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ICSE Class X Notes 2019 : Economics Public Finance (Jamnabai Narsee School (JNS), Mumbai)

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UNIT III- PUBLIC FINANCE (CH. 5,6,7,8) CLASS 10 2018-2019 CHAP 5-MEANING AND SCOPE OF PUBLIC FINANCE Public finance is the branch of knowledge which is concerned with the income and expenditure of public authorities and with adjustment of one to another. Public finance is concerned with the finance of state. Scope of Public finance/Subject matter i.Public revenue. Every govt. has to make a lot of expenditures. For this purpose it has to raise revenues. The major share of Public revenues is obtained through taxes. Again, government raises revenue through non-revenue sources like fees and penalties. Thus, under Public finance, we study different types of taxes, the principles of taxation, the burden of taxes, selection of proper tax policy etc which are the subject matter of public ii. Public expenditure. It deals with various types of expenditure needed for the proper functioning of the government. The principles that govern the allocation of government funds among various activities like- whether the expenditures are diverted to productive fields or non-productive fields. What will be the effects of Public expenditures on the level of income distribution and level of output? Become the subject matter of public expenditure. iii. Public debt. When the government borrows internally as well as externally for making necessary expenditure it is called public debt. The amount of public debt, the repayment of debt with interest, the impact of public debt, What type of bonds the government have to issue, which sources of public borrowing, will be more economical, etc become the subject matter of public debt. iv. Budgetary policyIt deals with the types of financial statement made by the government with regard to its probable revenue and expenditure any particular year. If the government expenditure is more than the revenue, there arises deficit in government budget. Different ways for meeting this budget deficit come under the purview of this branch of Public finance. v. Fiscal policyIt is concerned with the framing of proper tax and expenditure policies by the government for achieving the objective of economic growth and stability. (1) Similarities between Public Finance and Private Finance. 1. Same objective. Both have the same objective of satisfaction of wants. Public finance is concerned with satisfaction of collective wants for the society whereas Private Finance is concerned with satisfaction of personal wants. 2. Based on rationality. Just like financial decisions of individual may be irrational .Similarly that of public body may also be unwise and lead to destruction. 3. Limited resources. Both the government as well as the private finance has limited resources at their disposal for spending & both try to make the best use of these limited resources as possible. Optimum utilization of resources becomes the main issue for both. 4. Income and expenditure. Each has to face the problem of adjustment of income and expenditure. Both have to face the problem of raising the sources of income and proper allocation of funds among different heads of expenditure according to priorities. 5. Efficient management Both need efficient and effective management and administration. If not administered properly both are compelled to face financial crisis. Dissimilarities between Public Finance and Private Finance. 1. Adjustment of income and expenditure. At first Government determines its expenditure, and then tries to collect money to meet up the expenditure. Whereas, the individual must adjust his expenditure to his income. 2. Motives of expenditure. Private individuals are more concerned with the earning of profits related to his/her and family s welfare. Whereas, the public authorities are concerned by the welfare of society. 3. Nature of Budget. Private individual generally believe in surplus budget. Whereas, the government may find it useful to have deficit budget especially during war and for financing economic development. The government prepares its budget annually while the private individual may prepares its budget for a short period, monthly etc. 4. Nature of resources. The government can raise funds from foreign countries while and individual can t normally do so. Also the government can resort to printing of new currency to increase its resources. 5. Principle of Benefit. Individual distributes his expenditure in a manner such that personal benefits are maximum. Government spends money to secure maximum social advantage. 6. Long term consideration. Private capital is not invested in those fields of business where returns are nominal or after a very long time. But the government undertakes long term projects ex, construction of dams, roads etc (2) 7. Secrecy and audit. Secrecy prevails in private finance while public finance is open to all. Accounts of public finance are subject to audit and inspection whereas that of private is not generally audited or inspected. 8. Coercive method. No Tax payer can refuse to pay taxes if he is liable to pay them. If a person does not pay taxes he can be prosecuted in the court of law but private individuals cannot use force to get the income. SIGNIFICANCE OF PUBLIC FINANCE a. Allocation of resources. The importance of public sector lies in the fact that all human wants cannot be satisfied through the market. Thus, Public sector is used to make provision for social wants or collective wants (eg. Defense, railways etc). It is also used to determine the proportion in which different social goods are produced. b. To secure equal distribution of income and wealth. Through its revenue and expenditure policies, the government can reduce inequalities in the distribution of income and wealth. Progressive taxation can bring equality in the distribution of income and wealth. The government can spend its income to provide services for the poor. Heavy taxes on goods largely purchased by the rich and subsidies to the goods purchased by low income consumers. c. To secure economic stabilization. In times of inflation, the level of aggregate demand can be reduced by cutting the level of public expenditure and by increasing the level of taxes. When public expenditure is cut, it will reduce the income of the people. Likewise, when taxes are raised people will now be left with less income and less demand. Similarly, deflation can be curbed by increasing the volume of public expenditure and reducing the level of taxation. d. To accelerate economic growth. Fiscal instruments like taxation, borrowing, public expenditure, deficit financing etc are used for mobilization of resources to achieve higher rate of growth and to remove inequality in the distribution of income and wealth. This role of PF in underdeveloped countries is known as Activation Finance. e. Public Finance and Economic life. Fiscal operation is and used to reduce the income of the rich and increase that of the poor. Eg. Progressive taxes on higher incomes and high taxes on luxurious goods can prevent the concentration of wealth. Public expenditure on poor relief measures increases the purchasing power of the poor people. Public expenditure on education increases the productive capacity of the poor to enjoy better standard of living. FISCAL POLICY MONETARY POLICY This policy affects the revenue and expenditure of the This policy affects the aggregate supply of money in an government. economy. The instruments of fiscal policy are government The instruments of monetary policy are bank rate, cash expenditure, imposition of taxes etc reserve ratio etc. (3) This policy is reflected in the annual budgets of the This policy is implemented by the central bank of the government. country. The fiscal measures to control inflation includes The monetary measures to control inflation includes decrease in taxes, increase in expenditure etc. decrease in bank rate , decrease in CRR,SLR etc. The policy influences the demand for and supply of The policy influences the demand for and supply of money different goods and services in the economy. in the economy. CHAP 6-PUBLIC REVENUE The income of the government from all the sources is called public income or revenue. Eg. Taxes, fees, fines, commercial revenue, administrative revenue etc. SOURCES OF PUBLIC REVENUE. I. Taxes. A tax is a compulsory payment imposed on the person or companies by the government to meet the expenditure incurred on providing common benefit to the people. Following are the characteristics of taxes: a. Compulsory payment A tax is a compulsory payment made by the people to the government. It is not up to the citizen to decide whether he should or should not pay the tax. Refusal to pay taxes is subjected to legal action and punishment by the government. b. General welfare. The amount received from the taxes is spent for common benefit or general welfare. Tax revenue is incurred for the welfare of the whole society and not the tax payer alone. c. No quid pro quo. It means absence of direct proportional return to the tax payer. Ex. A person paying Rs.4 lakhs tax cannot get benefit worth the tax amount paid. d. Regular. A tax is payable regularly and periodically as determined by the taxing authority. e. It is a legal collection. II. Commercial Revenue. Revenue which are received by the government from public enterprises by selling their goods and services are called Commercial revenue Ex. Postage, toll, railway fares, irrigation charges etc. III. Administrative Revenue. They includea. Fees. Fees are paid only by those who receive special benefits from the services rendered by the government. The government provides certain special services to its people and as payment for these services it charges fee. Ex. registration of births and deaths by the municipal bodies. (4) b. License feesIt is a payment to grant a permission or provide privilege of doing certain things or activities by a government authority. Ex. License fee to keep a gun, fee charged for running a liquor shop. c. Fines and penaltiesA fine refers to a penalty or punishment which is imposed for the violation of law. Ex. A motorist charged for violating traffic rules. d. Special AssessmentGovernment confer special benefit to those whose property are nearby to public infrastructure like provision of drainage, constructed roads. These infrastructure add value to the property. Thus, a special tax called special assessment is levied. e. ForfeituresIt refers to the penalty imposed by courts for the failure of individual to appear in the court. f. EscheatThe government may acquire the property, bank balances etc. of a person who dies without having a legal heir or without keeping a will. IV. Gifts and Grants. A small proportion of the revenue of the government is also obtained from the gifts by individuals, organizations of foreign government. This is known as gifts or grants. V. Deficit budget. When the governments anticipated expenditure is more than its revenue. It gives rise to deficit financing. VI. Foreign Aid. The government also gets revenue through foreign aid in the form of loans or grants from abroad. Loans are repayable whereas grants are not repayable. TAX PRICE It is compulsory contribution to be paid by every It is paid by the person who purchases goods & citizen on whom it is imposed services provided by the government. A tax does not guarantee any benefit as per the amount and nature. Revenue generated through tax can be used in public interest. Price guarantee direct benefit for the payments made for goods and services. Price paid for goods and services are used for making personal interest. TAX It is compulsory contribution to be paid by every citizen on whom it is imposed Taxes are prerogative of the state. FEE Anybody can refuse its payment and no legal action can be taken against them. Fees can be imposed not only by the state but also by any authority. Ex. fees in educational institution. Ex. Direct taxes, indirect taxes etc (5) SIGNIFICANCE AND OBJECTIVES OF TAXES. a. Raising Revenue. The primary purpose of taxation is to raise revenue. Modern government performs a large number of welfare activities for the society. For carrying out these activities they require revenue. The revenue thus can be generated through taxes. b. Regulation of consumption and production. Taxes are sometimes used to discourage the consumption of harmful product such as cigarettes etc. Also, the government imposes heavy taxes on production of non-essential goods. This results in diversion of resources from production of non-essential to essential goods. c. Protection to domestic Industries. Taxes are used to reduce the imports of those goods which are domestically available and thereby encourage the domestic industries. This has a favourable effect on balance of payment. Ex. heavy import duties on TV, fridge etc will make these goods costlier as compared to domestically produced goods. d. Reducing income inequalities. Inequality of income is reduced through progressive taxation under which the rich are taxed more than the poor. Also, by spending the revenue collected from rich for providing social service and also by imposing heavy taxes on luxury goods and providing tax concession on essential goods purchased by poor. e. Promoting economic growth: Taxation policy of the government can be used in promoting development of agriculture and industry. The government can also use this revenue in providing infrastructure like transport and communication, power, irrigation etc. Direct taxes/Tax on income Indirect taxes/Tax on commodity i. Taxes imposed on production or income are direct i. Taxes imposed on consumption are indirect taxes taxes. ii. They are directly paid to government by the ii. They are paid to government by one person but person on whom it is imposed. their burden is borne by another person. iii. They cannot be shifted on to others. iii. They can be shifted on to others. iv. These taxes are levied according to the ability of iv. These are the taxes in which paying ability of the tax payer. the tax payer is assessed indirectly v .Example. Income tax, wealth tax, Estate duty, etc. v. Examples. Sales tax, Excise duty, Custom duty etc MERITS OF DIRECT DEMAND. a. EconomicalThe cost of collection of these taxes is relatively low as they are usually collected at source and also the tax payers make the payment of these taxes directly to the govt. (6) b .EquityDirect tax can be made to conform to the principle of ability to pay. The burden of direct taxes is equitably distributed on different people and institution. The rich are taxed more than the poor. c. CertaintyThe tax payer knows how much is due from him and when. The government also knows the amount of revenue coming to adjust its income and expenditure. d. ElasticityThey are based on the canon of elasticity because the government revenue can be increased by raising the tax rates in times of crisis. Moreover, the yield from direct taxes goes up with the increase in income of the people. e. Civic consciousnessDirect taxes inculcate a spirit of civic responsibility amongst the tax payers. Since the tax payers provide funds from their own pockets they take keen interest that these are utilized properly and keep a check on wastage. DEMERITS OF DIRECT TAXES. a. UnpopularThese taxes are directly imposed and cannot be shifted on to others, they are painful to the tax payers. Taxpayers feel the pinch directly. b. InconvenienceThe tax payers have to maintain accounts, submit statements and pay the tax amount in one instalment. They are inconvenient. Sometimes, the tax payers (High income group) are required to pay the entire tax in one instalment which causes inconvenience to the tax payer. c. Possibility of EvasionEvasion Tax takes place when the people report dishonest tax that includes declaring less gains, profits, or income than what has been actually earned. This is because each tax payer has a separate assessed for his income & wealth for which the government needs to maintain effective tax administrative machinery. d. UneconomicalDirect tax in many cases becomes expensive because each tax payer has to be directly contacted by the tax authorities. The cost of collection is heavy when the number of tax payers is large and the amount to pay is small. e. ArbitraryThe rates of taxes depend upon the whims of taxation authority and not on the ability to pay. Hence, there is always an element of arbitrariness as the rates of direct taxes are arbitrarily fixed by the government. f. Narrow in scopeIt is imposed only on the rich whereas low income group cannot be approached. Thus, direct tax is imposed only on certain group of person rather than on all groups. (7) MERITS OF INDIRECT TAXES. a. Convenient. They are paid in small amounts and at intervals instead of one lump sum amount. These taxes are included in the price of the commodity and hence the burden is not much felt by the tax payer. Also, these taxes are convenient from the point of view of the government since these taxes are generally collected from the manufacturers and importers. b. Wide coverage. It is imposed on large variety of goods. Therefore, all the people contribute towards increasing government revenue. Hence, indirect taxes help in making the tax system broad- based. c. Equity. Indirect taxes can be made equitable by imposing heavy taxes on luxury goods and low taxes on essential goods. d. No evasion. With proper administration, the chances of tax evasion in this case are less. It is difficult to evade such taxes because they are included in the price of the commodity. e. Check on consumption of harmful goods. Heavy indirect taxes on harmful and undesirable commodities like cigarettes, alcohol etc. serves as a check on their consumption. Curtailment of consumption of harmful commodities increases social welfare. f. Protection against foreign competition. Indirect Taxes (import duties) are used to reduce the imports of those goods which are domestically available and thereby encourage and protect the domestic industries from foreign competition. Ex. heavy import duties on TV, fridge etc. will make these goods costlier as compared to domestically produced goods. DEMERITS OF INDIRECT TAXES. a. Regressive. Indirect taxes are generally imposed on the consumption of goods. They fall on all persons indiscriminately in the sense that poor people have to pay as much as rich people. So they neglect the principle of ability to pay and therefore are regressive and unjust in nature. b. No civic consciousness. They are regarded as taxes in dark because these taxes are imposed and are inclusive in the price of the commodities and hence the tax payers do not feel at all that they are paying the tax. The tax payer thus becomes indifferent towards their responsibility and civic consciousness. c. Uncertain. Taxes on goods with elastic demand are very uncertain .When commodity is taxed its price rises and demand falls. Thus, making it difficult to anticipate the income from indirect taxes. d. Discourages savings. These are tax on commodity. Since prices of the commodity keeps on increasing, this discourages savings. (8) e. Inflationary. When indirect taxes are levied then price of commodity increases. This may lead to rise in cost of living as a result of which trade unions demand higher wages. This in turn leads to increase in price level and thus inflation. A TAX is a compulsory payment imposed on the persons or companies by the government to meet the expenditure on providing common benefits to the people. a) A tax is said to be progressive when the rate of tax increases when the tax payer income increases. (refer to text book for diagram) b) A Proportional tax in which the rate of tax remains the same .All incomes are taxed at uniform rate. (refer to text book for diagram) c) A tax will be regressive when the rates of tax decrease as the tax base increases. (refer to text book for diagram) d) Degressive tax is a mixture of proportional and progressive tax. Under this systems the rate of tax increase up to certain limit but after that a uniform rate is charged. (refer to text book for diagram) Different types of Taxation: ADDITIONAL QUESTIONS. 1. How can direct taxes help in fostering civic consciousness and Equality in the society? Ans. Direct taxes inculcate a spirit of civic responsibility amongst the tax payers. Since the tax payers provide the funds from their own pockets to the govt, they take keen interest in seeing that these funds are properly utilized. Equality direct taxes are progressive in nature. Rich people would be taxed higher than poor people. 2. Which income tax structure is most popular in India? Why? Or. Name the most popular tax structure in India. Give one reason. (9) Ans. Progressive tax structure. This progressive structure is the most popular tax system in any country. Higher taxes are imposed on people with higher income. This helps to reduce inequality of income and establish social justice. 3. What is the difference between impact and incidence of taxation? IMPACT OF TAXATION INCIDENCE OF TAXATION When the government of any country imposes a tax When the taxpayer can shift the burden of tax, then the then the person or the institution which bears the final resting point of the tax burden is called the burden of tax at the first instance, is known as the incidence of tax. impact of tax. Ex. Income tax-The person on whom this tax is Ex. Sales tax-The seller adds the sales tax to the price imposed must himself pay of his commodity. The purchaser has to pay a higher price. Thus, the tax burden is shifted. 4. Difference between income tax and entertainment tax. INCOME TAX They are imposed by the government of India. It is a direct tax ENTERTAINMENT TAX They are imposed by the State government It is an indirect tax. 5. State any two canons of taxation as indicated by Adam Smith. Ans. The criteria for determination of the tax policy are called canon of taxationa. Canon of abilityIt shows that tax rates imposed by the government should be in accordance with the ability to pay taxes or the economic conditions of the people b. Canon of certaintyThe government should ensure that there is no uncertainty regarding the rate of tax or the time of tax payment. Thus, the government should not collect taxes at arbitrary rates and at arbitrarily chosen times. 6. Mention any four sources of tax revenue of the State governments in India. Ans. a. Taxes on sale and purchase of goods(ex. Sales tax, VAT) b. Land revenue c. State excise duty on alcoholic liquor d. Professional tax. 7 What are Advalorem and Specific Taxes? Ans. Taxes which are imposed on the weight or some external measures of the the commodities are called Specific Advalorem Taxes. E.g Tax on sugar on the basis of units of weight. ( 10 ) Whereas when taxes are imposed on the basis of value of commodities, they are called Advalorem Taxes. E.g. Taxes on imported or exported goods have nothing to do with their size, length and weight ARGUMENTS IN FAVOUR OF PROPORTIONAL TAXES. a. Simplicity. Proportional taxes can be calculated easily without many complications. Hence it is this tax system is considered simple. It is simple and easy to understand. b. Uniformity. It is uniform for all tax payers. Therefore, it is not much opposed by the tax payers. Since everyone pays the same proportion of his income, this tax system enjoys a popular appeal. c. Productivity. This type of tax also does not affect the work effort of the tax payer. Hence, it does not generate any negative impact on productivity. ARGUMENTS AGAINST PROPORTIONAL TAXES. a. Fails to establish equity. In case of proportional taxes, both rich and poor are to pay taxes at the same rate. Hence, the absolute burden of tax falls more on the poor. It does not lead to equitable and just distribution of the burden of taxes. b. Not imposed according to taxpaying capability. In case of proportional taxes, both rich and poor are to pay taxes at the same rate. Hence, the absolute burden of tax falls more on the poor. These taxes are thus not imposed according to the tax payer s ability. c. Inadequate revenue. These taxes do not generate substantial amount of tax revenue to the government. It is not easy for the state to increase its income through proportional taxes because rates of taxes cannot be increased beyond a limit. ARGUMENTS IN FAVOUR OF PROGRESSIVE TAXES. a. Reduction of inequality. An important advantage of progressive taxation is that it leads to equitable and just distribution of burden of taxes as the rich pay higher tax than the poor based on their ability to pay. This help to reduce the gap between the rich and the poor. b. More elastic. These taxes can be increased to large extent especially in case of financial need of the country. Also, the revenue of the government can be substantially increased by increasing the tax rate marginally. c. Equitable distribution of the tax burden. Since these taxes are based on the ability to pay concept, the rich have to take more burden of tax. Thus, distribution of tax burden is according to the financial capability of the tax payer. ( 11 ) d. Helps maintaining economic stability. At the time of inflation, progressive taxes can be used to reduce the disposable income of the people. This in turn reduces demand and inflation. ARGUMENTS AGAINST PROGRESSIVE TAXES. a. Discourages work effort. It dampens people s incentives to work. A rich man feel discouraged from working hard since most of his income now is getting taxed. b. Discourages savings and capital formation. If investors, entrepreneur etc have to pay higher taxes than not only they end up saving less but also be discouraged to earn more. This in turn would result in low savings and low capital formation. c. Tendency of tax evasion. When taxes are imposed at progressive rates then the tendency of tax evasion among the tax payer increases. People may give false declaration of their income so as to save from the heavy taxation .It leads to creation of black money. CHAP 7-PUBLIC EXPENDITURE Public expenditure is the expenditure incurred by public authorities to satisfy those common wants which the people in their individual capacity are unable to satisfy efficiently. Example- Public expenditure is incurred in providing economic and social infrastructure like hospitals, schools, irrigation, power etc. TYPES OF PUBLIC EXPENDITURE PROTECTIVE EXPENDITURE COMMERCIAL EXPENDITURE. Expenditure incurred to protect the country from These include the expenditure incurred by the foreign aggression and to maintain law and order government on the commercial activities which are situation within the country. undertaken by the government in the public interest. Ex. expenditure on defence, police. courts etc. Ex. industrial exhibitions. PRIMARY EXPENDITURE These expenditure fall under 4 heads mainly,, Defence, law and order, civil administration and debt services. These are essential for the economy SECONDARY EXPENDITURE. All other expenditure other than primary fall under this category. OPTIONAL EXPENDITURE Those expenditures which the government may or may not incur. Ex. Expenditure on education, health etc. OBLIGATORY EXPENDITURE. That expenditure which the state must incur. Ex. Expenditure on roads, railways, subsidies etc. Ex. defence, legal commitments. ( 12 ) DIRECT EXPENDITURE TRANSFER EXPENDITURE. Refers to those against which the government obtains Transfer payment refers to those expenditure against goods and services which there is no corresponding transfer of goods and services to the government. Ex. Wages to army personnel, government school Ex. old age pensions, unemployment allowances. teachers etc CONSTANT EXPENDITURE It is that type of expenditure which does not depend upon the extent of use by the people. Ex. defence. VARIABLE EXPENDITURE. It refers to the expenditure which increases with every increase in the use of public services. Ex. postal services, telephone services etc. REVENUE EXPENDITURE It is current expenditure incurred on civil administration, defence, public health and education. It is recurring types and is non developmental. CAPITAL EXPENDITURE. Expenditure incurred on construction of dams, building , steel plants etc. These are non- recurring types and are developmental expenditure. DEVELOPMENTAL EXPENDITURE It refers to the expenditure which is incurred on social and economic development of the country. Ex. development on transport and communication, public health, public education etc. NON- DEVELOPMENTAL EXPENDITURE. It is that expenditure that does not promote economic development. Ex. Defence, police etc PRODUCTIVE EXPENDITURE UNPRODUCTIVE EXPENDITURE. Those expenditure which help in improving the It is that expenditure which does not help in improving productive capacity of the economy. the productive capacity of the economy Ex. machinery, education , training , health etc Ex. defence, law and order etc. REASONS FOR GROWTH IN PUBLIC EXEPNDITURE According to Wagner s law the states increasing activities is universally true in modern times. Justify. I. Political causes. a. Growth of democracy. A democratic structure of government is more expensive than a totalitarian. Expenditure on elections and by- elections is increasing. Number of ministers and executive officers has also increased. This also requires increasing state expense in order to provide new amenities to people at large. b. Increase in Defence expenditure. International political situation is uncertain and insecure. People are always afraid of war. Hence, every nation must be strong enough to protect itself to the extent possible for it. This requires increases in defence expenditure. II. Social causes. a. Population growth. With the increase in population, the responsibility of the country increases. Growth of population on this scale especially in India has increased the demand for various government services like education, public health, maintenance of law and order which in turn leads to the increase in public expenditure. b. Social services. Generalized social services like education, health, water supply and sanitation facilities etc which ( 13 ) are considered as the duty of the country has been increasing. New departments like Child Welfare, Women welfare, Labour welfare etc have been established. All this has lead to the growth of public expenditure. c. Social Security measures. Modern states are welfare states. Government is now eager to raise the standard of living people in lower income group. For providing Social Security government spends huge amount for providing benefits such as old age, free education etc. III. Economic causes. a. Rise in prices: There has been a gradual increase in the price level almost every country and the government has to spend more money for the same amount of goods and services that they desire, and to increase the salary and dearness allowance of government employees. b. Building up infrastructure base: Public expenditure in the country has increased also because of the need to build up strong infrastructure base. The government has to spend a large amount of money on expansion of economic and social infrastructure facilities like transport and communication, poor, education etc. c. Economic assistance to private sector: The private sector is also been subsidized. The state also gives economic assistance to various industries which have undertaken the programs of planned development. This has also increased the public expenditure to a great extent. d. Development programs: Most of the underdeveloped countries have initiated various programs of economic development. Various programs of economic development like provision of infrastructure of the economic such as transport, power etc. has led to increase the public expenditure. e. Growing trend of urbanization: With economic development and the growth of population, the extent of urbanization has increased. Urbanization has lead to increase in the government expenditures on civic administration, education, public health water supply etc. All these activities involve heavy expenditure. OBJECTIVES OF PUBLIC EXPENDITURE. i. Provision of collective wants Provision of collective wants in order to optimize society s consumption to maximize social and economic welfare. ii. To control the depressionary tendency Public expenditure has to be made for appropriate public work program, which facilitates employment and growth. Thus public expenditure is needed to sustain the level of aggregate demand in an economy. iii. Accelerate the tempo of economic development In backward economy, PE should accelerate the tempo of economic development by constructing the infrastructures of the economy and capital formation, for increasing industrial activity and allied production of goods and services. iv. To reduce inequalities of income and wealth in economy. Public expenditure helps to reduce inequalities of income and wealth in economy by providing public services at lower rates or at times with no cost. ( 14 ) ROLE OF PUBLIC EXPENDITURE IN ECONOMIC DEVELOPMENT. i. Generating employment: Public expenditure on economic and social infrastructure provides larger employment opportunities and raises the productive capacity of the economy. ii. Increase the productive capacity of certain essential goods To increase the productive capacity of certain essential goods to end private monopolies in various spheres. iii. Augmenting industrialization. Public expenditure on heavy and basic goods industries in initial periods increases the growth rate of the economy. iv. Lessen inequalities of income and wealth It tends to lessen inequalities of income and wealth through its welfare measures like free education, unemployment allowances, and subsidies to poor. v. Bring about regional balance It helps to bring about regional balance in the economy by diversifying industries in backward and less developed areas of country. vi. Encourages Private Sector It encourages them by establishing state-owned financial & banking institutions to provide cheap credit to them. ADDITIONAL QUESTIONS 1. What is meant by no- plan expenditure? Give example. Ans. The government expenditure on programs or schemes other than those included in the ongoing plan schemes, is considered as then on-plan expenditure. Ex. A railway bridge may be considered during the Ninth plan but government expenses for the maintenance of that bridge the Tenth Plan would be considered as non-plan expenditure. 2. What is Wagner s Law? Ans. According to Wagner, there is a persistent tendency both towards an extensive and an intensive increase in the functions of the state. New functions are continuously being undertaken and old are being performed more efficiently and on a larger scale. Hence, more and more public expenditure is spent to perform these activities. This is known as Wagner s Law of increasing expansion of state activites CHAP 8-PUBLIC DEBT Public debt refers to the loans raised by a government within or outside the country. The borrowing by the government is called public debt. The government may borrow from individuals, business enterprises, banks or from outside the country. DIFFERNCE BETWEEN THE PRIVATE AND PUBLIC DEBT. a. Compulsion Public debt-The government may force the people or institution in the country to lend. Private debt- They cannot compel another private individual to lend. ( 15 ) b. Repudiation. Public debt-Under abnormal conditions, the government can refuse the payment of loans taken from the public Private debt- They cannot refuse repayment to another private individual without inviting legal actions c. Time period. Public debt-Government generally borrows for long period. Private debt- They borrow often for short period of time. d. Rate of interest. Public debt-The government can borrow at a lower interest rate because of its credit- worthiness. Private debt- Private borrower has to pay a higher rate of interest because of the risk involved for the lender. e. Source. Public debt- The government can borrow from within the country and abroad Private debt- Private borrower can borrow only from within the country. f. Mode of payment. Public debt-The government repays its loan by taxing its people Private debt-The private borrower has to repay from his own savings. g. Welfare. Public debt-The Government generally borrows for welfare purpose Private debt-The aim of the private borrower is profit earning. TYPES OF PUBLIC DEBT /STRUCTURE OF PUBLIC DEBT Internal Debt is that debt, which is raised by government from individual and Institution within the country External Debt is that debt, which government borrows form person institution or governments of the foreign country Internal Debt only involves, transfer of wealth within a economy External Debt, Debt owed to foreign government, IMF, World bank, etc. Productive Debts Unproductive Debts Productive Debts are those debts which are used by government, which yield income. Unproductive Debts or Debt weight are loans which are incurred on those project, which do not yield any income. Example, for the purpose of building irrigation and power projects, heavy industries etc. For the purpose of financing war, or for relief operations. Gross Debts Net Debts ( 16 ) The sum total of all the debts is called gross debts. Net Debts is the balance amount of debt( gross debt) after exclusion of sinking fund & other assets meant for repayment of loans. Redeemable Debts Irredeemable Debts If a debt is such that the government pays it off after a fix period of time. It is called Redeemable debt. Irredeemable debt, are those debt whose principle is not refundable, but the interest is paid regularly by the government. The interest as well as the principal is paid back by the government It goes on paying only the interest on such debts perpetually. Funded Debts Unfunded Debts A debt fund is created in which some money is deposited every year by the government. The government does not creates any separate fund to repay the debt. They are long term loans These are short term loans, payable within a year. Voluntary Debts Compulsory Debts It is a debt taken from the people by the government on voluntary basis They are those loans which are forcibly taken by the government People on their own subscribe to government loans Generally taken during emergency like war, inflation etc ROLE OF PUBLIC DEBT. Why is there a continuous increase in public debt in India? i. Financing warModern wars being very expensive cannot be entirely financed through taxation. Government therefore may resort to public borrowing on a large scale to meet large expenditure arising out of war. ii. To meet budgetary deficitThe government may borrow on account of large expenditure incurred on administration, financing unforeseen events; meeting the rising expenditure etc. Many a times revenue obtained through taxation is not sufficient. In such, cases the government requires loans for short period to cover the gap between current revenue and expenditure. iii. To Relieve the economyPublic debt is necessary to relieve the economy from inflationary pressure, as it reduces the excess purchasing power .Therefore, reducing the pressure of excess demand. Like taxes, public debt also takes money away from the people .It is used alongside with taxes as an instrument of inflation control iv. To finance development plans( 17 ) Government in developing economies has to incur huge expenditure in undertaking various developmental projects. These governments cannot resort to heavy taxation because of low income. Thus, India has resorted to public borrowing heavily both internally and externally to financing its 5 year plans(development plans) v. To build up InfrastructureCreation of social and economic infrastructure( prerequisite for development) like energy, transport , communication ,education, health etc are less attractive due to less rate of returns. These developmental activities are undertaken by the government. The government cannot provide such funds only through taxes. Hence, for this purpose the government relies on public debt vi. Human Capital formationIndia can use debt finance to obtain resources to channelize priority areas mainly creating human capital because of its favourable impact on the economy. Human capital formation is the result of public education and better public health. The government finances expenditures in the schooling sector and setting up of hospitals. The government cannot provide such funds only through taxes. Hence, for this purpose the government relies on public debt GROWTH OF PUBLIC DEBT./EFFECTS OF PUBLIC DEBT a. Burden of Public debtBoth internal and external loans have to be paid after certain fixed time periods, interest payments are to be made regularly till loans are finally paid off. It is known as debt servicing burden. (Explain the term debt servicing burden) A substantial and continuously rising magnitude of internal debt has resulted in sharp increase in debt servicing burden. b. Growth PotentialPublic debt in India has contributed to the growth potential of the economy. Internal debts were utilized for development of industries, power projects, communication services etc. Investment in these forms has promoted economic growth. c. InflationaryIn order to repay permanent debts the RBI has to issue additional money & also the government undertakes short term borrowing by issuing treasury bills which are inflationary in nature. d. Increase in productive capacityIn India quite a large part of public borrowings has been used to meet the developmental expenditure. This has led to increase in the productive capacity of the economy. ADDITIONAL QUESTIONS. 1.What is a debt trap? Ans. It is a situation where the government has to incur new public debt for the purpose of meeting the interest obligation on old debts. The government falls in a debt trap if the outstanding amount of public debt becomes so huge that current tax revenue is not sufficient. The only way out is to incur fresh debt. Currently India is caught in a debt trap. 2.Mention the sources of Public debt. Ans. a. Individuals. They may purchase government bonds and other type of security. b. Banks. They may purchase government bonds. In many countries banks are under compulsion to purchase government bonds and other type of security. c. External sources. ( 18 ) The government can raise funds from abroad such as IMF, World banks. In most cases these external loans are either from foreign government or international agencies like IMF, World Bank etc. 3.State any two demerits of public debt. a. Possibility of excessive borrowing: Public debt is an easy way for the government to raise money. Hence, there is always a possibility that the government will over borrow and fall in a debt trap. Excessive borrowing will impose a burden on society in the future. b. External debt leads to outflow of resources: External debt has a special problem that the interest payments represent an outflow of economic resources from the country. ( 19 )

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