Public Finance in India class 12 | Maharashtra Board

Public Finance in India class 12

Meaning and Nature of Public Finance :

• Public finance is one of the old branches of economics which highlights the role and functions of the government in an economy.
• Public finance is the study of the role of the government in the economy. It is a field of economics concerned with how a government raises money, how that money is spent, and the effects of these activities on the economy and society.
• Public finance includes public revenue, public expenditure, public debt, and financial administration Thus, Public Finance is the branch of economics that studies the taxing and spending activities of the government.
• According to Prof. Findlay Shirras: “Public finance is the study of the principles underlying the spending and raising of funds by public authorities.”

These functions of the government can be classified as :

1. Obligatory functions: Protection from external attacks, maintaining internal law and order, etc. are obligatory functions of the government.
2. Optional functions: Provision of education and health services, provision of social security like pensions and other welfare measures, etc. are optional functions of the government.

Structure of Public Finance :

I) Public Expenditure :

• Public expenditure refers to the expenses of public authorities – central, state, and local government for the protection of their citizens, for satisfying their collective needs, and for promoting their economic and social welfare.
• Till the 20th century, the majority of the governments had adopted a policy of laissez-faire. Under this policy, the functions of government were restricted to the obligatory functions.
• But, the modern governments not only perform the obligatory functions such as defence and civil administration but also perform optional functions for promoting the social and economic development of their countries. Therefore, the study of public expenditure is an important part of the study of public finance.
• Classification of Public Expenditure :

1. Revenue Expenditure: Revenue expenditure of the government is for incurred carrying out day-to-day functions of the government departments and various services. It is incurred regularly. For example, administration costs of the government, salaries, allowances, and pensions of government employees, medical and public health services, etc.
2. Capital Expenditure: Capital expenditure of the government is expenditure on the progress and development of the country. For example, huge investments in different development projects, loans granted to the state governments and government companies, repayment of government loans, etc.
3. Developmental Expenditure: Developmental expenditure is productive in nature. The expenditure which results in the generation of employment, increase in production, price stability, etc. is known as a developmental expenditure. For example, expenditure on health, education, industrial development, social welfare, Research and Development (R & D), etc.
4. Non-Developmental Expenditure: On the other hand, that government expenditure which does not yield any direct productive impact on the country is called non- developmental expenditure. For example, administration costs, war expenditure, etc. These are unproductive in nature.

Reasons for Growth in Public Expenditure :

It is observed that there is a continuous growth in public expenditure in developing countries like India.
Let us study some of the important reasons :

1. Increase in the Activities of the Government: As mentioned earlier, the modern government performs many functions for the social and economic development of the country. These functions include the spread of education, public health, public works, public recreation, social welfare schemes, etc. This leads to an increase in public expenditure.
2. Rapid Increase in Population: The population of developing countries like India is increasing fast. In the 2011 Census, it was 121.02 crores. As a result, the government has to incur greater expenditure to fulfill the needs of the increasing population.
3. Growing Urbanization: Urbanization leads to an increase in government expenditure on water supply, roads, energy, schools and colleges, public transport, sanitation, etc.
4. Increasing Defence Expenditure: In modern times, defence expenditure of the government is increasing even in the peacetime due to unstable and hostile international relationships.
5. Spread of Democracy: The majority of the countries in the world are democratic in nature. A democratic form of government is expensive due to regular elections and other such activities. This results in an increase in the total expenditure of the government.
6. Inflation: Just like a private individual, the government has to buy goods and services from the market for the spread of economic and social development. Normally, prices show a rising trend. Due to this, the government has to incur increasing costs.
7. Industrial Development: Industrial development leads to an increase in production, employment, and overall growth in the economy. Hence, the government makes huge efforts for implementing various schemes and programmes for industrial development. This results in an increase in government expenditure.
8. Disaster Management: Many natural and man-made calamities like earthquakes, floods, cyclones, social unrest, etc. are occurring more frequently. The government has to spend a huge amount on disaster management which increases total expenditure.

II) Public Revenue :

Public revenue deals with the methods of raising income from tax and non-tax sources. So it deals with sources or methods (taxation & Fees) through which a government earns revenue. Public revenue holds a permanent position in the study of public finance which is part of the study of economics. Thus, the necessity of public revenue arises due to public expenditure.
The main sources of public revenue are as follows.

Sources of Public Revenue: A) Taxes B) Non-tax Revenue :

A) Taxes :

According to Prof. Seligman, “A tax is a compulsory contribution from the person to the government without reference to special benefits conferred.”

A tax possesses the following essential characteristics :

1. It is a compulsory contribution to the government and every citizen of the country is legally bound to pay the tax imposed upon him. It is a major source of revenue for the government. If any person does not pay a tax, he can be punished by the government.
2. Tax is paid by a taxpayer to enable the government to incur expenses in the common interests of the society.
3. The payment of a tax by a person does not entitle him to receive any direct and proportionate benefits or services from the government in return for the tax.
4. Tax is imposed on income, property, or commodities and services.

Types of Taxes :

1. Direct Tax: It is paid by the taxpayer on his income and property. The burden of tax is borne by the person on whom it is levied. As he cannot transfer the burden of the tax to others, the impact and incidence of the direct tax fall on the same person. For example- personal income tax, wealth tax, etc.
2. Indirect Tax: It is levied on goods or services. It is paid at the time of production or sale and purchase of a commodity or a service. The burden of an indirect tax can be shifted by the taxpayer (producers) to another person/s. Hence, the impact and incidence of tax are on different heads. For example, newly implemented Goods and Services Tax [GST] in India has replaced almost all indirect taxes, customs duty.

B) Non-Tax Revenue Sources :

Public revenue received by the government administration, public enterprises, gifts, and grants, etc. are called as non-tax revenue. These sources are different than taxes. Brief information about these sources are as follows :

1. Fees: Fee is paid in return for certain specific services rendered by the government. For example- education fees, registration fees, etc.
2. Prices of public goods and services: Modern governments sell various types of commodities and services to the citizens. A price is a payment made by the citizens to the government for the goods and services sold to them. For example- railway fares, postal charges, etc.
3. Special Assessment: The payment made by the citizens of a particular locality in exchange for certain special facilities given to them by the authorities is known as ‘special assessment.’ For example- local bodies can levy a special tax on the residents of a particular area where extra/ special facilities of roads, energy, water supply, etc. are provided.
4. Fines and Penalties: The government imposes fines and penalties on those who violate the laws of the country. The objective of the imposition of fines and penalties is not to earn income, but to discourage the citizens from violating the laws framed by the Government. For example, fines for violating traffic rules. However, the income from this source is small.
5. Gifts, Grants, and Donations: The government may also earn some income in the form of gifts by the citizens and others. The government may also receive grants from foreign governments and institutions for general and specific purposes. Foreign aid has become an important source of development finance for a developing country like India. However, this source of revenue is uncertain in nature.
6. Special levies: This is levied on those commodities, the consumption of which is harmful to the health and well-being of the citizens. Like fines and penalties, the objective is not to earn income, but to discourage the consumption of harmful commodities by the citizens. For example- duties levied on wine, opium, and other intoxicants.
7. Borrowings: The government can borrow from the people in the form of deposits, bonds, etc. It also gets loans from foreign governments and organizations such as IMF, World Bank, etc. Loans are becoming a more and more popular source of revenue for governments in modern times.

III) Public Debt :

Like a private individual, the government also needs to raise loans. In fact, raising debt is the most common activity of any government, because government expenditure generally exceeds government revenue. The public debt policy of the government plays an important role in public finance.
There are mainly two types of public debt.
They are 1) Internal Debt and 2) External Debt

1. Internal Debt: When a government borrows from its citizens, banks, the central bank, financial institutions, business houses, etc. within the country, it is known as internal debt.
2. External Debt: When a government borrows from foreign governments, foreign banks or institutions, international organizations like the International Monetary Fund, World Bank, etc., it is known as external debt.

IV) Fiscal Policy :

Fiscal policy is the part of government policy that deals with raising revenue through taxation and deciding the level and pattern of public expenditure. Fiscal policy is composed of tax policy, expenditure policy, investment or disinvestment strategies, and public debt management.

Budgetary policy refers to government strategies to implement and manage a budget.

V) Financial Administration :

A smooth and efficient implementation of revenue, expenditure, and debt policy of the Government, is referred to as financial administration. This includes the preparation and implementation of the Government budgets along with the overall growth of the country.

Government Budget :

The budget is an important instrument of financial administration through which all the financial affairs of the state are regulated. The budget is a financial statement showing the expected receipts and proposed expenditures of the government in the coming financial year.

In India, a financial year is from 1st April to 31st March. Article 112 of the Constitution of India has a provision for annual financial statements. In every budget, a set of seven budget documents describe the details of Government finance in India.
The word ‘Budget’ is derived from the French word ‘Bougette’, which means a bag or a wallet containing the financial proposals. These financial proposals are in the form of Government expenditure and revenue.

Revenue and Capital Budgets :

Central Budget provisions are divided into-
1) Revenue Budget and
2) Capital Budget

1. Revenue Budget: It consists of revenue receipts and revenue expenditure of the government. Revenue receipts are divided into tax and non-tax revenue. Revenue expenditure comprises of interest paid on Government borrowings, subsidies, and grants given to the state governments.
2. Capital Budget: The capital budget consists of capital receipts and capital payments. Capital receipts are Government loans raised from the public and the Reserve Bank of India, divestment of equity holding in the public sector enterprises, loans received from the foreign Governments and other foreign bodies, State deposit funds, special deposits, etc. Capital payments refer to the capital expenditures on various development projects, investments by the Government, loans given to the state Governments, and Government companies, corporations, and other parties. Besides, it includes expenditure on social and community development, defence, and general services.

Types of Budget :

Balance Budgets:

• When government revenue is equal to government expenditure is called as Balance budget
• A government budget is said to be balanced when its estimated revenue and its anticipated expenditure are equal. That is, Government receipts = Government Expenditure
• It implies that the government raised funds in the form of taxes and other means.
• The government must Exercise financial discipline and should keep its expenditure within the available income.

Surplus Budget:

• When Government revenue is greater than Government Expenditure it is called a surplus budget that is Estimated Government Revenue receipts > anticipated Government expenditure
• When estimated government receipts are more than the estimated government expenditure it is termed as Surplus budget
• A surplus budget is used either to reduce government public debts ( its liabilities) or increase its savings
• The Surplus budget can be used during inflation.

Deficit Budget:

• When Government revenue is less than government expenditure it is called a deficit budget
• When estimated government receipts are less than the estimated government expenditure than the budget is termed as Deficit Budget
• In modern economics, most of the budgets are of this nature. That is, estimated Government Receipts < anticipation government Expenditure
• A deficit budget increases the liability of the government or decreases its reserves
• A deficit budget may be useful during the period of depression.

Importance of Budget :

1. The Union Budget is important because it affects people and the economy in general in a number of ways. Taxes are the most interesting part of any budget. Taxes determine the fate of businesses and individuals. The level of disposable income of the taxpayers depends on the tax rates presented in the budget.
2. Government expenditure on various heads such as defence, administration, infrastructure, education, and health care, etc. affects the lives of the citizens and the overall economy.
3. Also, the budget is important because Governments use it as a medium for implementing economic policies in the country.
4. Budgetary actions of the Government affect production, size, and distribution of income and utilization of human and material resources of the country.
   Thus, the scope and importance of public finance in a modern economy have undergone an immense change for the last 100 years.

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Reference: MHSB books