Sunday, November 05, 2017

Public Finance Solved Question Papers: Nov' 2016

2016(November)
COMMERCE
(General/Speciality)
Course: 501(Public Finance)
The figures in the margin indicate full marks for the questions
(NEW COURSE)
Full Marks: 80
Pass Marks: 24
Time: 3 hours
1. Answer the following questions:                                          1x8=8
a)      What is ‘Public Finance’?
Ans: Public finance is a study of income and expenditure or receipt and payment of government. It deals the income raised through revenue and expenditure spend on the activities of the community and the terms ‘finance’ is money resource i.e. coins.
b)      Name the economist who named principles of public finance as ‘Principle of Maximum Social Advantage’.
Ans: Professor Hugh Dalton
c)       What do you mean by ‘budget’?
Ans: The budget is a document containing a preliminary approval plan of public revenue and expenditure.
d)      Write the full form of CAGI.
Ans: Comptroller and Auditor General of India
e)      Mention one canon of taxation.
Ans: Canon of Equality
f)       Mention one demerit of indirect tax.
Ans: Too many taxes
g)      Mention any one difference between public expenditure and private expenditure.
Ans: Elasticity exists in case of private expenditure, whereas electricity does not exist in case of public expenditure.
h)      What is ‘deficit financing’?
Ans: Deficit Financing: Deficit means an excess of public expenditure over public revenue. This excess may be met by borrowings from the market, borrowings from abroad, by the central bank creating currency. In case of borrowing from abroad, there cannot be compulsion for the lenders, but in case of internal borrowings there may be compulsion.
2. Write short notes on:                                                               4x4=16
a) Scope of Public Finance.
Ans: Scope of Public Finance (Subject Matter of Public Finance)
1.       Public Revenue: Public revenue concentrates on the methods of raising public revenue, the principles of taxation and its problems. In other words, all kinds of income from taxes and receipts from public deposit are included in public revenue. It also includes the methods of raising funds. It further studies the classification of various resources of public revenue into taxes, fees and assessment etc.
2.       Public Expenditure: In this part of public finance we study the principles and problems relating to the expenditure of public funds. This part studies the fundamental principles that govern the flow of Government funds into various streams.
3.       Public Debt: In this section of public finance, we study the problem of raising loans. Public authority or any Government can raise income through loans to meet the short-fall in its traditional income. The loan raised by the government in a particular year is the part of receipts of the public authority.
4.       Financial Administration: Now comes the problem of organisation and administration of the financial mechanism of the Government. In other words, under financial or fiscal administration, we are concerned with the Government machinery which is responsible for performing various functions of the state.
5.       Economic Stabilization: Now –a-day’s economic stabilization and growth are the two aspects of the Government economic policy which got a significant place in the discussion on public finance theory. This part describes the various economic polices and other measures of the government to bring about economic stability in the country.
b) Performance Budget.
Ans: Performance budgeting is generally understood as a system or technique of presentation of public expenditure in terms of functions, programmes, performance units, i.e. activities, projects etc, reflecting primarily the government output and its cost. The focus in a performance budgeting is basically different from that in the conventional budgets. The two approaches differ in their scope and context. Under the performance budgeting, emphasis is shifted from the budget as a means of accomplishment to the accomplishment itself. If concerns itself primarily with the objectives aimed at by the government rather than with the outlays incurred on several projects. According to U. S. Bureau of Budget, “A performance is one which presents the purpose the objectives for which funds are required, the cost of the programmes proposed for achieving those objectives and quantitative data measuring the accomplishment and work performed under each programme.”
Under performance budgeting system, the overall budget is divided into functions based on the major purpose of government and then subdivided into programme and activities, funds being granted for doing a specific quantity of work. Performance budgeting implies that the budget statement should indicate the actual achievements expected by a Ministry over a period of time from certain amount of expenditure. It forces attention on the size and cost of programme to be implemented.
c) Non-tax Revenue
Ans: Non Tax Revenue: The revenue obtained by the government from sources other then tax is called Non-Tax Revenue. The sources of non-tax revenue are:
1. Fees: Fees are another important source of revenue for the government. A fee is charged by public authorities for rendering a service to the citizens. The government provides certain services and charges certain fees for them. For example, fees are charged for issuing of passports, driving licenses, etc.
2. Fines or Penalties: Fines or penalties are imposed as a form of punishment for breach of law or non fulfillment or certain conditions or for failure to observe some regulations. Like taxes, fines are compulsory payments without quid pro quo. But while taxes are generally imposed to collect revenue. Fines are imposed as a form of punishment or to prevent people from breaking the law.
3. Surplus from Public Enterprises: The Government also gets revenue by way of surplus from public enterprises. In India, the Government has set up several public sector enterprises to provide public goods and services. Some of the public sector enterprises do make a good amount of profits. The profits or dividends which the government gets can be utilized for public expenditure.
4. Special assessment of betterment levy: It is a kind of special charge levied on certain members of the community who are beneficiaries of certain government activities or public projects. For example, due to a public park in a locality or due to the construction of a road, people in that locality may experience an appreciation in the value of their property or land. Thus, due to public expenditure, some people may experience 'unearned increments' in their asset holding.
5. Grants and Gifts: Gifts are Voluntary contributions by individuals or institutions to the government. Gifts are significant source of revenue during war and emergency. A grant from one government to another is an important sources of revenue in the modern days. The government at the Centre provides grants to State governments and the State governments provide grants to the local government to carry out their functions.
6. Deficit Financing: Deficit means an excess of public expenditure over public revenue. This excess may be met by borrowings from the market, borrowings from abroad, by the central bank creating currency. In case of borrowing from abroad, there cannot be compulsion for the lenders, but in case of internal borrowings there may be compulsion.
d) Canons of Public Expenditure
Ans: Prof. Findlay Shirras has explained four canons of public expenditure. They are canon of benefit, canon of sanction, canon of economy and canon of surplus.
CANON OF BENEFIT: The ideal of this is maximum social advantage. That is, public expenditure should be planned so as to yield maximum social advantage and social welfare of the community as a whole and not of a particular group. Public expenditure must be spent in those directions which will maximise utility. It is possible only when the marginal utility from different uses is equal. The public authorities should distribute resources so as to increase production, reduce inequalities of income distribution, preserve social life of the people, and improve the quality of social life etc. “Other things being equal, expenditure should bring with its important social advantages such as increased production, the preservation whole against external attack and internal disorder and as far as possible a reduction in the inequalities of income. In short, public funds must be spent in those directions most conducive to the public interest. i.e., maximum utility is to be attained in public expenditure.”---Findlay Shirras.
CANON OF ECONOMY: This implies that the state should be economical in spending money. It should not spend more than the necessary amount on items of expenditure. The sole aim is to avoid extravagance and corruption. Social benefit can be maximised when resources are not wasted. While incurring public expenditure social costs are to be minimised. To satisfy this canon Project Appraisal and Cost Benefit Analysis are to be adopted. “Economy means protecting the interests of the tax payers not merely in effecting economies in expenditure, but in developing revenue.”—Shirras.
CANON OF SANCTION: According to this canon, no expenditure should be incurred without the proper approval of the sanctioning authority. It also implies that the spending authorities should spend the amount for which it has been sanctioned and to see that the sanctioned amount is properly utilized. Public accounts are to be audited at the end of financial year. This canon acts as check on arbitrary, unwise and reckless spending of public funds.
CANON OF SURPLUS: This canon believes in the avoidance of deficit in public expenditure. According to Findlay Shirras,”Public authorities must earn their living and pay their way like ordinary citizens. Balanced budget must, as in the private expenditure; the order of the day. Annual expenditure must be balanced without the creation of fresh credits unrepresented by the new assets.”
3. (a) Explain the Keynes theory of public finance.                                          14
Ans: Keynes’ Theory of Public Finance: Functional Finance Keynes and Hansen have given us the ‘new economics’ which is primarily a new concept of public finance. They assume that a capitalist economy by itself cannot function and thereby the government will have to come to the rescue of the economy at certain times. They emphasize compensatory action through fiscal policy to stabilize and regulate the economic system of a country. The Keynesian concept of public finance has been called functional finance by Abba P. Lerner. Functional finance is the system of judging fiscal measures by the way they function in the economy. Functional finance reduces fiscal operation of taxation, public expenditure and the public debt to operations of policy so as to reduce the volume of money and the aggregate demand in the country. For example, according to functional finance, the main function of taxation is not to secure funds for the state but to be an effective weapon in the hands of the state so as to reduce the purchasing power of the people. In the same way, the main function of public expenditure is to influence the volume of aggregate demand to equal aggregate supply.
Thus, the old precepts vanished, economists began to visualize the instrument of fiscal policy as a means of promoting a healing to their economy. Public finance became Functional Finance signifying a study of the fiscal functions of the government that could eliminate unwanted distortions and fluctuations in the economic activity.
Or
(b) “The best system of public finance is that which secures the maximum social advantage.” Discuss this statement. 14
Ans: THE PRINCIPLE OF MAXIMUM SOCIAL ADVANTAGE
One of the important principles of public finance is the so – called Principle of Maximum Social Advantage explained by Professor Hugh Dalton. Just like an individual seeks to maximize his satisfaction or welfare by the use of his resources, the state ought to maximize social advantage or benefit from the resources at its command.
The principles of maximum social advantage are applied to determine whether the tax or the expenditure has proved to be of the optimum benefit. Hence, the principle is called the principle of public finance. According to Dalton, “This (Principle) lies at the very root of public finance” He again says “The best system of public finance is that which secures the maximum social advantage from the operations which it conducts.” It may be also called the principle of maximum social benefit. A.C. Pigou has called it the principle of maximum aggregate welfare.
Public expenditure creates utility for those people on whom the amount is spent. When the volume of expenditure is small with a slighter increase in it, the additional utility is very high. As the total public expenditure goes on increasing in course of time, the law of diminishing marginal utility operates. People derive less of satisfaction from additional unit of public expenditure as the government spends more and more. That is, after a stage, every increase in public expenditure creates less and less benefit for the people. Taxation, on the other hand, imposes burden on the people.


So, when the volume of taxation becomes high, every further increase in taxation increases the burden of it more and more. People under go greater scarifies for every additional unit of taxation. The best policy of the government is to balance both sides of fiscal operations by comparing “the burden of tax” and “the benefits of public expenditure”. The State should balance the social burden of taxation and social benefits of Public expenditure in order to have maximum social advantage.
Attainment of maximum social advantage requires that;
a) Both public expenditure and taxation should be carried out up to certain limits and no more.
b) Public expenditure should be utilized among the various uses in an optimum manner, and
c) The different sources of taxation should be so tapped that the aggregate scarifies entailed is the minimum.
Assumptions of this theory:
1.All taxes result in sacrifice and all public expenditures lead to benefit.
2. Public revenue consists of only taxes and there is no other source of income to the government.
3. The govt. has no surplus or deficit budget but only a balanced budget. 
Diagrammatical Explanation of the theory of maximum social advantages


In the above diagram, MSS is the marginal social sacrifice curve sloping upward from left to right. This rising curve indicates that the marginal social sacrifice goes on increasing with every additional dose of taxation.   MSB is the marginal social benefit curve sloping downwards from the left to right. This falling curve indicates that the marginal social benefit diminishes with every additional dose of public expenditure. The two curves MSS and MSB intersect each other at the point P. PM represent both marginal social sacrifice as well as marginal social benefit. Both are equal at OM which represents the maximum social advantage.
Criticism of the theory of Maximum Social Advantages
1. Non measurability of social sacrifice and social benefit: The major drawback of this principle is that it is not possible in actual practice to measure the MSS and MSB involved in the fiscal operation of the state.
2. Non applicability of the low of equimarginal utility in public expenditure: The low of equimarginal utility may be applicable to private expenditure but certainly not to public expenditure.
3. Neglect non-tax revenue: The principle says that the entire public expenditure is financed by taxation. But, in practice, a significant portion of public expenditure is also financed by other sources like public borrowing, profits from public sector enterprises, imposition of fees, penalties etc.
4. Lack of divisibility: The marginal benefit from public expenditure and marginal sacrifice from taxation can be equated only when public expenditure and taxation are divided into smaller units. But this is not possible practically.
5. Assumption of static condition: Conditions in an economy are not static and are continuously changing. What might be considered as the point of maximum social advantage under some conditions may not be so under some other.
6. Misuse of government funds: The principle of Maximum social advantage is based on the assumption that the government funds are utilized in the most effective manner to generate marginal social benefit. However, quite often a large share of government funds is misused for unproductive purposes
7. "The govt. has no surplus or deficit budget but only a balanced budget."- is an invalid assumption.
4. (a) What do you mean by ‘Financial Administration’? Discuss briefly the various instruments of Financial Administration.                                                                3+11=14
Ans: Meaning of Financial Administration
In simple words, financial refers to such a system or method by which one can analyse the financial working of the public authority. Thus the focuses on the procedure which ensure the lawful use of public funds. However the concept has been differently defined as under:
Prof .M.S Kenderic, “The financial administration refers to the financial measurement of govt. including the preparation of budget method of administering the various revenue resources the custody of the public fund, procedures in expending money, keeping the financial records and the like. These functions are important to the effective conduct of operation of public finance”
Prof. Dimock, “Financial administration consists of a series of steps whereby funds and made available certain official under procedures which will ensure their lawful and efficient use. The main ingredients are budgeting, accounting, auditing and purchase and supply.”
From these definitions one can easily find four ingredients (Methods/Process) of financial administration:
1)      Budget. The term budget has been derived from the French word “Bougette” which means a leather bag or a wallet. The chancellor of Exchequer in England used to carry his papers in the bag to House of Commons. Prof. Willoughby defined, “Budget-it should be at once a document through which the Chief Executive comes before the fund-raising and fund grading authority and makes full report regarding the manner and which he or his subordination have administered affairs during the last completed year ; in which he or exhibits the present conditions of public treasury and one the basis of such information sets forth his programme of for the year to come and the manner in which the purposes that such work should be financed.” In the word of Prof. Dimock, “Budget is a balanced estimate of expenditure and receipts for a given period of time. In the hands of the administration, the budget is a record of part performance a method of current control and a projection of future planes.”
2)      Accounting. Accounting is the record ingredient of financial administration. It is an art by which the financial effects of executive action are recorded, assembled and finally summarized in the form of the financial reports. A good according system is indispensable for adequate budgeting control. Therefore, there must be harmonious relationship between the goals in budget and financial statements prepared from accounts.
3)      Auditing. Auditing is a considered the final stage. In fact, it is investigation of report and legally, efficiency and accuracy of the financial transactions. Audition is of two types i.e. internal and external. The Chief Motto of audit is only to supervise the manner in which expenditure has been made in order to ascertain whether the executive has spent in accordance with rules and regulations. Auditing is an independent department who points out reregulation and submits its report to the higher authority.
4)      Purchase and Supply. As the name implies, it is the acquisition of the property. In other words, purchasing is a report of large category of supply which covers specialization traffic management, inspection, storage and proper utilization of different resources.
INSTRUMENTR OF FINANCIAL ADMINISTRATION
For the success of financial administration of the Government, different constitution play imperative role. These agencies can be grouped as:
a)      Executive
b)      Legislature
c)       Financial Department of Financial Ministry
d)      Auditing Department
a)      Executive. According to Prof. H. M. Grover, “The executive is the best position to the view the financial problem as a whole ant to assume the responsibilities for the success and failure of a financial programme.” Executive is responsible for running the administration, thus it is in the best position to say what funds are required for it. No tax or expenditure can be made without the permission of the executive. It is therefore, the responsibility of the executive to prepare the budget which is stupendous task.
In Parliamentary Government, there is a principle that no demands for grants can be made except on recommendation of the executive. It is therefore In India; executive refers to the Central Government. Since, Finance Ministry is responsible for the administration of the finance of the Central Government, even then it performs the policy making function and tries its best to get the final approval of the legislature.
b)      Legislature. In democratic parliamentary system, it is the legislature or parliament which is the time representation of the people. In India, under the constitution there is special provision to control the finances:
1.       Controller over Taxation. Indian constitution under Article 265 provides that no tax shall be levied or collected except the permission of law. Thus, The Government has to present all tax proposals before parliament in the form of a Bill to be passed into law and unless no art is passed, no tax can be levied. Similarly U.S.A constitution under article one mentions, “The congress shall have to levy and collect tax.”Therefore under, we can conclude that the power of taxation always vests with literature.
2.       Control over Public Expenditure. In Indian constitution states. “All revenues received of all loans by the union or state shall be paid into in the consolidated funds of the union or state, as case may be ad that no money can be written out of  the fund except in accordance with the law and for the purpose and in the manner provided for in the constitution.”
3.       Enforcement of Financial Accountability. Every Government is bound to spend the money granted by the parliament for no purpose other than it was sanctioned by the legislature or parliament. This function is performed by the Comptroller and Audit-General of India. In this way, one can say that Parliament is the supreme in Finance matters.
c)       Financial Ministry: This Finance Ministry plays significant role in financial administration as it ensure that proper use of public funds. It controls the both before the presentation of budget to parliament to and in it executive after approval by the parliament. The Finance Ministry possesses the expert knowledge in financial matters. It considers all proposals to each ministry in the perspective of the government as whole.
The various scheme and proposals of the different ministries are included in the budget after consultations and discussions with the finance ministry. After the final approval of the budget by the parliament, it seeks to ensure that the amounts are properly spent in accordance with the provision of budget. Therefore, it is the finance ministry which frames rules and regulations about the preparation and executive of the budget. The ministry of finance has been divided into four departments, viz
1.       Department of Economic Affairs.
2.       Department of Revenue and Insurance.
3.       Department of Expenditure.
4.       Department of Co-ordination.
d)      Auditing. Auditing is the most important ingredients of parliamentary control over the finances of country as a hole. In a democratic form of government, the supreme authority with the regard to financial policy is vested in legislature. This is ensured by the provision of audit of public expenditure by an independent statutory authority i.e. Comptroller and Audit-General. Therefore, audit supplies an essential link between the executive and parliament and helps in interpreting the action in so as the have a finance bearing of the former on the latter.
Or
(b) What is ‘Zero-based Budgeting’? What are its features? Discuss the various steps involved in Zero-based Budgeting. 3+4+7=14
Ans: Zero Based Budgeting: Zero Base Budgeting is a new technique for the preparation of budgets. It involves fresh evaluation of every item of expenditure as if it were a new item. It is reconsideration of each item of expenditure from the very beginning. It is like assuming that a zero expenditure has been incurred on a project at the time of its review, although the project may be in existence from a long time and may have involved some expenditure also. The review is meant to provide a justification or otherwise of the project as a whole in the light of objectives set for it and priorities of the society. The procedure is altogether different from the usual procedure followed in India.
Peter A. Phyrr describes, the concept of zero base budgeting as an operating, planning and budgeting process that requires each manager to justify a budget request in detail from scratch…….” It means, the budget as a whole is considered rather than to examine incremental change only.
According to Prof. R. A. Musgrave, “the idea of zero base budgeting is to consider the budget as a whole, rather than to examine incremental changes only.”
Essentially, the concept of zero base budgeting is that all the financial requirements of a budget unit are analyzed, evaluated and justifies annually and not just the increased or additional requirements. In more practical way, zero base budgeting means the evaluation and prioritization of all programmes at different levels of effects. To be simpler, under zero base budgeting, each department ministry is required to justify its budget requests from the bottom up, evaluating alternative programme packages and ranking programmes so as to select the best alternative and allocate resources accordingly. The budget is considered as a whole and a fresh one, i.e. from zero base.
Features of Zero Base Budgeting
a) Zerobase: ZBB works on the principle that every year, the projected expenditure for each project/programme must be start from zero. It means all budget requests should be considered freshly for every year with cost-benefit analysis.ZBB never uses the previous year’s amounts so as to eliminate the past mistakes.
b) Focus is on activities/programmes: The focus is on programs or activities instead of functional departments.
c) Best suited to discretionary costs: ZBB is best suited to discretionary costs, for example, advertising, research development and training costs.
d) Decision packages: A unit makes its budget request by preparing ‘decision packages’ for each activity it undertakes. Funding decisions are based on activity.
e) Cost-effective: ZBB helps policy makers to achieve more cost-effective delivery of public services.
f) Bottom-up approach: ZBB starts from the lowest level activity and then moves upwards.
g) Accountability: It makes the functionaries accountable for the amount they are responsible for. ZBB model was formulated to correct certain flaws of traditional budgeting system, which does not allow authorities to discover optional processes.
Steps in Zero-Base Budgeting
a)      Objective: The objective of budgeting should be determined. When the objective is clear, then efforts will be made to achieve that objective. Different organizations may have different objectives. One concern may try to reduce the expenditure on staff, another may try to discontinue one project in preference to another. So the first step will decide about the object and then other steps will be possible.
b)      Decision for operation: The extent to which zero base budgeting is to be applied should be decided. Whether it should be used for all operational areas or it should be applied in some areas only should be decided beforehand.
c)       Decision Package: The next step in ZBB is developing of ‘decision packages’. A decision package is “a document that identifies a specific activity in such a manner that management can evaluate and rank it against other activities competing for limited resources, and decide whether to approve or disapprove it.”
d)      Cost and Benefit: Cost and benefit analysis should be undertaken. We should consider the cost involved and the likely benefits to accrue. Only those projects should be taken first where benefit is more as compared to the cost involved. Cost benefit analysis will help in fixing priority for various projects on the basis of their utility or ranking of decision packages. It provides answers to the following questions.
1.       Is it necessary to perform the activity at all? If the answer is in the negative, there is no need for proceeding further.
2.       How much is the actual cost and what is the actual benefit of the activity?
3.       What is the estimated cost and estimated benefit of the activity?
4.       If the unit is dropped, can the unit be replaced by outside agency?


e)      Preparation of budgets: The activities and projects for which benefit is more than the cost are ranked. Priority is accorded to the most profitable projects/activities, in the allocation of funds.
f)       Selection and Approval: The final step involved in zero-base budgeting is concerned with selecting, approving decisions packages and finalizing the budget.
5. (a) What is ‘Public Revenue’? What are its various sources? How does it help in the economic development of a country?                                                              3+6+5=14
Ans: MEANING OF PUBLIC REVENUE AND ITS SOURCES
A government needs income for the performance of a variety of functions and meeting its expenditure. Thus, the income of the government through all sources like taxes, borrowings, fees, and donations etc. is called public revenue or public income.
However, Prof. Dalton has defined the term in two senses – broader and narrow sense. In broad sense, it includes all the income and receipts, irrespective of their sources and nature, which the government happens to obtain during any period of time. In the narrow sense, it includes only those sources of income of the government which are described as revenue resources. In broader view of the concept is that is includes all loans which the government raises under the term ‘public revenue’ or public income. The distinction in both can also be explained as the term ‘public revenue’ used in public finance. It includes only those sources of government income which are not subject to repayment. In a broad sense, it means all receipts of the government irrespective of the fact whether they are subject to repayment or not.
In a modern welfare state, public revenue is of two types:
(a)    Tax revenue and
(b)   Non-tax revenue.
(a) Tax Revenue: A fund raised through the various taxes is referred to as tax revenue. Taxes are compulsory contributions imposed by the government on its citizens to meet its general expenses incurred for the common good, without any corresponding benefits to the tax payer. Seligman defines a tax thus: “A tax is a compulsory contribution from a person to the government to defray the expenses incurred in the common interest of all, without reference to specific benefits conferred.
Examples of Tax Revenue 
Ø  Income Tax(on income of the individual as well as joint Hindu families) 
Ø  Corporation Tax (on income of the companies both domestic and foreign companies operating in India ) 
Ø  Interest Tax (on the gross interest income of the financial institutions like Bank) 
Ø  Expenditure Tax(expenditure incurred in luxury hotels and restaurants) 
Ø  Wealth Tax(total wealth of individuals and Hindu undivided families) 
Ø  Custom Duty.(import and export duty) 
Ø  Central excusive Duty.(duties on industrial products) 
Ø  Service Tax.(on services provided by hotels,telephones,port services etc.) 
(b) Non Tax Revenue: The revenue obtained by the government from sources other then tax is called Non-Tax Revenue. The sources of non-tax revenue are:
1. Fees: Fees are another important source of revenue for the government. A fee is charged by public authorities for rendering a service to the citizens. The government provides certain services and charges certain fees for them. For example, fees are charged for issuing of passports, driving licenses, etc.
2. Fines or Penalties: Fines or penalties are imposed as a form of punishment for breach of law or non fulfillment or certain conditions or for failure to observe some regulations. Like taxes, fines are compulsory payments without quid pro quo. But while taxes are generally imposed to collect revenue. Fines are imposed as a form of punishment or to prevent people from breaking the law.
3. Surplus from Public Enterprises: The Government also gets revenue by way of surplus from public enterprises. In India, the Government has set up several public sector enterprises to provide public goods and services. Some of the public sector enterprises do make a good amount of profits. The profits or dividends which the government gets can be utilized for public expenditure.
4. Special assessment of betterment levy: It is a kind of special charge levied on certain members of the community who are beneficiaries of certain government activities or public projects. For example, due to a public park in a locality or due to the construction of a road, people in that locality may experience an appreciation in the value of their property or land. Thus, due to public expenditure, some people may experience 'unearned increments' in their asset holding.
5. Grants and Gifts: Gifts are Voluntary contributions by individuals or institutions to the government. Gifts are significant source of revenue during war and emergency. A grant from one government to another is an important sources of revenue in the modern days. The government at the Centre provides grants to State governments and the State governments provide grants to the local government to carry out their functions.
6. Deficit Financing: Deficit means an excess of public expenditure over public revenue. This excess may be met by borrowings from the market, borrowings from abroad, by the central bank creating currency. In case of borrowing from abroad, there cannot be compulsion for the lenders, but in case of internal borrowings there may be compulsion.
SIGNIFICANCE OF PUBLIC REVENUE
The public revenue of one country differs in amount from that of another country. The difference is due partly to the size of country and partly to other causes. India is not a small country. It is sub-continental in itself. Its stages are as big as some counties of the west. But its public revenue is not very big in size. What does the size of public revenue then indicate. It depends on the following aspects.
1. Sign of Prosperity: A man who has a big income is in general respected more than the other who has a smaller income. It is only rarely that people with small income are held in high esteem by society. And in the same way a country that has a small volume of public revenue is not regarded as a big power and consequently not respected by other counties. A State that has a big volume of public revenue considered as a power to be reckoned with. America and United Kingdom have public revenue that is several times higher than that of our country. And we knows they do, that they can afford to do things that require much money.
2. Welfare of Country: Other things being equal, however, the welfare of a country can be judged from the size of its public revenue. A country whose resources, both natural and human, are not fully developed is a poor and backward country. And the government of such a country must necessarily be poor also. And with poverty of wealth goes also the poverty of welfare unless other things are not the same.
3. Composition of Public Revenue: Yet, it is not merely the size of public revenue the one should look to in order to form some idea of the prosperity or otherwise of a country. The composition of public revenue is as much important as its size. If a large part of the wealth of the government comes from the poor it is not a sign of a healthy state of affairs.
4. Mere Availability of Means: Public revenue is only, a means and the mere availability of means indicates nothing. All depends on how the means are utilized. It is not safe, therefore, to reckon with merely the size of revenue. Some countries of the world have public revenue in thousands of millions. The tendency today is on the one hand to spend an increasing percentage of public revenue on social services and social security. On the other hand, everywhere more and more money is being diverted to the building up of strong defensive and offensive force.
5. Manner of Public Revenue: A word may again be said about the manner in which revenue is obtained from the people. Every government tries to get more money from the rich that from the poor. But not all succeed in so doing. Some fail because they are ignorant and some fail because they are careless. And we have to say also that some fail because they are mischievous.
Or
(b) Define “Taxation”. Discuss the main characteristics of a good tax system.                                    3+11=14
Ans: Meaning and Definition of Tax
In simple words, it is a compulsory payment by the people. If a person defies the tax payment, he may be punished in the court of law. However, different economists tried to define taxation in a different style as stated below :
Adam Smith : “A tax is a contribution from citizens for the support of the state.”
Saligman: “A tax is compulsory payment from a person to govt. to defray the expenses incurred in the common interests of all without reference to special benefits conferred.”
Bastable : “Tax is a compulsory contribution of the wealth of a person or body of persons for the service of the public powers.”
Taussig : “The essence of a tax is distinguished from other charges by govt. in the absence of direct quid pro quo between the tax-payer and public authority.”
Dalton : “A tax is a compulsory contribution imposed by a public authority irrespective of the exact amount of service rendered to the tax-payer in return and not imposed as penalty for any legal offence.”
From these mentioned definitions, it is clear that the taxes are not a voluntary contribution by the tax-payer but it is compulsory in nature. Therefore, one can say that every payment by individuals to the state is not a tax. It is just like withdrawal from the people’s income which reduces their purchasing power. It should be noted here that tax checks production where as public expenditure may spurt the productive process. In the opinion of Dr. R.N. Bhargava, taxes are as much compulsory as other payment, like fees etc. In this context, Dalton says, “Where taxation, taken alone, may check production, public expenditure taken alone, should almost certainly increase it.” So, tax is a necessary contribution by the tax-payer to social objectives like reducing inequalities in income and wealth, securing high level of employment as well as promoting economic stability with growth.
CHARACTERISTICS OF IDEAL TAX SYSTEM OR REQUIESTES OF A SOUND TAX SYSTEM
A good or ideal tax system is one which fulfils all the canons of taxation, which is helpful to provide sufficient revenue to the government for meeting the expenditure and at the same time offer minimum inconvenience to the tax-payer. According to Edmund Burke, “It is difficult to tax and to please as it is to love and to be wise.” That we mean by a good or deal tax system is simply the predominance of good taxes; taxes which fulfils most the canons taxation. The following characteristics should be there in order to be called a good or deal tax system:
1)      Tax Ratio: It is difficult to determine the tax ratios by a fixed norm. The opportunity cost of raising more revenue, the benefit to be derived from extra public spending and cost of servicing public sector debt all changes over time and differ across countries. Decisions on public spending, borrowing the revenue are highly interrelated, if they are to set, they must be set jointly.
2)      Efficiency and Growth: It is often difficult to design a tax structure that will satisfy the aims of efficiency as well as growth. In order to raise higher revenue, there is need to change the base or rate of some taxes at least. In that case firms and individuals will bring about a change in the allocation of resources from heavily taxed industries to lightly taxed one. In the event of market prices reasonable reflecting social costs and benefits, the above tax change will require a tradeoff between revenue and efficiency. When market price do not reflect social costs and benefits, taxes can be utilized to improve allocation of resources.
3)      Equity in Taxation: Equity is another issue that is associated with any tax reform. There are two types of equity viz. horizontal equity and vertical equity. The former is concerned with the treatment of person with similar incomes, while the latter is more concerned with reduction in income inequality. Tax system of developing countries fails miserably in terms of horizontal equity. In the case of vertical tax equity too, the record is no better and it is so in spite of progressive tax structure because it is not fully applied. Another factor is large scale tax evasion.
4)      Taxes should observe all the Canons: The taxes should be so imposed that they are equitable, convenient to pay, certain, economic, productive, elastic and simple. The essence of the argument is that majority of the taxes should observe most of the canons.
5)      Taxes should ensure maximum Social Advantage: Another major characteristic of a good tax system is that it should ensure maximum social advantage. The imposition of taxes should be on the basis of this fundamental principle of public finance. It must ensure maximum social advantage or least aggregate sacrifice.
6)      Balanced Tax System: Another major pre-requisite of good tax system is that it should be balanced. It means that tax system is simply that it should exist not one kind of taxes but all kinds of them in a proper balance. For example, both direct and indirect tax systems have their advantages and disadvantages. But it is required of a good tax system to have both kinds of taxes in a proper balance.
7)      Many Dimensions of Tax System: A tax has many dimensions. We should look into its volume, composition, rates, coverage, timings of collection, mode of collection and so on in order to see its effects in their totality. Each system will have its own merits and demerits in terms of its social and economic effects. Thus, in general, it is very difficult to evolve a tax system which is the best or ideal in every respect.


8)      Universal Application of Taxes: Another main characteristic of a good tax system is that it should ensure universal and uniform application of taxes to each individual of the society without any discrimination.
9)      Desirable Effects on Production and Distribution: A good tax system is one which has desirable effects on production and distribution. It should ensure a rapid economic development of the country. A good tax system always promotes production, encourages people to work, save and invest, and increases national income and its equitable distribution.
10)   Source of Public Revenue: To consider a tax system ideal, it must have the quality to provide public revenue. Tax is an important part of the total revenue of the budget. It is a source of public revenue and hence it should provide necessary revenue to the government.
11)   Freedom from Harassment: A good or deal tax system recognizes that tax-payer has some basic rights. He is prepared to pay his taxes but would not like to undergo any harassment. With this in view, tax laws should be simple in language and the tax liability should be easily determinable with certainty.

6. (a) Discuss the effects of public expenditure on production and distribution.                                               7+7=14
Ans: Effects of public expenditure can be studied under the following heads:
a)      Effects of Public Expenditure on Production.
b)      Effects of Public Expenditure on Distribution.
c)       Miscellaneous Effects of Public Expenditure including Consumption.
Effects of Public Expenditure on Production: While analyzing the effects of public expenditure, Dalton very correctly said that just as taxation, other things being equal should reduce production as little as possible, so the public expenditure should increase it as much as possible. He further added that the level of production and employment in any country depends upon the following three factors:
1)      Effects Upon the Ability to Work, Save and Invest: If public expenditure increases the efficiency of a person to work, It will promote production and national income. Public expenditure on education, medical services, cheap housing facilities, means of transport and communications, recreation facilities etc. will increase the efficiency of persons to work. At the same time, public expenditure can promote saving on the part of the lower income groups by providing additional income to them, for a person who has larger income can be normally expected to save a larger amount. Finally, public expenditure, particularly repayment of public debt will place additional funds at the disposal of those who can save. Thus, it is evident that public expenditure can promote ability to work, save and invest and thus promote production and employment.
2)      Effects on Willingness to Work, Save and Invest: Public expenditure also affects the people’s willingness to work, save and invest. Pension, provident fund, interest-free loan, free medical aid, unemployment allowances and other government payments provide security to a person and, therefore, reduce the willingness of persons to work and save – after all, why should a person work hard and save when he knows fully he will be looked after by the government when he is not in a position to earn any income, i.e. he finds his future fully secured. In the absence of any savings, the question of investment does not arise at all.
3)      Effects on Diversion of Resources: Public expenditure also affects the diversion of resources. For example, if the government wishes to attract productive resources to a particular industry, it will start giving financial assistance from its own funds to such an industry. In the same way, if the government wishes to attract productive resources to a particular area or region, it will start giving a variety of incentives in the form of bounties, subsidies etc. (such as land at concessional rates, cheap electric supply and water, loans on nominal rates of interest, freedom from sales tax, income-tax etc. for a certain period, production subsidy etc.) to the industrialists to achieve this objective.
Effects of Public Expenditure on distribution: Public expenditure has its effects not only on production but is also a most powerful weapon in the hands of the government for bringing about an equitable distribution of wealth. For bringing about an equitable and just distribution of wealth the government can use not only its taxation policy but public expenditure policy can also help to a great extent in achieving this very objective. In fact, the role of taxation and public expenditure in removing inequalities of income is complementary and supplementary. If the government intends to minimize the economic inequalities that existed in the society, it should levy maximum about of taxation on richer sections of the community, because their taxable capacity is undoubtedly high. The income so earned through taxation should be spent on providing various types of facilities, subsidies and amenities to the poorer section of the community. For example, the state can extend to the poor benefits of old age pensions, social insurance, free medical aid, cheap housing, interest-free loans, subsidized food etc. This will automatically bring redistribution of wealth (national income) in favour of the poorer section of the community. On the contrary, public expenditure which confers larger benefits to the richer sections of the community, e.g., subsidies on luxury goods, provision of subsidized milk, other foodstuff etc. tends to widen the gap of inequalities. As Dalton puts, “That system of public expenditure is best which has the strongest tendency to reduce inequalities of income”. Public expenditure has, thus, an important rule in reducing economic inequalities in the community.
Or
(b) “Public Expenditure has a tendency to grow very fast in modern time.” Briefly discuss the factors responsible for the rapid growth of public expenditure.                                                                       14
Ans: Meaning of Public Expenditure
Public Expenditure refers to Government Expenditure. It is incurred by Central and State Governments. The Public Expenditure is incurred on various activities for the welfare of the people and also for the economic development, especially in developing countries. In other words The Expenditure incurred by Public authorities like Central, State and local governments to satisfy the collective social wants of the people is known as public expenditure.
Causes for increase in Public Expenditure
There has been a persistent and continuous increase in public expenditure in counties all over the world. It is due to the continuous expansion in the activities of the state and other public bodies on several fronts. The modern governments not only perform such primary functions as the civil administration as well as defence of the country, but also take considerable interest in promoting economic development of their countries. Today, the state is taking active part in social and economic matters, such as education, public health, removal of poverty and in commercial and industrial development. The public expenditure has increased enormously in recent years mostly due to the development activities of the state. Hence, the increase in public expenditure is fully justified.
FACTORS OR CAUSES OF INCREASE IN PUBLIC EXPENDITURE
One of the most important features of the present century is the phenomenal growth of public expenditure. Some of the important reasons for the growth of public expenditure are the following.
1) Welfare state: Modern states are no more police states. They have to look in to the welfare of the masses for which the state has to perform a number of functions. They have to create and undertake employment opportunities, social security measures and other welfare activities. All these require enormous expenditure.
2) Defence expenditure: Modern warfare is very expensive. Wars and possibilities of wars have forced the nation to be always equipped with arms. This causes great amount of public expenditure.
3) Growth of democracy: The form of democratic government is highly expensive. The conduct of elections, maintenance of democratic institutions like legislatures etc. cause great expenditure.
4) Growth of population: tremendous growth of population necessitates enormous spending on the part of the modern governments. For meeting the needs of the growing population more educational institutions, food materials, hospitals, roads and other amenities of life are to be provided.
5) Rise in price level: Rises in prices have considerably enhanced public expenditure in recent years. Higher prices mean higher spending on the part of the govt. on items like payment of salaries, purchase of goods and services and so on.
6) Expansion public sector: Counties aiming at socialistic pattern of society have to give more importance to public sector. Consequent development of public sector enhances public expenditure.
7) Development expenditure: for implementing developmental programs like Five Year Plans, Modern governments are incurring huge expenditure.
8) Public debt: Along with debt rises the problem like payment of interest and repayment of the principal amount. This results in an increase in public expenditure.
9) Grants and loans to state governments and UTs: It is an important feature of public expenditure of the central government of India. The government provides assistance in the forms of grants-in-aid and loans to the states and to the UTs.
10) Poverty alleviation programs: As poverty ratio is high, huge amount of expenditure is required for implementing alleviation programmes.
Justification for increase in Public Expenditure
Increase in public expenditure can be justified on the following grounds :
a)      Assists in increasing state activities,
b)      Increase in welfare activities,
c)       Reduces disparities between rich and poor,
d)      Boom for rapid economic development specially in underdeveloped and backward economy,
e)      Provides economic stability, and
f)       Brings prosperity etc.

(Old COURSE)
Full Marks: 80
Pass Marks: 32
Time: 3 hours
1. Answer the following questions:                                          1x8=8
a)      Write the name of a merit good.       Ans: Education, health care etc example of demerit goods: smoking, drugs, wine
b)      Which of the following is not a source of revenue of Central Government?
Ø  Income Tax.
Ø  Corporation Tax.
Ø  Land Revenue.
Ø  Import Duty.
c)       What do you mean by deficit financing?
Ans: Deficit Financing: Deficit means an excess of public expenditure over public revenue. This excess may be met by borrowings from the market, borrowings from abroad, by the central bank creating currency. In case of borrowing from abroad, there cannot be compulsion for the lenders, but in case of internal borrowings there may be compulsion.
d)      “Direct tax is one which is actually paid by the person on whom it is imposed.” Who defined it?
Ans: Prof. Dalton
e)      Mention two main causes of tax evasion.
Ans: High rate of tax, Huge profit making
f)       What is the exemption limit of income tax (personal) as per Union Budget, 2015 – 16?
Ans: 2,50,000
g)      Mention a tax levied by Municipal Corporation.
Ans: Water cess
h)      Write a special feature of federal finance.


2. Write short notes (on any four):                                          4x4=16
a)      Role of Public Finance.
Ans: There is great socio-economic significance of public finance, both in developed and developing countries. In developed country countries, price-stability and full employment are the main economic goals of public finance. In developing countries, rapid economic development through capital formulation and creation of infrastructure art the important goals of public finance operations. Socially equitable distributions of income, reduction of inequalities in income are some important functions of public finance operations. The importance of public finance can be clarified from the following functions.
1. TO INCREASE THE RATE OF SAVING AND INVESTMENT: Most of the people spend their income on consumption. Saving is very low so the investment is also low. The government can encourage the saving and investment.
2. TO SECURE EQUAL DISTRIBUTION OF INCOME AND WEALTH: Unequal distribution of income and wealth is the basic problem of the under developed countries. The rich are getting richer and richer while the poor are becoming poorer and poorer. So for the equal distribution of income and wealth there is need of government.
3. OPTIMUM ALLOCATION OF RESOURCES: Fiscal measures like taxation and public expenditure programmers can greatly affect the allocation of resources in various occupation and sectors.
4. CAPITAL FORMULATION AND GROWTH: Fiscal policy will be designed in a manner to perform two functions as of expanding investment in public and private enterprises and by diverting resources from socially less desirable to more desirable investment channels.
5. PROMOTING ECONOMIC DEVELOPMENT: The state can play a prominent role in promoting economic development especially through control and regulation of economic activities. It is fiscal policy which can promote economic development.
b)      Characteristics of Zero-based Budgeting.
Ans: Features of Zero Base Budgeting
a) Zerobase: ZBB works on the principle that every year, the projected expenditure for each project/programme must be start from zero. It means all budget requests should be considered freshly for every year with cost-benefit analysis.ZBB never uses the previous year’s amounts so as to eliminate the past mistakes.
b) Focus is on activities/programmes: The focus is on programs or activities instead of functional departments.
c) Best suited to discretionary costs: ZBB is best suited to discretionary costs, for example, advertising, research development and training costs.
d) Decision packages: A unit makes its budget request by preparing ‘decision packages’ for each activity it undertakes. Funding decisions are based on activity.
e) Cost-effective: ZBB helps policy makers to achieve more cost-effective delivery of public services.
f) Bottom-up approach: ZBB starts from the lowest level activity and then moves upwards.
g) Accountability: It makes the functionaries accountable for the amount they are responsible for. ZBB model was formulated to correct certain flaws of traditional budgeting system, which does not allow authorities to discover optional processes.
c)       Difference between Public and Private goods.
Ans: A public good is a good or service that can be consumed simultaneously by everyone and from which no one can be excluded. A public good is one for which consumption is non-revival and from which it is impossible to exclude a consumer.  A private good, by contrast, is rival. A good is rival if consumption of one unit by one person does decrease available units for consumption by another person. An example of rival consumption is eating a burger.

d)      Differences between Tax and Non-tax revenue.
Ans: Tax Revenue: A fund raised through the various taxes is referred to as tax revenue. Taxes are compulsory contributions imposed by the government on its citizens to meet its general expenses incurred for the common good, without any corresponding benefits to the tax payer. Seligman defines a tax thus: “A tax is a compulsory contribution from a person to the government to defray the expenses incurred in the common interest of all, without reference to specific benefits conferred. Non Tax Revenue: The revenue obtained by the government from sources other then tax is called Non-Tax Revenue. The sources of non-tax revenue are fees, fines, surplus from public enterprises.
e)      Gram Panchayat.
3. (a) Explain the rationale of public finance in the present-day scenario.                                                            12
Ans: Importance (Significance) of Public Finance
There is great socio-economic significance of public finance, both in developed and developing countries. In developed country countries, price-stability and full employment are the main economic goals of public finance. In developing countries, rapid economic development through capital formulation and creation of infrastructure art the important goals of public finance operations. Socially equitable distributions of income, reduction of inequalities in income are some important functions of public finance operations. The importance of public finance can be clarified from the following functions.
1. TO INCREASE THE RATE OF SAVING AND INVESTMENT: Most of the people spend their income on consumption. Saving is very low so the investment is also low. The government can encourage the saving and investment.
2. TO SECURE EQUAL DISTRIBUTION OF INCOME AND WEALTH: Unequal distribution of income and wealth is the basic problem of the under developed countries. The rich are getting richer and richer while the poor are becoming poorer and poorer. So for the equal distribution of income and wealth there is need of government.
3. OPTIMUM ALLOCATION OF RESOURCES: Fiscal measures like taxation and public expenditure programmers can greatly affect the allocation of resources in various occupation and sectors.
4. CAPITAL FORMULATION AND GROWTH: Fiscal policy will be designed in a manner to perform two functions as of expanding investment in public and private enterprises and by diverting resources from socially less desirable to more desirable investment channels.
5. PROMOTING ECONOMIC DEVELOPMENT: The state can play a prominent role in promoting economic development especially through control and regulation of economic activities. It is fiscal policy which can promote economic development.
6. IMPLEMENTATION OF PLANNING: Under democratic planning fiscal policy plays crucial role as financial plan is as much important as physical plan and the implementation of the financial will obviously depend upon the uses of fiscal measures.
7. INFRASTRUCTURE BUILDING: Public finance helps to build up well-development physical and institutional infrastructure.
8. TO CONTROL INFLATION: The imbalance between demand for and supply of real resources may lead to inflations to under-development countries inflation ruins the entire economic structure of the national and the process of economic development in these countries comes to stand still. So to check inflation, budgetary policies can be used by the government.
Role of public finance in an underdeveloped country
Public Finance occupies great significance in an underdeveloped or developing country. According to R. J. Chelliah, “Public finance has a positive and significant role in the context of economic development.” The importance of public finance in an underdeveloped/developing country like India may be summarized as under:
a)      Capital Formation: Since development entirely depends on the rate of capital formation in the country, the first and foremost aim of public finance is to promote capital formation. Students of commerce and economics are well aware of the fact that the burning problem of an underdeveloped or developing country is the low capital formation. In the words of Dr. Baljit Singh, “For an undeveloped country all economic policies and measures in the initial stages must concentrate on production and fiscal policy should act as a tool of capital formation.” Capital formation can be increased through an effective and well-planned taxation policy. In the words of R. Nurkse, “For economic development, it is not the aim of public finance to bring about reduction in inequalities of incomes but its aim is to increase that proportion of the income which goes into capital formation.”
b)      Unemployment Problem: Another major problem of an underdeveloped/developing country is the unemployment problem. Increased income may be eaten up by a large mass of unemployed people. This problem of unemployment leads again to low standard of living, poverty, backwardness, ignorance and above all starvation. It is the function of public finance to provide employment opportunity. In the connection must be remembered that fiscal policies (public finance policies) are most effective tools for tackling of the problem of unemployment.
c)       Planned Economic Development: In underdeveloped/developing countries the productive resources are limited in quantity as well as quality. Public finance renders valuable help in the planned economic development of the country. The entire machinery of planning works through the mechanism of public finance. The principles of public finance have paramount importance in the sphere of rapid economic planning because both of these are the closely related activities of the state. For example, the Government of India is raising necessary funds through taxation etc. for formulation and implementation of its five year plans.
d)      Increase in Income: Capital formation is not an end in itself but only a means of achieving another important end, i.e. increase in income. The object of public expenditure is to increase the income in underdeveloped countries so at to invest funds in such industries and in such an economical and efficient manner that least amount of money fetches the greatest possible output. The Government gives subsidies and grants to industries to enable them to increase production at cheaper rates. This will lead to prosperity and development with an overall increase in the income of the masses.
e)      Reduction in Economic Inequalities: Another problem of underdeveloped or developing countries is the unequal distribution of income and wealth to the public. Public finance has an important role to play in this context. For example, the Government can impose heavy taxes (such as income tax) on the richer sections of the society and spend the income so received on providing cheap food, cheap housing, employment, free medical aid etc. for poorer sections of the society.
f)       Optimum Utilization of Resources: Another major problem of underdeveloped or developing countries is the problem of non-utilization or even destruction of the scarce and limited resources. The solution of this basic problem lies in the optimum utilization of these available resources by means of adopting planned monetary and public finance policies. The state can direct the flow of consumption, production and distribution in the right direction by adopting balanced budget policy.
g)      Problem of Economic Stabilization: Another problem of an underdeveloped and developing country is the economic instability. After 1929-30 worldwide depression, it has been emphasised that public finance (revenue and expenditure process of the Government) may be used to secure economic stability or to remove economic fluctuations and distortion in the economy.


h)      Increase to Savings: The major problem of developing and underdeveloped countries is that savings are very nominal which hinder their economic development. Public finance encourages the accumulation of savings.
Or
(b) Critically explain the ‘Principle of Maximum Social Advantage’.                                                        12
Ans: THE PRINCIPLE OF MAXIMUM SOCIAL ADVANTAGE
One of the important principles of public finance is the so – called Principle of Maximum Social Advantage explained by Professor Hugh Dalton. Just like an individual seeks to maximize his satisfaction or welfare by the use of his resources, the state ought to maximize social advantage or benefit from the resources at its command.
The principles of maximum social advantage are applied to determine whether the tax or the expenditure has proved to be of the optimum benefit. Hence, the principle is called the principle of public finance. According to Dalton, “This (Principle) lies at the very root of public finance” He again says “The best system of public finance is that which secures the maximum social advantage from the operations which it conducts.” It may be also called the principle of maximum social benefit. A.C. Pigou has called it the principle of maximum aggregate welfare.
Public expenditure creates utility for those people on whom the amount is spent. When the volume of expenditure is small with a slighter increase in it, the additional utility is very high. As the total public expenditure goes on increasing in course of time, the law of diminishing marginal utility operates. People derive less of satisfaction from additional unit of public expenditure as the government spends more and more. That is, after a stage, every increase in public expenditure creates less and less benefit for the people. Taxation, on the other hand, imposes burden on the people.
So, when the volume of taxation becomes high, every further increase in taxation increases the burden of it more and more. People under go greater scarifies for every additional unit of taxation. The best policy of the government is to balance both sides of fiscal operations by comparing “the burden of tax” and “the benefits of public expenditure”. The State should balance the social burden of taxation and social benefits of Public expenditure in order to have maximum social advantage.
Attainment of maximum social advantage requires that;
a) Both public expenditure and taxation should be carried out up to certain limits and no more.
b) Public expenditure should be utilized among the various uses in an optimum manner, and
c) The different sources of taxation should be so tapped that the aggregate scarifies entailed is the minimum.
Assumptions of this theory:
1.All taxes result in sacrifice and all public expenditures lead to benefit.
2. Public revenue consists of only taxes and there is no other source of income to the government.
3. The govt. has no surplus or deficit budget but only a balanced budget. 
Diagrammatical Explanation of the theory of maximum social advantages


In the above diagram, MSS is the marginal social sacrifice curve sloping upward from left to right. This rising curve indicates that the marginal social sacrifice goes on increasing with every additional dose of taxation.   MSB is the marginal social benefit curve sloping downwards from the left to right. This falling curve indicates that the marginal social benefit diminishes with every additional dose of public expenditure. The two curves MSS and MSB intersect each other at the point P. PM represent both marginal social sacrifice as well as marginal social benefit. Both are equal at OM which represents the maximum social advantage.
Criticism of the theory of Maximum Social Advantages
1. Non measurability of social sacrifice and social benefit: The major drawback of this principle is that it is not possible in actual practice to measure the MSS and MSB involved in the fiscal operation of the state.
2. Non applicability of the low of equimarginal utility in public expenditure: The low of equimarginal utility may be applicable to private expenditure but certainly not to public expenditure.
3. Neglect non-tax revenue: The principle says that the entire public expenditure is financed by taxation. But, in practice, a significant portion of public expenditure is also financed by other sources like public borrowing, profits from public sector enterprises, imposition of fees, penalties etc.
4. Lack of divisibility: The marginal benefit from public expenditure and marginal sacrifice from taxation can be equated only when public expenditure and taxation are divided into smaller units. But this is not possible practically.
5. Assumption of static condition: Conditions in an economy are not static and are continuously changing. What might be considered as the point of maximum social advantage under some conditions may not be so under some other.
6. Misuse of government funds: The principle of Maximum social advantage is based on the assumption that the government funds are utilized in the most effective manner to generate marginal social benefit. However, quite often a large share of government funds is misused for unproductive purposes
7. "The govt. has no surplus or deficit budget but only a balanced budget."- is an invalid assumption.
4. (a) State and explain Adam Smith’s Canon of Taxation.                                                                            11
Ans: ADAM SMITH’S CANNONS TAXATION
Adam Smith was the first writer to give a detailed and comprehensive statement of the principles of taxation. Basically, he laid stress on the ways in which an economy could increase its productive capacity and ultimately achieve a higher rate of economic growth. According to him, if the principles enunciated by him, were adopted in a full spirit, the govt. would have a very sound taxation policy. Findlay Shirras has strongly commented on the contribution made by Adam Smith, “No genius, however, has succeeded in condensing the principles into such clear and simple canons as has Adam Smith.” Adam Smith has enumerated the following four canons of taxation which are accepted universally:
1)      Canon of Equality.
2)      Canon of Certainty.
3)      Canon of Convenience.
4)      Canon of Economy.
1)      Canon of Equality: According to this canon, a good tax is that which is based on the principle of equality. In a broader sense, equality may be considered to be same as justice. In this principle, it is maintained that the tax must be levied according to the taxpaying capacity of the individuals. Adam Smith had defined this principle as follows: “The subject of every state ought to contribute towards the support of the government, as nearly as possible, in proportion to their respective abilities that is , in proportion to the revenue which they respectively enjoy under the protection of states.”
In other words, the principle of benefit states that the burden of taxation should be fair and just. Thus, rich people must be subjected to higher taxation in comparison to poor. The higher the income and higher the tax, the lower the income of lower the tax.
2)      Canon of Certainty: Another canon of taxation is the certainty which implies that the tax-payer should determine the following manners carefully: (a) The time of payment, (b) Amount to be paid, (c) Method of payment, (d) The place of payment, (e) The authority to whom the tax is to be paid.
With this, a tax-payer will be able to keep equilibrium between his income and expenditure. There should not be any embarrassment and confusion about the payment of tax. Every tax-payer must know the time of payment, manner and mode of payment, so that he may adjust his expenditures accordingly. In the words of Adam Smith, “The tax which each individual is bound to pay ought to be certain the not arbitrary. The time of payment, the manner of payment, the quantity to be paid, all ought to be clear and plain to the contributor and to every other person.” This certainty creates confidence in the contributor of the tax.
3)      Canon of Convenience: The taxes should be levied and collect in such a manner that it provides the maximum of convenience to the tax-payers. The public authorities should always keep this point in view that the tax-payers suffer the least inconvenience in payment of the tax. For example, land revenue should best be collected at the harvest time. The income-tax from the salaried class be collected only when they get their salaries from their employers. To quote Adam Smith, “ Every tax ought to be levied at the time or in the manner in which it is most likely to be convenient for the contributor to pay it.” This canon is important both for the tax-payers and the govt. The tax-payer feel convenient in payment of tax. The authorities also come to know the incidence of taxation and get increased income by way of taxes.
4)      Canon of Economy: It implies that minimum possible money should be spent in the collection of taxes. The maximum part of the collected amount should be deposited in the govt. treasury. Thus, all unnecessary expenditure in the collection should be avoided at all costs. In the words of Adam Smith, “Every tax ought o be so contrived as little to take out and to keep out of the pockets of the people as possible over and above what is brings into public treasury of the state.” So more addition should be secured to the public revenue at the minimum maintenance cost. It also implies that a tax should interfere as little as possible with the productive activity and general efficiency of the community so that it may not create any adverse effect on production and employment.
Or
(b) Define taxable capacity. Discuss the factors which affect the taxable capacity.                           3+8=11
Ans: Taxable capacity of a country: Taxable capacity refers to the maximum capacity that a country can contribute by way of taxation both in the ordinary and extraordinary circumstances. It represents maximum limit to which the government can tax the people of the country. If the government exceeds this limit, it shall result in over taxation, which, besides being injurious to the long-term interests of the community, may pose a serious threat, to the political stability of the country concerned. The concept of taxable capacity, thus, indicates the limit to which the government can tax the citizens.
Taxation Inquiry Commission defined it as, Taxation capacity of different sections of the community may be said to refer to the degree of taxation, broadly speaking, beyond which productive effort and efficiency as a whole begin to suffer. The concept of taxable capacity has been interpreted by the economists in the following two senses: (i) the absolute taxable capacity of one single community, and (ii) the relative taxable capacity of two or more communities.
Factors Determining/Affecting/Influencing Taxable Capacity
The taxable capacity of a country/community/nation depends on the factors given below:
a)      Size of National Income: The taxable capacity of a country depends upon the size of national income and the size of national depends upon its natural resources and other resources and their proper utilization. The higher the size of the national income of a country, the greater is the taxable capacity of that country. The richer a community, the higher is the capacity to pay taxes.
b)      Size and Growth of Population: The size and growth of population is also one of the important factors determining taxable capacity. With a given volume of income of a country, the taxable capacity is indirectly proportional to the size of its population, i.e. the larger the population, the lower will be the taxable capacity. Again, if the growth rate of national income is lower than the population, per capita income will be reduced and vice versa.
c)       Stage of Economic Development: The stage of economic development also determines taxable capacity. Generally, there is a positive correlation between the fate of economic development and the taxable capacity of the economy. Ordinarily, the taxable capacity in industrially advanced countries is higher than that of the backward and underdeveloped countries.
d)      Distribution of Income and Wealth: The distribution of income and wealth also influences the taxable capacity of the people. The greater the inequality in the distribution of income and wealth in a country, the greater is the taxable capacity. Since a richer community can pay a higher percentage of taxation, so also a system of distribution which leads to concentration of income and wealth in the hands of a few may yield a higher volume of tax revenue and the one which brings about more or less equal distribution of income and wealth.
e)      Nature or Pattern of Taxation System: The taxable capacity also depends on the nature or pattern of taxation system in a country. If the taxation system of a country has been devised on a scientific basis, a well thought out mixture of taxation, the taxable capacity shall be inevitably high. The tax levies by the government under scientific system will satisfy the canons of taxation, i.e. canons of certainty, simplicity, equity, convenience etc. Hence, the taxable capacity shall automatically be high.
f)       Nature or Pattern of Public Expenditure: The nature or pattern of public expenditure also influences the taxable capacity. If the government incurs a major portion of its expenditure on encouraging production and increasing the level of efficiency of workers, this will raise the taxable capacity of the country.
g)      Nature of the Government: The taxable capacity is also influenced by the nature of the government. A democratically elected government by winning public sympathy and cooperation is in a position to raise more revenue from the people.
h)      Standard of Living of the People: Another, factor on which taxable capacity depends is the standard of living of the people. If the standard of living of the people is high, their production power shall also be high. Hence, their income shall be high and consequently, their capacity to pay taxes will also increase in the same proportion.
i)        Psychology of the Tax Payers: The taxable capacity of a country is also influenced by the psychology of the tax payers. In developed and developing countries when the people are satisfied that the government is spending the tax revenue on development activities and for the betterment of whole nation, the taxable capacity naturally goes up. In such a situation, the government can collect more and more revenue by way of taxation.
j)        Stability of Income: The stability of national income also influences the taxable capacity of the country. For example, the national income in developed countries like the U.S.A , U.K. Japan, Germany etc. is generally stable in the sense that there are no violent fluctuations in the national income of such countries. But in countries like India, Pakistan, Bangladesh, etc. there is lack of stability in national income. The taxable capacity in such countries is generally low.
k)      Political Conditions: Political conditions are another important factor which determines the taxable capacity of a country. Stable political conditions and successful planed economic development create confidence in the minds of tax payers. They feel that whatever is taken out from their pockets has been properly utilized for the welfare of the community as a whole. This encourages the tax payers to fulfill their tax obligations in time. On the contrary, if political conditions are instable and there is no planned economic development and the rich are becoming richer and the poor getting poorer, this may shatter the faith of the tax payer and community as a whole in the government resulting in tax arrears, tax evasion and the general disorder in the country.
l)        Other Factors: Besides the above-mentioned factors, fiscal, monetary and income policies of the government also affect the taxable capacity. For example, favourable tax balance of a country increase its taxable capacity.
5. (a) what are the factors responsible for the growth of public expenditure in a developing economy? Discuss.  11
Ans: Causes for increase in Public Expenditure
There has been a persistent and continuous increase in public expenditure in counties all over the world. It is due to the continuous expansion in the activities of the state and other public bodies on several fronts. The modern governments not only perform such primary functions as the civil administration as well as defence of the country, but also take considerable interest in promoting economic development of their countries. Today, the state is taking active part in social and economic matters, such as education, public health, removal of poverty and in commercial and industrial development. The public expenditure has increased enormously in recent years mostly due to the development activities of the state. Hence, the increase in public expenditure is fully justified.
FACTORS OR CAUSES OF INCREASE IN PUBLIC EXPENDITURE
One of the most important features of the present century is the phenomenal growth of public expenditure. Some of the important reasons for the growth of public expenditure are the following.
1) Welfare state: Modern states are no more police states. They have to look in to the welfare of the masses for which the state has to perform a number of functions. They have to create and undertake employment opportunities, social security measures and other welfare activities. All these require enormous expenditure.
2) Defence expenditure: Modern warfare is very expensive. Wars and possibilities of wars have forced the nation to be always equipped with arms. This causes great amount of public expenditure.
3) Growth of democracy: The form of democratic government is highly expensive. The conduct of elections, maintenance of democratic institutions like legislatures etc. cause great expenditure.
4) Growth of population: tremendous growth of population necessitates enormous spending on the part of the modern governments. For meeting the needs of the growing population more educational institutions, food materials, hospitals, roads and other amenities of life are to be provided.
5) Rise in price level: Rises in prices have considerably enhanced public expenditure in recent years. Higher prices mean higher spending on the part of the govt. on items like payment of salaries, purchase of goods and services and so on.
6) Expansion public sector: Counties aiming at socialistic pattern of society have to give more importance to public sector. Consequent development of public sector enhances public expenditure.
7) Development expenditure: for implementing developmental programs like Five Year Plans, Modern governments are incurring huge expenditure.
8) Public debt: Along with debt rises the problem like payment of interest and repayment of the principal amount. This results in an increase in public expenditure.
9) Grants and loans to state governments and UTs: It is an important feature of public expenditure of the central government of India. The government provides assistance in the forms of grants-in-aid and loans to the states and to the UTs.
10) Poverty alleviation programs: As poverty ratio is high, huge amount of expenditure is required for implementing alleviation programmes.
Justification for increase in Public Expenditure
Increase in public expenditure can be justified on the following grounds :
a)      Assists in increasing state activities,
b)      Increase in welfare activities,
c)       Reduces disparities between rich and poor,
d)      Boom for rapid economic development specially in underdeveloped and backward economy,
e)      Provides economic stability, and
f)       Brings prosperity etc.
Or
(b) Explain the effects of public expenditure on production and distribution.                                    11
Ans: Effects of Public Expenditure
Public expenditure incurred according to the sound principles of public finance, exerts healthy effects on the entire economy of a nation. The ultimate effects of public expenditure, in the form of greater production, more equitable distribution of wealth and all-round economic development of a country, are always expected to be present, if the expenditure is incurred after considerable thought and utmost rationality.
Gone are the days when it was advocated that the state should interfere the least in economic activities and the government is merely an agent for the people – responsible for the maintenance of justice, police and army. In those days public expenditure on economic activities was normally considered a waste. Contrary to this, a new concept of public expenditure has been developed by the modern economists. Today, public expenditure is regarded as a means of securing social ends rather than just being a mere financial mechanism. In present times, Wagner’s Law of Increasing Public Expenditure – both extensively and intensively, is considered universally true. The trend of rising public expenditure is not confined to any particular country, but it is found in almost all countries of the world, irrespective of its socio-economic and political set-up. Every public expenditure is considered desirable, when it is not wasteful, but has a positive effect on production, distribution, consumption and thus maximizes economic and social welfare of the country as a whole.
Effects of public expenditure can be studied under the following heads:
d)      Effects of Public Expenditure on Production.
e)      Effects of Public Expenditure on Distribution.
f)       Miscellaneous Effects of Public Expenditure including Consumption.
Effects of Public Expenditure on Production: While analyzing the effects of public expenditure, Dalton very correctly said that just as taxation, other things being equal should reduce production as little as possible, so the public expenditure should increase it as much as possible. He further added that the level of production and employment in any country depends upon the following three factors:
4)      Effects Upon the Ability to Work, Save and Invest: If public expenditure increases the efficiency of a person to work, It will promote production and national income. Public expenditure on education, medical services, cheap housing facilities, means of transport and communications, recreation facilities etc. will increase the efficiency of persons to work. At the same time, public expenditure can promote saving on the part of the lower income groups by providing additional income to them, for a person who has larger income can be normally expected to save a larger amount. Finally, public expenditure, particularly repayment of public debt will place additional funds at the disposal of those who can save. Thus, it is evident that public expenditure can promote ability to work, save and invest and thus promote production and employment.
5)      Effects on Willingness to Work, Save and Invest: Public expenditure also affects the people’s willingness to work, save and invest. Pension, provident fund, interest-free loan, free medical aid, unemployment allowances and other government payments provide security to a person and, therefore, reduce the willingness of persons to work and save – after all, why should a person work hard and save when he knows fully he will be looked after by the government when he is not in a position to earn any income, i.e. he finds his future fully secured. In the absence of any savings, the question of investment does not arise at all.
6)      Effects on Diversion of Resources: Public expenditure also affects the diversion of resources. For example, if the government wishes to attract productive resources to a particular industry, it will start giving financial assistance from its own funds to such an industry. In the same way, if the government wishes to attract productive resources to a particular area or region, it will start giving a variety of incentives in the form of bounties, subsidies etc. (such as land at concessional rates, cheap electric supply and water, loans on nominal rates of interest, freedom from sales tax, income-tax etc. for a certain period, production subsidy etc.) to the industrialists to achieve this objective.
Effects of Public Expenditure on distribution: Public expenditure has its effects not only on production but is also a most powerful weapon in the hands of the government for bringing about an equitable distribution of wealth. For bringing about an equitable and just distribution of wealth the government can use not only its taxation policy but public expenditure policy can also help to a great extent in achieving this very objective. In fact, the role of taxation and public expenditure in removing inequalities of income is complementary and supplementary. If the government intends to minimize the economic inequalities that existed in the society, it should levy maximum about of taxation on richer sections of the community, because their taxable capacity is undoubtedly high. The income so earned through taxation should be spent on providing various types of facilities, subsidies and amenities to the poorer section of the community. For example, the state can extend to the poor benefits of old age pensions, social insurance, free medical aid, cheap housing, interest-free loans, subsidized food etc. This will automatically bring redistribution of wealth (national income) in favour of the poorer section of the community. On the contrary, public expenditure which confers larger benefits to the richer sections of the community, e.g., subsidies on luxury goods, provision of subsidized milk, other foodstuff etc. tends to widen the gap of inequalities. As Dalton puts, “That system of public expenditure is best which has the strongest tendency to reduce inequalities of income”. Public expenditure has, thus, an important rule in reducing economic inequalities in the community.
6. (a) Discuss the techniques of budgetary control.                                                         11
Ans: Techniques of Budgetary Control
a)      Zero Based Budgeting
b)      Performance Budgeting
Zero Based Budgeting
Zero Base Budgeting is a new technique for the preparation of budgets. It involves fresh evaluation of every item of expenditure as if it were a new item. It is reconsideration of each item of expenditure from the very beginning. It is like assuming that a zero expenditure has been incurred on a project at the time of its review, although the project may be in existence from a long time and may have involved some expenditure also. The review is meant to provide a justification or otherwise of the project as a whole in the light of objectives set for it and priorities of the society. The procedure is altogether different from the usual procedure followed in India.
Peter A. Phyrr describes, the concept of zero base budgeting as an operating, planning and budgeting process that requires each manager to justify a budget request in detail from scratch…….” It means, the budget as a whole is considered rather than to examine incremental change only.
According to Prof. R. A. Musgrave, “the idea of zero base budgeting is to consider the budget as a whole, rather than to examine incremental changes only.”
Essentially, the concept of zero base budgeting is that all the financial requirements of a budget unit are analyzed, evaluated and justifies annually and not just the increased or additional requirements. In more practical way, zero base budgeting means the evaluation and prioritization of all programmes at different levels of effects. To be simpler, under zero base budgeting, each department ministry is required to justify its budget requests from the bottom up, evaluating alternative programme packages and ranking programmes so as to select the best alternative and allocate resources accordingly. The budget is considered as a whole and a fresh one, i.e. from zero base.
Performance Budgeting
Performance budgeting is generally understood as a system or technique of presentation of public expenditure in terms of functions, programmes, performance units, i.e. activities, projects etc, reflecting primarily the government output and its cost. The focus in a performance budgeting is basically different from that in the conventional budgets. The two approaches differ in their scope and context. Under the performance budgeting, emphasis is shifted from the budget as a means of accomplishment to the accomplishment itself. If concerns itself primarily with the objectives aimed at by the government rather than with the outlays incurred on several projects. According to U. S. Bureau of Budget, “A performance is one which presents the purpose the objectives for which funds are required, the cost of the programmes proposed for achieving those objectives and quantitative data measuring the accomplishment and work performed under each programme.”
Under performance budgeting system, the overall budget is divided into functions based on the major purpose of government and then subdivided into programme and activities, funds being granted for doing a specific quantity of work. Performance budgeting implies that the budget statement should indicate the actual achievements expected by a Ministry over a period of time from certain amount of expenditure. It forces attention on the size and cost of programme to be implemented.
Procedure for Performance Budgeting
Objectives of each program are ascertained clearly and then the resources are applied after specifying them clearly. The results expected from such activities are also laid down. Annual, quarterly and monthly targets are determined for the entire organization. These targets are broken down for each activity center. The next step is to set up various productivity or performance ratios and finally target for each program activity is fixed. The targets are compared with the actual results achieved. Thus the procedure for the performance budgets include allocation of resources, execution of the budget and periodic reporting at regular intervals.
The budgets are initially compiled by the various agencies such as Government Department, public undertakings etc. Thereafter these budgets move on to the authorities responsible for reviewing the performance budgets. Once the higher authorities decide about the funds, the amount sanctioned are communicated and the work is started. It is the duty of these agencies to start the work in time, to ensure the regular flow of expenditure, against the physical targets, prevent over runs under spending and furnish report to the higher authorities regarding the physical progress achieved.
In the final phase of performance budgetary process, progress reports are to be submitted periodically to higher authorities to indicate broadly, the physical performance to be achieved, the expenditure incurred and the variances together with explanations for the variances.
Or
(b) Critically examine the Central-State financial relation in India.                              11
7. (a) Discuss the recommendations of Fourteenth Finance Commission of India.                                              11
Or

(b) Discuss the reasons behind the increasing burden of external debt in present-day India.                        11

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