Public Expenditure: Nature and Principles of Public Expenditure

Concept of Public Expenditure

 

“Public expenditure refers to the expenses of the public authorities – central, state and local governments – either for protecting the citizens and/or for promoting their economic and social welfare.” - Sundharam and Andley

 

“Public expenditure refers to the expenses which the government incurs for its own maintenance as also for the society and the economy as a whole. These days governments are also incurring expenditure to help other countries.” - Bhatia.

There are two schools of thoughts or attitudes in relation to the scope of public expenditure. The first is led by Adam Smith and other by classical writers restricted state activities to mainly the primary functions. Adam Smith has pointed out ‘the sovereign has only three duties: protecting the society from violence and invasion from other independent societies; establishing the exact administration of justice; and erecting and maintaining certain public works and certain public institutions.'

J.B.Say said, “The very best of all plans of finance is to spend little.” 

 

H.Parnell says, “Every particle beyond which necessity absolutely requires for the preservation of social order and for protection against foreign attack is waste and unjust oppressive imposition on the public.”

The second school of attitude after 1880’s did not restrict public expenditure only to the primary functions. Writers like Pigou, Dalton advocated public expenditure on social welfare activities. Similarly, after 1930’s depression, writers like Keynes advocated for state role to control economic fluctuations for maintaining economic stability in the developed countries. Prof. Musgrave advocated public expenditure for the activities such as: reallocation of resources, redistribution of national income and wealth, stabilization of economy, and some necessary commercial activities. 

Reasons for Growth in Public Expenditure


Public expenditure in all countries is increasing throughout the passes of time. In this regard, Adolf Wagner, a noted German fiscal theorist, propounded an empirical law named as ‘Law of the increase of state activities’ in the late 19th century. The law is expressed as, “Comprehensive comparisons of different countries and different times show that an increase regularly takes place in the activity of both the central and local governments. This increase is both extensive and intensive. The governments constantly under-take new functions, while they perform both old and new functions more efficiently and completely.”

Similarly, the Italian economist F.S. Nitti observed that whatever be the nature of governments or nations, they have similar tendencies towards marked increase of public expenditure.

The factor behind the increase in state activities, and thus, the public expenditure are of different nature and purposes. They are:

1. Concept of welfare state

In the past, governments were restricted to perform minimum activities just to maintain an environment necessary for efficient working of the private sector economic activities being guided by the market mechanism. Now, governments are to perform so many activities to promote social welfare beside the traditional activities. There is no sphere where the state can not enter or undertake. The basic reason for this is the change in the philosophy of police-state until late 19th century to the welfare-state with the main objective of promoting socio-economic well-being of the citizens. It has been the responsibility of the state to take care of citizens from womb-to-tomb, and so, expenditure of modern governments has increased a lot.

2. War related activities

War and threat of war have compelled governments to be militarily strong with well equipped weapons and technology. The cost of defense due to the progress in war techniques along with the development of science and technology have made the war weapons highly expensive. And also, the rate of obsolesce of the weapons is extremely high. Besides, war obligations for governments even in peace time after war in the form of pensions, relief aids to war veterans and victims, repayment of war debt and reconstruction of war devastated infrastructures.

3. Growth of population

Population growth, mainly in the underdeveloped countries, has necessitated increase in government activities to fulfill the demand for more educational, health, housing, employment opportunities, social security and benefits.

4. Urbanization

The process of urbanization impose additional responsibilities upon governments to provide community benefit which are normally not possible from individual efforts. Such community benefits like supply of safe drinking water, sewage facility, link roads, public parks, sports and recreation centers, communication networks, public security services, etc. are to be provided by the governments.

5. Economic needs

The great depression of 1930’s recognized the need for state intervention in the economy. Accordingly, undertaking of new economic functions by the state to maintain economic stability, encourage economic activities and promotion of economic welfare have increased the volume of public expenditure in the developed countries. In the developing countries, after the Second World War, governments are to play the leading role in the development process performing the role of an investor, facilitator and regulator along with promotion of distributive justice, maintenance of economic stability and environmental protection. All these economic needs have caused increase in public expenditure a lot.

6. Rise in price level

Universal rise in price level has led to increase in public expenditure for purchasing the goods and services by the governments. There is a cause and effect relationship between increase in price level and public expenditure.

7. Political factors

Modern governments have to make expenses on the political institutions, organizations and constitutional bodies. The system of election in the democratic countries needs more expenses. In an authoritarian regime, governments are spending a huge amount to suppress the political opponents and voices, and popularizing the image of the ruler through propaganda.

8. Growth in international relations

Establishment of international organizations like UNO and many agencies under its regional co-operation organizations like European Union, ASEAN, SAARC, OAU, BIMSTEC, etc. have made the member countries to subscribe financial contribution for their operation, expenses on permanent and conference delegates. Besides, establishment of diplomatic missions and the practice of foreign aids are also responsible for increase in expenditure of modern governments.

Principles of Public Expenditure

Principles of public expenditure are the criterion or guidelines for making public expenditure decisions. Prof. Alfred Buckler has made an attempt to state some guidelines for public expenditure to be followed by public authorities. They are:
  1. Public expenditure should promote welfare of the society, even it may be to promote welfare of a particular class or group.
  2. Careful judgment should be exercised to ensure the advantages of expenditure on each public service exceed the costs in comparison to that from the private sector.
  3. Priority should be given to services that will best promote social welfare than the services that promote least social welfare.
The principles of public expenditure can be discussed as the Canons of Public Expenditure and the Principle of Maximum Social Advantage. The canons of public expenditure are accepted as the general guiding principles for overall public expenditure mechanism. The principle of maximum social advantage is accepted as the basic principle of public expenditure.

Canons of Public Expenditure

Prof. Findlay Shirras advocated the following canons of public expenditure: 
  1. Canon of Benefit- The ideal of public expenditure should be the promotion of maximum social benefit or advantage.
  2. Canon of Economy- It refers to be economical in spending public money as well as help to expand its revenue base.
  3. Canon of Sanction- It implies that there should be no public expenditure without proper sanction by the proper authority.
  4. Canon of Elasticity- It refers that public expenditure should be changeable as per the need of the country.
  5. Canon of Equitable Distribution- It implies that public expenditure should be carried out to reduce the inequality in national income distribution.
  6.  Canon of Productivity- It implies that public expenditure should encourage increase in national production.
You may also like:
No comments:
Related keywords , , ,

Characteristics of an Effective Tax System

The basic objectives of taxation is to generate maximum potential revenue with desirable effects on the economy. For this, the tax system should be based on sound objectives and policies along with overall effective tax system. Due and Friedlander are of the view that a sound tax system should have the following characteristics:
  1. Equality in the distribution of the tax burden
  2. Productivity of the tax-system generating adequate revenue along with encouraging production in the economy
  3. Appreciation of the rights and problems of the taxpayers and
  4. Adaptability of the tax structure to meet the changing needs of the economy.

Related Topic:
- Concept of Tax


The effectiveness of a tax system requires the effectiveness of its components or sub-systems. They can be mentioned as follows:

1. Sound objectives and policies

Taxes should be levied with clear and specific objectives and policies with due considerations of the possible effects in the economy. For this, the tax structure should be designed with careful planning and research. The active participation of the taxation-experts, legal-experts, tax-administrators, taxpayers and other related stakeholders helps in this concern.

2. Simple and specific Taxation Laws

The taxation laws and regulations should be simple and specific about each and every terms, provisions, procedures, etc. They all should be thoroughly examined as to their application and effectiveness. There must be certainty about what the law requires and intends. Complexities and ambiguities in taxation laws should be avoided as they may lead to discriminatory powers to the tax authorities as well as provide more chances for tax evasion by the taxpayers. 

3. Effective Tax Administration

The tax administration mechanism should have effective organization structure, competent personnel, integrated information technology, simple and convenient tax procedures, well organized revenue intelligence mechanism, simplified revenue appeal mechanism and well coordination with the governmental organizations and other stakeholders.

4. Well provision for Reward and Punishment

A well provision of reward and punishment is essential for an effective tax system. Rewards should be provided to the taxpayers who maintain their account honestly and file returns in prescribed time. Similarly, the tax authorities doing their job honestly should be rewarded. On the other hand, both the taxpayers and tax authorities violating the taxation laws should be punished without discretion.

5. Tax Consciousness and Voluntary Compliance

The great asset of a tax system is the higher degree of voluntary compliance on the part of taxpayers. For this, there should be attempts to increase tax consciousness. Tax consciousness and compliance can be increased with the involvement of the taxpayers in policy formulation, tax education, convenient taxation procedures and effective reward provisions.

6. Stable Government and Political Commitment

There is always necessity to reform tax administration for its effectiveness. This is possible, in a true sense, only with a stable government and strong political commitment & consensus mainly on policy making and implementation concerning the broadening the tax-base in a progressive manner.
You may also like this:
No comments:
Related keywords , , ,

Principles of Taxation and Its Strength and Weaknesses

Taxes will have significant effects upon the economic behavior of individuals and functioning of the economy as a whole. This fact must be well considered in designing and execution of the tax structure and policies in a way so that there will be positive or desirable effects, and avoid undesirable or adverse behaviors in achieving the economic goals of the society. And also, the burden of taxes must be distributed among the people in a manner consistent with these goals. The goals accepted for optimum level of economic welfare in a liberal society are:
  1. Maximum freedom of choice consistent with the freedom of others
  2. Optimum level of living standard in terms of available resources and technology in consistent with the consumer and factor owner’s preferences and
  3. Distribution of income in conformity with the standards of equity currently accepted by the society.
Principles of taxation refer to the appropriate criterion for designing and executing the tax structure and policies. Adam Smith was the first writer to prescribe the principles of taxation in the form of canons of taxation. Later writers added some more canons. The canons of taxation are basically accepted as the general guiding principles of over-all tax system. 

Related Topic:

The four canons of taxation advocated by Adam Smith were:

1. Equity: The burden of taxes should be distributed among the people in an equitable way. “The subjects of every state ought to contribute towards the support of the governments nearly as possible in proportion to their respective abilities, that is in proportion to the revenue they enjoy under the protection of the state”.

2. Certainty: The amount, time and mode (procedure) of tax payment should be certain.

3. Convenience: The time and mode of tax payment should be convenient to the taxpayers.

4. Economy: The cost of collection of taxes should be minimized as far as possible.

Later other writers like Bastable added other canons beside that of Adam Smith. They are:

5. Productivity: The tax system should be able to yield enough revenue so that government may not be forced to resort deficit financing, and also promote productivity of the economy.

6. Flexibility: The tax structure needs to be revised as per the need of the economy and the treasury.

7. Simplicity: All provisions and terms related with tax system must be clear and simple so that even a common man can understand, and not have ambiguities.

8. Diversity: It is necessary to have a wide range of taxes to avoid the chances of possible ill-effects some taxes as well as to generate maximum potential revenue.

Besides these canons, principle of taxation is mainly concerned with the distribution of the burden of tax on people (taxpayers) in an equitable way as accepted by the consensus of the society. Equity in the tax system refers to horizontal and vertical equity. The horizontal equity refers to equal treatment to the equals. The vertical equity refers to relative or discriminatory treatment to the unequals, There are two principles of taxation to maintain equity in taxation. They are the Benefit-received and Ability-to- pay principles.

Benefit-received Principle



The principle accepts benefit-received as justification for taxation as well as a standard for apportioning the tax burden among the people. The principle emphasizes on ‘quid-pro-quo’ term in the relationship between people and the state. The obligation to pay and the amount to pay are individualized like in case of market system. Government services (mainly protection) provide certain benefits to the community. The cost of providing the benefits should be apportioned among the individuals and organizations on the basis of relative benefits they enjoy under the protection of the state. The principle has two approaches in determining tax amount on the taxpayers. The first is the cost of service which refers to the cost to provide benefit one enjoys. The second is the value of service, which refers to the value of benefit one enjoys from the government services. 

This principle has its foundation on the Social-contract Theory of State up to the mid 18th. Century. Contract was the basis of the formation of the organized society in the form of the state, mainly for protection. Then, taxes were considered as the price for protection services. 

Sir William Petty, in late 17th. Century, argued that all men should contribute to the public charge according to the share and interest they have in public peace revealed by their estates and riches. Similarly, Adam Smith argued that citizen should contribute to support the government, as nearly as possible, in proportion to their respective abilities that is in proportion to the revenue they enjoy under the protection of the state. 

In late 19th. Century, this principle was considered as an approach for efficient allocation of resources. Since tax impositions for public services involve withdrawal of resources from private sector, tax and expenditure should be joint to maintain general equilibrium. 

Writers like Mazzola and De Marco advocated distribution of tax burden on the basis of marginal utility or benefit an individual get from the government services. So they argued different prices / tax for government services for different persons according to respective marginal benefit they enjoy. 

Strength of the Principle

  1. The principle is based on the assumption that benefit from government services justifies tax imposition.
  2. Since the principle considers both the income and expenditure of government, and so determine the size of government expenditure and tax shares on it at the time, making government cautious in maintaining fiscal balance as far as possible.
  3. The principle is practically applied in cases where benefit from government services can be individualized, and is in practice in the form of fees or charges.

Weaknesses or Limitations of the Principle

  1. Contribution to the government services on the basis of benefit is actually not a tax, rather it is like a price.
  2. In general cases, benefit from government services cannot be individualized.
  3. The principle does not incorporate the modern role of taxes in maintaining economic stability, promotion of economic growth and distributive justice.
  4. It is questionable to assume the income received by individuals is only because of the benefit from government services.
  5. It doesn’t incorporate the externalities of some public goods.


Ability-to- pay Principle


The term ability refers to the economic well-being or over-all standards of living enjoyed by the people. This principle is based on the logic that a person is to pay tax because he can. In other words, it is his duty to pay tax to support the government according to his relative ability. The principle accepts obligation to support the government as a social or collective responsibility. It does not accept the existence of the exchange relationship between the state and taxpayers.

According to this principle, equity in taxation requires that persons with the equal ability are to pay tax at equal rate and amount. Whereas, persons with greater ability are to pay tax at higher rate and amount. And persons, who have no ability need not pay. This principle is based on the assumption that the Law of diminishing marginal utility applies also in case of money or income, and also interpersonal comparison of utility is possible.

It is said that, even though this principle is older than the benefit-received principle, J.S.Mill, in early 19th. Century, was the leading person to advocate this principle strongly. His statement in this concern was, “The equality of taxation means equality of sacrifice. It means apportioning the contribution of each person towards the expense of government in a way so that he will feel neither more nor less inconvenience from his share of payment than every other person experiences from his.” So, in his opinion, taxation will be just and equitable only when the distribution of tax burden will be in such a way so that all the taxpayers incur equal sacrifice. 

The concept of equal sacrifice has been interpreted in three ways. Equal Absolute Sacrifice refers that the total loss of utility (sacrifice) as a result of tax should be equal for all tax payers. Equal Proportional Sacrifice refers to the loss of utility as a result of tax should be proportional the economic status of the taxpayers. Equal Marginal Sacrifice refers to the marginal sacrifice by all the tax payers should be the same. This is also called the least aggregate sacrifice.

Index of Ability-to-Pay

The subjective criteria of sacrifice approach in determining and apportioning the tax burden is difficult to apply in practice. So, the supporters of this principle have developed the objective indices or criterion for assessing one's ability for practical application of this principle. There are three indices to measure ones ability or economic well-being.
  1. Property or Accumulated wealth: Prior to the industrial revolution and development of monetization, property or accumulated wealth was considered the best index of ability. Wealth was accepted as the better index than the income because wealth is not only the source of income but also an indicator of one's social status, power and economic security. Property reflects additional source of income. It is also accepted that the inherited property has a higher ability to pay tax than that from personal efforts. However, with the progress of industrial society and development of monetization, there has been a shift from property to income as the best index of ability. 
  2. Income: Income is universally accepted as the best index of one’s ability. Musgrave emphasized that the relative welfare position on individuals should be measured in terms of their income, and sacrifice is a function of income surrendered for taxation. A family’s well being depends mainly on the income received in a specific time period. Generally, the net income after making allowances to maintain a family in a way as socially accepted is considered as an ability from the taxation point of view. The Classical writers defined taxable income as the clear income, which they meant the income above subsistence level. They advocated complete exemption of tax on low and middle income people and imposition of taxes on higher income people in a proportional rate. And also, imposition of higher rate on unearned income than the earned income, was suggested.
  3. Consumption expenditure: The pattern of consumption expenditure reflects one’s tax paying ability. So, taxes on consumption expenditure emphasized that the taxable capacity should be defined as the share of one’s consumption out of the national production.
All these indices, taken individually as the only index of ability do not cover all the potential sources of taxation. So, in modern times, all these indices are accepted as the indices of ability.

Strengths of the Principle

  1. This principle is justified on three grounds. The first is the ability as the basis of taxation and is quite justifiable.
  2. The second is the equality in sacrifice by all taxpayers which is also quite justifiable.
  3. Thirdly, the principle is justified as an approach for promoting distributive justice in the society.


Weaknesses or Limitations of the Principle

Critics of this principle opined that the assumption of application of the Law of Diminishing Marginal Utility on income and wealth, and inter-personal comparison of utility is quite subjective, and is difficult in practice. 

Application of this principle may cause disincentive to work, save and invest, and may have negative effects on the economy.

But these criticisms cannot be accepted in modern welfare-state thinking.
You may also like this:
No comments:
Related keywords , , , , , ,

Concept of Tax and Classification of Taxes

Concept of Tax


A tax is a compulsory levy and liability imposed upon the tax assesses, who may be an individual, group of individual or other legal entities. It is a liability to pay on account of the fact that the tax assesses have income of the specified amount from specified source, or own specified tangible or intangible property, or carry-on certain economic activities which have been legally accepted as criterion for taxation. The taxpayers are to pay taxes irrespective to any direct return or benefit of goods and services from the government. In other words, there is no quid pro quo in taxation.

Features of Tax

  1. Taxes are the main source of government revenue.
  2. Tax is the compulsory contribution.
  3. Tax is imposed only by the government.
  4. Tax is a legal receipt.
  5. There is no quid pro quo in taxation.
  6. Tax payment involves sacrifice by the taxpayers.
  7. Tax is paid out of taxpayers’ income.
  8. Receipt from tax is spent for social welfare.
  9. Tax is one of the fiscal instruments.


Classification of Taxes 


Taxes are classified in different ways. One way of classifying is single and multiple tax system. The single tax system comprises tax on only one source of income. 

In 18th.century, the physiocrats advocated tax only on the agricultural income. Similarly, the Mercantilists, in 19th.century, advocated tax only on the business income. But modern governments have a multiple tax. Since there are many potential areas of taxation, need to minimize the possible ill-effects of individual tax, need to attain multiple objectives and to generate substantial amount of revenue, the multiple tax system is common in practice.

Another way of classification is on the basis of the rates or progression. A tax is regressive when the burden of tax lies relatively more on low income people than the high income people, even though the amount of tax is the same. A tax is proportional when the tax liability increases in the same proportion to the increase in the tax base. 

Tax is progressive when the tax liability increases in both the absolute amount and relative terms (i.e. rates) with the increase in the tax-base. A tax is digressive when the rate is decreasing with the increase in tax-base after certain maximum limit. 

Another way of classification is direct and indirect taxes. The accepted way is on the basis of the determination of tax-liability. Accordingly, in case of direct tax, the liability is determined with direct reference to the tax-paying ability of the taxpayer. Whereas, in case of indirect tax, the liability is determined indirectly. And also, taxes on income and property are accepted as direct, and that on production and consumption as indirect. In case of direct tax the impact and incidence of tax lies on the same person, and in case of indirect tax the impact lies on the person who pays at first, but the incidence is shifted to others (fully or partially).

Objectives of Taxation


The basic objective of taxation is to raise government revenue. Besides, taxes are levied for other economic objectives like:
  1. Protection of local industries against foreign competition
  2. Restriction of general consumption level as well as harmful products
  3. Make contribution to government revenue even by the common people
  4. Promotion of capital formation and economic growth
  5. Maintain economic stability and optimum level of employment
  6. Reduction of inequalities national income and wealth among the people and
  7. Help in environmental protection.
You may also like this:
No comments:
Related keywords , , , ,
Subscribe to: Posts (Atom)