LET Unique Paper Code: 227508 Name of the Paper; DSE: PUBLIC ECO Name of Course B.A. (Hons.) Econom! NOMICS ics III Year Semester : V(CBCS) ; us: 48 Duration a8 ears Maximum Mar! y, c Questions No. 1 is compulsory. Attempt any four questions out of questions 2 10 7- SECTION A i i conomy, Q. 1.(@) Discussing key reasons to market failure in an ec distinguish between the public and private goods. ae Ans. Public Good: Economists define a public good as being non riva’ an non excludable. The non rival part of this definition means that my consume does not affect your consumption of a good; I do not “use it uP - The ne excludable portion of this definition means that I cannot prevent you {T0% consuming a good. Another way of understanding this concept is saying t Be adding an additional person to the public goods market has a marginal cost af $0. In other words, even those who do not explicitly (actually) pay for the goo can benefit from the good. Private Good: A private good is rival and excludable. An example of a private good is my professor's car. BMW has manufactured a fixed number of 5 series sedans; there are not enough built for everyone to own one. My professor’ 's BMW is also excludable; he does not have to allow anyone else to drive or ride in his car. . Why are public goods an example of market failure? + Pure public goods are not normally provided by the private sector because they would be unable to supply them for a profit. + It is up to the government to decide what output of public goods is appropriate for society. + Todo this, it must estimate the social benefits from making public goods available. What is meant by the Free Rider Problem? + Because public goods are non-excludable it is difficult to charge people for benefitting form a good or service once it is provided + The free rider problem leads to under-provision of a good and thus causes market failure where MB is the marginal benefit to each person of cosuming one more unit of the public good, and MC is the marginal cost of providing that good. In other words, the public good should Private Good and Market Failure In economics, a private good is defined as an asset that is both excludable and rivalrous, It is excludable in that it is possible to exercise private property rights over it, preventing those who have not paid from 240241 z person A may do so. Person 3 When per: of water, the same bottle o! Peon purcheseaa ewatany P nd drinks a bottle and consume is not available for person B to purchase A private good is a sca i i for it. Generally, people have to pay to eae te benches retin ” 'y to enjoy the benefits of a private good. Because people have to pay to obtain it, -private goods are much Ss likely to encounter a free-rider problem than public goods, Thus, generally, the market will efficiently allocate resources to produce private ‘ods, In daily life, examples of private goods abound, including food, clothing, and most other goods that can be purchased in a store. Take an example of an ice cream cone. It is both excludable and rivalrous. It is possible to prevent someone from consuming the ice cream by simply refusing to sell it to them. Additionally, it can be consumed only once, so its consumption by one individual would definitely reduce others’ ability to consume it. (bY Explain the process of provisioning of public goods in general equilibrium modcl and show how the economy will attain efficient mix of public and private goods to be produced. Ans. The Samuelson cond ion, authored by Paul Samuelson in the theory of public goods in economics, is a condition for the efficient provision of public goods. ‘When satisfied, the Samuelson condition implies that further substituting private for public goods (or vice versa) would result in a decrease of social utility. For an economy with n consumers the conditions reads as follows: > MRS, = MRT ial MRS, is individual i's marginal rate of substitution and MRT is the economy's marginal rate of transformation between the public good and an arbitrarily chosen private good. If the private good is a numierdire good then the Samuelson condition can be re-written as: . i i { consuming one more MB, is the marginal benefit to each person o! nst cai otthe public good, and MC is the marginal cost of providing that good. jn ie ‘ded as long as the overall ben words, the public good should be provide benefit oe aniers fron that good are at least as great as the cost of proading ie ee cone tiber that public goods are non-rival, socan be enjoyed by many cons simultaneously).ni a iblic 80° vision of Pele privat rate of substitution Of INC Tyginal rate individuals is equal to te ind for the public 600%" an, econ Pareto-efficient CO} : 1. Allocate private goods © I substitution between any 6° private eoods. sate of transformation between 1 i 8 ‘2. For efficient production, the the inputs to production of all goods mus be 3, Wherever public goods oxists : substitution (for all people in society) of Le goods: marginal rate of transformation between ‘efficient outcomes for Q. 2. “The existence of distorts “ms. society as a whole.” Explain.in Reval with diagrams. io efficiency” “Ane. Beonomic Efficiency : In econom a the tert “eco on of goods is defined as the use of resources in order to maxims ne vices and services. An economically efficient ‘society can prot than another society without using more resources. A market is said to be economically e + No one can be made better off without mal + No additional output can be obtained without inputs. + Production proceeds at t] Externalities ; An externality is @ cost activity or transaction and affects a third party 0 D gost or benefit, Externalities are either positive oF negative depending on the cost or benefit, Externaliet rd party. An example of a negative extoroa)%3 ae ot facturing plants emit pollution which impacts individel living pollution, Manufactyring Pr parties who are not involved in any aspect of in the surround ne nat aze impacted negatively by the pollution. An example te aac etait would be an individual who lives by, bee farm. he» of a positive “flowers are pollinated by the neighbor's bees. They have no cost or investment in the business, but they benefit from the bees. rN peternalities and Efficiency : Positive and negative externalities both impact economic efficiency. Neoclassical welfare economics states that the existence of externalities results in outcomes that are not ideal for society as a cision the case of negative externalities, third parties experience negative wpe es from an activity or transaction in which they did not choose to be involved Inorder to compensate for negative externalities, the market as a whole i ing 5 fits in order A 3 e ole is reducing its profits in order to repair the damage that was caused which d i jis polite in ovat tities are borleficial to the third;party ‘ek 1 cost to | cficieney Pn ea era walfareis improved, but the providers at the tenet thom rhe ec ae glared Repeat Auta result ltec of (ae ectg mooaeed ansaid Bom whieh is lees optimal oniety and deteexeer erent ey. y and decreases economic efficiency. In order to deal with externaliti . ies, markets i i benefits. For costs, the market has to spend adcitional funds: aa tc a ke Oo make + Efficient provision fficient if: king someone el increasing t] Ise worse off. he amounts of he lowest possible cost per unit. or benefit that results from an ‘who did not choose to incur the1 Inelastic Demand regulation: 8 are needed to reduce lizing externalities. When marley 8 8 é x S é 1 $ S vata BP Buyer's Tay muersTax tt Inccence Ineldence Pp supplier's - Suppltersw! Taxncidence o Texincidence 1 t 1 u . L Goaay L - —_ nk QQ Quanily Seat + 4 Elastic Supply 3. Inelastic Supply. + i z Buyer's Tax stax JP Inldence ee Suppliers Supplier's lax Tax Incidence Incidencege = ¢ Economics (3 Dee. 2014) Bis 244 Paper-DSE : Publi J vogulations Iai d Se sand re ‘The ineidoneo of tnx may also depend on 1aw"Ss rule down by the Government of a country | he ability to pay Q.4. (a) Present a eritically analytical picture ot taxation. principle of taxation vis-a-vis the benefit Bee von in discussion about Ans. The are two common philosophies typically give! aportioning tax; benefit received and ability to pay. Benefit Received Principle Ids and The benofit-received principle of taxation asserts that boa basically businesses should purchase the goods and services of Boverhel tt ine the sine manner in which other commodities are bought. Tb follows the same principle us the market - the individuals who receive the benefit of a goo ba service should pay the tax necessary to supply that good or service. For A A gasoline taxes ere typically earmarked for the financing of highway cons and repairs, Those who benefit from good roads pay the cost of those ro8 a Ability to Pay Principle 3 t to the The ability-to-pay principle of taxation stands in sharp contras' a i burden benefits principle. Ability-to-pay principle rests an the idea that the tax should be geared directly to one’s income ‘and wealth. As the ability-to-pay inci ied i i i individuals rinciph din the United States, it contends that ini principle has come to be applied in Saeeaae and businesses with larger incomes should pay more taxes and relatively - than those with more modest incomes. It does not make any connection between use and payment but simply states that the individuals who are most able to bear the burden of the tax should pay the tax. (b) Explain with diagram, whether the ability to pay principal of taxation necessarily implies a progressive tax structure. ‘Ans. The ability-to-pay taxation is a taxation in the form of a progressive tax. The ability-to-pay principle in taxation maintains that taxes should be levied according a taxpayer's ability to pay. This progressive taxation approach places an increased tax burden on individuals, partnerships, companies, corporations, trusts and certain estates with higher incomes. The theory is that individuals who earn more money can afford to pay more in taxes. Ability-to-pay taxation requires that higher earning individuals pay a higher percentage of income towards taxes. ‘The tax rate increases as a percentage along with income. For example, in the United States in 2010, a tax rate of 10% applied to incomes between $0 - $8,375; the tax rate increased incrementally up to.35% for those whose incomes were $373,651 or greater (these figures are based on single filers). Critics of ability-to-pay taxation state that the progressive tax reduces the incentive to earn more money, and penalizes those whose hard work and ingenuity have helped them earn higher incomes. Q. 5. (a) What do you understand to publically provided private goods and their rationale? Is there a way to rationale? Is there a way to ration these in cases where state provision leads to over consumption of such commodities?AMAR 1 B.A. (Hons:) Economics IIT Yenr (Semester-V) 5 Ans. Public provision of private goods is oxamined within a self-selection framework where production depends on labour supply of different. households and the level of public provision. It is shown that productivity and wage-structure effects can create a role for public provision, even if preferences are weakly separable between goods and leisure. Public provision of education may offer an intuitively appealing case for the production-side impacts. : (b) Would it be correct to say that progessive taxes are essentially inefficient as they are more distortionary than proportional taxes? Ans. Progressive Taxes: The current federal income tax is a progressive tax system, in that the proportion of tax liability rises as an individual or entity's income increases. Tax burdens are meant to be more of an imposition to wealthy, high-income earners than they are to low- or middle-class individuals. Under a progressive tax system, taxes assessed on income and business profits are based on @ progressive or increasing tax rate schedule. Marginal tax rates under a progressive tax system are often higher than-the average lax rates that are paid. Estate taxes.are ‘another example of progressive taxes, as @ greater burden is placed on wealthy individuals. a Proportional Taxes ‘A proportional tax system, or a flat tax system, assesses the same tax rate income or wealth. It is meant to create equality d average tax rate paid. ‘Under a proportional tax a set percentage of their income regardless of to taxpayers regardless of it between marginal tax rate an system, individual taxpayers pay total income earned. For example, an income tax of 10% that does not increass of decrease as yr falls results ina proportional tax. Inthis example, an individual who earns $20,000 annually pays $2,000 under a proportional tax system, while someone who earns $200,000 each year pays $20,000 in taxes. Some specific seamples of proportional taxes include per eapita taxes, gross receipts taxes and occupational taxes. income rises 0} SECTION B xamine the Indian tax structure and reforms which Q.6. Critically e have been taken place in it since 1991. vans, Over the past few years, a spate of high-level corruption scandals has sharply dented the credibility of Indian capitalism. ‘The rationale for economic saforms has also been called to question, given that India’s plutocrats and politicians seem to have captured a large share of the gains from reforms. In ps environment of cynicism, it is easy to forget that corporations today aimtribute much more to the public exchequer than they did in the pre- fiberalization era. Indeed; itis precisely because of economic liberalization that India today has a far more robust and progressive tax structure than earlier. The composition of India's tax structure has changed dramatically since liberalization of the Indian economy in 1991. Tin fiscal year 1991, India’s tax system was highly dependent on indirectPaper-DSE : Public Economics (3 Dee. 2014) taxes, widely considered as more regressive than direct tases DONE they affect the rich and the poor alike. Since then, the proportion of direct taxes has beon Steadily rising. The share of direct taxes in total taxe* eclipsed the share of indirect taxes in fiscal 2007, and has remained higher ever since. The surge in ect taxes is largely because of a phenomenal increas corporate taxes which have grown at an annual clip of 20% since 1991+ the fastest among all major categories of taxes. The share of corporate taxes alone eclipsed the share Of total indirees tasen ig Heal 2009, and has remained higher since ‘hen. The share of income taxes has also risen thanks to simplification of tax rules and better tax administration, but that story is well Ino ‘The sharper rise in corporate taxes is relatively under-emphasized. Instead, after each budget. we hear stories of revenues foregone thanks to writeofts for corporations. d transformation in India’s tax Such stories are partial and ignore the profoun structure over the past two decades, fuelled by the rise in corporate taxes. ” The surge in corporate taxes is directly linked to the freeing up of the economy, lowering of marginal tax rates. and the development of India’s capital market since 1991. Before 1991, high tax rates and the lack of a well-developed capital market meant that most corporations and their promoters had an incentive to under-report profits or net incomes. That changed after 1991. as more companies were listed on the bourses, and Indian stock markets emerged as a key source of funds for corporations. The market capitalization of all firms listed on BSE as a proportion of India’s gross domestic product (GDP) was a lowly 17% in 1991. The market-cap to GDP ratio crossed the 50% mark at the end of fiscal 2000, and reached 71% at the end of the last fiscal year. Companies began vaying with each other over the past two decades to declare higher profits to attract more investors, leading to better reporting of net incomes. The government was an indirect beneficiary of this process, as it saw its coffers swell because of higher tax revenues even as tax rates fell! The Indian government's ability to extract higher revenues from corporations is among the biggest success stories of the economic reforms, and one that has given the government the scope to fund ambitious social sector schemes. It is important to recognize this success to appreciate the potential and the necd for the next round of economic reforms. Q. 7. Write a note on the introduction o! Indian high-lighting the benefits, nature, coverage, rate stru political economy considerations. Ans. The Goods and Services Tax Bill or GST Bill, officially known as The Constitution (One Hundred and Twenty-Second Amendment) Bill, al Value added Tax to be implemented’ in India from 2014, proposes a nation june 2016. “Goods and Services Tax” would be @ comprehensive indirect tax on manufacture, sale and consumption of goods and services throughout India, on veplace taxes levied by the Central and State governments. Goods and services tax would be levied and collected at each stage of sale or purchase of goods or services based on the input tax credit method. This method allows GST-registered ‘pusinésses to claim tax credit to the value of GST they paid on £ Goods and Services Tax in cture andAMAR: R: B.A. (Hons.) Economics III Year (Semester-V) 247 Purchase of good: . sor services as ; 00 5 part of thei n . av foods and services are not distinguished frow ene anathes eeeaty- Taxable sil t * ingle rate in a supply chain till the pl one another and are taxed at a Administrative i Sie ere eres soreibal i 8 reach the consumer. levy tax ility wou id generally rest with a si ity to ¥ Lax on goods and services, Exports would be zerorted and smprte eas woul be levied the s ° destination pine as domestic goods and services adhering to the ‘The introduction : sor aie alone on of Goods and Services ‘Tax (GST) would be a significant and State taxes into a single tax ‘would nts, Amalgamating several Central facilitating a common national mace Thea te cascading or double taxaisony : ier administration and enforcement. Foo the onal pa parece ihe iiggest advantage would be i ; jon i point of view ee goods, which is currently Se ee OOeAON TE oT ieee Reese “cq, What changes there would be if India launche oD GST may be nominal or zero rated for the time ping Tae ae eel to insulate the revenues of the States from the impact of GST, with th Se eaatien that in due course, GST will be levied on petroleum and otrolousn products ‘According to current minister for state for Finance Mr. Jayant Sinha, the government has assured states of compensation for any revenue losses incurred by them from the date of introduction of GST for a period of three years. ‘The salient features about this legislation were first time discussed in its first discussion paper in year 2009. We will reproduce the features discussed here again to understand this act very well. () The GST shall have two components: one levied by the Centre (hereinafter referred to as Central GST), and the other levied by the States (hereinafter referred to as State GST). Rates for Central GST and State GST would be prescribed appropriately, reflecting revenue considerations and neceptability. This dual GST model would be implemented through multiple statutes (one for CGST and SGST statute for every State). the basic features of law such as chargeability definition of taxable event and taxable person, measure of levy including valuation provisions, basis of classification etc. would be ‘uniform across these statutes as far as practicable. (i) The Central GST and the State GST would be applicable to all transactions of goods and services made for a consideration except the exempted goods and services, goods which are outside the purview of GST and the transactions which are below the prescribed threshold limits. (ii) The Central GST and State GST are to be paid to the accounts of the Centre and the States separately. It would have to be ensured that account: heads for all services and goods ‘vould have indication whether it relates to Central GST or State GST (with identification ‘of the State to whom the tax is to be credited). * Since the Central GST paid against the Central G! However, e to be treated separately, taxes and State GST ar : as input tax credit ST shall be allowed to be takenDec. 2014) 248 Paper-DSE : Public Eeono™ @ he payment of rae y against the P onl ITC) fc Id be utilized Cohn oe Central GST and coul agnandtie state GST () Cross utilization of ITC between the Oe pp and services Would not be allowed except in the case of inter-Sta! Under the IGST model which is explained later on acco (¥) Ideally, the problem related to credit cour States except in of GST should be avoided by both the Centre and the: ‘thigher rate th Such as exports, purchase of eapital goods, inputtax et OT i agi tax ete, where, again refund/adjustment should be COMP. manner, ; To the extent feasible, uniform procedure aa State GST would be prescribed in the respect r 'T and State GST. and for State (+i) The administration of the Central GST to the ope Gantt padithe GST to the States would be given. This would imply t at ‘chain and for all States would have concurrent jurisdiction for the entire VON ad for the iarevers on the basis of thresholds for goods and services P tates and the Centre, (vii) The present threshold preseribed in different State a bees which VAT is not applicable varies from State to State. A unifor "att, t threshold across States is desirable and, therefore, it 18 consideret eA a threshold of gross annual turnover of £10 lakh both for goods and services Tor alltheS tatesandU nion Territoriesm ay be adopted ith adequate compensation for the States (particularly, the States in North-Eastern Region and Special Category States) where lower threshold had prevailed in the VAT regime. Keeping in view the interest of small traders and small scale industries and to avoid dual control; the States also considered that the threshold for Central GST for goods may be kept at Rs.1.5 crore and the threshold for Central GST for services may also be appropriately high. It may be mentioned that even now there is a separate threshold of services (@ 10 lakh) and goods (@ 1.5 crore) in the Service Tax and CENVAT. (x) The States are also of the view that Composition/Compounding Scheme for the purpose of GST should have an upper ceiling on gross annual turnover and a floor tax rate with respect to gross annual turnover. In particular, there would be a compounding cut-off at 7 50 lakh of gross annual turn over and a floor rate of 0.5% across the States. The scheme would also allow option for GST registration for dealers with turnover below the compounding cut-off ‘ST ant ly of goods unt of refund GST jon of both Central for co gislation for Central The taxpayer would need to submit periodical returns, in common format as far as possible, to both the Central GST authority and to the concerned State GST authorities (xi) Bach taxpayer would be allotted a PAN-linked taxpayer identification number with a total’of 19/15 digits. This would bring the GST PAN-linked \ anAMAR : B.A. Hons.) Economics III: Year (Semester-V) 249 oe with the prevailing PAN-based system for Income tax, facilitating xchange and taxpayer compliance. ee Keeping in mind the need of tax payer's convenience, functions such sessment, enforcement, scrutiny and audit would be undertaken by the authority which is collecting the tax, with information sharing between the Centre and the States. Qs What do you understand by fiscal deficit? Discussing certain shortcomings of the concept, explain, why it still remains the most important policy indicator of the fiscal health of an economy on the domestic front? Ans. A fiscal deficit occurs when a government's total expenditures exceed the revenue that it generates, excluding money from borrowings. Deficit differs from debt, which is an accumulation of yearly deficits. A fiscal deficit is regarded by some as a positive economic event. For example, economist John Maynard Keynes believed that deficits help countries climb out economic recession. On the other hand, fiscal conservatives feel that governments should avoid deficits in favour of a balanced budget policy. Fiscal Policy is the use of Government spending and taxation to influence the levei of economic activity. In, theory, fiscal policy can be used to prevent inflation and avoid recession. But, in practise there are many limitations of using fiscal policy. Fiscal Policy explained Evaluation / Criticism of Fiscal Policy 1. Disincentives of Tax Cuts. Increasing Taxes to reduce AD may cause disincentives to work, if this occurs there will be a fall in productivity and AS could fall. However higher taxes do not necessarily reduce incentives to work if the income effect dominates. ~ 2, Side Effects on Public Spending. Reduced government spending (@) to decrease inflationary pressure could adversely effect public services such as public transport and education causing market failure and social inefficiency. 3, Poor Information. Fiscal policy will suffer if the government has poor information. E.g. If the government believes there is going to be @ ‘¢ AD, however if this forecast was wrong and he government action would cause inflation. 4, Time Lags. If the government plans to increase spending this can take along time to filter into the economy and it may be too late Spending plans are only set once a year. There is also a delay in implementing any changes to spending patterns. 5. Budget Deficit. Expansionary fiscal policy (cutting taxes and increasing G) will cause an increase jn the budget deficit which has many adverse effects. Higher budget deficit will require higher taxes in the future and may cause crowding out. E 6. Other Components of recession, they will increas the economy grew too fast, t AD. If the government uses fiscal policy itsSkog nr 280 Paper-DSE : Public Economics (3 Dee: 2014) r 5 mponents of AD, for cflectiveness will also depend upon the other COMPONT. | not lead example if consumer confidence is very low, reducing a , an increase in consumer spending. . 7. Depends on ipli ange in injec en wi ignificant. the multiplier See esas ined of the multiplier w mn an 8. Crowding Out Increased government spending (G) to se government cause “Crowding out” Crowding out occurs when increase@ §| Spending results in decreasing the size of the private sector. * Forexample ifthe government increase spending it will have to venivate taxes or sell bonds and borrow money, both method reduce ee consumption or investment. If this occurs AD will not increase or increase only very slowly. : . * Also Classical economists argue that the government is more inefficient in spending money than the private sector therefore there will be a decline in economic welfare * Increased government borrowing, can also put upward pressure on interest rates. To borrow more money the interest rate on bonds may have to rise, causing slower growth in the rest of the economy. 9. Monetarist Critique. Monetarists argue that in the LR AS is inelastic therefore an increase in AD will only cause inflation to increase tions may be increased by 900eee _ Unique Paper Code: 227603 , (s pec. 2018} Name ofthe Paper : DSE: PUBLIC ECONOMICS Name of Course B.A, (Hons.) Economics Ill Year Semester : V(CBCS) Duration :_ 3 Hours Maximum Marks : 75 ‘Attempt Five Questions in all, Select three questions from Section A and vo from Section B. SECTION A Q. 1.(a) Distinguish between pure public goods, private goods and mixed goods. In which way can one achiove Parcto optimality when an economy provides private and public goods. Discuss. 18 Ans. Public Good : Economists define a public good as being non rival and non excludable. The non rival part of this definition means that my consumption does not affect your consumption of a good; I do not “use it up”. The non excludable portion of this definition means that I cannot prevent you from consuming a good. Another way of understanding this concept is saying that adding an additional person to the public goods market has a marginal cost of $0. In other words, even those who do not explicitly (actually) pay for the good can benefit from the good. Private Good A private good is rival and excludable. An an example of a private good is my professor's car. BMW has manufactured a fixed number of 5 series sedans; there are not enough built for everyone to own one. My professor's BMW is also excludable; he does not have to allow anyone else to drive or ride in his car. Mixed Good Some goods have elements of both public and private goods. Common Pool Resource ‘A perfect example of this type of good is a local fishing hole. The fishing hole has the non excludable element of public goods (we cannot exclude certain people from fishing in the public place), but also has the rival element of a private good (There is a limited amount of fish in the pond). This type of good is called a common pool resource. Here, because each individual only catches a small fraction of the total number of fish, we see people over fishing the pond. This over fishing may lead to the depletion of the fishing utility offered by the pond. Club Goods On the other hand, club goods are non rival, but are excludable. An example of a club good is cable TV. Your use of cable TV does not limit my ability to also view television shows on cable; as long are you live in an area where the necessary cable is present, you can get cable TV. However, it is excludable in that you have to pay the monthly fee. This is an example of an industry with a relatively flat marginal cost schedule; adding an additional user faces a small marginal cost.2015) ; Dec od Paper-DSE: Public Economics © POS The Samuelson Condition of the marginal ; the sum paar + Efficient provision of public goods requires oe Pasa arose all individuals. rate of substitution of the private good for the PUBLIC EO” |. ood for the public is equal to the marginal rate of transformation of the eee lic goods with pu Pareto-efficient conditions for an economy ee the marginal rate of 1. Allocate private goods until the point at which 1 Te marginal substitution between any two private goods is equal an ate of transformation between these goods. hpnical substitution of a 2. For efficient production, the marginal Ea of tecl © inputs to production ofall goods must be equal pctitution 8. Wherever public goods exist, the sum of the marein® anal (for ail people in soviet) of pevvate for public goods must equal the marginal rate of transformation between these goods. ternal Q. 2. Explain th ative and positive ex are the different Bacal coech externality could be regulated by the government? Ans. Positive and Negative Externalities: An externality is defined a a benefit or cost that is imposed on a third party, such as society, other than the Producer or consumer of a good or service, or, more simply. an economic side effect. The more of.a product that is consumed or produced, the more of an externality that results. When discussing externalities in general terms, positive externalities refer to the benefits and negative externalities refer to the costs associated with the production or consumption of a good or service. Externalities are not ususally fully reflected in prices. Externalities are regarded as a form of market failure. The costs and benefits related to externalities are not typically included as part of the decision to complete the economic activity. Given this, the chosen volume or frequency of activity is not directly related to the externality and becomes an inefficiency in terms of resource use. Negative externalities cause too much of a product to be produced and Positive externalities cause too little of a products production. When considered. as a supply-demand graph for a positive externality, the marginal benefit curve perceived by the decision maker will be to the left of the marginal benefit curve of society. This shows too little activity taking place. Public goods are one of the more common examples of positive externalities. Public goods are goods which are difficult to exclude people from benefiting from or from getting a free ride. Public goods, such as national defense, clean water, clean air, law enforcement, etc., are generally good for most, if not all of society. Negative externalities exist in many situations. One of the most common examples is that of pollution. In these situations, the producer and consumer finance the goods produced but society must bear the cost of pollution that is introduced into the environment as a by-product and is thus a negative externality. For example, a factory that produces widgets generates a hazardousAMAR: : RR : B.A. (Hons) Economics III Year (Semester-V) ae by prod a a ee widget production process. It dumps the by-product in ee cead aa thus the e more widgets produced, the more by-product is Cee Sh a ire pollution that goes nto the water. The factory may aoe in ase pm e pollution but not all. Any remaining cost is borne by Fights there way be ion and in the event of the absence of well defined property ae a : an isis of how much pollution may be dumped into the Siete e taepes into the water at all plus an issue over who is isha it way be e cost of the pollution. In the absence of well defined property Ieisletion, ee necessary for the government to step in to introduce regulation, , taxes, etc. to address the situation. An example where the government addressed an issue was the Clean Air Act. Regulation of externalities Taxing the polluters ‘The classic textbook solution to the problem of negative externalities (especially with pollution) is to use taxation. Remember that imposing a tax ona good causes its supply curve to shift to the left, ceteris paribus, because it causes the costs of the producer to rise. ‘Although the producer may pass on some, or all, of the tax on to the consumer through higher prices (depending on the elasticity of the demand curve), it is the producer who actually pays the tax bill. . The size of the negative externality, or external cost, is the difference between the marginal social cost curve and the marginal private cost curve: If the government can correctly assess the true external cost then it can set the tax at exactly that level, so that the marginal private cost curve shifts until it superimposes itself on to the marginal social cost curve. ‘This would mean that the equilibrium price and quantity reached by consumers and producers would now be the same as the socially optimal equilibrium. ‘The diagram below isa reproduction of the first diagram inthe ‘externalities’ section. As the government impose? taxes, the MPC curve will slowly shift. This makes the welfare loss triangle shrink, and it is totally eliminated once the MPC line shifts to the same position as the MSC line. Price Marginal social cost (Msc) Mtarginal private cost (MPC) D (MisB) 0 @-— & Quantity rnalising the externalities to explain what Some textbooks use the term inte! e is going on here. By imposing a tax, the government is forcing consumers andPublic Economics (6 Dec. pare) isions. The make their decisions. when they Beternality into the market nl whore it difficult to cope with it, that it is very difficult for the xternality is. Ifthey under. theo put not quite reach the ae PaperDS! Produors to allow for tho externality W Anternal ng" part of the phrase means ‘bring! mechanism’ rather than keoping it oxtornal ‘The major problem with this solution is Sovernment to work out oxactly what the size of rate its ei ill shi loft bu estimate its size, the MPC curve will shift to the left | kaaial reach ti MSC curve. Production will still be too high and the price too left, pushin, estimate its size, the MPC will shift pass the MSC.curve on ithe I ce icin up higher than they should be and causing output to . evel. Other problems include higher prices for consumers (especially for gece like petrol, where demand is very inolastic), which reduces their at PeIRLts. But some would say that, in the ease of petrol for example, cars are big Polluters so the ever increasing price of petrol is only now beginning to reflect the external cost of using cars. It is still cheaper to'travel from, say, London to Manchester by car as long as three or four people share one car, compared with buying separate return rail tickets. The use of subsidies Taxes shift firms’ supply curve to the left, forcing them, via the market mechanism, to reduce output and increase the price to reflect the external cast, Education is an example of a good that has huge external benefits for society, so if it were left to the free market, output (which in this case means the number of people educated) would be lower than the socially optimal level. In an effort to increase the output of these type of goods, the government can pay subsidies to the producers. This will cause the supply curve to shift to the right resulting ina higher output and lower prices. In fact, education in this country is free for all children up to the age of 16, The subsidy is so big that the price is zero at the point of use. Government regulation Although in an ideal world the solution of ‘internalising the externalities’, which uses the market mechanism, would be perfect, in the real world, as we have discussed, it is difficult to get the tax level right. In some situations the government feels that their intervention needs to be a little more direct. Instead of taxing pollution, why not just ban it? Or at least legislate to control pollution levels. For example, cars now have to do an emissions test when they go in for their MOT. This all seems very straight forward, but similar problems arise. How severe should the legislation be? If a piece of legislation causes £50 milion worth of benefit in terms of reduced pollution, but it cost £60 million to administer (the cost of fixing anti-pollution filters, for example), then the regulation has been a bit over the top. As you can see, again it is difficult for the government to get the balance right.AMAR : B.A. ons.) Economics III Year Q. 8. @) Explain aif n diff help of diagrams. Di seen Progressive taxation? (Semester—Vv) ersions of equal sacrifice rule with th oes equal sacrifice rule necessarily imply 5 Ans. Equal Sacrifice has three notions: f : i) equal absolute sacrifice (4) “equal proportional sacrifice Gi) equal marginal sacrifice a eal Absolute Sacrifice means that the total utility of income sacrificed by res mae ae be equal. Thus, total sacrifice of x = total sacrifice of y, ote. ns that a person in the higher i eae © higher income group should have to pay more In a relative sense, Person with % 50,000 i income pays % 2,200 as tax and bot! in terms of percentage, the forme: r pays 5 per cent of his income while Pays 6 per cent. That means a relatively higher burden on the lower income group. » however, this may imply a re a gressive tax. Suppose a income pays % 5,000 as tax while . Equal Proportional Sacrifice suggests that the sacrifices or loss of income utility in tax payment should be proportional to the total income of each tax payer. Thus, Sacrifice of X/ Total Income of X = — Sactifice of Y_ Total Income of Y If the tax burden is imposed in this fashion, tax-payer’s disposable income will remain unchai Equal Marginal Sacrifice means that the marginal utility of income sacrificed by all the tax payers should be the same. Thus, Marginal sacrifices of X= Marginal Sacrifices of Y, ete. This implies that since a person with a high income has a low marginal utility of income and a person with a lower income hea high marginal utility of income, so the rich should pay much more than the poor. the relative position of cach nged. When all tax payers pay in terms of their marginal utility of income and when it is equal, the aggregate sacrifice involved in tax payment is the minimum, Pigou states that: “the distribution of taxation required to conform to the principle of latest aggregate sacrifices is that which makes the marginal — not the total * — sacrifice borne by all the members of the community overall.” Since the marginal utility tends to diminish at a higher income level, equal marginal sacrifice calls for maximum progressive tax rates. Thus, this principle implies “lopping off the tax of all incomes above the minimum income and leaving everybody, after taxation, with equal income: Of these three versions, equal total sacrifice, equal proportional sacrifice and equal marginal sacrifice, the last one is regarded as the ultimate, b evan f generally accepted principle of taxation by modern economists. Equal marginal l sacrifice advocates progressive taxation and is conducive to general welfare:Economics (5 Dee: 2019) / ate sacrifice is the best ‘derived from the basic 256 hence, it is the b i the leat seine : i .s that the le e best. Pigou argues it is equitable and principle of tax distribution, bec: jlity from the last Utilitarian principle of maximum welfare. me uti canige Stal marginal sacrifice (where eachgives vp ie taxation. The idea is to income) It is often used to justify PFOBT TG Sr taxes is paid. No Paste e i Something essential, examine what a person gi when last £50 in taxes 4 a ee person hight have to give UP such as a parrot shone A nigitaincome person might #7 practical value or necessity. esordingly, taxes should be 1° income person and reduced on the low-income person unt! en the last pound of taxes is paid. be 2,3 Aid What is excoss burden? How ont magnitude of excess burden © measured using compensated demand curve analysis clearly specifying the various factors involved? 6) Ans, The excess burden of a tax refers to the welfare loss caused by imposition of the tax, over and above the revenue the tax generates. vith a demand curve. Although a The simplest way to show excess burden is \ a special type of demand curve is oss Wied called a compensated demand curve. eo ‘ype of demand curve takes out the income effects of price changes and iiabous the substitution effects. rdinary and Compensated Demand Curves up a luxury of little teased on the high h sacrifice equally Excess Burden of TaxAMAR : B.A. Hons.) Economics II Year (Semester-V) . . Gs) Ans, In Figure, with a proportional tax on wage income, the consumers budget constaraint is C= w(l-)(h-1+n where ¢ is the tax rate, In figure, the bidget constraint is DEF, and the consumer chooses point A, where C = C, and 1 = 1,. Now, suppose that’ the government taxes the consumer lump-sum, and the total tax the consumer Pays with the lump-sum tax is the same as it was with the proportional tax, so that the lump-sum tax is T wt (h-1)). The consumers budget constraint is now c= w(h-1)+n-wt(h-1) Figure 3 shows the new budget constraint, which is DGH. Note that the new budget constraint is steeper than the old one, and that point A is on the new budget constraint, because if (Cl,/1) satisfies the old budget constraint it must also satisfy the new budget constraint. Thus, the consumer will now choose point B, which must be on a higher indifference curve that A, so the consumer is better off with a lump-sum tax than witha proportional tax. The proportional tax distorts economic decisions and is therefore less efficient in extracting the same revenue that a lump-sum tax can generate. ‘Consumption © leisure, 1 Fig. Proportional vs. lump-sum income tax. Q. 5. Write short notes on the following : (i) Factors affecting incidence of taxation Ans. Taxes are an important source of revenue for the government. However, taxes decrease both supply and demand in the market, because buyers have to pay a higher price and sellers receive a lower price for their Product. Rarer the government tries to divide the burden of the tax, such as thePaper DSH Publle Economler (8 Dec. 2015) > payroll nx, rout Ht al omployeg to pay % of tho tax, which, for ‘2013 onward, lt 16.0% say ot oneh tax) However, do omployora and omployoor & bea thereanalmsly ax? Aftor all, ifomployors have to pay % of tho payrol nom (On tho othor , Pay thoir workora loss to compongato for thoir share of tho Lx. ST hand, Inbourers can docide not to work for loans than what thoy want i a i us the burdon of the payroll tax, As will bo seen from considering tho supply and demand nd their olnsticitios, the actual tax incidence, which ia dofined as the actual burden that each transnetion participant shares, cannot bo mandated by law, but depends on the respective olasticities of both supply and demand ‘To botter see how the clasticity of supply and domand affects tax incidence, consider & 20% tax on a can of soda, Suppose the government dec ides that the buyer should pay the 20% tax. Doos this mean that the buyers will be paying 20% more, or will sellers have to share some of the Wx burden? Since higher prices decrease domand, regardless of the reason for the higher prices, sellers will share some of the burden. How much of the burden will be determined by the clasticity of supply and demand for the product. 258 govornmont doon with th tually L tax, 2. Elastle Demand 1, Inctastle Demand my Buyer's ‘Tox 4] incldenco Supplier's4! Tax Incidence Buyers 1 Incidence] 4! P Suppliers ‘Tax Incidence ' i ' : QF Quanty 3. Price, Buyers Tax] p, Incidence Supplier's} P Tax Incidence QQ Quantity * QQ Quantity ene eee . y if cither demand or supply was either completely elastic or inelasticAMAR: BA. Hons.) Economics III Year (Semester-V) will the tax burden fall entirely 2 extremes, tax incidence varie - or perfectly elastic demand, wh, tax to the perfectly elastic su bear the entire burden. 259 on either the buyer or the seller. Between th S continuously from a ply perfectly inelastic supply ie a tax on a particular Product quantity supplied, since suppliers are getting quantity declines from @ + or tax burden, is shared between buyer and ; ind supply. The buyer bears a when either demand is inelastic or supply is and# 4, respectively. When demand is elastic eller bears the major portion of the tax, as respectively. F elastic, as depicted in diagrams # 1 or supply is inelastic, then the s depicted in diagrams #2 and #3, (ii) Coase Theorem Ans. The Coase Theorem, developed by economist Ronald Coase, states that, when conflicting property rights occurs, bargaining between the parties involved willlead toan efficient outcome regardless of which party is ultimately awarded the property rights, as long as the transaction costs associated with bargaining are negligible. Specifically, the Coase Theorem states that “if trade in an externality is possible and there are no transaction costs, bargaining will lead to an efficient outcome regardless of the initial allocation of property rights.” The Coase Theorem is most easily explained via an example. It's pretty clear that noise pollution fits the typical definition of an externality, since noise pollution from a factory, a loud garage band, or say, a wind turbine potentially imposes a cost on people who are neither consumers nor producers of these items. (Technically, this externality comes about because it’s not well defined who owns the noise spectrum.) In the case of the wind turbine, for example, it’s efficient to let the turbine make noise if the value of operating the turbine is greater than the noise cost imposed on those who live near the turbine. On the other hand, it’s efficient to shut the turbine down if the value of operating the turbine is less than the noise cost imposed on nearby residents. - Since the potential rights and desires of the turbine company and the households are clearly in conflict, it is entirely possible that the two parties will end up in court to figure out whose rights take precedence. In this instance, the court could either decide that the turbine company has the right to operate at the expense of the nearby households, or it could decide that the households have the right to quiet at the expense of the turbine company’s operations. Coase’s main thesis is that the decision that is reached regarding the assignment of property rights has'no bearing on whether the turbines continue to operate in the area as long as the parties can bargain without cost.PaperDooih" _— ~ B sacri vot and capital budgot in onen' Q 1 () Explain the comp India. sof the governmont Ans. 1, Rovenue Budget aceipt Judes the revente Ee Tt also contains the his financial statement ine receipts ie. revenue collected by way of tases and Pa ip items of expenditure met from such rev a IM Ss eae roceivod by the ipts: the int (a) Revenue Receipt : These are , s These receipts ca from all sourves inits ordinary course iat i rernanc do not create a liability or lead to 8 reduction in assets. ee Revenue receipts are further classified 88 18% revente an (i) Tax Revenue i iv ifferent taxes and other ve is ‘he income recelv ed from di Nn o Serena rce of public revenue. Every nt, It is a major sow them and non-paymel xes and Indirect Taxes. duties levied by the governmel A , iu, by nbd PY nti punishable Taxes are of two types, viz. Direct Tat (ii) Non-Tax Revenue: Apart from taxes, governments also receive revenue from other non-tax sources ‘The non-tax sources cf public revenue are aS 1. Fees: The government provides variety o! to be paid. E.g. fees paid for registration of property, 2, Fines and penalties Fines and penalties are impos government for not following (violating) the rules ‘and regulations. 3, Profits from public sector enterprises Many enterprises are owned and managed by the government. The profits receives from them is an important source of non-tax revenue For example in India, the Indian Railways. Oil and Natural Gas Commission, Air India, Indian Airlines, ete are owned by the Government of India. The profit generated by them isa source of revenue to the government. B 4. Gifts and grants : Gifts and grants are received by the government when there are natural calamities like earthquake, floods, famines, etc. Citizens of the country, foreign governments and international organisations like the UNICEF. UNESCO, etc. donate during times of natural calamities. 5, Special assessment duty It is a type of levy imposed by the government on the people for getting some special benefit. For example, in a Fertcula locality roads are improved, property prices wil rise. The Property ‘owners in that locality will benefit due to the appreciation in the value of property ‘Therefore the government imposes a levy on them which is known as at follows: {services for which fees have births, deaths, ete. ed by the assessment duties. (iii) India’s Revenue Receipts ‘The tax revenue provides major share of i y revenue receipts to the central government of India. In 2006-07 tax revenue (direct + indirect taxes) of ental government was % 3,27,205 crores while non-tax revenue was % 76,260 croresAMAR, ii) Whatis then India, Ans, i + Constingieationale behind Moving towards GST + Presei maniac ion ©mpowers the Central Government to levy excis tase ke and service tax on the supply of, services. Further, it eins pbb tolevy sales tax or value added tax (VAT) on ‘ase ‘ i = exclusive division of fiscal powers has led toa multiplicity aie coe In addition, central sales tax (CST) is levied on inter-State een co y a Central Government, but collected and retained by the iis ‘3 a es, uurther, Many States levy an entry tax on the entry of goods This multiplicity of taxes at the State and Central levels has resulted ina complex indirect tax structure in the Country that is ridden with hidden costs for the trade and industry, Firstly, there is no uniformity of tax rates and structure across States, Secondly, there is, cascading of taxes due to ‘tax on tax’, No credit of excise duty and service tax paid at the stage of mai available to the tradi nufacture is ers while paying the State level sales tax or VAT, and view versa. Further, no credit, of State taxes paid in one State can be availed in other States. Hence, the prices of Boods and services get artificially inflated to the extent of this ‘tax on tax’, The introduction of GST. distribution of fiscal powers Fons.) Economies 11 Year (Semester-V) 261 nale behind the Proposed Goods and Service (1.5, 7.8) ntly, the e duty on empowers the sale of of indirect Ta: would mark a clear departure from the scheme of envisaged in the services, simultaneously by both the Centre and the States. Therefore, both Cenire and States will be empowered to le vy GST across the value chain from the stage of manufacture to consumption. The ctedit of GST paid on inputs at every stage of value addition would be available for the discharge of GST liability on the output, thereby ensuring GST is ch arged only on the component of value addition at each stage. This would ensure that there is no ‘tax on tax’ in the country. GST will simplify and harmionise the indirect tax regime in the country-It is expected to reduce cost of production and inflation in the economy, thereby making the Indian trade and industry more competitive, domestically as well as internationally. It is also expected that introduction of GST will foster a common or seamless Indian market and contribute significantly to the growth of the economy. : Further, GST will broaden the tax base, and result in better tax. compliance due to a robust IT infrastructure. Due to the seamless transfer of input tax credit from one stage to another in the chain of value addition, there isan in- built mechanism in the design of GST that would incentivize tax compliance by traders. | : Q.2. (i) Whatis the difference between vertical and horizontal fiscal imbalance? ‘Ans. Fiscal imbalance isa mismatch in the revenue powers and expenditure responsibilities of a government.i 15) 28 Paper-DSE : Public Economics (6 Dec. 2015) — i 8 0! In the literature on fiscal federalism, two ba Fiscal Imbalance. When measured: Vertical Fiscal Imbalance and Horiz0 yvernment (Cent; the fiscal imbalance is measured between the two et eee When the fisea) and States or Provinces) it is called Vertical Fiscal riaeanne level itis calleg imbalance is measured between the governments 4) wn as regional disparity Horizontal Fiseal imbalance, This imbalanceis alsokmowh at oer While Horizontal Fiscal Imbalance requires equalization , : be corrected by Fiscal Imbalance is a structural issue and ta ee ben ihe two setne reassignment of revenue and expenditure responsiDi ‘ies order of the governments. Di Horizontal Fiscal Imbalances as Du . A horizontal fiscal imbalance (H F) emerges when sub-national governments have different abilities to raise funds from their tax bases and to provide Seve This creates differences in ‘net fiscal benefits’, which are a combination of levels of taxation and public services. It is these NFBs which are the main cause of horizontal fiscal disparities that in turn generate the need for equalization grants. Prominent among thé objectives commonly attributed tointergovernmental fiscal transfers is ‘equalization’ of fiscal capacities or resolution of Horizontal Fiscal Imbalances. Thus, the transfer system can promote efficiency in the public sector and can level the field for intergovernmental competition. The discussion of horizontal fiscal imbalance and equalisation was of particular importance in the drafting of the new Iraqi constitution. It was a sticking point for the drafting process— with the oil rich regions seeking to minimise the reallocation of revenue while other regions sought to maximise equalisation payments. Vertical Fiscal Imbalance as a Particular Type of Fiscal Asymmetry Though there are multiple usages of the term in the fiscal federalism literature, yet, Sharma (2012) holds that strictly speaking, it shall only be used to denote a particular type of revenue-expenditure asymmetry. This can be understood as follows: Any existing revenue-expenditure asymmetry between the two levels of a government should simply be called, what it is, that is, a Vertical Fiscal Asymmetry (VFA). The precise nature of this asymmetry, in a particular country, is a matter of research. Q. 2. (ii) Briefly discuss the different channels of transfer of resources from the centre to the state in India Federalism. Ans, Over the last six decades, an overarching institutional framework had emerged to deal with Centre-state financial relations in India. The main pillars of this frame work are: (a) Finance Commission appointed periodically as per Article 280 of the Constitution of India, intended to address the, vertical imbalance in financial resources between the centre and states and to address the horizontal distribution of resources among the states. (b) Planning Commission set up-by a Resolution of the Government of f fiscal imbalances arg {ferences in Net Fiscal Benefits- or bonds of a privat AMAR : B.A, (Hons,) Economies 11 Yar Somoster-V) 263 Indi Lay jth pa 1950 to make an assessment of the material, capital ant rrésourees of the country, and to formulate» plan for effective and alanced utilization of the country’s resource: . on Cee Development Council set up in August 1952 to strengthen nd mobilize the effort and resources of the nation in support of the Five year plans. Q 3. (i) Briefly discuss the views of difforent schools of thought regarding the effect of fiscal deficit on investment and growth. ‘Ans, Fiscal deficits arise whenever a government spends more money than it brings in during the fiscal year. This imbalance, sometimes called the current is common among contemporary accounts deficit or the budget deficit, governments allover the world. Since 1970, the U.S. government has had greater expenditures than revenues for all but four years. ‘The four largest budget deficits in American history occurred between 2009 and 2012, each year showing & deficit of more than $1 trillion. Beonomists and policy analysts disagree about the impact of fiscal deficits on the economy. Some, such 8s Nobel laureate Paul Krugman, suggest that the government does not spend enough money ‘and that the sluggish recovery from the Great Recession of 2007-09 was attributable to the reluctance of Congress to run larger deficits to boost aggregate demand. Others argue that budget late capital structures and interest deficits crowd out private borrowing, manipul rates, decrease net exports, and lead to either higher taxes, higher inflation or both. Even though the long-term macroeconomic impact of fiscal deficits are subject to debate, there is far less debate about certain immediate, short-term consequences. However, these consequences depend on the nature of the deficit. If the deficit arises because the government has engaged in extra spending projects — for example, ‘nfrastructure’spending or giants to businesses — then those sectors chosen to receive the money receive & short-term boost in operations and profitability. Tf the deficit arises because receipts to the government have fallen, either through tax cuts or a decline in business activity, then no such stimulus takes place. Whether stimulus spending is desirable is also a subject of debate, put there can be no doubt that certain sectors benefit from it in the short run. ‘All government deficits need to be financed. This is initially done through the sale of government securities, such as Treasury bonds (T-bonds). Individuals, businesses and other governments purchase these bonds and lend money to the government with the promise of future payment. ‘The clear, initial impact of government borrowing is that it reduces the pool of ‘available funds to be lent to or invested in other businesses. dividual who lends ‘his is necessarily true an int $5,000 to the government. cannot use that same $5,000 to purchase the stocks te company. Thus, all government deficits have the effect of reducing the potential capital stock in the economy. This would differ if the Federal Reserve monetized the debt entirely; the danger would be inflation rather than capital reduction.i ics (5 Dec: 2015) Paper-DSE : Public Economics ( pyaar ee 264 sourities used to finance the defig, has a direct impact on interest TF! . ; id on loans to the governmen, extremely safe investments, so the interest rate pala arly all other financial . represent risk-free investments agains’ ‘nt bonds are paying 2% interes, instruments must compete. If the ee th enough rate to entice buyer, other types of financial assets must pay a DiE® Nea. ne Federal Reserve away from government bonds. This function is Uset ot within the when it engages in open market operations to ac) confines of monetary policy. In short, whenever the ere ects it makes it relatively more difficult for busin } Q. 3. (ii). Examine the limitations of using the concept of naa deficity for policy purpose. 2 i me Fiscal as the use of Government spending and taxation to - , se hi fiscal policy can be used to influence the level of economic activity. In theory, reinvent prevent inflation and avoid recession. But, in practise there are many limitations of using fiscal policy. Evaluation / Criticism of Fiscal Policy 1. Disincentives of Tax Cuts. Increasing Taxes to reduce AD may cause disincentives to work, if this occurs there will be a fall in productivity and AS could fall. However higher taxes do not necessarily reduce incentives to work if the income effect dominates. . 2. Side Effects on Public Spending. Reduced government spending (G) to decrease inflationary pressure could adversely effect public services such ‘as public transport and education causing market failure and social inefficiency. 8. Poor Information Fiscal policy will suffer if the government has poor information. E.g. If the government believes there is going to be a recession, they will increase AD, however if this forecast was wrong and the economy grew too’fast, the government action would cause inflation. 4. Time Lags. If the government plans to-increase spending this can take along time to filter into the economy and it may be too late. Spending plans are only set once a year. There is also a delay in implementing any changes to spending patterns. 5. Budget Deficit Expansionary fiscal policy (cutting taxes and increasing G) will cause an increase in the budget deficit which has many adverse effects.Higher budget deficit will require higher taxes in the future and may cause crowding out. : 6. Other Components of AD. If the government uses fiscal policy its effectiveness will also depend upon the other components of AD, for example if consumer confidence is very low, reducing taxes may not lead to an increase in consumer spending. 1 Depends on Multiplier And change in injections may be increased by the multiplier effect, therefore the size of the multiplier will be significant. . Crowding Out Increased government spending (G) to increased AD s its financing in any capacity, to raise capital in any capacity.AMAR : B.A. , (Hons.) Economies III Year (Semester-V) es may.cause “Crowding out” Crowdi: aml : re ; Spending vedults in dée-aneing tities erihe toe oe a + For example if the e private sector. government i ing it wi taxoslor| sall\bondelendi Barrer eaten eanteaeod eames consumption or investment: If this oceurg AD sill nt increase ov inereene énly veryislowly, will not increase or increase Also Classical economists 7 if argue that th ii ‘ i in spending money than the private nectar dhoecione thors williee deding in economic welfare. Se ee eaue Increased government borrowing can i eaten, To borrow more mone ie can also put upward pressure on interest . 1 n y the interest rate on bonds may have to rise, ene slower growth in the rest of the economy. 5 , . Monetarist Critique. Monetarists argue that in i i ieee 4 ] the LRAS is inelastic a gas a pote in AD will only cause inflation to increase. . 4, (i) Briefly discuss the views of different schools of thought regarding the effect of fiscal deficit on investment and growth. = Ans. s ingle Code for direct taxes: all the direct taxes have been brought under a single Code and compliance procedures unified. This will eventually pave the way for a single unified taxpayer reporting system. Use of simple language: with the expansion of the economy, the number of taxpayers can be expected to increase significantly. The bulk of these taxpayers will be small, paying moderate amounts of tax. Therefore, it is necessary to keep the cost of compliance low by facilitating voluntary compliance by them. This is sought to be achieved, inter alia, by using simple language in drafting so as te convey, with clarity, the intent, scope and amplitude of the provision of law. Each sub-section is a short sentence intended to convey only one point. All directions and mandates, to the extent possible, have been conveyed in active voice. Similarly, the provision and explanations have been eliminated since they gre incomprehensible to non-experts. The various conditions embedded in a provision have also been nested. More importantly, keeping in view the fact that a tax law is essentially a commercial law, ‘extensive use of formulae and tables has been made. Reducing the scope for litigation: wherever possible, an attempt.has been made to avoid ambiguity in.the provisions that invariably give rise to rival interpretations. The objective is that the tax administrator and the tax payer are ad idem on the provisions of the law ‘and the assessment results in a finality ity of the tax payer. To further this objective, power has also to the tax liabil i has al been delegated to the Central Government/Board to avoid protracted litigation on procedural issues. Flexibility: the struc ture of the statute has been developed in a manner ich ii ‘i i tructure of a growing which is capable of ‘accommodating the changes in the si economy without resorting to frequent amendments Therefore, to the extent possible, the essential and general principles have been reflected in the statute and the matters.of detail are contained in the rules/schedules. Ensure that the law can be refl particularly the ‘small and marginal category, lected in a Form: for most taxpayers, the tax law is what is reflected inDSE: Public Eeono™ = 26S Paper Feta Taw has been di igned so thatitis —— e ‘ the Form, Therefore, the structure off 7 . SRpable of being logically reproduced in a Pom enable a better understanding Consolidation of provisions: in °F" tions, incentives, procedure and of tax legislation, provisions relating 0&7 20 ye various provision® have also patos of taxes have been consolidated. Fur yh the general scheme of the Act. been rearranged to make it consistent wi srcomally, the taxing statute Elimination of regulatory functions: (0 sculatory authorities has also been used as a regulatary tool. However, Ni jatory function of being established in various sectors of the economy Te“ 1. contributed to the taxing statute has been withtrawne This has is ly the simplification exercise. oe eeeelal Providing stability: At present, the rates xes . Finance Act of the welevant yeah, Therefore, there is a certain degree ee tncarnines and instability in the prevailing rates of taxes. Under {f° <0: Sof tance Y ibed in the First to the Fourth Schedule rates of taxes are proposed to be prescribed in i Bill. Th to the Code itself thereby obviating the need for an annual Finance Bill. The changes in the rates, if any, will be done through appropriate amendments to the Schedule brought before Parliament in the form of an Amendment Bill. Q. 4. Gi) Equity and Efficiency in Indian Tax System. ‘i ‘Ans. In addition to tax efficiency, another consideration of tax systems *S their equity. The equity of a tax system concerns whether the tax burden is distributed fairly among the population. Vertical equity is the idea that taxpayers with a greater ability to pay taxes should pay larger amounts. Vertical equity is a justification for wealthy people to pay more in taxes than poor people. Horizontal equity is the idea that taxpayers with similar abilities to pay taxes should pay the same amount. Horizontal equity suggests that a married couple should pay the same amount of taxes as an unmarried couple with the same combined income. In 2004, President George W. Bush initiated a reform of the U.S. tax code that eliminates the penalty on taxpayers who file jointly as a married couple. Most disagreements about taxation occur because of different opinions about what is fair. According to the benefits principle, it is fair for people to pay taxes based on the benefits they receive from the government. Admission fees for parks are based on the benefits principle. A person who visits a park and pays the admission fee every week would pay more in total park fees over the course ofa year than a person who visits the park once a month. Most people consid this fair since the person who visits the park each week probably receiv: Bo benefits from the park than the person who visits it less frequently. Taxes on gasoline and diesel fuel are also based on the benefits principle. Th ‘neome generated by fuel taxes is used primarily to pay for the construction and maintenance of roads and highways. People who drive a lot semen, ane taxes over the course of a year than people who drive vi little Tein fuel consider this fair since people who drive a lot receive vnove = e. Most people roads and highways than people who drive very Kttle on eee rom the ‘There are some situations, however, in which it is difficult to use the benefit ats re stipulated in theAMAR : B.A. i . Hons.) Economics III Year (Semester-V) principle. If the afford the nec government provides additi he government provides additional incom = pay 0 taxes esis Anerd i done not make sense to Pal lea tak a Saree aily and using it transfer payments. Takin icant their net ineoie Coaserteslie 1000 of income for ceeaenea low-income I a are atently, another principle is used i es not increase eee eee s. According to the ability- used in the constructio1 Reales . y-to-pay-principle, it is fait nat (Suey arte Dacod on thet capability inhanilathe pee eee dette on ose ta inline safe fae Uied Severe eel ena . A progressive tax i tates, are based faopayers pay a larger percentage of their Cents han ie Sah The US. individual income tax structure isbased on aed eer re ginal tax rate rises asincome rises. deductions, : ‘oportional tax, by contrast, i ; i ancome canna 0 rast, is a tax for which high-inc ico spnyere atthe nae nae ofan le Fret coand tee Hat tases have boos ppsed co rae perenage a individual income tax structure. P: een proposed as alternatives to the current CN ae Wa en User ae a es aterm coe Sane tien erased aie an ‘much less information is needed t the simpl ‘o the current individual incom: 2 mplest form of a flat tax, the only information need Sen aone A regressive ei y 8 eeded is total income. e a tax for which high-i percentage of their income than do eee aay alana smaller ane oe can paye the same dollar amount i ee A mete tax. A park vontrance fee of $10 per person is an example are era example of a poll tax in literature occurs i Feat end his curs in tl i ii band of merry men who rob or steal from Se ee et eee ie poor. Part.of their motivation was that King bee tte el preryone to pay the same amount, regardless of their i Ee , a a of their that Robin Hood considered the poll ax to be unfair ee Pe erieecd in the ability-to-pay principle. se itis not age The fines for speeding in the Unit : P ed States are not bi ¥ income, Thus, receiving a speeding ticket is a kind See {nsome Buropean countries, however, the fines vary with the speeder’s income and can be proportional or progressive. Most sales taxes are regressive. Even though everyone pays a tax that is the same percentage of the purchase price e.g. 7%), the amountof tax paid isa higher percentage of income for a poor person than a rich person. To illustrate this, consider two people, Chris Cash and Pat Poor, who both buy a portable television with a price of $142.85. Suppose both pay 7% sales tax on their purchases. Thus, each person pays $.07 in sales tax on the purchase of the portable television. (($142.85)(07) = ‘Sig, Suppose Chris has an income of $1000 per week and Pat has an income of $loo per week. The Sio sales tax on the purchase of the television js ten percent of Pat's weekly income, but is only one percent ©! at pay the same f Chris’s weekly income. ven though Chris and P: dollar amount in sales tax (both pay $lo) and both pay the same percentage of the purchase price in sales tax (both pay 7% of the price of the television), the amount of sales tax paid is a larger percentage of Pat's income than of Chris's jncome. Thus, sales taxes are usually regressive. 900 267Unique Paper Code + 26 pupLIC BCONOMICS Rare opie Paper+ BSE tay Boonies HI Year Semoster oY cure) Maximum Marks, 5 oa eae Five Questions in all. All questions carry equal marks. SECTION A ; ‘. ment in Q. 1.(a) Write down the three major funetions of goneEnTENt oh a mixed econmoy provide examples to show that overlap in practice. blic sector plays an Ans. In a mixed economy, the governments besidene rch eaventeland important role in the economic life of the state throug! expenditure measures of its budget. The important functions are: @ Allocation function <= (ii) Distribution function * (iii) Stabilization function : (i) Allocation Function : Government has to provide for public goods. Public goods such as national defense, government administration and so on are different from private goods. These goods can not be provided through market mechanism but are essential for consumers and therefore, government has to provide them. Because of that government has to allocate resources between private goods and public goods. Private goods are limited to some individual or individuals but public goods are available to all. Secondly, private goods are available to those only who can buy them but this is not the case with regard to public goods. These are available to those also who can’t afford them financially, (ii) Distribution Function : Through its tax and expenditure policy government affects distribution of personal income of households in a manner which is just and fair. As such it taxes the rich and spends for the schemes which benefit more the poor. (iii) Stabilization Function : Economy of a country is affected by economic fluctuations such as conditions of boom and depression. Such changes benefit some and harm others. In such a situation appropriate policy measures are required by the government to affect the levels of aggregate demand. Such measures.are called stabilization measures. These measures aim at avoiding the situations of inflation and unemployment, (b) When is it desirable to provide private goods publicly? can the nationing devices achieve efficiency when Private goods are provided publicly’ Ans. Public provision of private goods may be justified on pure efficiency grounds in an environment where individuals consume both public and private 268AMAK : B.A, (Hons,) 20 it with information about raiment in tho provision of private goods provides more efficient roveho ea a ytunls’ private good purchanon that teilitaton provisionteruncieaens eeaetien for the provision of public goods, Public Sein Nproves economic officioncy under cortain ‘conomien 111 Your (Somontor=V) goods. The governmént’s involv Univers ‘si : from tag tal Provision of certain typos of private goods can rodistribute income imply that such sane neeeeilie important to note, howover, that this docs not package. rm part of a properly designed ro-distributional Wi ‘ . died eee map edets deadweight Joss associated with universal provision = oe other feasible policic i : distributional goals more officiate that can achieve the same There lt i : om : kote pureed ereeaine eye of allocating the public provision of private goods Rationing devices are optinal if quality is at the minimum level. Alternatively, the authorities may view many of the publicly provided goods as merit goods and not wish to lower their quality below a certain Level. When that level is reached, queueing and qualifying restrictions become optimal as further sefl-selection devices. Q. 2. Explain in detail with diagrms, the general equilibrium condition for attaining Pareto optimality in an ccoonomy providing a mix of public and private goods. : Ans. Cecil and Dorothy (These are the two individuals assumed for this) are roommates, too. They are not interested in card games or the temperature of their room. Each of them cares about the size of fclie flat that they share and tlie amount of money he or she has left for “private goods”. Private goods, like chocolate or shoes, must be consumed by one person or the other, rather than being jointly consumed like an apartment or a game of cards. Cecil and Dorothy B do not work, but have a fixed money income %W. This money can be used in three different ways. It can be spent on private goods for Cecil, on private goods for Dorothy, or it can be spent on rent for the apartment. The rental cost of a flat is %c per square foot. Let X, and X, be the amounts that Cecil and Dorothy, respectively, spend - on private goods. Let Y be the number, of square feet of space in the flat, The set of possible outcomes for Cecil and Dorothy consists of all those triples, (X,, Xp Y) that they can afford given their wealth of $W. This is just the set: (K Xq YW) Xe + Xp + eX SW) In general, Cecil’s utility function might, depend on Dorothy’s private con- sumption as well as ou his own and on the size of the apartment. He might, for example, like her to have more to spend on herself because he likes her to be happy. Or he might be an envious lout who dislikes her having more to spend than he does. Thus, in general, we would want him to have a utility function of the form: : Up&Xp¥)—_ jon / Dee 2016) ic Beonomics ee = ify mattors by Assunyiy, Jet us simtP ivate B00d8. ‘Thay i, ul P igiane fish cele goods. IF this is, in Paper DSE : Publ Burr ou fit pss at the etl that both Cecil and:Dorothy are i spe neither cares how much or little thet! fe we the form ease, then their utility functions would he on) Uc Ky and Up DY Dorothy in mind, y, cil and i With the examples of Anne and Brut on aot and of private goody, are ready to present a general definition of public rs simullancou We define a public god tobe a social deision variable aie the tale atin, as an argument in more than one person's tity Fun es of eibbage and Bruce, both the room temperature and the aE oth persons are elf were public goods, In he case of Cexl and Dorothy” uh Col an the size of their flat is the only public good. But if, for a aie hosting Dorothy care about Dorothy's consumption: of chocolate, then le would by our definition have tobe a public goods Fe acconplcals wos . py yd Perhaps surprisingly, the notion of a “private 600 ic modi and special idea than that of a public good. In the standard economic models, private goods have two distinguishing features. One is the distribution technology, Fora good, say chocolat, to bea private good it must be that th total supply of chocolate can be partitioned among the consumers in ony Way such thet the sum of the amounts received by individuals adds to the total supply available. The second feature is selfishness. In the standard models of private goods, consumers care only about their own consumptions. of any private good and not about the consuimptions of private goods by others. In the story of Cecil and Dorothy, we have one public good and one private good.” To fully describe an allocation of resources on the island we need to know not only the total output of private goods and of public goods, but also how the private good is divided between Cecil and Dorothy. The allocation problem of Cecil and Dorothy is mathematically more complicated than that of Anne and Bruce. There are three decision variables instead of two and there is a feasibility constraint as well as the two utility functions, ‘Therefore it is more difficult to represent the whole story on a graph. It is. however, quite éasy to find interesting conditions for Pareto optimality using Lagrangean methods. In fact, as we will show, these conditions can also be deduced by a bit of careful “literary” reasoning. We begin with the Lagrangian approach. At a Pareto optimum it should be impossible to find a feasible allocation that makes Cecil better off without making Dorothy worse off. Therefore, Pareto optimal allocations can be found by setting Dorothy at an arbitrary (but possible) level of utility. UD and maximizing Ceci’s utility subject, to the constraint that Up (Xp ¥)> Up and the feasibility constraint. Formally, we seek a solution tothe constrained maximization problem: Choose Xp—Xp and ¥ to maximize U, (X.—Y) subject to: UyKp¥)2 Up and X, +X +,Y¥ nd= 2)lic Economics (Nov./Dec. 2016) 276 PaperDSE : Publi a Combining Equation (2}) and (3), AP ESS nd= = NsX—p = : yd x AP = 1, XAP-1%T => yd X AP-yd x AP = XT 2 AP [n,—Nal = 1 *T . Rewrite equations (1), “aps Ms__|xq ol ap [fm sol If supply is perfetly inelastic (ns = 0) using the equation (1) we can find: xt Na => aP=0 The market equilibrium does not change. Since the producer in sending the + check to the government she bear the full burden of the tax. The consumer bears no burden of the tax. Again call the equation (1), woe (I «:), using the equation (1) we can find: If supply is perfectly elastic (n, aP= xT oon = AP=1xt => ~ AP = The market equlibrium price increases by the full amount of the tax. off setting the producers tax payment so that the producer has no remaining tax. The consumer bear the full burden of tax. ¥ The most straight forward means of computing the deadweight loss (DWL) of a tax is to use the formal for the area of a triangle: area = 4 x base x height the base of the deadweight loss triangle is the change is quantity induced by the tax (AQ) and the height is the size of the tax, so DWL = -%xaQxt wld) ‘The dead weight loss (DWL) is positive because quentity is falling (AQ <0- Recall the equaion (2') and (1) for part (a), : AQ AP ; = @) BS = xs Q P