negative list of services
that are exempt. It is paid by the service provider to the government who in turn collects it from
the end user by the service provider at the time of provision of such service. Service tax is applied
generally at the rate of 12.36%, which has been revised to 14% from April 2015. This type of
indirect tax is levied by the service tax provider and paid by the recipient of the services. However,
in some cases the liability for the tax is divided between the recipient as well as the provider of
service.
There is also a provision for abatement of service tax if the final price is a mixture of services as
well as material, such as restaurant bills. In general, restaurants levy service tax on 40% of the bill
amount as 60% of the amount is considered to be cost of materials. Service taxes fall under the
ambit of the central government.
3. Excise Duty
The tax imposed by the government on the manufacturer or producer on the production of some
items is called excise duty. The liability to pay excise duty is always on the manufacturer or
producer of goods. The duty being a duty on manufacture of goods, it is normally added to the cost
of goods, and is collected by the manufacturer from the buyer of goods. Therefore it is called an
indirect tax. This duty is now termed as “Cenvat”. There are three types of parties who can be
considered as manufacturers-
 Those who personally manufacture the goods in question
 Those who get the goods manufactured by employing hired labour
 Those who get the goods manufactured by other parties For example, excise duty on the
production of sugar is an indirect tax because the manufacturers of sugar include the excise
duty in the price and pass it on to buyers. Ultimately it is the consumers on whom the
incidence of excise duty on sugar falls, as they will pay higher price for sugar than before
the imposition of the tax.
In order to attract Excise duty liability, following four conditions must be fulfilled:
a) The duty is on “goods”.
b) The goods must be “excisable”
c) The goods must be “manufactured” or produced. d) Such manufacture or production must be
“in India”
Merits of Indirect Taxes
1. Indirect taxes are usually hidden in the prices of goods and services being transacted and,
therefore their presence is not felt so much.
2. If the indirect taxes are properly administered, the chances of tax evasion are less.
3. Indirect taxes are a powerful tool in molding the production and investment activities of
the economy i.e. they can guide the economy in its resource allocation.
4. Variety is found in these taxes. Every citizen of the country has to pay these taxes in one
form or the other.
5. By imposing these taxes on harmful goods such as wine,cigarettes etc. prices of these items
can be made prohibitive.It may check their consumption and save the society of their
harmful affect.
6. These taxes are convenient. Taxes are paid only when goods are purchased.This tax is
convenient to the government also because the government realizes the amount of these
taxes straight from the producers or importers.
Demerits of Indirect taxes
1. It is claimed and very rightly that these taxes negate the principle of ability- to-pay and are
therefore unjust to the poor. Since one of the objectives is to collect enough revenue, they
spread over to cover the items, which are purchased generally by the poor. This makes
them regressive in effect.
2. If indirect taxes are heavily imposed on the luxury items then this will only help partially
because taxing the luxuries alone will not yield adequate revenue for the State.
3. Direct taxes take away a part of the purchasing power of the taxpayer and that has the effect
of reducing demand and prices. On the other hand, indirect taxes are added to the sale
prices of the taxed goods without touching the purchasing power in the first place. The
result is that in their case inflationary forces are fed through higher prices, higher costs and
wages and again higher prices.