Chapter Eight: Public Finance

It is a body of knowledge that deals with public revenue and public expenditure in achieving
economic objectives

Sources of government revenue

1) Taxes

2) Fines Penalties

3) Profits from public institutions

4) Fees

5) Lisenses

Types of taxes

There are two main kinds of tax:

A direct tax will refer to any levy that is both imposed and collected on a specific group of
people or organizations. An example of direct taxation would be income taxes that are collected
from the people who actually earn their income.

Indirect taxes are collected from someone or some organization other than the person or
entity that would normally be responsible for the taxes. A sales tax, for instance, would not be
considered a direct tax because the money is collected from merchants, not from the people who
actually pay the tax (the consumers)

These can further be classified into the following categories as well:

Payroll Tax:

There are two major types of payroll tax

One which is deducted from the salaries by the employers. This is known as withholding
tax, pay-as-you-go tax, and pay-as-you-earn tax.

Second tax is levied on the funds owned by the employers and is taken for employing the
workers.

Capital Gains Tax:

 In most of the countries the capital gains tax is regarded as part of the income tax.
Normally this tax is levied on capital assets’ sale. The capital assets are ones that cannot
be sold through conventional procedures.

Sales Tax:

Sales tax is charged when a product or service is marketed to a final customer. Retail
companies have often stated that these taxes hamper their activities. Flat rate sales tax is
regarded as regressive because lower income people are affected more.

Estate Tax:

Estate tax is also referred to as inheritance tax and are paid by individuals when they
inherit any property or money. These taxes are calculated on the basis of aggregate value
of the estates’ worth.

Excise Tax:

Excise tax is imposed on the quantity of goods or products bought, as opposed to their
total worth. This makes this tax different from others where the value of the products or
goods forms the basis of tax.

Corporate Tax:

Corporate tax or company tax is imposed in certain countries on certain types of legal
business entities. This tax are also applicable at state levels or other lower levels of
administration.

Gift Tax:

In economic parlance, gift tax is the tax charged on the property or money gifted by one
person to another. This tax is different from the inheritance tax, which is imposed on
property or money inherited after a person’s death.

Transfer Tax:
 The transfer tax is collected on money or property that changes hands from one owner to
another. From a legal point of view, it can be defined as a transfer fee that is collected on
the changing of property titles.

Property Tax:

Property tax is also referred to as millage tax. In economic terms it is defined as an ad

valorem levy which has to be paid by the owner of a property. This tax is charged by
governing authorities of the particular area where the property is located.

Consumption Tax:

Consumption tax is imposed on expenditure for various products and services. Usually
the money spent on buying or using these goods and services, serves as the basis of these
tax.

Toll Tax:

Toll tax is taken for using a road that has been constructed publicly or privately. Roads which
do not take toll tax use other ways of financing their expenses like general tax funds or fuel
tax.

Canons of Taxation

a. Equitable: Equal treatment of similarly situated taxpayers. horizontal equity: all

purchasers of the same equity pay the same tax vertical equity: unequally situated
taxpayers being taxed on their ability to pay as per progressive taxation philosophies. The
cannon of equality arises from the following idea: 'The subjects 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 the state.' This canon embodies the principle of equity or justice
and lays down the moral foundation of the tax system. Thus, tax should in proportion to
the ability to pay.
b. Convenient: A tax that can be readily and easily assessed, collected, and administered.
The cannon of convenience states that 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.

c. Certainty: The consistency & stability in the prediction of taxpayers' bills and the
amount of revenue collected over time. The canon of certainty is highlighted in the
following statement by Smith: "The tax which each individual is bound to pay ought to
be certain, and not arbitrary. The time of payment, the manner of payment, the quantity to
be paid ought all to be clear and plain to the contributor and to every other person. Where
it is otherwise, every person subject to tax is put, more or less, in the power of tax-
gatherer, who can either aggravate the tax upon any obnoxious contributor, or extort, by
the terror of each aggravation, some present or perquisite to himself." Certainty is needed
not only from the point of view of the tax payer but also from that of state.

d. Economical : Compliance and administration of a tax should be minimal in terms of cost.

Finally the cannon of economy dictates that every tax ought to be so contrived as both to
take out and to keep out of the pocket of the people as little as possible, over and above
what it brings into the public treasury of the state.

e. Fiscal adequacy: Tax should have the ability to produce a sufficient and desired amount
of revenue to the taxing authority.

f. Neutrality: Tax should not encourage inefficient allocation of resources by being so

extreme
that taxpayers make counterproductive economic decisions.

Canons of Public Expenditure

a. The Principle of Maximum Social Advantage: The government expenditure should be

incurred in such a way that it should give benefit to the community as a whole. The aim
of the public expenditure is the provision of maximum social advantage. If one section of
the society or one particular group receives benefit of the public expenditure at the
expense of the society as a whole, then that expenditure cannot be justified in any way,
 because it does not result in the greatest good to the public in general. So we can say that
the public, expenditure should secure the maximum social advantage.

b. The Principle of Economy: The principle of economy requires that government should
spend money in such a manner that all wasteful expenditure is avoided. Economy does
not mean miserliness or niggardliness. By economy we mean that public expenditure
should be increased without any extravagance and duplication. If the hard-earned money
of the people, collected through taxes, is thoughtlessly spent, the public expenditure will
not confirm to the cannon of economy.

c. The Principle of Sanction: According to the principle, all public expenditure should be
incurred by getting prior sanction from the competent authority. The sanction is
necessary because it helps in avoiding waste, extravagance, and overlapping of public
money. Moreover, prior approval of the public expenditure makes it easy for the audit
department to scrutinize the different items of expenditure and see whether the money
has not been overspent or misappropriated.

d. The Principle of balanced Budgets: 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.

e. The Principle of Elasticity: The principle of elasticity requires that public expenditure
should not in any way be rigidly fixed for all times. It should be rather fairly elastic. The
public authorities should be in a position to vary the expenditure as the situation
demands. During the period of depression, it should be possible for the government to
increase the expenditure so that economy is lifted from low level of employment. During
boom period, the state should be in a position to curtail the expenditure without causing
any distress to the people.
f. No unhealthy effect on Production and Distribution: The public expenditure should be
arranged in such a way that it should not have adverse effect on production or distribution
of wealth in the country. Public expenditure should aim at stimulating production and
reducing inequalities of wealth distribution. If due to unwise public spending, wealth gets
concentrated in a few hands, then its purpose is not served. The money really goes waste
then.