By the Same Author and Publisher

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 PUBLIC
FINANCE
Twenty-Ninth Edition

H L Bhatia
Ex-Reader
Shri Ram College of Commerce
University of Delhi
Delhi

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Public Finance
ISBN: 978-93-5271-850-4

28th Edition 2017

29th Edition 2018

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 Preface to the Twenty-Ninth Edition

Most modern economies, including ours, are undergoing a rapid multi-dimensional transformation.
In this boiling pot, the conventional advocacy by advanced economies for a global ‘free trade
regime’ is being tempered with elements of protectionism. In addition, these economies do not
mind using international institutions like WTO for promoting their self-interest at the cost of others.
International economic activities are being tweaked with the help of tax havens, manipulations of
the global financial system, rapid advancements in information technology, trade treaties, and so
on. The line of demarcation between ‘market-oriented’ and ‘State-regulated’ economies is fading
away. Their functioning is generating a host of fresh issues, problems and opportunities relating
to social welfare, stability, and equitable and sustainable growth. In addition, several developing
countries like India face umpteen additional problems like those of economic backwardness,
pervasive poverty, poor infrastructure, institutional weaknesses, data deficiency, regional disparities
and productive inefficiency, as also those emanating from fluctuations in FDI flows and increasing
protectionism being pursued by some advanced economies.
All this and much more is persuading modern governments to assume a greater pro-active role
in dealing with the emerging issues faced by their respective economies. The result is an expanding
functional field for a typical modern government supplemented with multi-dimensional developments
in the theory of public finance. Quite a few conventional concepts are being redefined.
India is in the forefront of this transformation. It is also experiencing changes in its fiscal
federalism. GST, subsuming several Central and State level indirect taxes, is feeding this process.
It has brought in concurrency of taxation in the case of several indirect taxes, though direct taxes
are still non-concurrent. Consequently, the role of the Finance Commission has also undergone
a significant modification and its terms of reference include several fresh issues. Starting with
2017–18 Budget, Railway budget stands merged with the main budget of the GOI. The GOI has
also abolished classification of its expenditure into plan and non-plan components. The Planning
Commission has been replaced by the Niti Ayog. The transformation process is still incomplete.
The 29th edition of Public Finance is a balanced blend of:
(a) theoretical developments,
(b) issues and problems confronted by India, and
(c) their proposed and adopted solutions.
It also aims at:
(i) coverage of UGC syllabus and syllabi of the Indian universities for Honours, Postgraduate
and Professional courses;
(ii) meeting the requirements of competitive exams conducted by various bodies;
vi Preface to the Twenty-Ninth Edition

(iii) providing an objective and analytical coverage of fiscal problems and issues faced by
India;
(iv) providing authentic references on the subject;
(v) enhancing ease of comprehension of the subject and its reasoning with chapter-wise
value-added features like ‘learning objectives’, ‘summary’, ‘key terms’, and ‘review
questions and exercises’.
The edition in hand makes use of the latest available data and information from diverse sources,
including GOI budget (inclusive of the Railway Budget) for 2018–19, State Budgets for 2016–17,
reports including that of the Fourteenth Finance Commission, as also a brief introductory note on
the constitution and terms of reference of the Fifteenth Finance Commission. Mention may also
be made of the detailed coverage of GST and its pervasive impact on our economy as also the
elaboration of some other special topics in Appendices.
The book is divided into two parts. Part I provides an analytical and comprehensive discussion
of both the basics and frontiers of the theory of public finance. Part II covers the framework,
issues and working of the Indian fiscal field backed by theoretical underpinnings and international
practices and experience.
As before, this thoroughly revised and updated edition not only meets the wide-based needs
of students, teachers, and the general public, but also serves as a reference volume for researches
and others.
I am happy to place on record my sincere thanks to Prof Ashma Bhatia of PGDAV College,
University of Delhi, for her invaluable help in thorough revision and updating of this volume.
Public Finance has completed over four decades of its life and hopefully would continue to
serve its esteemed readers in future also.
H L Bhatia
 Preface to the First Edition

Public Finance is a subject which has the distinction of intimate interaction between theory and
practice. As such it acquires a meaning and usefulness only in the context of institutional framework
of the economy with reference to which it is being studied. The theoretical concepts and policy
applications in public finance feed upon and grow out of each other. No single theoretical model
can adequately fit in the framework of every economy since its institutional framework is a thing
unique to itself. It is important, therefore, that the discussion of public finance should be in the
context of a single economy. An attempt has been made to satisfy this criterion in the present book.
Care has been taken to draw illustrations mainly from the Indian economy and present analysis
of the theoretical problems in the context of Indian setting. As our society is committed to a rapid
economic growth along with economic justice, there is an undercurrent of ‘growth’ and ‘welfare’
considerations: in the treatment of the subject.
Public finance is a vast subject and in any book there is inevitably an involved question of
the choice of the problems and the relative emphasis accorded to them. In the present context the
issue has been resolved with reference to the syllabi of the Indian universities with the hope this
would make the book additionally useful to the students. It is divided into two Parts: part 1 covers
the Theory of Public Finance and part 2 covers the field of Indian Public Finance. The style of the
book is a lucid and simple one and an attempt has been made to clarify the nature of the issued
involved along with the main body of the argument.
I owe a debt to Dr A M Khusro under whose guidance I learnt the use of tools of research.
I would also like to express my gratitude to Dr C B Gupta, my teacher and principal, Shri Ram
College of Commerce, who has been a constant source of encouragement to me; and to Dr T
Mathew, Chairman, Department of Economics, North-Eastern Hill University, who was deeply
interested in seeing this book through.
H L Bhatia
 Contents

Preface to the Twenty-Ninth Edition  v

Preface to the First Edition  vii

PART-I
THEORY OF PUBLIC FINANCE

1. ECONOMIC ACTIVITIES AND THE STATE 1–20

Learning Objectives; Introduction; Some Concepts—Public Goods vs. Private Goods;
Scope of Government Activities—Theoretical Underpinnings; Historical Landmarks;
The Concept of a Mixed Economy; State and Economic Planning; Summary; Key
Terms; Review Questions and Exercises

2. MEANING AND SCOPE OF PUBLIC FINANCE 21–30

Learning Objectives; What is Public Finance?; Subject Matter of Public Finance;
Distinction Between Private and Public Finances—Similarities; Dissimilarities;
Public Finance and The Economic System; Summary; Key Terms; Review Questions
and Exercises

3. PRINCIPLE OF MAXIMUM ADVANTAGE 31–39

Learning Objectives; The Principle; The Principle in Practice—Case for State
Activities; The Tests; Conclusion; Summary; Key Terms; Review Questions and
Exercises

4. PUBLIC REVENUE—GENERAL CONSIDERATIONS 40–55

Learning Objectives; Introduction; Tax Revenue Distinguished from Non-Tax
Revenue—Laffer Curve; Principles/Canons of Taxation—Additional Principles;
Latest Additions; Characteristics of a Good Tax System; Objectives of Taxation;
Summary; Key Terms; Review Questions and Exercises

5. DIVISION OF TAX BURDEN—I 56–72

Learning Objectives; Introduction; Theories; First Set of Theories—Expediency
Theory; Socio-Political Theory; Second Set of Theories—Benefits Received Theory;
Cost of Service Approach; Summary; Key Terms; Review Questions and Exercises
x Contents

6. DIVISION OF TAX BURDEN—II 73–92

Learning Objectives; Third Set of Theories—Ability to Pay Theory; Taxable Capacity;
Summary; Key Terms; Review Questions and Exercises

7. INCIDENCE OF TAXES 93–120

Learning Objectives; The Concept—Forward and Backward Shifting; Shifting of
Incidence through Tax Capitalization; Theories of Tax Shifting; Incidence of Some
Select Taxes; Additional Factors Influencing Shifting of Tax Incidence; Deficit
Financing as a Hidden Tax—Crowding Out of Private Investment; Problem of Double
Taxation; Summary; Key Terms; Review Questions and Exercises

8. CLASSIFICATION AND CHOICE OF TAXES 121–150

Learning Objectives; Introductory; Single vs. Multiple Tax System—Single Tax
System; Multiple Tax System; Proportional vs. Progressive Taxes—Arguments for
and Against Proportional Taxation; Arguments for and Against Progressive Taxation;
Direct vs. Indirect Taxes—Criteria for Distinction; Merits and Demerits of Direct
Taxes; Merits and Demerits of Indirect Taxes; Are Direct Taxes Less Burdernsome?;
Value Added Tax—Forms of VAT; Merits of VAT; Demerits of VAT; Expenditure
Tax—Forms; Case for Personal Consumption Expenditure Tax; Hurdles; Capital
Gains Tax; Summary; Key Terms; Review Questions and Exercises

9. EFFECT OF TAXATION 151–178

Learning Objectives; Introductory; Effects of Taxation on Production and Growth—
Allocative Effects of Taxes; Allocative Effects of Individual Direct Taxes; Effects
of Taxation on Supply of Resources—A. Effect on Savings and Investment;
B. Effect on Supply of Labour; C. Indirect Taxation and Supply of Labour; Taxation
and Distribution—Measuring Inequality; Taxation and Economic Stabilisation/
Inflationary Pressures; Alternative Measures of Progressivity of the Tax System;
Summary; Key Terms; Review Questions and Exercises

10. PUBLIC DEBT 179–195

Learning Objectives; Meaning; Public Debt and Private Debt; Why Public Debt?;
Prominent Kinds of Debt; Limits of Raising Public Debt; Public Debt and Economic
Growth—Role in The Financial System; Facilitating Saving and Investment; Public
Debt and Inflation; Public Debt and Economic Regulation; Public Debt vs. Taxation;
Burden of Debt—Debt Burden and Future Generations; Debt Redemption; Some
Issues in Debt Management; Summary; Key Terms; Review Questions and Exercises

11. PUBLIC EXPENDITURE—GENERAL CONSIDERATIONS 196–213

Learning Objectives; Meaning and Nature of Public Expenditure; Wagner’s Law
of Increasing State Activities—Extending Wagner’s Law; Wiseman–Peacock
Hypothesis; Demand Supply of Government Services; Comparison Between Private
and Public Expenditure; Pure Theory of Public Expenditure—Arrow’s Impossibility
Theorem (or Arrow’s Paradox); Classification of Public Expenditure; Canons of
Expenditure; Summary; Key Terms; Review Questions and Exercises
Contents xi

12. EFFECTS OF PUBLIC EXPENDITURE 214–223

Learning Objectives; Introductory; Public Expenditure and Economic Stabilisation;
Public Expenditure and Production; Public Expenditure and Economic Growth;
Public Expenditure and Distribution; Summary; Key Terms; Review Questions and
Exercises

13. PUBLIC BUDGET 224–262

Learning Objectives; Introductory—Meaning; Indian Budget and its features; Concept
of a Good Budget; Kinds of Budget–I—Executive versus Legislative Budgets;
Multiple versus Unified Budgets; Cash-flow Based versus Accrual Based Budgeting;
Revenue and Capital Budgets; Kinds of Budget–II—Economic and Functional
Classification; Economic Classification; Functional Classification; Inferences;
Limitations; Classification of State Budgets; Performance and Programme Budgeting
System (PPBS)—Rationale of PPBS; Elaboration; Zero-Based Budgeting—ZBB in
India; Summary; Key Terms; Review Questions and Exercises

14. BALANCED BUDGET AND FISCAL POLICY 263–280

Learning Objectives; Balanced Budget—Arguments for Balanced Budgets;
Arguments Against Balanced Budgets; Balanced Budget Multiplier; Fiscal Policy—
Fiscal Policy and Stability; Fiscal Policy and Economic Growth; Fiscal Policy and
Distributive Justice; Summary; Key Terms; Review Questions and Exercises

15. FEDERAL FINANCE 281–293

Learning Objectives; The Federal Set up—Meaning of Fiscal Federalism; Evolution;
Feature Framework; Rationale; Financial Issues—Principles for Efficient Inter-
government Division of Financial Resources; Financial Imbalance: Vertical and
Horizontal Inequity; Financial Adjustment; Summary; Key Terms; Review Questions
and Exercises

16. PUBLIC UNDERTAKINGS 294–313

Learning Objectives; Meaning; Rationale; Forms of Public Undertakings; Some
Issues—Objectives; Cost–Benefit Analysis and Choice of Projects; Pricing Policy;
Management, Accountability and Incentives; Latest Trend: PPP; Summary; Key
Terms; Review Questions and Exercises

PART-II
INDIAN PUBLIC FINANCE

17. INDIAN FEDERAL FINANCE—I 314–338

Learning Objectives; Pre-Independence Evolution—The Meston Award; The
Government of India Act, 1935; Neimeyer Award; Deshmukh Award; Financial
Federalism Under Constitution—Four Stages; Allocation of Functions/Resources;
Salient Features of the Indian System—GST in India; International Experience;
Summary; Key Terms; Review Questions and Exercises
xii Contents

18. INDIAN FEDERAL FINANCE—II 339–373

Learning Objectives; PART 1: The Finance Commission—Rationale; History;
Jurisdiction; Position Prior to Amendments; Position after Amendments; PART 2:
The Finance Commission and Tax Sharing—Before 80th Amendment; After 80th
Amendment; PART 3: The Finance Commission and Grants in Aid—A. Grants in
Lieu of Tax on Railway Passenger Fares; B. Grants for Specific Purposes; C. Relief
Expenditure / Disaster Management Grants; D. Grants-in-Aid of Revenues; E. Grants
for Local Bodies; F. Fiscal Consolidation; G. Salient Aspects of FC Suggestions;
H. Concluding Observations on FCs; PART 4: Special Category States; PART 5:
Comments on our Fiscal Federalism; Summary; Key Terms; Review Questions and
Exercises

19. PUBLIC DEBT IN INDIA 374–398

Learning Objectives; Introductory; Central Government Debt—I.Composition;
II. Rapid Growth and its Causes; III. Ownership Pattern; IV. Maturity Pattern;
V. Burdensomeness; Debt of State Governments—1. Size; 2. Composition and
Ownership Pattern; 3. Burdensomeness; 4. Indebtedness to the Centre; 5. Debt
Relief to States by Finance Commissions; Summary; Key Terms; Review Questions
and Exercises

20. GOVERNMENT OF INDIA FINANCES 399–431

Learning Objectives; Introduction—1. Revenue and Capital Accounts; 2. Growing
Size; 3. Deficit Spending; Expenditure Trends—Revenue versus Capital Expenditure;
Plan and Non-Plan Expenditures; Major Components; Expenditure Policy Control of
Public Expenditure in India—Budget Secrecy; Reforming the Budget—Suggestions;
Recent Reforms; Trends in Receipts—A. Revenue Account; B. Capital Account;
Deficit Financing; Summary; Key Terms; Review Questions and Exercises

21. THE INDIAN TAX SYSTEM 432–449

Learning Objectives; Introduction; Features and Assessment of the Indian Tax System;
Some Comments on Direct Taxes; Tax Evasion and Tax Avoidance—Understanding
the Problem; Some Comments on Indirect Taxation; Summary; Key Terms; Review
Questions and Exercises

22. RAILWAY FINANCES 450–460

Learning Objectives; Introduction; Railway Finances During and after the Planning
Period— 1. Growing Needs; 2. Revenue Constraints; 3. Railway Funds; 4. Operating
Ratios; 5. Social Burden; 6. Chronic Indebtedness; 7. Rationalising Freight Rates
and Fares; Summary; Key Terms; Review Questions and Exercises

23. PUBLIC SECTOR UNDERTAKINGS IN INDIA 461–481

Learning Objectives; Meaning; Rationale; Hurdles; PSEs in India—Meaning;
Role; Governance; Origin; Growth and Diversification; Kinds; Some Problems;
Accountability; MoUs; Performance; Additional Observations on SLPEs; Summary;
Key Terms; Review Questions and Exercises
Contents xiii

24. STATE FINANCES 482–502

Learning Objectives; Introduction—Data Limitations; Revenue Account;
Capital Account; Financial Trends—Revenue Account; Capital Account; Fiscal
Consolidation; Summary; Key Terms; Review Questions and Exercises

25. AGRICULTURAL TAXATION IN INDIA 503–513

Learning Objectives; Introductory—Lack of Uniformity; Rationale—Case for
Increasing Agricultural Taxation; Case Against Increasing Agricultural Taxation;
Revenue Potential; A New System of Agricultural Taxation—Agricultural Holdings
Tax; Summary; Key Terms; Review Questions and Exercises

26. LOCAL FINANCE 514–527

Learning Objectives; Multi-Level Governance—Rationale for LBs; Recommendations
of FC-X To FC-XIII; Summary; Key Terms; Review Questions and Exercises

27. COMMENTS ON RECENT CENTRAL GOVERNMENT

BUDGETS (2014–15 TO 2018–19) 528–570
Learning Objectives; Introductory—Estimates of Revenue Foregone;
BUDGET 2014–2015 [July 2014]—I. Overview of the Economy; II. Objectives;
III. Strategy; IV. Budgetary Measures; V. Budget Estimates; VI. Tax Proposals; VII.
Revenue Foregone; Comments;
BUDGET 2015–16—I. Overview of the Economy; II. Objectives-cum-Strategy; III.
Budgetary Proposals; IV. Budget Estimates; V. Tax Proposals; Revenue Foregone in
2013–14 and 2014–15; Comments;
BUDGET 2016–17—I. Overview of the Economy; II. Thrust of the Budget; III. Some
Salient Features; IV. Budget Estimates; V. Tax Proposals; VI. Revenue Foregone in
2014–15 and 2015–16;
BUDGET 2017–18—I. Review of Economy; II. The Budget; Thrust; Some
Noteworthy Points; Revenue Foregone;
BUDGET 2018–19—I. Introductory; II.Review of Economy; III. Challenges and
Budget Objectives; IV. Some Significant Schemes and Budget Allocations; Education,
Health and Social Security; Tax Proposals; Tax revenue Raised by not Realized; Tax
Incentives in 2017-18.

APPENDICES 571–587
I. Budgetary Deficits: Concepts and Measures 571–577
II. Gender Budgeting 578–582
III. Incremental Budgeting 583–587

SELECT READINGS 588–594