CHAPTER 9

PUBLIC FINANCE
• Public finance is that branch of economics which describes the mechanism to collect
taxes for state and their spending to perform its various functions. Public finance is
divided into public income and public expenditure.
• Public Expenditures is about spending of the government bodies. It describes objectives
and kinds of public expenditures.
• Public Revenue (Income) covers main sources of government revenue i.e., tax and non-
tax.
• Public Debt arises when government expenditures exceed over it revenues, it forces
government to depend on public borrowing.
• Financial Administration deals with administration of public finance. It includes the
economic policy making and its implementation to achieve various stated economic
objective.
• Fiscal policy is the measure initiated by government to stabilize the economy, especially
by manipulating taxes and government expenditures.
• Tools of Fiscal Policy
➢ Changes in Government Revenue i.e., Tax Revenue and Non-Tax Revenue
➢ Changes in Government Expenditure i.e., Development expenditures and non-
Development expenditures
• Two types of fiscal policies
➢ Expansionary Fiscal Policy or Anti-Deflationary Policy
✓ Reducing Taxes
✓ Increasing government spending
➢ Contractionary Fiscal Policy or Anti-Inflationary Policy
✓ Reducing Taxes
✓ Increasing government spending
• Limitations Of Fiscal Policy
✓ Forecasting
✓ Time lag
✓ Crowding out: Increased government spending for stimulating aggregate demand
might result in crowding out; that refers to decreasing the size of private sector
due to increased government spending.
✓ Negative impact of Tax
✓ Lack of Coordination with Monetary Policy
• Functions of taxation
✓ Fiscal
✓ Allocation
✓ Regulatory
✓ Incentive
• Canons of Principles of Taxation by Adam Smith
➢ Canon of Equality: In case of income tax, high rate of tax is imposed on high
income groups, whereas low rates for lower income groups.
➢ Canon of Certainty: The time of payment, the manner of payment, the quantity
to be paid ought all to be clear and plain.
➢ Canon of Convenience: The time and manner of payment should be convenient.
➢ Canon of Economy: Tax is economical when the cost of collecting it is small and
when the amount of tax collected is equal to the treasury.
• Other Canons
➢ Canon of Fiscal Adequacy: Taxes should be such that the government is able to
meet the expenses with the taxes collected by the citizens.
➢ Canon of Flexibility: The tax system should not be rigid which means it should
be able to adjust to changing conditions.
➢ Canon of Simplicity: The system of taxation should be simple enough for
everyone to understand without which corruption or oppression might prevail
because it would be too complicated for the common man and the power will go
to the tax gatherers.
➢ Canon of Diversity: Furthermore, there should be diversity in taxes which means
there should be a large variety of direct and indirect taxes so that every citizen
who is able to pay can do so.
• Types/ Kinds or Classification of Taxes
✓ Direct Tax: A tax is said to be ‘direct tax’ if the burden of tax cannot be shifted to
anyone else. E.g., income tax, property tax.
✓ Indirect Taxation: If the burden of tax is possible to shift to someone else is called
‘Indirect Tax’. E.g., General Sale Tax (GST).
✓ Progressive Tax: A tax is said to be progressive if its rate increases along with increase
in tax base (taxable amount of asset or income). If tax rate and tax base are directly
proportion.
✓ Proportional Tax: A proportional tax is that wherein the rate of tax remains unchanged
irrespective of change in tax base. Sometimes it is also known as ‘flat’ tax.
✓ Regressive Tax: This is a tax system in which poor shares more burden of tax as
compare to rich one. Term “Regressive” states of moving from high to low, hence the
burden of tax increases from high income to low-income group.
• Economic growth depicts a long-term increase in economic activity.
• Rostow’s Stages of Economic Growth:
➢ Pre-take of stage: A stage where economy is switching from traditional farming to
modern farming with limited use of mechanization.
➢ Take of stage: This stage reflects the age of industrial revolution. Although majority of
people remain dependent on agriculture, yet agriculture assumes relatively less important.
➢ Drive to maturity: As technology becomes more relevant in the economy, industry gets
more diversified.
➢ Age of mass consumption: In this stage leading sectors produce consumer durables. As
per-capita income increase, people enjoy high living standards.
 • Indicators Of Growth and Recession
➢ Leading Economic Indicators (Signal Future Events): The nature of these indicators is
that they are used to forecast at what stage the economy will be in, at some time in the
future.
Index of business confidence
Manufacturers’ new orders
New building permits for private housing
The money supply
➢ Coincident Economic Indicators (Ongoing Events): These indicators are events and
measures that occur at the same time as peak or trough occurs. They are used by
governments to assess at what stage the economy is.
Number of people in employment
Industrial production
Personal incomes
Manufacturing and trade sales
➢ Lagging Economic Indicators (Based on Events Already Happened): These indicators
are used to assess whether an economy has reached a peak or trough 3-12 months after it
would have occurred.
Consumer Price Index (i.e., a measure of inflation)
Rate of unemployment
Interest rates
Average income (income per-capita)
• Advantages of Economic growth
✓ Higher living standards
✓ Increase in Employment
✓ Fiscal benefits
✓ Reduction in poverty
• Disadvantages of Economic growth
✓ Environmental concerns
✓ Income inequality
✓ Inflation risk
✓ Social cost
✓ Negative Externalities
✓ Current Account Deficit