CALSS 12 ''CHAPTER 11 : GOVERNMENT FINANCE'' ECONOMICS

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CHAPTER 11: GOVERNMENT FINANCE

CONCEPT:

Government Finance also called Public Finance is that part of economic activities which deals with income and expenditure of the government.

In the revenue side, Government Finance studies the principles of taxation, effect and impacts of taxation, collection of tax and non tax revenues, public debt management and their effects on economic development covering growth, price stability, unemployment, poverty, inequality etc.

On the expenditure side, Government Finance deals with principles of government expenditure. It studies how a democratic government should allocate its expenditures on various headings to promote social welfare through the achievement of economic efficiency.

According to Bastable ‘Public Finance deals with income and expenditure of public authorities of a state and their mutual relation with financial administration and control’

IMPORTANCE OF PUBLIC FINANCE:

1. To minimize the disparity in living standard: Different classes of people live together in a country. Some people are rich and others may be poor. So, the government aims to manage equitable distribution of income and wealth to its citizens. It helps to narrow down the gap between rich and poor people in the society.

2.To maintain economic stability:Different types of economic instability may appear in the economy. In order to maintain economic stability, the government implements contractionary fiscal policy during overproduction and expansionary fiscal policy during underproduction. So, public finance is an important tool to implement economic stability in the country.

3.For economic development:The responsibility of developing different types of infrastructures  like transportation, communication, electricity, schools and colleges, drinking water and so on goes to the government. Government should make large amounts of investment through public expenditure for the development of infrastructures.

4.To increase agricultural and industrial production:The development of agriculture and industry depends upon government’s fiscal policy. If the government implements subsidized tax policy and business friendly environment then it helps for agricultural and industrial development respectively. Thus, public finance plays a big role for the development of agricultural and industrial sectors.

5.To achieve favourable balance of payments:Balance of Payments is the systematic record of receipts and payments of visible and invisible trade between a country and the rest of the world. A government may achieve surplus in BOP either by raising import taxes on foreign goods or by reducing export taxes on domestic goods in international market. Therefore, the tax policy of the government may play significant role to achieve favourable balance of payments.

GOVERNMENT EXPENDITURE

Meaning:

The expenditure made by government in different sectors for the welfare of public is called Public Expenditure or Government Expenditure. Public Expenditure is broadly classified into two categories: a. Regular Expenditure and b. Development Expenditure.

CLASSIFICATION:

1. Regular or Administrative Expenditure: It includes expenditure made by government on various government offices to run daily administration and to provide salary and allowances for civil service sector.

a.Constitutional Organs:It includes expenditures made by the government to provide salary and other administrative works in various constitutional organs as Election Commission, Auditor General’s Office, Public Service Commission, Council of Ministers and so on.

b.General Administration:It includes expenditure made by government on Office of Council of Ministers, various ministries, departments and regional and local offices of the government.

c.Revenue Administration:It includes expenditure made on the offices that collect various types of revenues like land revenue office, customs office, VAT office, sales tax office and so on.

d.Economic Administration and Planning:It includes expenditure made by government on offices like National Planning Commission, Department of Statistics etc.

e.Judicial Administration:It includes expenditure made by the government on various courts like district courts, high courts, and supreme courts.

f.Defence:It includes expenditure made on various security organizations like military, police, border security force, armed police force etc.

g.Social and Economic Services:It includes expenditure made on education, health, drinking water, agriculture, communication, transportation and so on.

2.Capital or Development Expenditure:It is related with long term expenditure of government for the development of various infrastructures.

a.Constitutional Organs

b.General Administration

c.Revenue Administration

d.Economic Administration and Planning

e.Judicial Administration

f. Defence

g.Social and Economic Services

GOVERNMENT REVENUE

Meaning

The revenue that government collects from various sources in one fiscal year is called Government Revenue. It is also called Public Revenue. Government collects the revenue through various revenue offices. Government also manages revenue from borrowing and foreign grants.

SOURCES OF GOVERNMENT REVENUE:

1. Tax Revenue:

a. Tax on income, property and profit: Government imposes different types of taxes on income and property of the people. It includes revenue received by government from income tax, tax on property etc.

b.Land revenue and registration tax:It includes income received by government from land tax, land registration tax, house tax, house registration tax and so on.

c.Customs:It is the greatest source of tax revenue. It includes income obtained from import and export duties imposed by government on goods and services.

d.Tax on production and consumption of goods and services:Government imposes different types of taxes on consumption and production of goods and services. So it includes value added tax, sales tax, excise duty, entertainment tax, road tax and so on.

2.Non Tax Revenue:

a. Fees, Licenses and Permits: Government collects revenue in the name of fees and by providing licenses for vehicles, businesses and so on.

b.Fines:Fines are legal obligations if it is not a compulsory payment. Those people who violate the law or do not pay their duties on time should pay fine to the government. Though government does not charge fine in order to collect revenue, it does so to maintain law and order in the country.

c.Income from Public Properties and Public Enterprises:The income that government receives from sale of public goods and services or public properties lies under this heading. It includes income obtained from sale of public properties. It also includes dividend received from public enterprises.

3. Foreign Aid:The income received by government from foreign government and institutions for various purposes is called Foreign Aid. Most of the developing countries depend upon foreign aid for development expenditure. Foreign Aid is also of two types i.e. loan and grants.

TAX

Meaning:

Tax is a compulsory monetary charge imposed by government for its citizens and institutions for the services provided in different sectors. Tax payers get indirect benefits in the fields of health, education, drinking water and so on.

According to Dalton ‘A tax is compulsory contribution imposed by a public authority irrespective of the exact amount of services provided to the taxpayer in return’. The revenue that the government collects from taxes is used for public welfare purpose.

TYPES:

1. Direct Tax: The tax which is paid by the person or an institution upon which it is imposed by the government and cannot be shifted to others is called Direct Tax. The major feature of direct tax is that its burden, incidence and impact falls upon the same person or institution. Eg. Income tax, property tax etc.

Merits:

1. Ensures Equality in the Society:Direct tax is imposed on the basis of level of income and ability to pay. It bridges the gap between rich and poor people.

2.Ensures Certainty:Direct tax ensures certainty to the taxpayers in different aspects. It is certain regarding amount of tax to be paid, time of tax payment, place of tax payment etc. So, direct tax ensures certainty to the taxpayers and government as well.

3.Elastic in Nature:For development expenditure government can change the rate of direct tax to meet its need. So, direct tax is elastic in nature and government can manage extra amount of revenue by changing present tax rate and tax base.

4.Economic in Nature:Direct tax is economic in the sense that government should not make heavy expenditure to collect it. So, government does not need to manage extra money and manpower to collect direct tax.

5.Progressive in Nature:Under direct tax system rate of tax is imposed according to the level of income of taxpayers which is called progressive tax system.

Demerits:

1. Difficult to Taxpayers:One of the demerits of direct tax is that it is difficult to the taxpayers. The rich taxpayers should maintain records of their income, tax payment etc which needs additional human resource, extra expenditure, separate account section and so on.

2.Limited Scope of Revenue Collection:The burden of direct tax falls upon rich people. Government collects direct tax from few rich people and hence the tax system has limited scope.

3.Possibility of Corruption:Under direct tax system there is possibility of corruption. Tax payers may influence tax officers by any means necessary and try to cheat actual tax payment.

4.Lack of Inspiration/Reduces Working Spirit:Direct tax is imposed on the income of taxpayers which in return kills the spirit of taxpayers to work more and earn more. Due to this taxpayers may reduce their working hours.

5.Unscientific Tax System:Direct Tax system may not be scientific in nature in a sense that government may increase the rate of tax as per the need of government. Increase in tax rate every year may not be a scientific way of collecting revenue.

2.Indirect Tax:It is a type of tax which is imposed on one person or an institution but its burden can be shifted to another person. The government imposes indirect taxes on goods and services but it is ultimately paid by consumers. Eg. Customs duty, value added tax, sales tax, excise duty etc.

Merits:

1. Convenient to Taxpayers:The indirect tax is ultimately paid by consumers while purchasing goods and services from market. The taxpayers or consumers should not bear extra burden to keep the record of indirect tax and therefore indirect tax system is easy and convenient system for tax payers.

2.Impossible to Avoid Tax Payment:It is almost impossible to avoid or cheat the payment of indirect tax as it is included in the prices of goods and services. The consumers who purchase goods and services must pay tax.

3.Broad Base of Tax Collection:As indirect tax is imposed on goods and services and it is included in their prices, it is collected from all consumers who consume such goods and services. Indirect tax is paid by both rich and poor consumers.

4.Progressive in Nature:Consumers consume different types of goods and services in their daily life and therefore government imposes high rate of tax to rich people and low rate of tax to poor people.

5.Maintains Social Values and Norms:The revenue collected by government is used in social welfare programs. It maintains social values and norms.

Demerits:

1. Uneconomic in Nature:Indirect tax is imposed on goods and services. Government should spend more resources and manpower to collect indirect tax. Sometimes the cost of revenue collection may be greater than collected revenue. So indirect tax is an expensive tax system.

2.Uncertainty in Revenue:Indirect tax is imposed on goods and services due to which goods and services become expensive. The consumer then starts to consume cheaper substitute products. In such situation the revenue collection target of the government becomes uncertain.

3.Unproductive Tax System:Imposition of indirect tax increases the price of goods and services. The consumers should spend majority of income to purchase goods and services. It reduces the savings and investment in the economy.

4.Regressive in Nature:Under indirect tax system the price of a product is same for rich and poor people i.e. both income groups of people should pay same rate of tax. In this sense indirect tax looks regressive in nature.

PROGRESSIVE TAX:

If the rate of tax increases with the rise in level of income then it is called Progressive Tax. Under progressive tax system high rate of tax is imposed on high income and low rate of tax is imposed on low income.

Level of Income (Rs.)	Rate of Tax (%)	Amount of Tax (Rs.)
10,000	2	200
20,000	4	800
30,000	6	1800

 

 

 

 

 

 

 

 

 

 

PROPORTIONAL TAX:

If same rate of tax is imposed to rich and poor taxpayers then it is called Proportional Tax System. In this tax system, same rate of tax is imposed irrespective of income level of taxpayers.

Level of Income (Rs.)	Rate of Tax (%)	Amount of Tax (Rs.)
10,000	4	200
20,000	4	800
30,000	4	1200

 

 

 

 

 

 

 

 

 

 

 

 

REGRESSIVE TAX:

If low rate of tax is imposed to rich people and high rate of tax is imposed to poor people then it is called Regressive Tax System. Under this tax system the level of income and rate of tax are inversely related. This type of tax system is rarely found in real life.

Level of Income (Rs.)	Rate of Tax (%)	Amount of Tax (Rs.)
10,000	6	600
20,000	4	800
30,000	2	600

 

 

 

 

 

 

 

 

DEGRESSIVE TAX:

If rate of tax increases up to certain level of income and then remains fixed thereafter then it is called Degressive Tax System.

Level of Income (Rs.)	Rate of Tax (%)	Amount of Tax (Rs.)
10,000	2	200
20,000	4	800
30,000	6	1800
40,000	6	2400
50,000	6	3000

 

 

 

 

 

 

 

 

 

CHARACTERISTICS OF A GOOD TAX SYSTEM (CANONS OF TAXATION)

1. Canon of Ability:A tax system is said to be good if it has the feature of ability to pay. The tax should be imposed according to the ability to pay of the taxpayers.

2.Canon of Certainty:A good tax system should have the feature of certainty regarding various elements as amount of tax to be paid, time of tax payment, methods of tax payment and so on. Pre-information regarding to these points helps taxpayer to manage the resources for tax and for expenditure purpose.

3.Canon of Convenience:A good tax system should be convenient for taxpayer. The time and date of tax payment should be according to the convenience of taxpayer. So, government should find suitable and convenient time for the payment of tax.

4.Canon of Uniformity:A good tax system should be applicable to all the citizens of the country according to their financial status.

5.Canon of Simplicity:A good tax system should be very simple for taxpayers to understand. Therefore, rules and regulations should be very simple so that all taxpayers can understand it very easily.

6.Canon of Elasticity:Elasticity refers to flexibility. So, a good tax system should be flexible in nature to meet the increasing demand for government expenditure. The rate of tax should not be rigid and fixed. Therefore, rates of direct and indirect taxes should be elastic in nature.

7.Canon of Diversity:To be a good tax system, it should have broad base of tax collection. The tax system should identify newer areas of possible tax collection. It should also increase the tax base and not only rate of tax every year.

8.Canon of Popularity:A tax system is said to be good if it is popular among taxpayers. It should be liked by all the taxpayers. There should be least burden of tax so that everyone would be ready to pay tax to government.

9.Canon of Economy:Economy refers to situation where maximum amount of tax revenue could be collected at minimum cost. So a good tax system aims to collect maximum amount of tax revenue from the taxpayers by spending less amount.

10.Canon of Productivity:The tax system which does not reduce purchasing power of consumers and producing capacity of producers is called good tax system. The government should impose business friendly tax rate to taxpayers.

GOVERNMENT BORROWING:

Meaning

Government Borrowing also called Public Borrowing is the money or fund taken by the state in the form of loan from different sources. In majority of developing countries the existing resource is not sufficient for overall development of the country. In such situations they need extra fund to manage these problems and public borrowing is the most appropriate method of managing resources. The fund taken by the country must be repaid with interest after maturity period.

Sources:

1. Internal Borrowing: The fund or loan collected by government from its people and financial institutions within the country is called Internal Borrowing. It is of two types and they are as follows:

a.Market Borrowing:It is that borrowing in which government collects loan by selling transferable government securities as treasury bills, bills of exchange, government bonds etc. The government pays attractive rate of interest to attract borrowing.

b.Non-Market Borrowing:If the government borrows loan without selling its securities then it is called Non-Market Borrowing. Under this type government collects loan from public and private organizations. The government pays interest to them.

2.External or International Borrowing:If the government borrows from foreign governments and international institutions then it is called External or International Borrowing. There are two sources of External Borrowing and they are:

a.Bilateral Borrowing: If the government borrows loan by making agreements with various countries then it is called Bilateral Borrowing.

b.Multilateral Borrowing: When government borrows loan from international organizations then it is called Multilateral Borrowing. Eg. Loan taken from World Bank, Asian Development Bank etc.

GOVERNMENT BUDGET:

Meaning:

The word ‘Budget’ has been derived from French word ‘Bougette’ which means a leather bag. Budget means a document that contains estimate of government income and expenditure for one fiscal year. Budget is that major financial plan of the government. There are three types of budget and they are:

a. Balanced Budget (Income = Expenditure)

b. Surplus Budget (Income > Expenditure)

c. Deficit Budget (Income < Expenditure)

A complete budget document contains actual report of the previous year, planning and estimate of budget for the next fiscal year, proposals for new tax rates and so on.

Steps or Process of Budget Formulation:

The annual financial statement of revenue and expenditure i.e. budget of a country is formulated through following processes:

A. Preparation Stage:

1. Appraisal or Evaluation of Previous Budget: The finance ministry makes an honest evaluation about strength and weakness of previous budget. The strength or good programs of previous budget are continued in current budget as well whereas unproductive components are discontinued practically.

2.Estimate of Revenue and Expenditure Proposals:On the basis of opinion of experts current realities of country and experiences of previous budget, the finance ministry makes an estimation of revenue and expenditure proposal. Revenue and Expenditure proposals are based on realities of the country.

a. Sources of Revenue: i. Tax Revenue: Direct and Indirect Tax Revenue

                             ii. Non-Tax Revenue

b. Components of Expenditure: i. Regular/Administrative Expenditure

                                                   ii. Development/Capital Expenditure

3. Determination of Objectives and Priorities:On the basis of Revenue and Expenditure proposals, the finance ministry formulates and determines the realistic objective which can create realistic economic development to provide benefit to common people. In order to achieve specified objectives, priorities and policies are also formulated by finance ministry in current budget.

4.Development Programs:In order to achieve objectives various programs are formulated by government which can support socio-economic development of country.

B.Legislation Stage:After preparing budget, finance ministry presents the detail budget in parliament. In fact, the budget speech is delivered by finance minister in joint session of parliament. When majority of members of parliament provide their verdict in favour of budget then such budget obtains legal validity.

C.Implementation Stage:On the basis of verdict of parliament, government implements budget in favour of economic development of the country. The success of a budget depends upon quality of implementation of budget. It becomes duty of government to implement budget honestly and effectively in favour of the country.

D.Monitoring and Evaluation:Whether budget is properly implemented or not? It is monitored by group of experts under guidance of Finance Ministry. If any lacking is found in implementations of budget, government and Finance Ministry takes serious steps and action to minimize problems and irregularities.

The periodical evaluation is also made on basis of Quarterly basis. On the basis of evaluation of budget, finance ministry makes action plan for scientific implementation of budget.