public budgeting and taxtation

38
Unit 1 Public Budgeting and Financial Management What is a budget? A budget is a statement of allocation of (scarce) resources to achieve an organization's objectives for a specific time period. A budget is the financial plan for how an organization will receive and spend money for a set time period (the fiscal period). According to Aaron Wildavsky, a preeminent expert, a budget is: o a prediction of expenses; o the "link between financial resources and human behavior in order to accomplish policy objectives"; o a representation in monetary terms of governmental activity o a record of the outcomes of the struggle over political preferences; and "attempts to allocate scarce financial resources through political processes in order to realize disparate visions of the good life." According to the Office of Management and Budget : o "The budget system of the United States Government provides the means for the President and Congress to decide how much money to spend, what to spend it on, and how to raise the money they have decided to spend. Through the budget system, they determine the allocation of resources among the agencies of the Federal Government. The budget system focuses primarily on dollars, but it also allocates other resources, such as Federal employment." Why is a Budget required? Accountability: Public is not taxed any more than that required for appropriate government functions Prioritization: Identify those public functions to which scarce resources should be allocated What are the major components of a Public Budget? Revenues: Funds that are raised through various means. Expenditure: Funds used for spending on specific programs or capital projects. What are the revenue sources for a government? The revenue sources differ depending on the level of government (i.e. federal, state, and local). Although the federal government collects most amount of tax, states and local governments have a wider menu of choices with respect to taxing: Federal government: o Federal taxes Individual and Corporate taxes Capital gains tax Excise (i.e. manufacturing) taxes

Upload: praveen-soni

Post on 03-Nov-2014

112 views

Category:

Documents


1 download

DESCRIPTION

Public Budgeting

TRANSCRIPT

Page 1: Public Budgeting and Taxtation

Unit 1

Public Budgeting and Financial Management

What is a budget?

A budget is a statement of allocation of (scarce) resources to achieve an organization's objectives for a specific time period.

A budget is the financial plan for how an organization will receive and spend money for a set time period (the fiscal period).

According to Aaron Wildavsky, a preeminent expert, a budget is:o a prediction of expenses;o the "link between financial resources and human behavior in order to accomplish policy objectives";o a representation in monetary terms of governmental activityo a record of the outcomes of the struggle over political preferences; and "attempts to allocate scarce

financial resources through political processes in order to realize disparate visions of the good life." According to the Office of Management and Budget:

o "The budget system of the United States Government provides the means for the President and Congress to decide how much money to spend, what to spend it on, and how to raise the money they have decided to spend. Through the budget system, they determine the allocation of resources among the agencies of the Federal Government. The budget system focuses primarily on dollars, but it also allocates other resources, such as Federal employment."

Why is a Budget required?

Accountability: Public is not taxed any more than that required for appropriate government functions Prioritization: Identify those public functions to which scarce resources should be allocated

What are the major components of a Public Budget?

Revenues: Funds that are raised through various means. Expenditure: Funds used for spending on specific programs or capital projects.

What are the revenue sources for a government?

The revenue sources differ depending on the level of government (i.e. federal, state, and local). Although the federal government collects most amount of tax, states and local governments have a wider menu of choices with respect to taxing:

Federal government:o Federal taxes

Individual and Corporate taxes Capital gains tax Excise (i.e. manufacturing) taxes Social security tax (Federal Insurance Contributions Act, FICA tax). Inheritance and estate taxes

o Borrowings (e.g. treasury bonds)o User charges

State governmentso Intergovernmental transferso State taxes

Individual and Corporate taxes Sales taxes Fuel taxes Inheritance and estate taxes Special taxes on specific products/ services (e.g. tobacco, alcohol, parimutuels)

Page 2: Public Budgeting and Taxtation

o Licenses (business; occupation; hunting and fishing; motor vehicles; motor vehicle operators; public utilities)

o Lotteryo Borrowings (e.g. state bonds)

Local governments (city/ county)o Intergovernmental transferso Local taxes

Property taxes (ad valorem) Sales tax

o Special Assessments (for special districts like school districts; mosquito districts; water management districts; business improvement districts; etc.)

o User fees/ chargeso Borrowings (e.g. local bonds)

What are the major classes of public expenditure?

Public Program budgets: These are costs due to specific public policy programs. Examples include welfare programs (e.g. entitlements); medical programs; environmental programs; housing programs; education programs.

Capital budgets: These are costs due to specific capital projects. Examples include infrastructure (highway, sewage, water, utilities, etc.) costs; building costs.

Debt servicing: Repayment of borrowings Administration: Personnel and other general costs

What are the major differences between the Federal government and other governments (i.e. state and local) in terms of budgeting?

Federal government is in charge of the mint; hence, it can legally print money (i.e. currency). Federal government directly monitors circulation of currency through the Federal Reserve. State and local governments cannot mint money.

Federal government monitors/ regulates the economy through interest rates, to control inflation and to boost economy during stagnation. State governments do not control the interest rates.

Since the Federal government can monitor the economy, it could indulge in deficit spending for achieving broader economic goals. In times of economic recession, the federal government could increase spending (despite lower revenue sources) in order to boost the economy (such as large capital projects started after the Depression to increase employment). In times of economic surplus, the federal government could reduce spending to keep the surplus (at least theoretically). (This is a rather crude statement of Keynesian economics). Unfortunately, however, the federal government deficit has ballooned over the years, despite a short period of economic surplus created by the internet economic boom. State and local governments cannot indulge in large scale deficit spending.

Federal government is in charge of national defense; state governments have a much much smaller role. Much of federal government budget is allocated to defense, much of which could be secretive.

What are the different approaches to preparing a budget? [The time periods shown in parentheses are when the Federal government broadly subscribed to such policies]

Lumpsum budget (Until about World War I): In lumpsum budgets, agency funds were fixed as an overall amount with little political control on how to spend it. In modern times, public agencies hardly use such lumpsum budgets. Small scale contracts could be based on lumpsums, where detailing each of the items could be time consuming and more costly.

Line-item budget (1920 to 1940s): Also called traditional budgeting, the Line item budget is in contrast to lumpsum budget in giving control over each spending item. The budget outlines the items on which money will be spent, but may not necessarily provide  information on what exactly will be done. Each line item is given the same weight or importance even though some are more complex. Generally a line item budget has categories such as personnel, equipment, maintenance, etc. Revenue sources are linked to each item of expenditure, providing a greater degree of relationship between revenue source and expenditure.

Performance budget (1940-60): Performance budget classifies expenditures by administrative units, by functions, and by items. It includes outputs as well as inputs to government activity. Administrative skills are emphasized; activities are given preference over item purchases; management responsibility is centralized.

Page 3: Public Budgeting and Taxtation

It involves: (i) formulation and adoption of a plan of activities and programs for a time period; (ii) funding, i.e. relating program costs and performance to resources; and (iii) execution, i.e. achievement of the plan within the time frame.

Program budget: Although somewhat similar to performance budget, the program budget is different in considering the purpose (i.e. the program) as a unit, rather considering the separate administrative units. Thus, program budgets may overlap certain administrative units.

PPBS (Planning Programming Budgeting System) (1960-71): PPBS involves four stages of budget making: (i) planning, where program goals are defined; (ii) programming, where different alternatives of achieving the goals are identified; (iii) evaluation, where the costs and benefits of the various alternatives are evaluated; (iv) implementation, where the best alternatives are adopted for implementation.

Zero base budgeting (1976): This was introduced as a rational budget innovation by President Carter in 1976, along with the concept of "Sunset" provisions (where a program or an agency expires after a certain time unless specifically renewed). The concept of ZBB is that existing programs and activities should not automatically be funded, but rather should have to justify their continuation as part of the annual budget cycle. Each program or project is thus vulnerable to zero funding.

Supply side economics (1980s): Not exactly a budgeting practice, but this was Reagan's formula for federal government. The approach argues for a reduced government role in the economy--less regulation, lower taxes. More regulation is considered unhealthy since it limits corporate entrepreneurship; high taxation is considered unhealthy since it removes money from further investment in the private sector. If corporations are taxed less, they will have more money for employment and reducing prices, thus benefiting even the poor (the "trickle down economy"). Budget deficits, however, increased sharply during Reagan years.

 New Performance Budgeting (1990s): This is a results oriented (or objectives oriented) budgeting under the Government Performance and Results Act of 1993. The effort is to link resource allocation with managerial performance. According to GPRA, agencies are required to formulate five year strategic plans, along with annual performance plans.

Balanced Budget (1997-2002): In a balanced budget, income equals or exceeds spending. Deficits from one fiscal year cannot be carried over to the next. Most states require balanced budgets, but the federal government does not (as you may have noticed from difference between Federal and State/ Local governments). 32 states have constitutional requirements on balancing the budget; 11 more have statutory provisions. In practice, much of the balancing the budget at state level is applied to general funds (where much of the taxes are pooled in) and expenditure in this category.

Most of the above budget approaches are managerial in their nature, in the sense that there is a rational decision making process involved. Yet, budgets also have a political angle, where the decisions are ratified based on political power play and narrow interests of one's constituency. For example, "pork barrel" projects tend to be based on one's political ability to get such projects to his or her constituency.

Public Finance and Private Finance:

Finance can be divided into two broad categories :-

1.Private Finance

2.Public Finance

Private Finance can be categorized into :-

i.Personal Finance :-

It basically deals with the optimization of finances in the individual (single consumer, family,

personal savings, etc.) level subjected to the budget constraint. For example, a consumer

can finance his/her purchase of a car by taking a loan from any bank or financial institutions.

In short, it can be said that Personal Finance is financial planning on the individual level. It

Page 4: Public Budgeting and Taxtation

deals with the utilization of the monetary resources by individuals and families by means of

budgeting, saving and spending after taking into consideration the probable life events of

the future and risks associated with them. Personal Finance generally includes :-

(a)Savings account

(b)Insurance policies

(c)Consumer Loans

(d)Stock market investments

(e)Retirement plans

(f)Managing of income taxes

(g)Credit cards

ii.Business Finance :-

It tries to optimize the goals (profit, sales, etc.) of a corporation or other business

organization by estimating future asset requirements and then allocating funds in

accordance to the availability of funds.

Business Finance deals with the monetary provisioning at the commercial level. A business

constantly requires capital based on different perspectives :-

Short-term

Medium-term

Long-term

Short term and medium term capital are used for meeting current liabilities.Long term

capital are generally utilized for acquiring fixed cost assets (like land, machinery, etc.),

investment in patents and trademarks, etc.Sources of short term and medium term capital

includes retained earnings, temporary loans from sister concerns or directors, exchange

Page 5: Public Budgeting and Taxtation

bills, and many more.Long term Capital sources are commercial banks, finance houses,

merchant banks, etc.

Public Finance is that part of finance which hovers around the central question of

allocation of resources subjected to the budget constraint of the government or public

entities. It is that branch of economics which identifies and appraises the means and effects

of the policies of the government. Public Sector Finance tries to examine the effects and

consequences of different types of taxation and expenditures on the economic agents

(individuals, institutions, organizations, etc.) of the society and ultimately on the entire

economy. It also analyzes the effectiveness of the policies aimed at certain objectives and

consequently to the development of procedures and techniques for increasing the

effectiveness of the policy.

Professor Richard Musgrave defined Public Finance as, “The complex of problems that

centres around the revenue-expenditure process of Government is referred to traditionally

as public finance.”

Some of the branches of Public Sector Finance are :-

(1)Public Revenue

It includes revenue earned by government from both tax (income tax, sales tax, import duty,

etc.) and non-tax sources (different kinds of fines, fees, etc.).

(2)Public Expenditure

It deals with the various types of expenditures of the government required for its proper

functioning.

(3)Public Debt

Page 6: Public Budgeting and Taxtation

When the public expenditure of a government exceeds its revenue, for continuation of its

proper functioning, the government borrows from the public giving rise to public debt.

Subject matters under this head are :-

(a) Total amount of public debt

(b)Redemption of public debt

(c)Impact of public debt on different policy matters

(4)Budgetary Policy

Public or budgetary deficit arises when public expenditure exceeds public revenue. This

branch of public finance deals with the different ways of solution of public deficit.

(5)Fiscal Policy

Fiscal Policy is concerned with the policy framework of the government after taking into

consideration government spending, avenues of government earning, government

borrowings, etc.Hence, Public Finance and Private Finance are different from each other by

the fact that one is dealt in a public domain and the other on the individual level.

Hugh Dalton explains the principle of maximum social advantage with reference to

:-

1. Marginal Social Sacrifice

2. Marginal Social Benefits

This principle is however based on the following assumptions :-

1. All taxes result in sacrifice and all public expenditures lead to benefits.

Page 7: Public Budgeting and Taxtation

2. Public revenue consist of only taxes and no other sources of income to the

government.

3. The government has no surplus or deficit budget but only balanced budget.

4. Public expenditure is subject to diminishing marginal social benefit and taxes are

subject to increasing marginal social sacrifice.

Marginal Social Sacrifice (MSS) ↓

Marginal Social Sacrifice (MSS) refers to that amount of social sacrifice undergone by public

due to the imposition of an additional unit of tax.

Every unit of tax imposed by the government taxes result in loss of utility. Dalton says that

the additional burden (marginal sacrifice) resulting from additional units of taxation goes on

increasing i.e. the total social sacrifice increases at an increasing rate. This is because, when

taxes are imposed, the stock of money with the community diminishes. As a result of

diminishing stock of money, the marginal utility of money goes on increasing. Eventually

every additional unit of taxation creates greater amount of impact and greater amount of

sacrifice on the society. That is why the marginal social sacrifice goes on increasing.

The Marginal social sacrifice is illustrated in the following diagram :-

Page 8: Public Budgeting and Taxtation

The above diagram indicates that the Marginal Social Sacrifice (MSS) curve rises upwards

from left to right. This indicates that with each additional unit of taxation, the level of

sacrifice also increases. When the unit of taxation was OM1, the marginal social sacrifice was

OS1, and with the increase in taxation at OM2, the marginal social sacrifice rises to OS2.

Marginal Social Benefit (MSB) ↓

While imposition of tax puts burden on the people, public expenditure confers benefits. The

benefit conferred on the society, by an additional unit of public expenditure is known as

Marginal Social Benefit (MSB).

Just as the marginal utility from a commodity to a consumer declines as more and more

units of the commodity are made available to him, the social benefit from each additional

unit of public expenditure declines as more and more units of public expenditure are spent.

In the beginning, the units of public expenditure are spent on the most essential social

activities. Subsequent doses of public expenditure are spent on less and less important

social activities. As a result, the curve of marginal social benefits slopes downward from left

to right as shown in figure below.

Page 9: Public Budgeting and Taxtation

In the above diagram, the marginal social benefit (MSB) curve slopes downward from left to

right. This indicates that the social benefit derived out of public expenditure is reducing at a

diminishing rate. When the public expenditure was OM1, the marginal social benefit was OB1,

and when the public expenditure is OM2, the marginal social benefit is reduced at OB2.

The Point of Maximum Social Advantage ↓

Social advantage is maximised at the point where marginal social sacrifice cuts the marginal

social benefits curve.

This is at the point P. At this point, the marginal disutility or social sacrifice is equal to the

marginal utility or social benefit. Beyond this point, the marginal disutility or social sacrifice

will be higher, and the marginal utility or social benefit will be lower.

At point P social advantage is maximum. Now consider Point P1. At this point marginal social

benefit is P1Q1. This is greater than marginal social sacrifice S1Q1. Since the marginal social

sacrifice is lower than the marginal social benefit, it makes more sense to increase the level

of taxation and public expenditure. This is due to the reason that additional unit of revenue

raised and spent by the government leads to increase in the net social advantage. This

situation of increasing taxation and public expenditure continues, as long as the levels of

taxation and expenditure are towards the left of the point P.

Page 10: Public Budgeting and Taxtation

At point P, the level of taxation and public expenditure moves up to OQ. At this point, the

marginal utility or social benefit becomes equal to marginal disutility or social sacrifice.

Therefore at this point, the maximum social advantage is achieved.

At point P2, the marginal social sacrifice S2Q2 is greater than marginal social benefit P2Q2.

Therefore, beyond the point P, any further increase in the level of taxation and public

expenditure may bring down the social advantage. This is because; each subsequent unit of

additional taxation will increase the marginal disutility or social sacrifice, which will be more

than marginal utility or social benefit. This shows that maximum social advantage is attained

only at point P & this is the point where marginal social benefit of public expenditure is equal

to the marginal social sacrifice of taxation.

Conclusion ↓

Maximum Social Advantage is achieved at the point where the marginal social benefit of

public expenditure and the marginal social sacrifice of taxation are equated, i.e. where MSB

= MSS.

This shows that to obtain maximum social advantage, the public expenditure should be

carried up to the point where the marginal social benefit of the last rupee or dollar spent

becomes equal to the marginal social sacrifice of the last unit of rupee or dollar

taxed…………………..

Unit 2

This guide provides an overview of the tax structure and current tax rates in India. The tax

regime in India has undergone elaborate reforms over the last couple of decades in order to

enhance rationality, ensure simplicity and improve compliance. The tax authorities

constantly review the system in order to remain relevant. India has a federal system of

Government with clear demarcation of powers between the Central Government and the

State Governments. Like governance, the tax administration is also based on principle of

Page 11: Public Budgeting and Taxtation

separation therefore well defined and demarcated between Central and State Governments

and local bodies.

The tax on incomes, customs duties, central excise and service tax are levied by the Central

Government. The state Government levies agricultural income tax (income from plantations

only), Value Added Tax (VAT)/ Sales Tax, Stamp Duty, State Excise, Land Revenue, Luxury

Tax and Tax On Professions. The local bodies have the authority to levy tax on properties,

octroi/entry tax and tax for utilities like water supply, drainage etc.

DIRECT TAXESIndividual Income Tax & Corporate Tax

The provisions relating to income tax are contained in the Income Tax Act 1961 and the

Income Tax Rules 1962. The Income Tax Department is governed by the Central Board for

Direct Taxes (CBDT) which is part of the Department of Revenue under the Ministry of

Finance. In terms of the Income Tax Act, 1961, a tax on income is levied on individuals,

corporations and body of persons. Tax rates are prescribed by the government in the

Finance Act, popularly known as Budget, every year.

The Government of India has recently taken initiatives to reform and simplify the language

and structure of the direct tax laws into a single legislation – the Direct Taxes Code (DTC).

After public consultation the Direct Taxes Code 2010 was placed before the Indian

Parliament on 30 August 2010, when passed DTC will replace the Income Tax Act of 1961.

The DTC consolidates the provisions for Direct Tax namely the income tax and wealth tax.

When it comes into effect, probably April 2012, it is likely to have significant impact on the

tax payers especially the business community.

In the case of Individuals, incomes from salary, house and property, business & profession,

capital gains and other sources are subject to tax. Women and Senior citizens are extended

some special privileges. Individuals’ incomes are subjected to a progressive rate system.

Tax treatment differs depending on the residence status.

Income of the company is computed and assessed separately in the hands of the company.

Income of company is subjected to a flat rate plus a surcharge. In addition to these, an

education cess is also charged on the tax amount. Dividends distributed are subjected to

special tax and the distributed income is not treated as expenditure but as appropriation of

profits by the company. Tax treatment differs depending on the residence status.

A company is liable to pay tax on the income computed in accordance with the provisions of

the Income Tax Act. Although many companies have huge profits, and declare substantial

dividends, they are relieved from tax liabilities because their income when computed as per

provisions of the Income Tax Act is either nil or negative or insignificant. Therefore a

provision called Minimum Alternative Tax (MAT) was introduced by an amendment in 1997.

Page 12: Public Budgeting and Taxtation

As per the MAT provision such companies are required to pay a fixed percentage (presently

18% for 2011-2012) of book profit as minimum alternate tax.

Additionally, by an amendment in 2005 companies are required to pay Fringe Benefit Tax

(FBT) on value of fringe benefits provided or deemed to have been provided to the

employees.

In addition to income tax chargeable in respect of total income, any amount declared,

distributed or paid by a domestic company by way of dividend shall be subjected to dividend

tax. Only a domestic company is liable for the tax.

Wealth Tax

Wealth tax, in India, is levied under Wealth-tax Act, 1957. Wealth tax is a tax on the benefits

derived from property ownership. The tax is to be paid year after year on the same property

on its market value, whether or not such property yields any income. Similar to income tax

the liability to pay wealth tax also depends upon the residential status of the assessee. The

assets chargeable to wealth tax are Guest house, residential house, commercial building,

Motor car, Jewelry, bullion, utensils of gold, silver, Yachts, boats and aircrafts, urban land,

cash in hand (in excess of INR 50,000 for Individual & HUF only),etc. But in reality majority of

the potential tax payers do not pay this tax as most of the movable items such as jewelry,

bullion etc are stashed away from accounting. Invariably they just pay tax for the immovable

wealth such as real estate.

Capital Gains Tax

The central government also charges tax on the capital gains that is derived from the sale of

the assets. The capital gain is the difference between the money received from selling the

asset and the price paid for it. To restrict the misuse of this provision, the definition of

capital asset is being widened to include personal effects such as archaeological collections,

drawings, paintings, sculptures or any work of art.

Capital gain also includes gain that arises on “transfer” (includes sale, exchange) of a capital

asset and is categorized into short-term gains and long-term gains. The Long-term Capital

Gains Tax is charged if the capital assets are kept for more than three years or 12 months in

the case of securities and shares that are listed under any recognized Indian stock exchange

or mutual fund. Short-term Capital Gains Tax is applicable if the assets are held for less than

the aforesaid period.

In case of the long term capital gains, they are taxed at a concession rate. Normal corporate

income tax rates are applicable for short term capital gains. In case of the short term and

long term capital losses, they are allowed to be carried forward for 8 consecutive years.

INDIRECT TAXESExcise Duty

Page 13: Public Budgeting and Taxtation

The central government levies excise duty under the Central Excise act of 1944 and the

Central Excise Tariff Act of 1985. Central Excise duty is an indirect tax levied on goods

manufactured in India and meant for domestic consumption. The Central Board of Excise

and Customs under the Ministry of Finance, administers the excise duty. Central Excise Duty

arises as soon as the goods are manufactured. It is paid by a manufacturer, who passes on

its incidence to the customers. Excisable goods have been defined as those, which have

been specified in the Central Excise Tariff Act as being subjected to the duty of excise.

There are three main types of excise duty -

Basic Excise Duty is charged on all excisable goods other than salt at the rates mentioned

in the said schedule

Additional Duties of Excise is charged on goods of special importance, in lieu of sales Tax

and shared between Central and State Governments

Special Excise Duty is charged on all excisable goods on which there is a levy of Basic

excise Duty. Every year the annual Budget specifies if Special Excise Duty shall be or shall

not be levied and collected during the relevant financial year.

Note: Under the Cenvat (Central Value Added Tax) Scheme, introduced under The Cenvat

Credit Rules, 2004, a manufacturer of product or provider of taxable service shall be allowed

to take credit of duty of excise as well as of service tax paid on any input received in the

factory or any input service received by manufacturer of final product. Such credits can be

used to setoff any excise duty tax payable.

In the recent budget, a number of tax exemptions have been initiated. Specific goods enjoy

concessional duty rates. Exemptions are allowed to tax payers engaged in the manufacture

of certain goods such as, water treatment, bio-diesel, processed food etc and certain types

of establishments such as small scale industries, cottage industries that create jobs are also

exempted.

Customs Duty

Customs duty in India falls under the Customs Act 1962 and Customs Tariff Act of 1975.

Customs duty is the tax levied on goods imported into India as well as on goods exported

from India. Taxable event is import into or export from India. Additionally educational cess is

also charged. The customs duty is evaluated on the value of the transaction of the goods.

The Central Board of Excise and Customs under the Ministry of Finance manages the

customs duty process in the country. The rate at which customs duty is applicable on the

goods depends on the classification of the goods determined under the Customs Tariff. The

Customs Tariff is generally aligned with the Harmonized System of Nomenclature (HSL). It

should be noted that preferential/concessional rates of duty are also available under the

various Trade Agreements.

Service Tax

Page 14: Public Budgeting and Taxtation

Service tax was introduced in India way back in 1994 and started with mere 3 basic services

viz. general insurance, stock broking and telephone. Subsequent Budgets have expanded

the scope of the service tax as well as the rate of service tax. More than 100 services are

subjected to tax under this provision. An education cess is also charged on the tax amount.

The Central Board of Excise and Customs under the Ministry of Finance manages the

administration of service tax.

Every service provider of a taxable service is required to register with the Central Excise

Office in the concerned jurisdiction. Exemptions are available for services that are exported,

small service providers whose revenue fall below the prescribed level, services provided to

UN and International Agencies and supplies to SEZ(Special Economic Zones). Subject to

conditions, service tax is not payable on value of goods and material supplied while

providing services.

Securities Transaction Tax (STT)

Transactions in equity shares, derivatives and units of equity-oriented funds entered in a

recognized stock exchange attract Securities Transaction Tax. Service Tax, Surcharge and

Education Cess are not applicable on STT. Taxation of profit or loss from securities

transactions depends on whether the activity of purchasing and selling of shares /

derivatives is classified as investment activity or business activity. Treatment of STT also

depends upon whether the income from these securities transactions are included under the

head “Income from Capital Gains” or under the head ‘Profits and Gains of Business or

Profession’.

NOTE: The Indian Government is keen on merging all taxes like Service Tax, Excise and VAT

into a common Goods and Service Tax (GST).  GST system has been proposed in order to

simplify current indirect tax system which is very tedious and complicated. All goods and

services will be brought into the GST base. There will be no distinction between goods and

services. Alcohol, tobacco, petroleum products are likely to be out of the GST regime. The

state and central combined tax rate is speculated to be between 16%-20% in line with the

global trend.  Originally slated for implementation by the year 2010 it has been postponed

twice and now scheduled for the year 2012. The central and state tax authorities which had

locked horns earlier are seemingly nearing a consensus. If implemented this will be the most

outstanding reform ever to the Indian tax system.

STATE TAXESApart from the central taxes, the states also levy taxes on various good and services. Main

state taxes consist of:

Value Added Tax (VAT)

Sales tax charged on the sales of movable goods has been replaced with VAT in most of the

Indian states since 2005. This was introduced to counter the rampant double taxation issues

Page 15: Public Budgeting and Taxtation

and resultant cascading tax burden that occurred due to the flaws inherent in the previous

sales tax system.

VAT, chargeable only on goods and does not include services, is a multi-stage system of

taxation, whereby tax is levied on value addition at each stage of transaction in the supply

chain. The term ‘value addition’ implies the increase in value of goods and services at each

stage of production or transfer of goods and services. VAT is a tax on the final consumption

of goods or services and is ultimately borne by the consumer. VAT comes under the state

list. Tax payers can claim credit for the taxes paid at earlier stages and purchases known as

Input Tax Credit, by producing relevant tax invoices. The credit can be used to setoff any

VAT tax liability.

Different rates of VAT are charged depending on the category to which the goods belong.

Rates vary for essential commodities, bullion and valuable stones, industrial inputs and

capital goods of mass consumption, and others. Petroleum tobacco, liquor and so on are

subjected to higher rate and differ from state to state.

Notably, there is no VAT on imports and export sales are not subjected to VAT. Therefore

VAT charged on inputs purchased and used in the manufacture of export goods or goods

purchased for export, is available as a refund.

Note: The Central Sales Tax which is levied on inter-State sales would be eliminated

gradually.

Stamp Duty 

It is a tax that is levied on the transaction performed by means of a document or instrument

as per the regulations of Indian Stamp Act, 1899. It is collected by the government of the

state where the transaction is carried out. Stamp duty rates vary between the states.

Stamp duty is paid on instruments, which are essentially a document to create, transfer,

limit, extend, extinguish or record a right or liability.  Document acquires legality once it is

stamped properly after the payment of the requisite stamp duty charges. Stamp duty is

payable for transfer of shares, share certificate, partnership deed, bill of exchange, shares,

share transfer, leave and license agreement, debentures, gift deed, bank guarantee, bonds,

demat shares, development agreement, demerger, power of attorney, home loans, houses &

house purchase, lease deed, loan agreement and lease agreement.

State Excise

Power to impose excise on alcoholic liquors, opium and narcotics is granted to States under

the Constitution and it is called ‘State Excise’. The Act, Rules and rates for excise on liquor

are different for each State.

In addition to the above taxes by the Central and State Governments the local bodies have

the authority to levy tax on properties, octroi/entry tax and tax onutilities

Page 16: Public Budgeting and Taxtation

OTHER KEY NOTESFiling of VAT, CENVAT, Service Tax returns

Periodic returns must be submitted by companies registered for CENVAT or VAT/CST or

Service Tax in India.

CENVAT filings are monthly, on the 10th day following the period end.

VAT reporting is either monthly or quarterly, depending on the particular State’s rules.

Service Tax filings are bi-annual.

Permanent Account Number (PAN)

PAN is an all India, unique ten-digit alphanumeric number, issued in the form of a laminated

card by the Income Tax Department.

Who Must Have a PAN

Every person,—

if his total income or the total income of any other person in respect of which he is

assessable, during any previous year, exceeded the maximum amount which is not

chargeable to income-tax; or

carrying on any business or profession whose total sales, turnover or gross receipts are or is

likely to exceed INR 500,000 in any previous year; or

who is required to furnish a return of income or

being an employer, who is required to furnish a return of fringe benefits

PAN is increasingly being recognized as a valid Identity Proof across India and a mandatory

document for important transactions such as purchase of property, motor vehicles, share

transactions, opening of bank accounts, obtaining loans, maintaining deposits etc., therefore

any person not fulfilling the above conditions may also apply for allotment of PAN.

Tax Deduction at Source (TDS)

The Income-tax Act enjoins on the payer of specific types of income, to deduct a stipulated

percentage of such income by way of Income-tax and pay only the balance amount to the

recipient of such income. Some of such incomes subjected to T.D.S. are salary, interest,

dividend, interest on securities, winnings from lottery, horse races, commission and

brokerage, rent, fees for professional and technical services, payments to non-residents etc.

Tax Collection at Source (TCS)

Tax is collected at the point of sale. It is to be collected at source from the buyer, by the

seller at the point of sale. Such tax collection is to be made by the seller, at the time of

debiting the amount payable to the account of the buyer or at the time of receipt of such

amount from the buyer, whichever is earlier. The goods to be subjected to TCS are clearly

specified and the type of buyers, sellers and purpose are clearly defined in the Act. Tax rates

vary depending on the goods.

Page 17: Public Budgeting and Taxtation

Note: All those persons who are required to deduct tax at source or collect tax at source on

behalf of Income Tax Department are required to apply for and obtain Tax Deduction and

Collection Account Number (TAN), a 10 digit alpha numeric number, which is required to be

quoted in all documents involving TDS/TCS transactions. Failure to apply for TAN or not

quoting the same in the specified documents attracts a penalty.

Double Taxation Relief

India has entered into Avoidance of Double Taxation Agreement (DTAA) with 65 countries

including countries like U.S.A., U.K., Japan, France, Germany, etc. The agreement provides

relief from the double taxation in respect of incomes by providing exemption and also by

providing credits for taxes paid in one of the countries. These treaties are based on the

general principles laid down in the model draft of the Organisation for Economic Cooperation

and Development (OECD) with suitable modifications as agreed to by the other contracting

countries. In case of countries with which India has double taxation avoidance agreements,

the tax rates are determined by such agreements and vary between countries.

Unilateral Relief

The Indian government provides relief from double taxation irrespective of whether there is

a DTAA between India and the other country concerned, if

1. The person or company has been a resident of India in the previous year.

2. The same income must be accrued to and received by the tax payer outside India in the

previous year.

3. The income should have been taxed in India and in another country with which there is no

tax treaty.

4. The person or company has paid tax under the laws of the foreign country concerned.

A Taxing Problem, I: What is Tax Justice?

As they say, there are two things certain in life: death and taxes. At least the former only

comes once. The latter is a perennial problem. It also manages to bring in discussions on

politics and religion, two of the three subjects you are not supposed to discuss in polite

company. (The third subject is, at least according to Linus Van Pelt, the Great Pumpkin.)

Anyway, as a follow-up to yesterday's posting (which was itself a follow-up to the posting of

the day-before-yesterday) we thought we'd address some of the concerns expressed by our

faithful readers in greater depth. As one of them commented, in words edited for

publication,

Page 18: Public Budgeting and Taxtation

"I see that Capital Homesteading has a floor that excludes some persons (lower income)

from paying income taxes for the general support of the national government. I am curious,

since everyone pays sales taxes or payroll taxes for unemployment, Social Security and

Medicare, why would not the demands of equal justice require that all pay some support of

the general government, say a straight tax on income?"

As we have seen, a basic principle of just taxation is that people are taxed according to their

ability to pay, it being considered unjust to demand that people pay taxes when their

resources are inadequate to cover their own subsistence or that of their dependents. This

principle of civil society is also reflected in the teachings of the Catholic Church, which has

as a precept that people are to contribute to the support of their pastors according to their

means. It is considered unjust in civil, religious or domestic society to be forced to

contribute, either as taxes or as a donation, anything in excess of one's ability to contribute;

neither human positive law nor moral philosophy requires that we do that which is

impossible.

The tax proposals under Capital Homesteading take this basic principle as fundamental to a

just social order. The present system, that requires people to pay taxes in such amounts as

to force them to accept government assistance to make up the difference is patently unjust,

as well as obviously contrary to common sense. It is interesting to note that, before the

current economic downturn, the employee portion of Social Security and Medicare taxes on

the median income was approximately equal to the amount of per capita non-mortgage

revolving consumer debt. In other words, the government takes away income from private

consumption, which the consumer then makes up by borrowing to keep the economy

limping along — wage earners were thus paying into Social Security from the first dollar of

wage income, and making up the difference by using credit cards.

We propose the abolition of all taxes (especially the ad valorem ["value added"] sales taxes,

tariffs, and payroll taxes that are strongly regressive) except for an income tax, and a single

rate on all income from whatever source derived above a meaningful exemption sufficient

to, as Pope Pius XI put it, meet common domestic needs adequately. Otherwise, all that is

being done is that the State takes away in taxes what it then returns as welfare, making

recipients into dependents on the State, or (as the Supreme Court put it in another context),

turning nominally independent adults into mere creatures of the State (Pierce v. Society of

Sisters, 1925). All sales taxes, payroll taxes, property taxes, and so on, would be merged

into this single rate. If the exemption is adequate, this would result in a "typical" family of

four paying no taxes on the first $100,000 of aggregate income, and an effective, if

moderate progressive rate above that. There would be no special rates for property

incomes, whether dividends or capital gains, with the exception that capital gains should be

Page 19: Public Budgeting and Taxtation

inflation-indexed.

The basic fact is that, until the New Deal, few Americans paid any taxes at all, except for

property taxes and whatever resulted from the increase in the price of consumer goods due

to the tariff. As Dr. Harold G. Moulton related in The New Philosophy of Public Debt (1943),

the primacy of Keynesian economics convinced policy makers that taxation was

unnecessary for raising revenue to defray government expenditures (it being believed that

the public debt could safely rise to at least twice GNP (!), according to Alvin Hansen, "the

American Keynes"), but that taxation was still useful as a means of "social engineering."

To be cynical, the income tax ceased to be used primarily for funding government, and was

changed into 1) a means for controlling people (as Justice John Marshall noted in McCulloch

v. Maryland, "the power to tax is the power to destroy"), 2) a means of encouraging saving

by the rich for reinvestment in new capital, further concentrating property and power and

widening the wealth gap, and, in last place, 3) revenue.

A project of NYCOM

The Tax Shift

Tax shifting is the practice of one government shifting its taxes, costs and/or revenue shortfalls onto a lower level of government. Stopping New York State's penchant for tax shifting is the first step in taking control of what many New Yorkers would say is our state's number one problem: the oppressive and regressive real property tax.

Just about any way you measure the property tax burden in New York, we rank at or near the top compared to all other states. Tax shifting is one of the reasons for this dubious distinction. As StopTheTaxShift.org highlights, the state-local relationship in New York has been characterized, historically, by a pattern of the state (1) underfunding aid to municipalities, and (2) using state mandates to dictate inefficient ways in which local governments must perform services.

As it relates to state aid, though, New York has begun to provide an antidote to tax shifting and it is yielding much-needed relief for property taxpayers. In recent years, the state has made significant headway in building a tradition of predictable growth in state aid - formerly known as Revenue Sharing Aid, now referred to as Aid and Incentives for Municipalities (AIM). This renewed fiscal commitment is producing positive and measurable results. The growth in municipal property taxes is slowing. For example, there has been a net decline in city property tax levies between 2005 and 2008. It is a fair statement to make that AIM is New York's one property tax relief program that works, and works in a way that does not foster higher local

Page 20: Public Budgeting and Taxtation

spending. We thank the Governor and state legislators for their support for such a proactive, pro-taxpayer approach to state-local relations.

Now, with the state facing a daunting fiscal challenge, AIM funding could be a potential target for mid-year and future year reductions. StopTheTaxShift.org shows that this is the wrong approach. Such a budget-balancing strategy was utilized by the state in the early 1990s and quickly put numerous New York cities into fiscal distress, some of which were taken over by control boards, and most of which still receive less aid today than they did prior to those cuts (when adjusted for inflation). AIM aid represents less than 1% of the state budget, but is an important piece of local government budgets throughout the state. StopTheTaxShift.org urges the Governor and state legislators to maintain this relatively small investment by the state so that fiscally distressed New Yorkers will be protected from the punishing effects of property tax increases.

StopTheTaxShift.org also focuses on the other avenue for shifting taxes: state mandates. While New York has begun to make progress in its commitment to municipal aid, efforts to achieve relief from state mandates have been marked by much talk and little action. For every mandate local officials have sought to have repealed, a special interest group that benefits from such mandate has stood in the way of reform and enhanced cost effectiveness at the local government level. Now, more than ever, New York and our property taxpayers cannot afford to pay for the hundreds of millions of dollars in costs caused by state mandates.

StopTheTaxShift.org describes the real impact numerous state mandates have on the capacity of local officials to manage government costs consistent with the desires of their constituents. Our Web site allows visitors to review a comprehensive listing of nearly fifty state mandates pertaining to workforce costs, local taxation and other non-property tax revenues, government operations and procurement. The home page also features a Mandate of the Week, which delves deeper into a particular mandate, its cost to local taxpayers, and the action that can be taken by the state to provide relief from the negative aspects of the mandate. It is time for New York to put an end to the practice of dictating local policy without having to be accountable for the local tax impact of such policy.

Finally, StopTheTaxShift.org offers all New Yorkers an opportunity to join the fight to stop any attempts at tax shifting. By clicking on the "Take Action" button on the top of the home page, visitors to StopTheTaxShift.org can seamlessly draft and send a message to statewide elected officials, state legislators and local media.

We encourage you to spread the word about tax shifting, get involved and make sure your voice is heard. The future of our communities and our state depends upon it

Unit III

Page 21: Public Budgeting and Taxtation

What is Public Expenditure ? Meaning, Definition

Public expenditure refers to Government expenditure i.e. Government spending. It is incurred by Central, State and Local governments of a country.

Public expenditure can be defined as, "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."

Image Credits © rappaportcenter.

Throughout the 19th Century, most governments followed laissez faire economic policies & their functions were only restricted to defending aggression & maintaining law & order. The size of pubic expenditure was very small.

But now the expenditure of governments all over has significantly increased. In the early 20th Century, John Maynard Keynes advocated the role of public expenditure in determination of level of income and its distribution.

In developing countries, public expenditure policy not only accelerates economic growth & promotes employment opportunities but also plays a useful role in reducing poverty and inequalities in income distribution.

Classification of Public Expenditure

Classification of Public expenditure refers to the systematic arrangement of different items on which the government incurs expenditure.

Page 22: Public Budgeting and Taxtation

Different economists have looked at public expenditure from different point of view. The following classification is a based on these different views.

1. Functional Classification

Some economists classify public expenditure on the basis of functions for which they are incurred. The government performs various functions like defence, social welfare, agriculture, infrastructure and industrial development. The expenditure incurred on such functions fall under this classification. These functions are further divided into subsidiary functions. This kind of classification provides a clear idea about how the public funds are spent.

2. Revenue and Capital Expenditure

Revenue expenditure are current or consumption expenditures incurred on civil administration, defence forces, public health and education, maintenance of government machinery. This type of expenditure is of recurring type which is incurred year after year.

On the other hand, capital expenditures are incurred on building durable assets, like highways, multipurpose dams, irrigation projects, buying machinery and equipment. They are non recurring type of expenditures in the form of capital investments. Such expenditures are expected to improve the productive capacity of the economy.

3. Transfer and Non-Transfer Expenditure

Page 23: Public Budgeting and Taxtation

A.C. Pigou, the British economist has classified public expenditure as :-

Transfer expenditure

Non-transfer expenditure

Transfer Expenditure :-

Transfer expenditure relates to the expenditure against which there is no corresponding return.

Such expenditure includes public expenditure on :-

National Old Age Pension Schemes,

Interest payments,

Subsidies,

Unemployment allowances,

Welfare benefits to weaker sections, etc.

By incurring such expenditure, the government does not get anything in return, but it adds to the welfare of the people, especially belong to the weaker sections of the society. Such expenditure basically results in redistribution of money incomes within the society.

Non-Transfer Expenditure :-

The non-transfer expenditure relates to expenditure which results in creation of income or output.

The non-transfer expenditure includes development as well as non-development expenditure that results in creation of output directly or indirectly.

Economic infrastructure such as power, transport, irrigation, etc.

Page 24: Public Budgeting and Taxtation

Social infrastructure such as education, health and family welfare.

Internal law and order and defence.

Public administration, etc.

By incurring such expenditure, the government creates a healthy conditions or environment for economic activities. Due to economic growth, the government may be able to generate income in form of duties and taxes.

4.1 Productive and Unproductive Expenditure

This classification was made by Classical economists on the basis of creation of productive capacity.

Productive Expenditure :-

Expenditure on infrastructure development, public enterprises or development of agriculture increase productive capacity in the economy and bring income to the government. Thus they are classified as productive expenditure.

Unproductive Expenditure :-

Expenditures in the nature of consumption such as defence, interest payments, expenditure on law and order, public administration, do not create any productive asset which can bring income or returns to the government. Such expenses are classified as unproductive expenditures.

4.2 Development and Non-Development Expenditure

Modern economists have modified this classification into distinction between development and non-development expenditures.

Page 25: Public Budgeting and Taxtation

Development Expenditure :-

All expenditures that promote economic growth and development are termed as development expenditure. These are the same as productive expenditure.

Non-Development Expenditure :-

Unproductive expenditures are termed as non development expenditures.

5. Grants and Purchase Price

This classification has been suggested by economist Hugh Dalton.

Grants :-

Grants are those payments made by a public authority for which their may not be any quid-pro-quo, i.e., there will be no receipt of goods or services. For example, old age pension, unemployment benefits, subsidies, social insurance, etc. Grants are transfer expenditures.

Purchase prices :-

Purchase prices are expenditures for which the government receives goods and services in return. For example, salaries and wages to government employees and purchase of consumption and capital goods.

6. Classification According to Benefits

Public expenditure can be classified on the basis of benefits they confer on different groups of people.

Page 26: Public Budgeting and Taxtation

Common benefits to all : Expenditures that confer common benefits on all the people. For example, expenditure on education, public health, transport, defence, law and order, general administration.

Special benefits to all : Expenditures that confer special benefits on all. For example, administration of justice, social security measures, community welfare.

Special benefits to some : Expenditures that confer direct special benefits on certain people and also add to general welfare. For example, old age pension, subsidies to weaker section, unemployment benefits.

7. Hugh Dalton's Classification of Public Expenditure

Hugh Dalton has classified public expenditure as follows :-

Expenditures on political executives : i.e. maintenance of ceremonial heads of state, like the president.

Administrative expenditure : to maintain the general administration of the country, like government departments and offices.

Security expenditure : to maintain armed forces and the police forces.

Expenditure on administration of justice : include maintenance of courts, judges, public prosecutors.

Developmental expenditures : to promote growth and development of the economy, like expenditure on infrastructure, irrigation, etc.

Social expenditures : on public health, community welfare, social security, etc.

Pubic debt charges : include payment of interest and repayment of principle amount.

Principles of Public Expenditure

Page 27: Public Budgeting and Taxtation

Public expenditure is related to macro economics. Public ecpenditure has some principles. Public Expenditure contain following Principles: 

1. Principle of maximum social benefits

2. Principle of economy, i.e., wasteful expenditure should be avoided

3. Canon of sanction, i.e., authorized expenditure

4. Principle of balanced budget

5. Canon of elasticity, i.e., fairly flexible

6. Avoidance of unhealthy effects on production and distribution

 1. Principle of Maximum Social Benefits: Public expenditure should be made to attain the maximum social advantage from activities conducted by it. Attainment of maximum social advantage requires: (i)                  both public expenditure and taxation should be carried out up to certain limits and no more,(ii)                public expenditure should be so utilized among the various uses in an optimal manner:(iii)               the different sources of taxation should so tapped that the aggregate sacrifice entailed is minimum

2. Principle of Economy: It means that extravagance and waste of all types should be avoided.  Public expenditure has great potentiality for public good but it may also prove injurious and wasteful.  If the revenue collected from the taxpayer is heedlessly spent, it would be obviously uneconomical.To satisfy the canon of economy, it will be necessary to avoid all duplication of expenditure and overlapping of authorities.  Further, public expenditure should not adversely affect saving.  In case government activity damaged the individual’s will or power to save, it would be repugnant to the canon of economy.3. Canon of Sanction: Another important principle of public expenditure is that before it is actually incurred, it should be sanctioned by a competent authority.  Unauthorised spending is bound to lead to extravagance and over-spending.  It also means that the amount must be spent on the purpose for which it was sanctioned.  Allied to the canon of sanction, there is another, viz., auditing.  A postmodern examination is equally important.  That is, all the public accounts at the end of the year should be properly audited to see that the amounts have not been misappropriated or mis-spent.4. Principle of Balanced Budget: Every government must try to keep its budgets well balanced.  There should be neither ever-recurring surpluses nor deficits in the budgets.  Ever recurring surpluses are not desired because it shows that people are unnecessarily heavily taxed.  If expenditure exceeds revenue every year, then that too is not a healthy sign because this is considered to be the sign of financial weakness of the country.  The government, therefore, must try to live within its own means.5. Canon of Elasticity: Another same principle of public expenditure is that it should be fairly elastic.  It should be possible for public authorities to vary the expenditure according to the needs.  A rigid level of expenditure may prove a source of trouble and embarrassment in bad times.  Alteration in the upward direction is not difficult.  But elasticity is needed most in the downward direction.  It is not so easy to cut down expenditure.  When the economy axe is applied, it is a very painful process.  Retrenchment of a widespread character creates serious social discontent.  Perfect elasticity is out of question.  But a fair degree of elasticity is essential if financial breakdown is to be avoided at the time of shrinking revenue.6. Avoidance of Unhealthy Effects on Production or Distribution: It is also necessary to see that public expenditure exercises a healthy influence both on production and distribution of wealth in the community.  It should stimulate productive activity so that the volume of production in the country increases and it may be possible to raise the standard of living.  But this object of raising of the standard of living of the masses will be served only if wealth is fairly distributed.  If the newly created wealth goes to enrich the already rich, the purpose is not served.  Public expenditure should aim at toning down the inequalities of wealth distribution.  These two objectives may be in conflict when attempts at reducing inequalities of income and wealth distribution adversely affect production.  This it can do by adversely affecting: 

(i)                  power to work and save, and

Page 28: Public Budgeting and Taxtation

(ii)                will to work and savePublic expenditure can also benefit production through diversion of resources from less productive to more productive occupations.As for (i) power to work and save, it may be pointed out that much of the socially desirable public expenditure incurred by modern governments undoubtedly increases the community’s productive power and, consequently, also the power to save.  Such expenditure includes provision of means of communication and transport; education, public health, scientific and industrial research; controlling of human, animal and plant diseases and expenditure on social insurance, like health insurance, unemployment insurance and old age pensions.As for (ii) the will to work and save, much depends on the character of public expenditure and the policy governing it.  By giving the people expectations of future benefits from public expenditure, it may blunt the edge of the desire to work and save.  The granting of old age pensions, insurance against sickness and unemployment and provision of education of state expense must make the people indifferent towards the future and make them neglect savings.  People will work less.  But if such expenditure is kept within proper limits and if it helps the really helpers, the check on savings may be mitigated.  But when taxes are too heavy, the people’s will to work and save may be discouraged and their power to do so reduced.  That limit should not be reached.

Effects of Public Expenditure On Economy Production Distribution

1. Effects on Production

The effect of public expenditure on production can be examined with reference to its effects on ability & willingness to work, save & invest and on diversion of resources.

Ability to work, save and invest : Socially desirable public expenditure increases community's productive capacity. Expenditure on education, health, communication, increases people's productivity at work and therefore their incomes. With rise in income savings also increase and this in turn has a beneficial effect on investment and capital formation.

Willingness to work, save and invest : Public expenditure, sometimes, brings adverse effects on people's willingness to work and save. Government expenditure on social security facilities may bring such unfavourable effects. For e.g. Government spends a considerable portion of its income towards provision of social security benefits such as unemployment allowances old age pension, insurance benefits, sickness benefit, medical benefit, etc. Such benefits reduce the desire to work. In other words they act as disincentive to work.

Effect on allocation of resources among different industries & trade : Many a times the government expenditure proves to be an effective instrument to

Page 29: Public Budgeting and Taxtation

encourage investment on a particular industry. For e.g. If government decides to promote exports, it provides benefits like subsidies, tax benefits to attract investment towards such industry. Similarly government can also promote a particular region by providing various incentives for those who make investment in that region.

2. Effects on Distribution

The primary aim of the government is to maximise social benefit through public expenditure. The objective of maximum social welfare can be achieved only when the inequality of income is removed or minimised. Government expenditure is very useful to fulfill this goal. Government collects excess income of the rich through income tax and sales tax on luxuries. The funds thus mobilised are directed towards welfare programmes to promote the standard of poor and weaker section. Thus public expenditure helps to achieve the objective of equal distribution of income.

Expenditure on social security & subsidies to poor are aimed at increasing their real income & purchasing power. Public expenditure on education, communication, health has a positive impact on productivity of the weaker section of society, thereby increasing their income earning capacity.

3. Effects on Consumption

Public expenditure enables redistribution of income in favour of poor. It improves the capacity of the poor to consume. Thus public expenditure promotes consumption and thereby other economic activities. The government expenditure on welfare programmes like free education, health care and housing certainly

Page 30: Public Budgeting and Taxtation

improves the standard of the poor people. It also promotes their capacity to consume and save.

4. Effects on Economic Stability

Economic instability takes the form of depression, recession and inflation. Public expenditure is used as a mechanism to control instability. The modern economist Keynes advocated public expenditure as a better device to raise effective demand & to get out of depression. Public expenditure is also useful in controlling inflation & deflation. Expansion of Public expenditure during deflation & reduction of public expenditure during inflation control money supply & bring price stability.

5. Effects on Economic Growth

The goals of planning are effectively realised only through government expenditure. The government allocates funds for the growth of various sectors like agriculture, industry, transport, communications, education, energy, health, exports, imports, with a view to achieve impressive growth.

Government expenditure has been very helpful in maintaining balanced economic growth. Government takes keen interest to allocate more resources for development of backward regions. Such efforts reduces regional inequality and promotes balanced economic growth.

Conclusion

Page 31: Public Budgeting and Taxtation

Modern economies have all experienced tremendous growth in public expenditure. So it is absolutely necessary for governments to formulate rational public expenditure policies in order to achieve the desired effects on income, distribution, employment and growth.