3

PUBLICEXPENDITURE
THEORIES/HYPOTHESIS,
JUSTIEICATON.
DANING, SCOPE, CASSIEICATION, DIFFERENCE
AIMS AND OBJECTS
PUBLIC EXPENDITURE AND PRIVATE
BETWEEN IMPORTANCE
EXPENDITURE PRINCIPLES AND

expense that is incurred beyond what necessity

"Every particle of order and for
absolutely requires for the preservation of social
against foreign attack is waste and an unjust and oppressive
protection -Sir Henry Parencl.
imposition on the public."
Introduction
Traditional thinking and philosophy didmechanism not favour public
Cxpenditure because they felt that ratcd market is a better
guide for the working of the cconomy and allocation of its resources.
According to Robert Peei, "Money can be more fruitful in even the hands of
the public as comparcd to government." Sir Henry Pamell went to
thc extent and saidthat every public erpenditure is a waste. In those days
the scope of public finance was limited. That is why during the grcater
part of the ninetieth century, very litle attention was paid, cspecially by
English, American, German and French writers to public expenditure. In
this way, old cconomists ignored public expenditure. The main reasons
may be summarised as under :
(i) The main function of the state is confined to maintenance of
law order and peace in the country and provide safety against
foreign aggression only. Hence government should not
interfere in administration and economic field.
(ii) Old cconomists were of the opinion that every public
expenditure is unproductive and totally wasteful.
(iii) Old economists held the view that government should adopt
laissez faire policy. Government interfernce reduces
individual freedom. The state is the best which governs the
least.
However, with the passage of time, the situation has altogether
changed and economic activiies nave become complex which have
 Public Expenditure | 35
.nodthe cconomists to pay grcater attention to public
modern times, public expenditure is not only the mostexpenditure. In
the central part of the study of public important but
2s Einance revolve round this pivotal finance. All other branches of
uhlic debt are not raised for themselves but branch. Public revenuc or
aised for theultimate aim of public they are collected and
expenditure which is spending bythe
Government in performance of its various
thus, occupies the same important place infunctions. Public expenditure.
that consumption occupies in the studytheofstudy of pubic financc
nnsumption is the cnd of all economic activities, so economics. Just as
public expenditure is
also the end of all financial activities of the
state. Public expenditure is
incrcasing
India.
rapidly particularly in developed and developing countries like
MEANING OF PUBLICEXPENDITURE
Public expenditure is the expenditure incurred by public autho
rities central, state or local governments either for the
satisfaction of
collective necds of the citizens or for promoting their economic
social welfare or for protecting the citizens and the country. and
consumption is the end of all economic activities, so also Just as
public
expenditure is the end of all financial activities of the state. It is aimed to
provide maximum socio-economic welfare of the society. It is considered
to be the backbone of cconomic development of a country. Public
expenditurc is an important part of public finance. During past few ycars
there is a trend of continuous increase in public expenditure. in almost all
the countries of the world. For instance, during last few decades the
volutae of public cxpenditure has increased 10times in France, 6times in
England, 5 times in America, 2 times in Japan and above all, 150 times in
India.
 their care.
IMPORTANCE OF PUBLIC EXPENDITURE
OR
ROLEOF PUBLICFINANCE
Gone are the days when any kind of state intervention in the
socio-economic affairs of a country was considered as a positive
hindrance in the smooth working of the economy. The state was to act as
passive spectator and the countries were left to the free working of the
economic forces. It was Prof. J. M. Keynes in the twenieth century, who
realised that state interference is necessary to keep the economy of a
country in a stable equilibrium and the road leading to the destination of
full employment. At a time when there was world-wide depression
(1929-30), the economies of the world were facing the acute problems of
overproduction and mass unemployment, private investment was showing
a chronic deficiency, the emphasis was shifted from private spending to
public spending. The doses of public spending served to uplift the
economic system of the world through the interaction of multiplier
principle, from the cruel hands of worldwide depression. The
importance/significance/role of public expenditure may be studied under
the following heads:
(1)Economic Development and Planning. Public expenditure plays
a crucial role in theeconomic development and planning. The success of
economic planning depends on the public expenditure because
(i) Economic planning itself requires heavy public expenditure; (ii) For
the success of economic planning proper allocation of public expenditure
is to be done on different items, such as, roads,
electricity and power, industries,agriculture etc.; (ii)transport, irrigation,
The government is
required to establish and manage the working of several government
undertakings including public utility undertakings; (iv) Speedy capital
formation is to be undertaken; and (v) Balanced economic development.
All these require heavy public expenditure. Planned development
progranmes cannot be undertaken without
expenditurec. increasing public
(2) Reduction in Disparities of Income and Wealth. Today, great
emphasis is being given in almost all countries of the world to the
reduction of disparities of income and wealth. Public expenditure has a
vital importance in the attainment of this vital objective. Programmes for
the uplift of the poor and backward classes may be undertaken by
adopting a suitable policy of public expenditure.
(3) Economic Stability. Economic stability of a country depends on
the public expenditure. In case of depression, heavy public expenditure is
to be incurred for increasing investment, capital formation and
Cmployment and also for saving the economy from adverse effects of
 54 | Public Finance expenditure is
of boom period public
depression. On the contrary, in case
increase production and control the rising
rredin such a way as to
price-level.
Welfare. Economic-social welfare in a country
(4) Economic-Social expenditure incurred on them.
public
depends on the amount of programmes like labour welfare, child
Economic and social welfare mentally handicapped
wellare, women welfare, welfare of physically and
welfare of scheduled castes. scheduled tribes, backward classes
persons, sections
and backward areas,welfare of economicallyand socially weaker
of the society etc., all these require huge public expenditure.
(5) Economic Development of Underdeveloped Countries. It is now
unanimously agreed that publicexpenditure plays apositive role specially
in the economic development of an underdeveloped country. The
problems of underdeveloped countries are in such a magnitude that they
cannot be left at the mercy of the old laissez-faire policy. Private sector
cannot undertake the development projects, where the large amount of
riskand capital investment is involved. The only available solution lies in
the rapid increase of public expenditure.
(6) Increase in State's Activities. Formerly, the activities of the
state were limited, i.e., internal administration, maintenance of peace and
order, judiciary and defence of the countries. Nowadays the state is
required to perform several functions over and above the basic functions
Such as, education, providing basic necessities like water and
transport, establishment of basic industries in particular, labour electricity.
welfarp
banking including issue of currency,
agriculturalto industries and
socio-economic welfare, medical service, assistance development,
trade. entertainmcnt etc. All these require huge public expenditure
 JUSTIFICATION OF INCREASING PUBLIC EXPENDITURE
OR
FACTORS OR CAUSES OF INCREASE IN PUBLIC EXPENDITURE
There has been a persistent and continuous increase in public
expenditure in countries all over the world. This tendency was observed
in the closing stages of the 19th century, but it has been clear and definite
in the 20th century. It is due to the continuous expansion ia the activities
of the state and other public bodies on several fronts. The modern
governments not only perform such primary functions as the civil
administration as well as defence of the country, but also take
considerable interest in promoting economic development of their
countries. Today, the state is taking active part in social and economic
matters, such as education, public health, removal of poverty and in
commercial and industrial development. The public expenditure has
increased enormously in recent years mostly due to the development
activities of the state. Hence, the increase in public expenditure is fully
justified.
Factors or Causes of Increase in Public Expenditure
There have been many factors or causes which explain why there
has been an increase in development activities of the state and
consequently increase in public expenditure. "The important factors or
causes responsible for this increasing tendency are as follows:
(1) Increase in the Activities of the State. In recent years there has
been enormous increase in the activities of the state, particularly in the
social and economic fields, such as education, public health, public
recreation, public works, commerce and industry, five year plans etc. In
this context, Wagner's Law of increasing state's activities is
true in modern times. "Wagner maintained that there is universally
both towards an extensive and intensive' increase in thepersistent tendency
Newfunctions are continually being undertaken and old functions of state.
performed more efficiently on a large scale." Hence morefunctions are being
and more public
expenditure is resorted to, to perform these activitics. This leads to the
increase of public expenditure.
(2) Rapid Increase in Population, It is an admitted fact that
the
population is increasing rapidly. In June 2000, the population of India
 38 Public Finance
exceeded 100 crores figure. As a result, the government have to
greater expenditure to mect the requiremcnts of the incur
population. In fact, thc public expenditure should increase in the san
proportion inwhich the population increases.
increasing
(3) Urbanisation Effects. The spread of urbanisation is
important factor leading to relative growth of public expenditure i
modern times. The rapid race of urbanisation is a global phenomenon of
the day. Urbanisation is responsible for the increase in cxpenditure on
water supply, electricity, construction and maintenance of hospitals
roads, schools and colleges, play-grounds, provision of transport, Darke
libraries, sanitation, community hall, street-lights, organised recreation
etc.
(4) Rising Trend of Prices. Public expenditure is increasing in every
country of the world due to rising trend of prices. The reason is that like
the private individuals, the government has to buy goods and services
from the market at higher prices. Government has to
salaries, dearness allowances etc. of government employees increase tothea
rapid increase in government expenditure. leading
(5) Political
ReasonsGrowth of Democracy. Growth of
democracies and socialism has been
tendency of public expenditure to a greatresponsible for the increasing
extent. The democratic form of
government very expensive. To achieve the goodwillof the public, the
is
ruling party has to incur heavy expenditure on
services and facilities to the public. For instance, bothproviding variety of
governments in India are providing farm central and state
to become popular to win subsidies on a large scale so as
elections.
rupees per kilo rice scheme, free water toSomc examples are NTR's two
farmers
Government and Jayalalita, (the other chief minister), free by Tamil Nadu
tube-wells and free canal water for irrigation to farmers byelectricity for
Government and free electricity to farmers by Bihar the Punjab
is considered to be the Government,is, which
states may also use thispoorest
cheap
state in the country. The danger other
disastrous for the country. Central popularity weapon and that may prove
of rupees by way of subsidy every Government,
year in
too, is spending crores
bank. For example, the Central order to strengthen its vote
(wheat and rice) to about 32 crore Government providing 10 kg. foodgrain
is
per month at little over half the people living below the poverty lince
Public Distribution system whichaverage has
price level under the Targeted
1997. This exercise had increased the been enforced from 2nd April.
by Rs. 8,282.9 crores per burden of the Central Government
above the existing subsidyannum from 1997-98 budget. It is over and
under the Public Distribution system for
1996-97, Rs. 5.884 crorcs. In June, 2000 Government of India
a newLife Insurance Policy announced
half premium for the called Janshri Life Insurance Policy
masses living below poverty linc. Under thisplan on
every person living below poverty line will be plan,
annun1 by way of premium. Out of this, Rs. 100 required to pay Rs. 200 per
will be paid from the
 Public Expenditure | 39
social securityandfund of Lifc Insurancc Corporation by the Central
Government Rs. 50 by the Statc
Government. Hcnce actually the
insured will be required to pay Rs. 50 only.
such vote bank Thus, almost cvery day you
may hear of announccment by
ministers--both central
and states simply to strengthen their vote bank. As a result of all lhese,
public expenditure increases rapidly.
(6) Problem of Defence. One of the major
causes for the sharply
upwardtrend of public expenditure has been the problem of defence
the country. If one nation wants to Strengthen its defence, the others areof
hond to take a similar step in sheer self-defence. For example. India is
compelled to increase its defence expenditure on account of the rising
defence expenditure in Pakistan and China. The technique of war and
weapons has undergone a remarkable change. This has led to the
increase in government expenditure.
(7) Welfare State. The modern state is a welfarc state. It has to
spend increasing amounts On such items as social insurance,
unemployment reliet, free medical aid, free education, child welfare,
women's welfare, labour welfare, concessional rates of water supply,
foodstuffs, electricity etc. to improve the cconomic and social welfare of
the country. As a result, the public expenditure is bound to increase.
(8) General Expenditure on Internal Security. Internal political
situation of a country is becoming uncertain and insecure day by day. It is
true in the case of almost every country of the world including India.
Hence, every government, today, has to spend more on the maintenaace
of law and order in the country. As a result, the public expenditure is
bound to increase.
(9) Nationalisation of Industries and Trade. In order to regulate
monopolies, providing consumers with goods and services at cheaper
rates, improving the conditions of labour and proper distribution of
income and wealth, governments are undertaking the policy of
nationalisation of industries and trade. Huge amounts are to be paid by
Way of compensation and also running up these loss incurring enterprises.
This factor is also responsible for increase in public expendiure.
(10) Economic Planning. What to say of socialist countries, almost
the
all democratic countries of the world inciuding India are following
Path of economic planning for the rapid cconomic development ol the
cOuntry. So far in India, we have completed eight five year plans and the
Ve year plan is in progress. Every ycar crores of rupees are to e
On cconomic planning. This factor is cqually responsible tor rapid
P
increase in public expenditure. O
ndustrial Develonment. With the increascdwithoutput
incrcascd
4
industry, income and level of living rose, rising population of consumers,
old and new wants and their satisfaction, the protcctionand above al,
relal ions uMernmcnt
regulation of industry, new problems in labourexpansion ol
expansion of industries etc. have called for an
action andthereby increase in ppublic expenditure.
 40 | Public Finance
of developing
pevelopment of Agriculture. The governmentsdevelopment of
ies like India are spending hupe amounts for the
countries
gicuiure on account of rapid increase in population. They provae
loans to the farmers at lOw rate interest oive export subsidies, fertilisers
subsidies, assure minimum guarantee prices. tariff protection, supply ol
foodgrains at subsidised rates through public distribution system,
agricultural research, soil conservation programme etc. This factor 15 alsO
responsible for rapid increase in public expenditure.
Justification. Increase in publicexpenditure can be justified on the
tollowing grounds : (i) Assists in increasing state activities, (ii) Increase in
welfare activities, (ii) Reduces disparities between the rich and the poor,
(iv) Boomn for rapid economic development specially in undeveloped and
backward economy, (v) Provides economic stability, and (vi) Brings
prosperity etc.
 13
PUBLICDEBT
OR
THEORY OF PUBLIC DEBT

«Public debt is a comparatively modern phenomenon and has

come into existence with the development of democratie form of
governments in the world. " -Dr. J. K. Mehta
Introduction
Gone are the days when the function of the State was confined to
civil administration and defence of the country against foreign
aggression. The modern governments not only perform these two primary
functions but also take considerable interest in economic development of
their respective countries. Today, the state is taking active part in social
and economic matters, such as education, public health, removal of
poverty and in economic, commercial and industrial developments. The
concept of a welfare state has also widened the scope of the State
activities. On account of the expansion of State activities the public
expenditure has enormously increased in recent years. Now there are two
major sources of the State income : () public revenue, and (ii) public
debt. The public revenue falls much short of the total expenditure. Hence
there is no other alternative before the State except to raise money
through public debt, i.e., to borrow money from the public. The Central
government, State governments and the local government bodies borrow
money from the public from time to time so as to meet their growing
expenditure. These accumulated borrowed amounts constitute
government or public debt.
MEANING AND DEFINITION OF PUBLIC DEBT
Public debt is a debt or lo¡n taken by the government from its own
people as well as from foreign countries. It is a term used for short-term
and long-term borrowings of the government/State. The government may
borrow from banks, business organisations, business houses, individuals
and also from forcign countries. Thus, the borrowings of the government
maybe within the country or outside thecountry or both. The public debt
is generally in the form of bonds or treasury bills if the loans are rcquircd
 Public Debt or Theory of Public Debt 183
for a short period which carrics with them the promises of the
government to pay interest to the holders of these bonds at stipulated
rate of interest at regular intervals, or lump sum at the end of the
stipulated period, in addition to the principal amount which has to be
repaid at the stated timc. In the words of Philip E. Taylor The debt is in
the form of promises by the treasury to pay to the holders of these
promises aprincipal sum and in most cases intercst on that principal."
According to J. K. Mehta, Public debt is a comparatively modern
phenomenon and has come into existence with the development of
democratic form of governments in the world."
Since current public revenue is usually insufficient to meet the
current and development expenditure of the modern government, the
government has no alternative except to borrowmoney within the country
or outside the country or both. While differentiating public debt from
public revenue, Prof. J. K. Mehta has rightly remarked, Public revenue
consists of the money that the government is not obliged to return to the
very individuals from whom it is obtained, public debt on the other hand,
carries with it the obligation on the part of the government to pay money
back to the individuals from whom it has been obtained." According to
Prof. Findley Shirras, National debt is a debt which a state owes to its
subject or to the nationals of other countries."
 METHODSOF RAISING PUBLIC DEBT
OR
SOURCES OF PUBLIC BORROWINGS
OR
FLOATATION OF PUBLICDEBT
Every government has two major sources of borrowing (I)
internal, and (II) external. Internally, the government can borrow from
individuals, financial institutions, commercial banks, nonbanking
institutions, and central bank. Externally, the government borrows from
individuals and banks, international institutions and foreign governments.
Now we shall discuss both the sources of raising debts :
 190 | Public Finance
() Internal Sources of Public Debt
public decbt arc asfollows :
Internal sources of raising the important mcthods of
Individuals. Onc of
() Borrowing fromindividuals is in theformof bonds, debenturcs or
dates.
raising public dcbt from ropayablc on duc
loan. They bear a fixcd ratc of intercst and arc
purchascd by individuals from the government and are repaid
ney are
by the government on duc dates.
Borrowing from Commercial Banks. Public debts arc als0
(2) commercial banks in the form of loans.
raised by the government from creation
Commercial banks can subscribe to government loans through
of credit.
Institutions.
(3) Borrowing from Nonbanking Financial
companies, trusts,
as, insurance
Nonbanking financial institutions, such government bonds and thus it is
mutual savings banks etc. subscribe to public debt. These nonbanking
also an important source of raising
financial institutions prefer government bonds because of the security
high negotiability and
provided by the latter and also due to their
iquidity.
The central bank of country is
(4) Borrowing from Central Bank. government loans. Central bank
also an important subscriber to the
Central Government and the
purchases bonds of the government- both
government bonds, the central
State Governments. By purchasing
government creditsthe account of the government concerned.
(II) Borrowing from External Sources
foreign individuals and
External sources of borrowings include foreign
and governments. In
foreign banks, international institutions two important sources of
recent years, apart from other foreign sources, They are (i) I.M.E,
raising foreign publicdebts have become prominent.
for short term mainly for
L.D.A., LEC., I.B.R.D., which give loans difficulties and also for the
overcoming temporary balance of payment Government assistance is
long term for development purposes. (1)
projects to mainly underdeveloped and
generally for developmentIndia.
developing countries like External sources of borrowing are
becoming considerably important in recent years.
REDEMPTION OF PUBLIC DEBT
OR
METHODS OF REDEMPTION OF PUBLIC DEBT
Redemption means repayment of a debt. Just as the private
individual or organisation has to repay the loan he or it has borrowed, so
also the government has to pay not only interest on the public debt but
also repay the principal on the due date. The sooner the debt is cleared,
the better for the government. Hence every government tries to redeem
the loan at the earliest. However, the redemption of debtor loan depends
upon the nature of debt. If debt is taken for productive purposes, it may
not be strictly necessary to redeem it at the carliest because the
 Debt 191
Public Debt or Theory of Public
pay off the interest of
government is also getting a sourcc of income to purposes
the debt. On the contrary, if loan is taken for non-productive
bctter, both or the
such as war dcbt, the sooner it is paid ofl, the without any
government as wcll as for the public, because it is burden
return. Accumulation of such a debt may causc bankruptcy.
Methods of Redenption of Public Debt
Following arc the main methods of the rcdemption or repayment of
public debt.
(1) Repudiation.Repodiation of public debt means refusai to repay
a public debt by the government. It means that the concerned
government does not recognize its obligation and refuses to repay the
loan taken by it. Repudiation is not paying off a loan but destroying it.
This method was followed by the U.S.A, after the civil war and by tte
U.S.S.R. after the 1917 revolution. However, this method is mos!
undesirable because (i) it shakes the confidence of the people in public
debt, (i) may provoke retaliation from the creditor countries, and (ii) it
is considered immoral and dishonest. That is why this method of
redemption of publicdebt has not been used recently anywhere in the
world.
(2) Refunding, Refunding is the process by which the maturing
bonds are replaced by new bonds. In this case new bonds are issued by
the government in order to pay off the matured loans. This process of
refunding involves no liquidation of money burden of the public debt.
(3) Conversion. Conversion of public debt means exchange of new
debts for the old ones. In this method, the loan is actually not repaid, but
it is converted into a new loan.
(4) Annual Repayment. Under this method of redemption of public
debt, the public debt is repaid in equal instalments which include both
the interest and the principal. It is done annually and hence is also called
terminal annuity. The main benefit of this method is that it leads to a fall
in the burden of public debt every year.
(5) Sinking Fund. Sinking fund is probably the most popular and
systematic method of redeeming public debt. Under this method, the
governmnent establishes a separate fund known as the 'Sinking Fund for
the repayment of the public debt. The government goes on crediting
the debt matures,
every year fixed sum of money to this fund. Bythe time
the fund accumulates enough amount to pay off not only the principal but
also the interest charges.
(6) Serial Bond Redemption. The government may decide to pay
off every year a certain portion of the bonds issued previously. Therefore,
public debt may
aprovision may be made so that a certain portion of the beginning
mature every year and decision may also be taken in the about
the serial numbers of bonds which are to mature every year. This method
enables a portion of the debt being paid off every year.
192 | Public Finance
Loans. The government may redeem its public debt
() Buying up from the market. Whenever the government has
through buying up loans
Surplus income in its budgct, it may spend the amount for buying off
bought and sold. It is
government bonds from the market where they are
a good method, provided the government can
secure budget surplus.
However, this is not a redemption of debt but buying upadebt.
be redeemed through a
(8) Capital Levy. Public debt may also with
capital levy which may be levied once in a way the special objective
advocated
of redeeming public debt. In fact, capital levy is usually
Immediately after the war to repay the unproductive war debts. It is
imposed on the net assets on progressive scale.
(9) New Taxation, Another method of redemption of public debt is
to levy new taxes, both direct and indirect, and thus secure necessary
revenue to pay off theold publicdebts.
(10) Redemption of External Debt. The redemption of external
debt can be made only through accumulation of necessary foreign
exchange to pay it off. This can be done by creating export surpluses, i.e.,
exporting more than imports. Temporarily, the redemption of an old debt
can be made through the floating of new foreign debts.