CHAPTER

9 Fiscal Economics

“Incomings may be scant; but yet, no failures there,

If in expenditure you rightly learn to spare”.
- Thirukkural No.478

Learning Objectives

1 To understand the meaning and subject matter of public finance.

2 To understand the direct and indirect taxes.

3 To describe the functions of finance commission.

9.1
Introduction
The modern state is a welfare state. The
The term ‘Fiscal Economics’ is a
activities of the state have increased
new one; the old and popular term of the
extensively and intensively. To perform
subject is ‘Public Finance’. The subject
these activities, the state needs funds. This
Public Finance is related to the financing
chapter deals with the Public Revenue,
of the State activities and it discusses the
Public Expenditure, Public Debt, Budget,
financial operations of the Government
Federal Finance and Local Finance.
treasury. The term fiscal is derived from
Greek word which means basket and 9.2
symbolizes the public purse. Hence the Meaning of Public Finance
subject ‘Public Finance’ has been newly
termed ‘Fiscal Economics’.
Public finance is a study of the
Public Finance studies the manner financial aspects of Government. It
in which the state raises and spends is concerned with the revenue and
the resources. The state is concerned expenditure of the public authorities and
with the collective wants of the citizens. with adjustment of the one to the other.
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 9.3 1. Public Revenue

Definitions Public revenue deals with the

methods of raising public revenue such as
tax and non-tax, the principles of taxation,
“Public finance is one of those
rates of taxation, impact, incidence and
subjects that lie on the border line between
shifting of taxes and their effects.
Economics and Politics. It is concerned
with income and expenditure of public 2. Public Expenditure
authorities and with the adjustment of one
to the other”. This part studies the fundamental
-Huge Dalton principles that govern the Government
expenditure, effects of public expenditure
“Public finance is an investigation and control of public expenditure.
into the nature and principles of the state
revenue and expenditure”. 3. Public Debt
-Adam Smith Public debt deals with the methods
of raising loans from internal and
9.4
external sources.The burden, effects and
 ubject Matter / Scope of Public
S redemption of public debt fall under this
Finance head.
In Modern times, the subject ‘Public 4. Financial Administration
Finance’ includes five major sub-divisions,
viz., Public Revenue, Public Expenditure, This part deals with the study of the
Public Debt, Financial Administration different aspects of public budget. The
and Fiscal Policy. budget is the Annual master financial
plan of the Government. The various
objectives and steps in preparing a public
1. Public Revenue budget, passing or sanctioning, allocation
Scope of Public Finance

evaluation and auditing fall within

financial administration.
2. Public Expenditure
5. Fiscal Policy
Taxes, subsidies, public debt and
3. Public Debt public expenditure are the instruments of
fiscal policy.

4. Financial Administration 9.5

Public finance and Private finance

5. Fiscal Policy
Public finance deals with study
of income, expenditure, borrowing
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 and financial administration of the
9.5.2. Dissimilarities
government. Private finance is the study
of income, expenditure, borrowing and 1. Income and Expenditure adjustment
financial administration of individual
or private companies. Both public and The government adjusts the income
private finance are fundamentally similar to the expenditure while individuals adjust
in nature but different from each other their expenditure to the income. Private
on various operational aspects. The finance involves stitching coat according
similarities and dissimilarities between to cloth available whereas public finance
public and private finance have been decides the cloth according to the need for
explained below. the coat.

2. Borrowing
9.5.1. Similarities
The government can borrow from
1. Rationality internal and external sources; it can
borrow from the people by issuing bonds.
Both public finance and private
However, an individual cannot borrow
finance are based on rationality.
from himself.
Maximization of welfare and least cost
factor combination underlie both.
3. Right to print currency
2. Limit to borrowing The government can print currency.
This involves the creation, distribution
Both have to apply restraint with
and monitoring of currency. The private
regard to borrowing. The Government
sector cannot create currency.
also cannot live beyond its means. There
is a limit to deficit financing by the state 4. Present vs. future decisions
also.
3. Resource utilisation The public finance is more involved
with future planning and making long-
Both the private and public sectors term decisions. These investments could
have limited resources at their disposal. include building of schools, hospitals and
So both attempt to make optimum use of infrastructure. The private finance makes
resources. financial decisions on projects with a
short term vision.
4. Administration
The effectiveness of measures of the 5. Objective
Government as well as private depends The public sector’s main objective is
on the administrative machinery. If the to provide social benefit in the economy.
administrative machinery is inefficient The private sector aims to maximize
and corrupt it will result in wastages and personal benefit i.e. Profit.
losses.

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 6. Coercion to get revenue (i) Defence
The sources of income of a private The primary function of the
individual is relatively limited while Government is to protect the people from
those of the Government is wide. The external aggression and internal disorder.
Government can use its power and The government has to maintain adequate
authority. police and military forces and render
protective services.
7. Ability to make huge and deliberate
changes (ii) Judiciary:
The public finance has the ability Rendering justice and settlement
to make big decisions on income. For of disputes are the concern of the
example, it can effectively and deliberately government. It should provide adequate
adjust the revenue. But individuals cannot judicial structure to render justice to all
make such massive decisions. classes of citizens.

9.6 (iii) Enterprises

Functions of Modern State The regulation and control of
private enterprise fall under the purview
The modern state is a welfare state of the modern State. Ownership of
and not just police state. The state assumes certain enterprises and operating them
greater roles by creating economic and successfully are the responsibilities of the
social overheads, ensuring stability both government.
internally and externally, conserving
resources for sustainable development
and so on.
Defence
Control of
Judiciary
Monopoly

Social Justice Functions of a Enterprises

Government

Macro Economic Social Welfare

Policy
Infrastructure

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 (iv) Social Welfare 9.7
It is the duty of the state to make Public Expenditure
provisions for education, social security,
social insurance, health and sanitation
for the betterment of the people in the
country. 9.7.1. Meaning

Public expenditure refers to

(v) Infrastructure
Government spending incurred by
Modern States have to build the Central, State and Local governments of
base for the economic development of the a country.
country by creating social and economic
infrastructure. 9.7.2. Definition

Public expenditure can be defined

(vi) Macro-economic policy
as, “The expenditure incurred by public
The Government has to administer authorities like central, state and local
fiscal policy and monetary policy to governments to satisfy the collective
achieve macro-economic goals. social wants of the people is known as
public expenditure”.
(vii) Social Justice
During the process of growth of an 9.7.3. 
C lassification of public
economy, certain sections of the society expenditure are as follows:
gain at the cost of others. The Government 1. Classification on the Basis of Benefit:
needs to intervene with fiscal measures to
redistribute income. Cohn and Plehn have classified the
public expenditure on the basis of benefit
(viii) Control of Monopoly into four classes:
Concentration of economic power
is another evil to be corrected by the a) Public expenditure benefiting the entire
Government. So, the state intervenes society, e.g., the expenditure on general
through control of monopolies and administration, defence, education,
restrictive trade practices to curb public health, transport.
concentration of economic power.
b) Public expenditure conferring a special
In fine, the state can play three kinds of benefit on certain people and at the
roles. same time common benefit on the
entire community, e.g. administration
i) As a producer of goods and services. of justice etc.
ii) As a supplier of public goods and social
goods. c) Public expenditure directly benefiting
particular group of persons and
iii) As a regulator of the system.
indirectly the entire society, e.g. social
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 security, public welfare, pension, 36.1 crore in 1951, to 121 crore in 2011.
unemployment relief etc. The growth in population requires massive
investment in health and education, law
d) Public expenditure conferring a special and order, etc. Young population requires
benefit on some individuals, e.g., increasing expenditure on education
subsidy granted to a particular industry. & youth services, whereas the aging
population requires transfer payments
2. Classification on the Basis of Function: like old age pension, social security &
health facilities.
Adam Smith classified public
expenditure on the basis of functions of
2. Defence Expenditure
government in the following main groups:
There has been enormous increase
a) Protection Functions: This group in defence expenditure in India during
includes public expenditure incurred planning period. The defence expenditure
on the security of the citizens, to protect has been increasing tremendously due to
from external invasion and internal modernisation of defence equipment. The
disorder, e.g., defence, police, courts defence expenditure of the government
etc. was ₹ 10,874 crores in 1990-91 which
b) C ommercial Functions: This group increased significantly to ₹ 2,95,511crores
includes public expenditure incurred in 2018-19.
on the development of trade and
commerce, e.g., development of means 3. Government Subsidies
of transport and communication etc. The Government of India has been
providing subsidies on a number of
c) Development Functions: This group items such as food, fertilizers, interest on
includes public expenditure incurred priority sector lending, exports, education,
for the development infrastructure and etc. Because of the massive amounts of
industry. subsidies, the public expenditure has
increased manifold.
9.7.4. 
C auses for the Increase in
Government Expenditure The expenditure on subsidies by
The modern state is a welfare state. central government in 1990-91 was ₹ 9581
In a welfare state, the government has crores which increased significantly to
to perform several functions viz Social, ₹ 2, 29,715.67 crores in 2018-19. Besides
economic and political. These activities this, the corporate sectors also receive
are the cause for increasing public subsidies (incentives) of more than ₹ 5
expenditure. lakh crores.

1. Population Growth 4. Debt Servicing

During the past 67 years of planning, The government has been borrowing
the population of India has increased from heavily both from the internal and external
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 sources, As a result, the government has to 9.8
make huge amounts of repayment towards
debt servicing. Public Revenue

The interest payment of the central

Public revenue occupies an important
government has increased from ₹ 21,500
place in the study of public finance. The
crores in 1990-91 to ₹5, 75,794crores in
Government has to perform several
2018-19.
functions for the welfare of the people.
5. Development Projects They involve substantial amount of public
The government has been expenditure which can be financed only
undertaking various development projects through public revenue. The amount of
such as irrigation, iron and steel, heavy public revenue to be raised depends on
machinery, power, telecommunications, the necessity of public expenditure and
etc. The development projects involve the people’s ability to pay.
huge investment.
9.8.1. Meaning
6. Urbanisation
The income of the government
There has been an increase in
through all sources is called public income
urbanization. In 1950-51 about 17% of
or public revenue.
the population was urban based. Now the
urban population has increased to about According to Dalton, the term
43%. There are more than 54 cities above “Public Income” has two senses — wide
one million population. The increase in and narrow. In its wider sense it includes
urbanization requires heavy expenditure all the incomes or receipts which a public
on law and order, education and civic authority may secure during any period
amenities. of time. In its narrow sense, it includes
7. Industrialisation only those sources of income of the public
authority which are ordinarily known as
Setting up of basic and heavy “revenue resources.” To avoid ambiguity,
industries involves a huge capital and long the former is termed “public receipts” and
gestation period. It is the government the latter “public revenue.”
which starts such industries in a planned
economy. The under developed countries In a narrow sense, it includes only
need a strong of infrastructure like those sources of income of the Government
transport, communication, power, fuel, which are described as “revenue resources”.
etc. In broad sense, it includes loans raised by
the Government also.
8. Increase in grants in aid to state and
union territories
9.8.2. Classification of Public Revenue.
There has been tremendous increase
in grant-in-aid to state and union Public revenue can be classified into
territories to meet natural disasters. two types.
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 Sources of 9.9.3. Characteristics of Tax
Public Revenue
1. A tax is a compulsory payment made to
the government. People on whom a tax
is imposed must pay the tax. Refusal to
pay the tax is a punishable offence.
Tax Revenue Non - Tax Revenue
2. There is no quid pro quo between a
taxpayer and public authorities. This
9.9
means that the tax payer cannot claim
Tax Revenue any specific benefit against the payment
of a tax.

9.9.1. Meaning 3. 
Every tax involves some sacrifice on
part of the tax payer.
Tax is a compulsory payment by the
4. A tax is not levied as a fine or penalty
citizens to the government to meet the
for breaking law.
public expenditure. It is legally imposed
by the government on the tax payer and in Some of the tax revenue sources are
no case tax payer can refuse to pay taxes to
 Income tax
the government.
 Corporate tax
 Sales tax
 Surcharge and
 Cess

9.9.4. Non-Tax Revenue

9.9.2 Definitions The revenue obtained by the
government from sources other than tax
“A Tax is a compulsory payment made
is called Non-Tax Revenue. The sources of
by a person or a firm to a government
non-tax revenue are
without reference to any benefit the payer
may derive from the government.” 1. Fees
-Anatol Murad Fees are another important source
of revenue for the government. A fee is
“A Tax is a compulsory contribution charged by public authorities for rendering
imposed by public authority, irrespective of a service to the citizens. Unlike tax, there
the exact amount of service rendered to the is no compulsion involved in case of fees.
tax payer in return and not imposed as a The government provides certain services
penalty for any legal offence.” and charges certain fees for them. For
- Dalton example, fees are charged for issuing of
passports, driving licenses, etc.
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 2. Fine 6. Escheats
A fine is a penalty imposed on It refers to the claim of the state to
an individual for violation of law. For the property of persons who die without
example, violation of traffic rules, payment legal heirs or documented will.
of income tax after the stipulated time etc.
9.9.5. Canons of Taxation:
3. Earnings from Public Enterprises
The Government also gets revenue The characteristics or qualities which
by way of surplus from public enterprises. a good tax should possess are described as
Some of the public sector enterprises do canons of taxation. It must be noted that
make a good amount of profits. The profits canons refer to the qualities of an isolated
or dividends which the government gets tax and not to the tax system as a whole.
can be utilized for public expenditure. A good tax system should have a proper
combination of all kinds of taxes having
4. Special assessment of betterment levy different canons.
It is a kind of special charge levied on According to Adam Smith, there are
certain members of the community who four canons or maxims of taxation. They
are beneficiaries of certain government are as follows:
activities or public projects. For example,
due to a public park or due to the Canons of Taxation
construction of a road, people in that
locality may experience an appreciation in
the value of their property or land. 1. Canon of Ability
2. Canon of Certainty
5. Gifts, Grants and Aids
3. Canon of
 A grant from one government to Convenience
another is an important source of 4. Canon of Economy
revenue in the modern days. The
government at the Centre provides
grants to State governments and the 1.Canon of Ability
State governments provide grants
to the local government to carry out The Government should impose tax
their functions. in such a way that the people have to pay
taxes according to their ability. In such
 Grants from foreign countries are case a rich person should pay more tax
known as Foreign Aid. Developing compared to a middle class person or a
countries receive military aid, food poor person.
aid, technological aid, etc. from other 2.Canon of Certainty
countries.
The Government must ensure that
there is no uncertainty regarding the
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 rate of tax or the time of payment. If the only those taxes whose collection costs
Government collects taxes arbitrarily, then are very less and cheap .
these will adversely affect the efficiency of
the people and their working ability too. 9.9.6. Direct Tax and
Indirect Tax
3.Canon of Convenience
The method of tax collection and Direct Tax
the timing of the tax payment should
suit the convenience of the people. The A direct tax is referred to as a tax
Government should make convenient levied on person’s income and wealth and
arrangement for all the tax payers to pay is paid directly to the government; the
the taxes without difficulty. burden of such tax cannot be shifted. The
tax is progressive in nature. It is levied
4.Canon of Economy according to the paying capacity of the
person, i.e. the tax is collected more from
The Government has to spend
the rich and less from the poor people.
money for collecting taxes, for example,
salaries are given to the persons who The plans and policies of the Direct
are responsible for collecting taxes. The Taxes are being recommended by the
taxes, where collection costs are more are Central Board of Direct Taxes (CBDT)
considered as bad taxes. Hence, according which is under the Ministry of Finance,
to Smith, the Government should impose Government of India.

Direct Taxes Indirect Taxes

Ultimate burden of tax Ultimate burden of tax

payment payment: purchaser

Responsibility
Responsibility to to pay tax:
pay tax shopkeeper

Example: Income Tax Example: GST

When you earn income, When you buy stuff, the
you are responsible for shopkeeper is responsible
tax payment, and you for tax payment, but he
also have the burden can collect it from you

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 3. Inconvenient
9.9.7. Merits of Direct Taxes
The tax payers find it inconvenient
1.Equity to maintain accounts, submit returns and
pay tax in lump sum.
Direct taxes are progressive i.e. rate
of tax varies according to tax base. For 4. Tax Evasion
example, income tax satisfies the canon of
equity. The burden of direct tax is so heavy
that tax-payers always try to evade taxes.
2.Certainity This ultimately leads to the generation
of black money, which is harmful to the
Canon of certainty can be ensured by
economy.
direct taxes. For example, an income tax
payer knows when and at what rate he has 9.9.9. Indirect Tax
to pay income tax.
Indirect Tax is referred to as a tax
3. Elasticity:
charged on a person who purchases the
Direct taxes also satisfy the canon of goods and services and it is paid indirectly
elasticity. Income tax is income elastic in to the government. The burden of tax can
nature. As income level increases, the tax be easily shifted to the another person. It
revenue to the Government also increases is levied on all persons equally whether
automatically. rich or poor.

4. Economy There are several types of Indirect Taxes,

such as:
The cost of collection of direct taxes
is relatively low. The tax payers pay the tax Excise Duty: Payable by the manufacturer
directly to the state. who shifts the tax burden to retailers and
wholesalers.
9.9.8. Demerits of Direct Taxes
Sales Tax: Paid by a shopkeeper or
retailer, who then shifts the tax burden to
1.Unpopular customers by charging sales tax on goods
Direct taxes are generally unpopular. and services.
It is inconvenient and less flexible.
Custom Duty: Import duties levied on
2. Productivity affected goods from outside the country, ultimately
According to many economists direct paid for by consumers and retailers.
tax may adversely affect productivity.
Citizens are not willing to earn more Entertainment Tax: Liability is on the
income because in that case they have to cinema theatre owners, who transfer the
pay more taxes. burden to cinema goers.

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 Service Tax: Charged on services like along with the price. They do not feel the
telephone bill, insurance premium such as pinch of paying tax.
food bill in a restaurant etc.
9.9.11. Demerits of Indirect Taxes
9.9.10. Merits of Indirect Taxes

(1) Higher Cost of Collection

(1) Wider Coverage
The cost of collection of indirect
All the consumers, whether they are
taxes is higher than the direct taxes. The
rich or poor, have to pay indirect taxes.
Government has to spend huge money to
For this reason, it is said that indirect
collect indirect taxes.
taxes can cover more people than direct
taxes. For example, in India everybody (2) Inelastic
pays indirect tax as against just 2 percent
paying income tax. Indirect taxes are less elastic
compared to direct taxes. As indirect taxes
(2) Equitable are generally proportional.
The indirect tax satisfies the canon
of equity when higher tax is imposed on (3) Regressive
luxuries used by rich people.
Indirect taxes are sometimes unjust
(3) Economical and regressive in nature since both rich
and poor persons have to pay same amount
Cost of collection is less as producers as taxes irrespective of their income level.
and retailers collect tax and pay to the
Government. The traders act as honorary (4) Uncertainity
tax collectors.
The rise in indirect taxes increase the
(4) Checks harmful consumption price and reduces the demand for goods.
The Government imposes indirect Therefore, the Government is uncertain
taxes on those commodities which are about the expected revenue collection. So
harmful to health e.g. tobacco, liquor etc. Dalton says under indirect taxes 2+2 is
They are known as sin taxes. not 4 but 3 or even less than 3.

(5) Convenient (5) No civic Consciousness

Indirect taxes are levied on As the tax is hidden in price, the

commodities and services. Whenever consumers are not aware of paying tax.
consumers make purchase, they pay tax

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 9.9.12. Comparison Chart

Basis For
Direct Tax Indirect Tax
Comparison
Indirect Tax is referred to as
Direct tax is referred to as the
the tax, levied on a person who
tax, levied on person’s income
Meaning consumes the goods and services
and wealth and is paid directly
and is paid indirectly to the
to the government.
government.
Nature Progressive Regressive
Incidence and
Falls on the same person. Falls on different persons.
Impact
Income or wealth of the Purchase/sale/manufacture of
Tax base
assessee goods and provision of services
Tax evasion is hardly possible
Evasion Tax evasion is possible. because it is included in the price
of the goods and services.
Direct tax helps in controlling Indirect taxes push up price
Inflation
the inflation. inflation.
Imposed on and collected Imposed on and collected from
Imposition and from assesses, i.e. Individual, consumers of goods and services
collection HUF (Hindu Undivided but paid and deposited by the
Family), Company, Firm etc. assesse.
Burden Cannot be shifted. Can be shifted

9.9.13. GST (Goods and  I

n simple words, Goods and Service
Service Tax) Tax (GST) is an indirect tax levied on
the supply of goods and services. This
G
ST is an Indirect Tax law has replaced many indirect tax laws
which has replaced that previously existed in India.
many Indirect Taxes in India. The
ST is one indirect tax for the entire
G
Goods and Service Tax Act was passed
country.
in the Parliament on 29th March
2017. The Act came into effect on U
nder the GST regime, the tax will be
1st July 2017; Goods & Services Tax levied at the final point of sale. In case
in India is a comprehensive, multi- of intra-state sales, Central GST and
stage, destination-based tax that is State GST will be charged. Inter-state
levied on every value addition. sales will be chargeable to Integrated
GST.
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 consumer in Karnataka. Since Goods
& Service Tax is levied at the point of
consumption, in this case, Karnataka, the
entire tax revenue will go to Karnataka
and not Tamil Nadu.

Components of GST
The component of GST are of 3 types.
They are: CGST, SGST & IGST.
CGST: Collected by the Central
Government on an intra-state sale (Eg:
Within state/ union territory)
SGST: Collected by the State Government
Single Tax to replace multiple levies, on an intra-state sale (Eg: Within state/
right from manufacturer / supplier to union territory)
consumer
IGST: Collected by the Central
Destination Based Government for inter-state sale (Eg:
Maharashtra to Tamil Nadu)
Consider goods manufactured in
Tamil Nadu and are sold to the final

In most cases, the tax structure under the new regime will be as follows:

Transaction New Regime Old Regime

Sale within CGST + VAT + Central Revenue will be shared equally
the State SGST Excise/Service tax between the Centre and the State
Sale to IGST Central Sales Tax There will only be one type of tax
another State + Excise/Service (central) in case of inter-state sales.
Tax The Center will then share the IGST
revenue based on the destination of
goods.

Nature of Sales tax, VAT and GST Advantages of GST

1. Sales tax was multipoint tax with 1. GST will mainly remove the cascading
cascading effect. effect on the sale of goods and services.
2. VAT was multipoint tax without Removal of cascading effect will directly
cascading effect. impact the cost of goods. Since tax on
3. GST is one point tax without tax is eliminated in this regime, the cost
cascading effect. of goods decreases.

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 2. 
G
 ST is also mainly technologically to induce the private sector to release
driven. All activities like registration, manpower and real resources and to finance
return filing, application for refund the purchase of these resources or to make
and response to notice need to be done welfare payments or subsidies”.
online on the GST Portal. This will – Carl S.Shoup
speed up the processes.

9.10 9.10.2. Types of Public Debt

Public Debt
i)Internal public debt

In the 18th and An internal public debt is a loan

19th centuries, the taken by the Government from the citizens
role of the state was or from different institutions within the
minimum. But since country. An internal public debt only
20th century there involves transfer of wealth.
has been enormous
increase in the The main sources of internal public debt
responsibilities are as follows:
of the state. Hence the state has to
 I
ndividuals, who purchase government
supplement the traditional revenue
bonds and securities;
sources with borrowing from individuals,
and institutions within and outside the B
anks, both private and public, buy
country. The amount of borrowing is bonds from the Government.
huge in the under developed countries to
finance development activities. The debt N
on-financial institutions like UTI,
burden is a big problem and most of the LIC, GIC etc. also buy the Government
countries are in debt trap. bonds.

9.10.1. Definitions C
entral Bank can lend the Government
in the form of money supply. The Central
“The debt is the form of promises
Bank can also issue money to meet the
by the Treasury to pay to the holders of
expenditures of the Government.
these promises a principal sum and in
most instances interest on the principal.
ii) External public debt
Borrowing is resorted to in order to provide
funds for financing a current deficit.” When a loan is taken from abroad
or from an international organisation it
– Philip E.Taylor
is called external public debt. The main
sources of External public debt are IMF,
“The receipt from the sale of financial
World Bank, IDA and ADB etc. Loan from
instruments by the government to
other countries and the Governments.
individuals or firms in the private sector,
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 Countries External Debt as on June-2018
External
Per capita
Rank Country/Region debt (USD % of GDP
US dollars
Millions)
1 USA 21,171,000 58,200 98
2 UK 8,475,956 127,000 313
3 France 5,689,745 87,200 213
4 Germany 5,398,267 65,600 141
7 Japan 3,586,817 28,200 74
13 China 1,710,625 1,200 14
21 Russia 537,458 3,700 40
22 India 529,000 380 20
(Source: World Bank Report and India’s External Debt as at the end of March 2018 – RBI
REPORT DATED 29-06-2018)

to the citizens of the country. To finance

9.10.3. Causes for the Increase in these, the State has to incur a heavy public
Public debt debt.
The causes for enormous growth
of public debt may be studied under the 3. Economic Development and Deficit
following sub-headings: The government has to undertake
many projects for economic development
1. War and Preparation of war of the country. Construction of railways,
Waging war has become one of the power projects, irrigation projects, heavy
important causes for incurring debts by industries, etc., could be thought of only
the governments. In modern times, the by means of mobilising resources in the
preparation for war and nuclear defence form of public debt. Due to heavy public
programmes take away the major share of expenditure, the governments always face
the government’s revenue and so it incurs deficit budget. Such deficits have to be
debt. financed only through borrowings.

2. Social obligations 4.Employment

Modern states are considered to be Most of the governments of modern
‘Welfare States’ and they have to undertake days face the problem of unemployment
many social obligations like public health, and it has become the duty to solve this by
sanitation, education,insurance, transport making huge public expenditure. To solve
and communications, etc., besides the unemployment problem, and to fight
providing the minimum necessaries of life recession, the government has to make

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 huge expenditures. For this the States have a new loan. Under this system a high
to resort to public debt. interest public debt is converted into a
low interest public debt. Dalton felt that
5.Controlling inflation debt conversion actually relaxes the debt
The Government can withdraw burden.
excess money from circulation, by raising (3) Budgetary Surplus
public debt and thus prevent prices from
rising. When the Government presents
surplus budget, it can be utilised for
6.Fighting depression repaying the debt. Surplus occurs when
During the depression phase, private public revenue exceeds the public
investment is lacking. The Government expenditure. However, this method is
applies compensatory public spending rarely possible.
by borrowing from internal and external (4) Terminal Annuity
sources.
In this method, Government pays off
the public debt on the basis of terminal
9.10.4. M
 ethods of Redemption of
annuity in equal annual instalments. This
Public Debt
is the easiest way of paying off the public
The process of repaying a public debt debt.
is called redemption. The Government
(5) Repudiation
sells securities to the public and at the
time of maturity, the person who holds the It is the easiest way for the Government
security surrenders it to the Government. to get rid of the burden of payment of a
The following methods are adopted for loan. In such cases, the Government does
debt redemption. not recognise its obligation to repay the
loan. It is certainly not paying off a loan
(1) Sinking Fund
but destroying it. However, in normal case
Under this method, the Government the Government does not do so; if done it
establishes a separate fund known as will lose its credibility.
“Sinking Fund”. The Government credits
(6) Reduction in Rate of Interest
every year a fixed amount of money to this
fund. By the time the debt matures, the Another method of debt redemption
fund accumulates enough amount to pay is the compulsory reduction in the rate of
off the principal along with interest. This interest, during the time of financial crisis.
method was first introduced in England
(7) Capital Levy
by Walpol.
When the Government imposes
(2) Conversion
levy on the capital assets owned by an
Conversion of loans is another individual or any institution, it is called
method of redemption of public debt. It capital levy. This levy is imposed on
means that an old loan is converted into capital assets above a minimum limit on
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 a progressive scale. The fund so collected
9.11.3. Types of Budget
can be used by the Government for paying
off war time debt obligations. This is Revenue and Capital Budget
the most controversial method of debt
repayment. On the basis of expenditure on
revenue account and other accounts, a
9.11 budget can be presented in two ways:
Budget i) Revenue Budget: It consists of revenue
receipts and revenue expenditure.
The word ‘budget’ is said to have Moreover, the revenue receipts can be
its origin from the French word “Bougett” categorised into tax revenue and non-tax
which refers to ‘a small leather bag’.The revenue. Revenue expenditure can also be
budget is an annual financial statement categorised into plan revenue expenditure
which shows the estimated income and and non-plan revenue expenditure.
expenditure of the Government for the
ii) Capital Budget: It consists of capital
forthcoming financial year.
receipts and capital expenditure. In this
9.11.1. Definitions case, the main sources of capital receipts
are loans, advances etc. On the other side
“It is a document containing a capital expenditure can be categorised
preliminary approved plan of public into plan capital expenditure and non-
revenue and expenditure”. plan capital expenditure.
-Reney Stourn. iii) Supplementary Budget: During the
“The budget has come to mean the time of war emergencies and natural
financial arrangements of a given period, calamities like tsunami, flood etc, the
with the usual implication that they expenditures allotted in the budget
have been submitted to the legislature for provisions are not always enough. Under
approval”. these circumstances, a supplementary
- Bastabale budget can be presented by the
Government to tackle these unforeseen
events.
9.11.2. Union Budget and State Budget
iv) Vote - on - Account: Under Article
India is a federal economy, hence 116 of the Indian Constitution, the
public budget is divided into two layers of budget can be presented in the middle of
the Government. According to the Indian the year. The reason may be political in
Constitution, the Central Government nature. The existing Government may or
has to submit annual financial statement, may not continue for the year, on account
i.e., Union Budget under Article 112 to the of the fact that elections are due, then the
Parliament and each State Government Government places a ‘lame duck budget’.
has to submit the same for the State in the This is also called ‘Vote-on-account
Legislative Assembly under Article 202. Budget’.

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 Components of Budget

Budget Receipts Budget Expenditure

Revenue Capital
Revenue Receipts Capital Receipts
Expenditure Expenditure

Tax Non - Tax Plan Non Plan Plan Non Plan

Receipts Receipts Expenditure Expenditure Expenditure Expenditure

Recovery Borrowing and Disinvestment

of Loans other Liabilities

The vote on account budget is a special justification or otherwise for the project as
provision by which the Government gets a whole in the light of the socio-economic
permission from the parliament to incur objectives which have been already set up
expenditures on necessary items till the for this project and as well as in view of
budget is finally passed in the parliament. the priorities of the society.
The legal permission of both the Houses
of the parliament for the withdrawal of vi) Performance Budget: When the
money from the Consolidated Fund of outcome of any activity is taken as the
India to meet the requisite expenses till base of any budget, such budget is known
the budget is finally approved is known as ‘Performance Budget’. For the first time
as vote-on - account budget. This type in the world, the performance budget
of budget is generally sanctioned for not was made in USA. The Administrative
more than two months. Reforms Commission was set up in
1949 in America under Sir Hooper. This
commission recommended making of
v) Zero Base Budget: The Government
a ‘Performance Budget’ in USA. In the
of India presented Zero-Base-Budgeting
Performance Budget, it is the compulsion
(ZBB first) in 1987-88. It involves
of the government to tell ‘what is done’,
fresh evaluation of expenditure in the
‘how much done’ for the betterment of the
Government budget, assuming it as a new
people. In India, the Performance Budget
item. The review has been made to provide
is also known as ‘Outcome Budget’.
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 vii) Balanced Budget Vs Unbalanced 2. Deficit Budget
Budget
Deficit budget is one where the
A. Balanced Budget estimated government expenditure is
more than expected revenue.
Balanced budget is a situation,
in which estimated revenue of the
Government’s estimated Revenue
government during the year is equal to its
<
anticipated expenditure.
Government’s proposed Expenditure.
Government’s estimated Revenue
=
9.11.4. Budgetary Procedure
Government’s proposed Expenditure.

TYPES OF BUDGET Budgetary procedure refers to the

system through which the budget is
DEFICIT BALANCED SURPLUS prepared, enacted and executed.
BUDGET BUDGET BUDGET
(A) Preparation of the Budget
+ + +
The Ministry of Finance prepares the
Central Budget every year. At the state level
EXPENSE EXPENSE EXPENSE
> = < the finance department is responsible for
REVENUE REVENUE REVENUE the Annual State Budget. While preparing
the budget, the following factors are taken
B. Unbalanced Budget into account:

The budget in which Revenue &  The macro economic targets to be

Expenditure are not equal to each other is achieved within a plan period;
known as Unbalanced Budget.  The basic strategy of the budget;
Unbalanced budget is of two types:  The financial requirements of different
1. Surplus Budget projects;
2. Deficit Budget  Estimates of the revenue expenditures
(includes defence expenditure,
1. Surplus Budget subsidy, interest payment on debt
The budget is a surplus budget when etc.);
the estimated revenues of the year are  Estimates of the capital expenditures
greater than anticipated expenditures. (includes development of railways,
Government Estimated revenue roadways, irrigations etc.);
>  Estimates of revenue receipts from tax
Estimated Government Expenditure. and non-tax revenues;

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 Estimates of capital receipts from the
  first placed before the LokSabha at the
recovery of loans, disinvestment of Centre, and before the VidhanSabha at the
public sector units, market borrowings State level. The demands of various tax
etc. proposals are included in the budget. After
the finance bill is passed, an appropriation
Estimates of the gap between revenue
 
bill is presented to give legal effect to
receipts and revenue expenditure; and
the voted demands, and to authorise the
Estimates of fiscal deficit, primary
  expenditure as per the budget. In this way,
deficit, and revenue deficit. the budgets are enacted in India.
(c) Execution of the Budget
Process in the Preparation The budget is mainly executed by
of the Budget different departments of the Government.
Budget estimates are prepared by the Proper execution of the budgetary
Ministry of Finance provisions are important for the efficient
utilisation of the allocated funds.
Based on the estimated income and
expenditure of various ministries and Parliamentary Control over the Budget
departments, sent to the Ministry of
In India,the Government Accounts are
Finance
maintained in three parts:
Prepares budget (i) Consolidated Fund
(ii) Contingency Fund
Presented by the finance minister to the (iii) Public Accounts
cabinet for approval
There are also two committees of
Budget is ready for presentation to the parliament, viz,
Parliament
(i) 
The Public Accounts Committee,
and
(B) Presentation of the Budget (ii)The Estimates Committee.

The hon’ble Minister of Finance, on These committees keep a constant vigil

behalf of the Central Government, places on the expenditure so that no Ministry
the Union Budget before Parliament on or Department exceeds the amount
the eve of a new financial year. Similarly at sanctioned to it.
state levels, the Hon’ble Finance Minister
of the respective State Government
places the State Budget before the State 9.11.5. Budgetary Deficits
Legislature.
Budget deficit is a situation where
According to the Indian Constitution, budget receipts are less than budget
all money bills must be initiated in the expenditures. This situation is also known
Lower House. All the money bills are as government deficit.
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 the real burden of the government and it
In reference to the Indian
does not include the interest burden on
Government budget, budget deficit is of
loans taken in the past. Thus, primary
four major types.
deficit reflects borrowing requirement of
(a) Revenue Deficit the government exclusive of interest
(b) Budget Deficit payments.
(c) Fiscal Deficit, and Primary Deficit (PD) = Fiscal deficit
(d) Primary Deficit (PD) - Interest Payment (IP)
(A) Revenue Deficit
9.12
It refers to the excess of the
government revenue expenditure over Federal Finance
revenue receipts. It does not consider
capital receipts and capital expenditure. Federal finance refers to the system
Revenue deficit implies that the of assigning the source of revenue to the
government is living beyond its means to Central as well as State Governments for
conduct day-to-day operations. the efficient discharge of their respective
functions i.e. clear-cut division is made
Revenue Deficit (RD) = Total Revenue regarding the allocation of resources of
Expenditure (RE) - Total Revenue revenue between the central and state
Receipts (RR), authorities.
 Division of Powers: In our Constitution,
When RE - RR > 0 there is a clear division of powers so
(B) Budget Deficit that none violates its limits and tries
to encroach upon the functions of the
Budget deficit is the difference other and functions within own sphere
between total receipts and total of responsibilities. There are three lists
expenditure (both revenue and capital) enumerated in the Seventh Schedule of
Budget Deficit = Total Expenditure – constitution. They are: the Union list,
Total Revenue the State list and the Concurrent List.
 heUnion List consists of 100 subjects
T
(C) Fiscal Deficit of national importance such as Defence,
Railways, Post and Telegraph, etc.
Fiscal deficit (FD) = Budget deficit +
 The State List consists of 61 subjects
Government’s market borrowings and
of local interest such as Public Health,
liabilities
Police etc.

(D ) Primary Deficit  he Concurrent List has 52 subjects

T
important to both the Union and the
Primary deficit is equal to fiscal State, such as Electricity, Trade Union,
deficit minus interest payments. It shows Economic and Social Planning, etc.

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 Central State Financial Relationship 18. 
Taxes other than stamp duties on
transactions in stock exchanges and
(I) Union Sources future markets.
1. Corporation tax 19. 
Taxes on the sale or purchase of
2. 
Currency, coinage and legal tender, newspapers and on advertisements
foreign exchange. published therein.

3. 
Duties of customs including export 20. Terminal taxes on goods or passengers,
duties. carried by railways, sea or air.
4. Duties of excise on tobacco and certain
goods manufactured or produced in (II) State Sources
India. 1. Capitation tax
5. Estate duty in respect of property other 2. 
Duties in respect of succession to
than agricultural land. agricultural land.
6. Fees in respect of any of the matters in
3. 
Duties of excise on certain goods
the Union List, but not including any
produced or manufactured in the State,
fees taken in any Court.
such as alcoholic liquids, opium, etc.
7. Foreign Loans.
4. Estate duty in respect of agricultural
8. Lotteries organized by the Government land.
of India or the Government of a State.
5. Fees in respect of any of the matters in
9. Post Office Savings Bank.
the State List, but not including fees
10. 
Posts and Telegraphs, telephones, taken in any Court.
wireless, Broadcasting and other forms
of communication. 6. Land Revenue.

11. Property of the Union. 7. 

R ates of stamp duty in respect of
documents other than those specified
12. Public Debt of the Union.
in the Union List.
13. Railways.
8. Taxes on agricultural income.
14. R ates of stamp duty in respect of Bills
of Exchange, Cheques, Promissory 9. Taxes on land and buildings.
Notes, etc. 10. 
Taxes on mineral rights, subject to
15. Reserve Bank of India. limitations impose by Parliament
16. Taxes on income other than agricultural relating to mineral development.
income. 11. Taxes on the consumption or sale of
17. 
Taxes on the capital value of the electricity.
assets, exclusive of agricultural land of 12. Taxes on the entry of goods into a
individuals and companies. local area for consumption, use or sale
therein.
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 13. 
Taxes on the sale and purchase of (IV) 
Duties levied by the Union but
goods other than newspapers. collected and Appropriated by the
14. 
Taxes on the advertisements other states (Art.268)
than those published in newspapers.
Stamp duties and duties of excise on
15. Taxes on goods and passengers carried medicinal and toilet preparation (those
by road or on inland waterways. mentioned in the Union List) shall be
16. Taxes on vehicles. levied by the Government of India but
17. Taxes on animals and boats. shall be collected.

18. Taxes on professions, trades, callings (i) 

In the case where such duties are
and employments. leviable within any Union territory, by
the Government of India.
19. Taxes on luxuries, including taxes on
entertainments, amusements, betting (ii) In other cases, by the States within
and gambling. which such duties are respectively
leviable.
20. Tolls.
(v) Taxes which are Levied and Collected
(III) Taxes Levied and Collected by the by the Union but which may be
union but Assigned to the States Distributed between the Union and
(Art.269) the States (Arts.270 and 272)
1. 
Duties in respet of succession to 1. Taxes on income other than agricultural
property other than agricultural land. income.

2. Estate duty in respect of property other 2. Union duties of excise other than such
than agricultural land. duties of excise on medicinal and
toilet preparations as are mentioned
3. Taxes on railway fares and freights. in the Union List and collected by the
Government of India.
4. 
Taxes other than stamp duties on
transactions in stock exchanges and “Taxes on income” does not include
future markets. corporation tax. The distribution of
income-tax proceeds between the
5. 
Taxes on the sale or purchase of Union and the States is made on the
newspapers and on advertisements recommendations of the Finance
published therein Commission.
6. Terminal taxes on goods or passengers
carried by railways, sea or air. 9.12.1. Principles of Federal Finance

7. Taxes on the sale or purchase of goods

In the case of federal system of finance,
other than newspapers where such sale
the following main principles must be
or purchase taxes place in the course of
applied:
inter-State trade or commerce.
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 1. Principle of Independence. that the resources of each Government
i.e. Central and State should be adequate
2. Principle of Equity.
to carry out its functions effectively. Here
3. Principle of Uniformity. adequacy must be decided with reference
4. Principle of Adequacy. to both current as well as future needs.
Besides, the resources should be elastic
5. Principle of Fiscal Access. in order to meet the growing needs and
6. P
 rinciple of Integration and unforeseen expenditure like war, floods
coordination. etc.
7. Principle of Efficiency. 5. Principle of Fiscal Access
8. Principle of Administrative Economy. In a federal system, there should
9. Principle of Accountability. be possibility for the Central and State
Governments to develop new source of
1. Principle of Independence revenue within their prescribed fields
to meet the growing financial needs. In
Under the system of federal finance, nutshell, the resources should grow with
a Government should be autonomous and the increase in the responsibilities of the
free about the internal financial matters Government.
concerned. It means each Government
should have separate sources of revenue, 6. 
Principle of Integration and
authority to levy taxes, to borrow coordination
money and to meet the expenditure. The financial system as a whole
The Government should normally enjoy should be well integrated. There should
autonomy in fiscal matters. be perfect coordination among different
layers of the financial system of the
2. Principle of Equity
country. Then only the federal system
From the point of view of equity, the will survive. This should be done in such
resources should be distributed among the a way to promote the overall economic
different states so that each state receives a development of the country.
fair share of revenue.
7. Principle of Efficiency
3. Principle of Uniformity The financial system should be well
In a federal system, each state should organized and efficiently administered.
contribute equal tax payments for federal There should be no scope for evasion and
finance. But this principle cannot be fraud. No one should be taxed more than
followed in practice because the taxable once in a year. Double taxation should be
capacity of each unit is not of the same. avoided.
8. Principle of Administrative Economy
4. Principle of Adequacy of Resources
Economy is the important criterion
The principle of adequacy means of any federal financial system. That is,
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 the cost of collection should be at the Finance Commission aims to reduce
 
minimum level and the major portion the fiscal imbalances between the
of revenue should be made available centre and the states (Vertical
for the other expenditure outlays of the imbalance) and also between the
Governments. states (horizontal imbalance). It
promotes inclusiveness.
9. Principle of Accountability
A Finance Commission is set up
 
Each Government should be once in every 5 years. It is normally
accountable to its own legislature for its constituted two years before the
financial decisions i.e the Central to the period. It is a temporary Body.
Parliament and the State to the Assembly.
The 14th Finance Commission was
 
9.13 set up in 2013. Its recommendations
History of Finance Commission were valid for the period from 1st
April 2015 to 31st March 2020.
Finance commission is a quasi-
 
The 15th Finance Commission
 
judicial body set up under Article
has been set up in November
280 of the Indian Constitution. It was
2017. Its recommendations will be
established in the year 1951, to define
implemented starting 1 April 2020.
the fiscal relationship framework
between the Centre and the state.

Finance Year of Operational

Chairman
Commission establishment duration
First 1951 K. C. Neogy 1952–57
Second 1956 K. Santhanam 1957–62
Third 1960 A. K. Chanda 1962–66
Fourth 1964 P. V. Rajamannar 1966–69
Fifth 1968 MahaveerTyagi 1969–74
Sixth 1972 K. Brahmananda Reddy 1974–79
Seventh 1977 J. M. Shelat 1979–84
Eighth 1983 Y. B. Chavan 1984–89
Ninth 1987 N. K. P. Salve 1989–95
Tenth 1992 K. C. Pant 1995–2000
Eleventh 1998 A. M. Khusro 2000–05
Twelfth 2002 C. Rangarajan 2005–10
Thirteenth 2007 Dr. Vijay L. Kelkar 2010–15
Fourteenth 2013 Dr. Y. V Reddy 2015–20
Fifteenth 2017 N. K. Singh 2020–25

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 9.13.1. F
 unctions of Finance 9.14
Commission of India Local Finance
rticle 280 (3) speaks about the
A
functions of the Finance Commission. Local finance refers to the finance
The Article states that it shall be the of local bodies in India. There is a large
duty of the Commission to make the variety of local bodies in India. We have
recommendations to the President as to: the following main four local bodies which
are functioning today in our country:
1. T
 he distribution between the Union Types of Local Bodies
and the States of the net proceeds of
taxes, which may be divided between 1. Village Panchayats
them and the allocation among the 2. District Boards or ZilaParishads
states of the respective shares of such 3. Municipalities
proceeds;
4. Municipal Corporations
2. T
 o determine the quantum of grants-
in-aid to be given by the Centre to states 1. Village Panchayats:
[Article 275 (1)] and to evolve the
principles governing the eligibility of
the state for such grant-in-aid;

Article 280 of the


Constitution mandates
the finance commission
to recommend the
distribution of the
net proceeds of taxes
between the Centre
and the states every five
years.  Establishment: The jurisdiction of
a panchayat is usually confined to one
15th Finance

Commission’s revenue village. In some cases, though
recommendations on tax not very frequently, two or more small
sharing between Centre
and States are to kick in villages are grouped under one panchayat.
form April 2020 The establishment of panchayat raj is the
3. A
ny other matter referred to the avowed policy of most states in India.
Commission by the President of India
 Functions
in the interest of sound finance. Several
a) The functions of panchayats range over
issues like debt relief, financing of
a wide area including civil, economic
calamity relief of states, additional
and so on. Thus small disputes may be
excise duties, etc. have been referred to
disposed of by panchayats on the spot.
the Commission invoking this clause.

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 b) Roads, primary schools, village district level. The territorial jurisdiction
dispensaries etc. are to be managed by of a district board is generally a revenue
panchayats. district.
c) The supply of water, both for drinking  Functions
and irrigation, falls within their field
of responsibility, and in some cases In Tamil Nadu, the Zila Parishad
farming, marketing, storage, etc. are is a co-ordinating body which exercises
entrusted to them. general supervision over the working of
Panchayat Samitis and advises them on
Sources of revenue of Village Panchayats implementation of Development Schemes.
The following are the sources of Sources of revenue of District Boards
revenue of village panchayats.
(i) Grants-in-aid from the state
(i) general property tax, government.
(ii) taxes on land, (ii) Land Cesses.
(iii) profession tax, and (iii) Toll, fees etc.
(iv) tax on animals and vehicles. (iv) Income from the property and loans
from the state governments.
Other taxes include service tax,
octroi, theatre tax, pilgrim tax, tax on (v) Grants for the centrally sponsored
marriage, tax on birth and deaths, and schemes relating to development
labour tax. As a matter of fact, taxes are work.
levied by the panchayats only with the (vi) Income from fairs and exhibitions.
sanction of the state government, and
(vii)Property tax and other taxes which
there are certain limits in respect of tax
the state governments may authorise
rates which have to be observed.
the district boards.
2. District Boards Or ZilaParishads: 3. Municipalities

 Establishment and Functions: The

 Establishment: In rural areas, district
municipalities are bodies or institutions
boards or Zila Parishads are established at
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 which are established in urban areas drainage, lighting, roads, slum clearance,
for looking after local affairs, such as, housing and town planning etc. The
sanitation, public health, local roads, rapid increase in the population of cities
lighting, water supply, cleaning of streets, has definitely added to the functions of
maintenance of parks and gardens, municipal corporations.
maintenance of hospitals, dispensaries
and veterinary hospitals, provision of Sources of revenue of Corporations
drainage, provision of primary education, (i) tax on property,
organising of fairs and exhibitions (ii) tax on vehicles and animals,
etc. However, all these functions are
(iii) tax on trades, calling and employment,
performed subject to the control of the
state government. (iv) theatre and show tax,
(v) taxes on goods brought into the cities
Sources of revenue of municipalities for sale,
(i) taxes on property (vi) taxes on advertisements,
(ii) 
taxes on goods, particularly octroi (vii) octroi and terminal tax etc.
and terminal tax
The corporations have a fair degree
(iii) personal taxes, taxes on profession, of freedom in respect of their choice and
trades and employment modification of these taxes, subject to the
(iv) taxes on vehicles and animals maximum and minimum rates laid down
by the law.
(v) theatre or show tax, and
(vi) grants-in-aid from state government.
9.15
Fiscal policy
4. Municipal Corporations
As an instrument of macro-economic
policy, fiscal policy has been very popular
among modern governments. The growing
importance of fiscal policy was due to the
Great Depression and the development of
‘New Economics’ by Keynes.

9.15.1. Meaning of Fiscal Policy

Establishment and Functions: In common parlance fiscal policy

means the budgetary manipulations
The municipal corporations have affecting the macro economic variables –
wide powers and enjoy greater freedom as output, employment, saving, investment
compared to municipalities. The municipal etc.
corporations are usually entrusted with
the functions, such as, water supply and

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 i) Taxation: Taxes transfer income from
9.15.2. Definitions the people to the Government. Taxes
“The term fiscal policy refers to a are either direct or indirect. An increase
policy under which the Government uses in tax reduces disposable income. So
its expenditure and revenue programmes taxation should be raised to control
to produce desirable effects and avoid inflation. During depression, taxes are to
undesirable effects on the national income, be reduced.
production and employment”
ii) Public Expenditure: Public
– Arthur Smithies expenditure raises wages and salaries of
“By fiscal policy is meant the use the employees and thereby the aggregate
of public finance or expenditure, taxes, demand for goods and services. Hence
borrowing and financial administration to public expenditure is raised to fight
further our national economic objectives” recession and reduced to control inflation.

– Buehler iii) Public debt: When Government

borrows by floating a loan, there is
9.15.3. Fiscal Instruments transfer of funds from the public to the
Government. At the time of interest
Fiscal Policy is implemented through
payment and repayment of public debt,
fiscal instruments also called ‘fiscal tools’
funds are transferred from Government
or fiscal levers: Government expenditure,
to public.
taxation and borrowing are the fiscal tools.

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 excess demand is due to private spending.
9.15.4. Objectives of Fiscal Policy:
Taxation reduces disposable income and
so aggregate demand.
1. Full Employment To fight depression, the Government
Objectives of Fiscal Policy

needs to increase its spending and reduce

2. Price stability taxation.

3. Economic growth 3. Economic Growth

Fiscal Policy is used to increase
4. Equitable distribution
the productive capacity of the economy.
Tax is to be used as an instrument for
5. External stability encouraging investment. Tax holidays and
tax rebates for new industries stimulate
6. Capital formation investment. Public sector investments are
to be increased to fill the gap left by private
7. Regional balance investment. When resource mobilization
through tax measures is inadequate, the
Government resorts to borrowing both
The Fiscal Policy is useful to achieve the from internal and external sources to
following objectives: finance growth projects.

1. Full Employment 4. Equitable distribution

Full Employment is the common Progressive rates in taxation help
objective of fiscal policy in both to reduce the gap between rich and poor.
developed and developing countries. Similarly progressive rates in public
Public expenditure on social overheads expenditure through welfare schemes
help to create employment opportunities. such as free education, noon meal for
In India, public expenditure on rural school children and subsidies promote the
employment programmes like MGNREGS living standard of poor people.
is aimed at employment generation.
5. Exchange Stability
2. Price Stability
Fluctuations in international trade
Price instability is caused by cause movements in exchange rate. Tax
mismatch between aggregate demand and concessions and subsidy to export oriented
aggregate supply. Inflation is due to excess units help to boost exports. Customs
demand for goods. If excess demand is duties on import of non-essential items
caused by Government expenditure in help to cut import bill. The reduction in
excess of real output, the most effective import duty on import of raw material
measure is to cut down public expenditure. and machinery enables reduction in cost
Taxation of income is the best measure if and make the exports competitive.
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 6. Capital formation investment, interest rate, consumption
and income growth.
Capital formation is essential for
rapid economic development. Tax relief
helps to increase disposable income, Glossary
savings and thereby capital formation.
Government expenditure on infrastructure Tax: Compulsory payment paid by the
development like power and transport citizens to the Government without any
encourages private investment. quid pro quo.
Quid pro quo: A favour or advantage
7. Regional balance
granted in return for something.
Fiscal incentives for industries in the
Proportional Tax: Tax is imposed at the
backward regions help to narrow down
same rate irrespective of tax base
regional imbalances. Public expenditure
may be used to start industrial estates so Progressive Tax: The rate of tax increases
that industrial activity is stimulated in with the increase in tax base (income)
backward regions. Regressive Tax: High rate of tax is levied
on the poor and low rate is levied to the
Summary: rich
The science of public finance deals Internal public debt: A loan taken by the
with the revenue and expenditure of the Government from the citizens or from
Centre, state and local Government. different institutions with in the country
In modern times, this subject includes
External public debt: A loan is taken
five major divisions: Public revenue,
from abroad or from an international
public expenditure, public debt, fiscal
organisation
administration and Fiscal Policy. Thus,
public finance plays a vital role in Fiscal Policy: Policy related with the
both developed and underdeveloped revenue and expenditure process of the
economies. In advanced or developed Government
economies, this is a problem of economic Deficit Budget: The gap between
instability due to either ‘lack of demand’ Government anticipated revenue and the
or ‘excess of demand’. In under developed targeted expenditure
countries, fiscal policy is one of the
Budget: It is an annual financial statement
instruments for achieving faster economic
which shows the income and expenditure
growth.
of the Government
Fiscal Policy became popular after Federal Finance: The system of assigning
the Great Depression. Governments the source of revenue to the Central as
intervention was emphasised by well as State Governments.
J.M.Keynes to get the economies out of
Local Finance: Local finance refers to the
the Depression. There is close association
finance of local bodies in India
between governments spending, private

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 MODEL QUESTIONS
Part – A
Multiple choice questions

ii. 
The Constitution also provides for
1. The modern state is transferring certain tax revenues from
union list to states.
a) Laissez-faire state
b) Aristocratic state a) i only
c) Welfare state b) ii only
d) Police state c) both
d) none
2. One of the following is NOT a feature
of private finance 6. GST is equivalence of

a) Balancing of income and a) Sales tax

expenditure b) Corporation tax
b) Secrecy c) Income tax
c) Saving some part of income d) Local tax
d) Publicity
7. The direct tax has the following merits
3. The tax possesses the following except
characteristics a) equity
a) Compulsory b) convenient
b) No quid pro quo c) certainty
c) Failure to pay is offence d) civic consciousness
d) All the above
8. Which of the following is a direct tax?
4. Which of the following canons of a) Excise duty
taxation was not listed by Adam smith? b) Income tax
a) Canon of equality c) Customs duty
b) Canon of certainty d) Service tax
c) Canon of convenience
9. Which of the following is not a tax
d) Canon of simplicity
under Union list?
5. C onsider the following statements and a) Personal Income Tax
identify the correct ones. b) Corporation Tax
c) Agricultural Income Tax
i. 
C entral government does not have
d) Excise duty
exclusive power to impose tax which is
not mentioned in state or concurrent
list.
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 10. “Revenue Receipts” of the Government 15. Methods of repayment of public debt
do not include is
a) Interest a) Conversion
b) Profits and dividents b) Sinking fund
c) Recoveries and loans c) Funded debt
d) Rent from property d) All these

11. The difference between revenue 16. 

C onversion of public debt means
expenditure and revenue receipts is exchange of
a. Revenue deficit a) new bonds for the old ones
b. Fiscal deficit b) low interest bonds for higher
c. Budget deficit interest bonds
d. Primary deficit c) Long term bonds for short term
bonds
12. 
The difference between total d) All the above
expenditure and total receipts
including loans and other liabilities is 17. 
The word budget has been derived
called from the French word “bougette”
which means
a. Fiscal deficit
b. Budget deficit a) A small bag
c. Primary deficit b) An empty box
d. Revenue deficit c) A box with papers
d) None of the above
13.The primary purpose of deficit
financing is 18. Which one of the following deficits
does not consider borrowing as a
a) Economic development
receipt?
b) Economic stability
c) Economic equality a) Revenue deficit
d) Employment generation b) Budgetary deficit
c) Fiscal deficit
14. Deficit budget means d) Primary deficit
a) An excess of government’s revenue
19. Finance Commission determines
over expenditure
b) An excess of government’s current a) The finances of Government of
expenditure over its current India
revenue b) The resources transfer to the states
c) An excess of government’s total c) The resources transfer to the
expenditure over its total revenue various departments
d) None of above d) None of the above

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 20. C onsider the following statements and identify the right ones.
i. The finance commission is appointed by the President
ii. The tenure of Finance commission is five years
a) i only
b) ii only
c) both
d) none
Answers

1 2 3 4 5 6 7 8 9 10
c d d d b a b b c d
11 12 13 14 15 16 17 18 19 20
a a a c d b a c b c

Part B
Two mark questions
21. Define public finance.
22. What is public revenue?
23. Differentiate tax and fee.
24. Write a short note on zero based budget.
25. Give two examples for direct tax.
26. What are the components of GST?
27. What do you mean by public debt?

Part C
28. Three mark questions:
29. Describe canons of Taxation.
30. Mention any three similarities between public finance and private finance.
31. What are the functions of a modern state?
32. State any three characteristics of taxation.
33. Point out any three differences between direct tax and indirect tax.
34. What is primary deficit?
35. Mention any three methods of redemption of public debt.
Part D
36. Five mark questions:
37. Explain the scope of public finance.
38. Bring out the merits of indirect taxes over direct taxes.
39. Explain the methods of debt redemption.

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 40. State and explain instruments of fiscal policy.
41. Explain the principles of federal finance.
42. Describe the various types of deficit in budget.
43. What are the reasons for the recent growth in public expenditure?

ACTIVITY
Collect various bills and tabulate different rates of GST for different
goods and services.

References

1. Public Finance – Dr.H.L.Bhatia – Vikas Publishers-2018

2. Public Finance – R.K.lekhi – Joginder Sing – Kalyani Publications-2010
3. Public Finance – AmbarGhose, Chandra Ghosh – PHI Publications -2014
4. Public FinaceTheroy and Practice – Dr. S.K.Sing – S.Chand Publication -2010

Website Link
https://edurev.in/courses/10460_Public-Finance-Notes--Videos.
https://eclass.uoa.gr/modules/document/file.php/ECON123/Lectures/Lecture%20
01%20Introduction.pdf

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