CHAPTER I INTRODUCTION

Transcription

1 CHAPTER I INTRODUCTION The study of public finance is concerned with the revenue expenditure process of a government. In India, since Independence, there has been a sustained and significant expansion in the budgetary operations of the government at the Centre and in those of the different States, reflecting the increasing involvement of the governments in diverse, regulatory, welfare and investment activities. 1 In general, public finance deals with the collective wants of the people and satisfaction of these wants. Collective wants are satisfied by social goods. Social goods have some characteristics. No individual can be excluded from utilising the benefit of social goods the so called exclusion principle does not apply to social goods. Examples of such benefits are health, public education, defence, power, transportation and similar things. The basic principle behind public finance is providing maximum social advantage or maximum social welfare. The principle includes two aspects: (i) Public expenditure should be incurred in such a way that the marginal utility from all is equal, and (ii) public expenditure should be incurred at the point where the 1 Madras Institute of Development Studies, Tamil Nadu Economy Performance and Issues, Oxford and IBH Publishing Co., Pvt. Ltd., New Delhi, 1988, p. 301.

2 2 marginal social benefit derived from the last rupee spent is equal to the marginal sacrifice of the last rupee collected by taxation. 2 The government revenue and expenditure programmes have some influence upon the level of national income. The net effect is likely to be expansionary. This recognition has led to the realization of the possibility of making deliberate adjustment in revenue and expenditure to forward the aims of economic policy under which the government uses its expenditure and revenue programme to produce desirable effects and avoid undesirable effects on national income, production, distribution and employment. Fiscal policy may be defined as the policy of the government to achieve and maintain the objective of stability, full employment and growth. The fiscal agents are taxes, government spending and public debt. In other words, fiscal policy operates through both taxation and expenditure programmes of the government. Obviously fiscal policy is fundamentally concerned with the aggregate effects of public expenditure, taxation on income, output and employment. 3 2 S.K. Singh, Public Finance in Developed and Developing Countries, Sultan Chand Companies, New Delhi, 1991, pp K.P.M. Sundaram and K. Andley, Public Finance, Theory and Practice, S. Chand & Company Ltd., New Delhi, 2001, p. 266.

3 3 In developed countries, the taxation policy is used to achieve a three fold objective of resource allocation, income redistribution and economic stabilisation. The principal objective of taxation policy in a developing country is to augment adequate revenues for sustaining and toning up the capital formation of the country. This has been particularly the case in India. Since the inception of economic planning, the taxation policy has been geared to mobilise resources to finance the increasing revenue requirements of the successive five year plans. 4 Tax Revenue It is the most important source of revenue and different writers have placed it under different classes and have called it with different names. Prof. Adam Smith speaks of the source as Revenue from the People. Contemporary writers speak of it as that taking of the revenue from the society by the power of sovereign, Prof. Adams calls it derivative revenue. Taxes are the dues that the citizens of a nation pay for the privileges of membership in an organized society. Taxation is the process of securing funds compulsorily from the public to meet government expenditure without any direct tax payer and the public authority. By taxation, internal resources are canalized from the 4 M.Q. Dalvi and M.M. Ansari, Measuring Fiscal Performance of the Central and the State Governments in India: A Study in Resource Mobilisation, Indian Economic Journal, Vol. 33, No. 4, 1985, p. 106.

4 4 private and uneconomic avenues of expenditure into more productive channels of the economy. 5 The science and art of creating the tax structure involves choice of tax bases, determination of tax rates and other elements of tax structure such as exemptions and deductions to make the tax structure serve the objectives of the government. A good tax system must bring in adequate revenue, reduce the inequalities, mitigate the economic fluctuations, impose minimal restraints on the development and trade and involve minimum waste and inconvenience for both the tax payers and the government. The most common method of financing government activities is by taking resort to the fruitful device of taxation. In every country, the largest part of the public revenue is raised through taxation. Taxes may be imposed on person s wealth, they may be direct or indirect and they may be of different rates and nature. According to 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 a penalty for any legal offence. 6 5 Raja J. Chelliah, Trends in Taxation in Developing Countries, International Monetary Fund Staff Papers, Vol. 18, July 1991, p M.C. Vaish and H.S. Agarwal, Public Finance, Somaiya Publishers Pvt. Ltd., New Delhi, 1985, p. 171.

5 5 In a developing country like India, taxation for economic development should aim at fully mobilizing the available resources. Tax collections represent collective savings of the economy. Where private savings are inadequate, it becomes necessary to rely more and more on collective savings. But care has to be taken to ensure that increased taxation does not affect the incentive of capital accumulation and business investment. 7 In the Indian fiscal system the Centre enjoys more powers in levying taxes than the States. It has many elastic sources of revenue. It has a wide national tax base. The important Central taxes are income tax, corporate tax, wealth tax, customs duties and excise duties. Role of Taxation in India Taxation can be a powerful engine of forced savings in India. Taxation may be used to achieve the following objectives: (i) To curtail consumption and, thus transfer resources from consumption to investment; (ii) (iii) To increase the incentives to save and invest; To transfer the resources from the hands of public to the hands of the government in order to make public investment possible; 7 James Cult and Jakation, Economic Development in India, Allied Publishers Pvt. Ltd., Calcutta, 1999, p. 338.

6 6 (iv) (v) To modify the pattern of investment into socially desirable manner; To reduce economic inequalities; and to make equitable distribution of incomes and wealth in the society; (vi) To mobilize economic surplus; and to increase national output and income. Public Expenditure and Economic Life Public expenditure has been increasingly done in recent times with the aim of influencing the economic life of a nation. The total amount of governmental expenditure, and the amounts spent on various heads and in various localities influence production. In fact, the government can bring about desired changes in these spheres through public expenditure. It must be remembered that the public expenditure policy of a government is only one part of its total economic policy and the other step is taxation. The total effects of the activities of the government can only be seen when all these aspects are considered together. In particular, the economic effects of expenditure cannot be fully judged unless we know how the money has been obtained from various types of taxes, loans or by the issue of paper money. It may be convenient, however, for the purpose of this study to treat them separately, though we must remember that they are closely inter-related and must always try to co-ordinate their results whenever possible.

7 7 Role of Public Expenditure in India The underdeveloped and the developing countries like India suffer from many deficiencies. The economy in them operates at less than full employment. Hence there are idle productive resources and manpower. Productivity is low not only because of poor allocation of resources but also because of low efficiency of labour due to poor education and poor health. Due to this, people earn less and consume less. Savings and investments are naturally inadequate and hence economic growth suffers. Development is largely lop-sided. Inequality of income and wealth is wide and the regional disparity is vast. All these contribute to widespread poverty and poor standard of living. Under such an economy, public expenditure has a larger role to play in the underdeveloped countries than in advanced economy. Public expenditure in India is broadly categorized as revenue and capital expenditure. However, the important heads of revenue expenditure are defence, interest payments and subsidies. The components of capital expenditure, are loans and advances and capital outlay. Public expenditure plays a vital role in the economy to provide public goods of high positive externalities. The expenditure policies have repercussions in terms of their effect, on the level and the composition of aggregate demand in the economy,

8 8 the taxation of the household and corporate sectors and on the growth of the real income. Public expenditure also affects the distribution of income between various social groups in the form of transfer payments and provision for social services. The market economy does not take care of providing goods characterized by non-rivalry and non-exclusion, but the non-availability of these goods leads to bottlenecks in the supply of factors of production, both human and capital. Public expenditure caters to 40 per cent of total demand for core and basic industries in India. So it acts as a significant factor from both demand and supply side of the economy. The objectives of fiscal policy are stabilisation of economic activity, efficient allocation of resources, equitable distribution of income and promotion of economic growth. Public expenditure is one of the most important fiscal tools to achieve these macro economic objectives. Increasing public expenditure, productivity can yield large returns in terms of budgetary savings, increased positive externalities and efficiency. After liberalization, when fiscal consolidations are of utmost importance in fiscal policy, expenditure cuts need to emphasise the protection of key public investment programmes. In particular those aimed at growth as well as social expenditure targeted at the poor budgetary support to public sector undertakings

9 9 (PSUs) which are not cost effective and supporting large employees, facilitate the emergence of unproductive expenditures but their removal may be far from easy for political reasons. It is, therefore, much more difficult politically to reduce over employment in the public sector than to reduce spending on text books or hospital supplies. In India, institutions promoting good governance and well-informed public may help to put-forth appropriate public expenditure priorities. This can be achieved by fostering public participation in the assessment of alternative goals and the exploration of cost-effective strategies. It can also help to maintain accountability of the government. Under the Indian fiscal system, the budget of the Indian Government is a statement of its estimated receipts and expenditure for a given period of time and is called Annual Financial Statement. The receipts and payments are divided into three parts, namely, i) Consolidated Fund of India, ii) iii) Contingency Fund of India, and Public Account Fund of India. All tax and non-tax receipts, recoveries of outstanding loans granted by it and fresh borrowings which belong to the Government of India go to the Consolidated

10 10 Fund. Similarly, the Contingency Fund is an imprest placed at the disposal of the President to meet urgent and unforseen expenditure, pending authorisation from the Parliament. In the same way, there are several transactions which enter into government accounts in respect of which the government acts more as a banker. All receipts and payments of this type belong to the Public Account Fund. The study of central finance in the Indian fiscal system assumes importance on various grounds. Firstly, it enables to forecast the ability of the Central Government to raise additional resources through taxation. Secondly, it helps to assess the relation between tax efforts of various Central Government taxes. Thirdly, it may explain the pattern of expenditure of the Central Government on revenue and capital heads. In the above background, the present study aims at analysing the fiscal performance of the Central Government in terms of taxation and expenditure. The fiscal performance of a Central Government refers to the resource mobilisation effort of the Central Government and the collective result of an overall financial prudence of economy of expenditure consistent with efficiency. 8 The government efforts on resource mobilisation and the commitment of the government to the peoples development are reflected in the anlaysis of the tax structure and expenditure pattern. 8 H.L. Bhatia, Tax Devolutions in a Framework of Federal Resource Transfers! The Indian Case, The Indian Economic Journal, Vol. 26, No. 1, July-September, 1978, p. 98.

11 11 So this study tries to analyse the trends and responsiveness of tax system, and the expenditure pattern of the Central Government. This research work addresses also the following vital issues relating to the fiscal performance of the Central Government: (i) Is there any evidence to suggest that the tax system of Central Government has been moving towards progressivity (or becoming less regressive) in the course of economic development? (ii) What is the causal link between the government revenue share in income (T/Y) and economic development (as measured by (Y/N)? An increase in (Y/N) leads to an increase in (T/Y). But what about the impact of an increase in (T/Y) on economic growth? Does it promote or depress economic growth? 1.1. Choice of the Study The study of public finance is acquiring an important place in the modern economic analysis. The functions and responsibilities are changing day by day. The days of Lassiz-faire have gone. In those days, the primary aim of the centre was to raise funds, so as to meet the financial requirements for the maintenance of law and order. It becomes necessary to identify new sources of new taxes. There are many studies on the principles and the manner of distribution of resources between the

12 12 Union and the States, but there are only very limited studies on the intrinsic financial structure of the Central Government and also their position and performance. The present study is an extension in this area of research with an analysis of responsiveness of taxation and expenditure in terms of elasticity and buoyancy coefficients using regression analysis, growth pattern and the determinants of taxes and expenditures during the study period Objectives The major objective of the present work is to analyse the fiscal performance of Central Government in terms of responsiveness of the tax system, its tax efforts and pattern of public expenditure during a period of 20 years, from to The specific objectives of the study are the following. a. To study the trend, pattern and growth performance of various taxes of the Union Government during the period from to , b. To anlayse the responsiveness of the tax system in terms of buoyancy and elasticity coefficients and to study whether the tax system in India has been moving towards progressivity (or becoming less regressive) in the course of economic development, c. To examine the nature of tax efforts undertaken by the Central Government,

13 13 d. To study the growth trends and determinants of various items of Central Government expenditure and determinants of public expenditure, and e. To test the increasing Central Government expenditure by Wagner s Law Hypotheses of the Study While the general hypothesis of improvement in the fiscal performance of the Central Government has been formulated, the following specific hypotheses have been made and tested using relevant statistical tools in this study. 1. There has been a growing trend in the amounts of taxes and expenditure incurred by the Central Government during the period covered by the study. 2. The tax system of the Central Government has been buoyant and elastic due to the discretionary changes made in different individual items of taxes. 3. The fiscal performance of the Central Government in terms of tax effort during the period covered in this study has been improving. 4. The tax system in India is progressive. 5. Wagner s Law of increasing government expenditure operates in India.

14 Limitations of the Study The findings emerging from this study are subject to the following limitations. 1. This study covers only a period of 20 years (from to ). The conclusions arrived at in this study are applicable to this period only. 2. This study is intended to analyse the fiscal performance of the Central Government of India only. No attempt has been taken to make any comparative study with the fiscal performance of other countries. 3. This study covers only some limited aspects of fiscal performances relating to taxation and expenditure. Other aspects such as Centre- State financial relations, non-tax revenue, debt, fiscal deficit, primary deficit, income from public sector undertakings, States overdraft have not been covered by this study. 4. This study, by and large, utilises the time series data on Central Finances, published by the Reserve Bank of India Bulletin for various years. The conclusions arrived at in this study are subject to the veracity and limitations of those data. 5. The statistical tools of regression analysis have been employed for the study for elasticity calculations. The limitations of regression analysis are to be kept in mind while interpreting the conclusions of this study.

15 15 6. The tax and expenditure functions are estimated and analysed by the application of single equation regression technique. Consequently, problems connected with simultaneous equation bias are not dealt with. 7. In this study, the time series data of taxes, and expenditure of the Central Government have been analysed to find the linear trend and compound growth rates only. Various advanced econometric tools of forecasting models of time series analysis have not been attempted in this study. 8. The progressivity of tax system in India has been studied only at the aggregate level, not at the level of individual taxes considering the requirements of enormous data Layout of the Thesis The present thesis has been organised in seven chapters. The first chapter is an introductory one dealing with the importance of fiscal performance of the Central Government, the problem focus, choice of the topic, objectives, hypotheses, limitations and layout of the thesis and a brief profile of the Central Government. The second chapter delineates the fiscal economy of Central Government finance in terms of its revenue and expenditure, both on revenue and capital accounts.

16 16 The third chapter gives an account of a review of related studies and methodology adopted in the present research work. The fourth chapter is concerned with the growth performance of tax system, and it analyses, the responsiveness of the tax system in terms of elasticity and buoyancy coefficients. It also includes a study of progressivity of tax system in India. An analysis of tax effort of the Central Government using six different approaches has been carried out in chapter five. The sixth chapter analyses the trend, the determinants and the responsiveness of expenditure to GDP, both on revenue and capital accounts of the Central Government. It also deals with the testing of Wagner s Law of Public Expenditure. The concluding chapter summarises the findings and salient conclusions emerging from this study.