Public Finance

Learning Outcomes:

1. Understand the scope of public finance, including government revenue, expenditure, debt, and fiscal policy.
2. Differentiate between earned and unearned public revenue, and identify tax and non-tax revenue sources.
3. Explain the structure and types of taxes, including direct and indirect taxes, their significance, and recent changes.
4. Recognize key components of Goods and Services Tax (GST), its types, and exclusions.
5. Comprehend the objectives and working of the Finance Commission and Union Budget.

Public Finance

Public Finance studies the revenue and expenditure of government activities. It extends beyond income and spending to include public debt, financial administration, and fiscal policy. The core sections are:

1. Public Revenue: Sources of government income.
2. Public Expenditure: Government spending activities.
3. Public Debt: Borrowings by the government.
4. Fiscal Policy: Government policies on taxation, spending, and borrowing.
5. Financial Administration: Procedures for managing government finances.

Public Revenue

Public revenue refers to all income and receipts the government collects through various means, categorized into earned and unearned revenue:

1. Earned Revenue: Includes income from government-owned assets like rent, royalties, and profits from public sector enterprises.
2. Unearned Revenue: Obtained without any obligation to the payee, including taxes, fines, special assessments, escheats, gifts, and grants.

Sources of Public Revenue

These can be divided into tax revenue and non-tax revenue:

Tax Revenue

Tax is a compulsory payment imposed by the government. Types of taxes include:

1. Direct Tax: Borne by the taxpayer, directly impacting them without shifting the burden to others. Examples:

• Personal Income Tax: Levied on individual incomes.
• Corporate Tax: Levied on company profits, a key revenue source for the central government.
• Wealth Tax: Imposed on net wealth to reduce wealth concentration.
• Gift Tax: Levied on donations and gifts exceeding prescribed limits.
• Interest Tax: Charged on bank interest income (currently not applicable in India).

1. Indirect Tax: Impact falls initially on one entity but shifts to another. Examples:

• Central Excise Duties: Imposed on domestically produced goods.
• Value Added Tax (VAT): Multi-point sales tax with a credit mechanism, removing cascading effects.
• Custom Duties: Charged on imported/exported goods.
• Service Tax: Imposed on specified services, recently expanded with economic growth.

Important Note: The Goods and Services Tax (GST), implemented in 2017, unified various indirect taxes under a single tax system.

Indirect Tax: Goods and Services Tax (GST)

GST converts India into a unified market, replacing many indirect taxes. It features a dual tax structure—Central GST (CGST) and State GST (SGST)—and encompasses all goods and services except exempted items. Key features include:

1. Two components: Central GST and State GST.
2. Applicable to most goods and services transactions.
3. Two-rate structure: Lower rate for essential goods; standard rate for general goods.
4. Taxes on imports and services integrated under GST.
5. Administration divided between the central and state governments.

Types of GST

1. Central GST (CGST): Imposed by the central government, consolidating several previous taxes like central excise and service tax.
2. State GST (SGST): Imposed by state governments, including previous taxes like VAT and entertainment tax.
3. Integrated GST (IGST): Imposed on interstate transactions and imports.
4. Union Territory GST (UTGST): Applicable in Union Territories without legislative assemblies.

Important Note: Exclusions from GST include alcohol, real estate, crude oil, and natural gas.

Non-Tax Revenue

Non-tax revenue arises from sources other than taxes, such as fees, fines, licenses, and public enterprises:

1. Fees: Payments for government services, e.g., land registration fees.
2. Licenses and Permits: Payments for permissions granted by the government.
3. Escheats: Income from properties without legal heirs.
4. Special Assessments: Payments by property owners benefiting from government activities.
5. Income from Public Enterprises: Profits from government-owned businesses, like Indian Railways.

Sources of Revenue: Union and States

Union Sources	State Sources
Corporation tax	Capitation tax
Excise duties on specific goods	Excise duties on goods produced in the state
Taxes on income (non-agricultural)	Taxes on agricultural income
Customs duties	Taxes on land and buildings
Property of the union	Land revenue
Public debt	Taxes on mineral rights

Public Expenditure

Public expenditure in India expanded post-independence due to government intervention in economic growth and welfare. Sources of expenditure include:

1. Subsidies: Financial assistance for various sectors.
2. Goods and Services: Costs related to defense, infrastructure, education, etc.
3. Debt Management: Expenditure to manage government borrowings.

Important Concept: Debt Management Strategy includes measures like computerizing the Public Distribution System (PDS) and using the Aadhar system for subsidy transfers.

Finance Commission

As per Article 280 of the Constitution, the Finance Commission is appointed every five years to review the allocation of revenue between the center and states. Its objectives include:

1. Determining tax revenue distribution.
2. Recommending grants to states.
3. Reviewing changes in agreements between central and state governments.

Recent Commissions:

• The 15th Finance Commission, chaired by N.K. Singh, examines the GST’s impact on finances and recommends measures for revenue sharing.
• The 14th Finance Commission, led by Y.V. Reddy, increased the states’ share in central taxes to 42%.

Union Budget

The Union Budget is a comprehensive statement of the government’s finances, detailing revenue and expenditure for the fiscal year. It follows these classifications:

1. Revenue Account: Involves receipts/expenditures that do not create assets or liabilities.
2. Capital Account: Deals with receipts/expenditures from asset liquidation or creation.

Budget Types

1. Zero-Based Budgeting: Resets all allocations to zero annually.
2. Gender Budgeting: Allocates resources considering gender equality.
3. Capital Budgeting: Plans long-term investments in machinery, buildings, and equipment.

Important Note: The Railway Budget was merged with the Union Budget, removing a 92-year-old tradition.

Deficits in Public Finance

Various deficits indicate different fiscal conditions:

1. Revenue Deficit: Difference between revenue receipts and expenditure.
2. Fiscal Deficit: Gap between government earnings and total expenditure.
3. Budget Deficit: Total budgeted receipts minus expenditure.
4. Primary Deficit: Fiscal deficit minus interest payments.

Key Taxation Terms

Term	Description
Tax Haven	Countries with low or no taxes, aiding in revenue loss.
Pigouvian Tax	Tax on negative externalities, e.g., carbon tax.
Tobin Tax	Tax on foreign exchange transactions.
Transfer Pricing	Price setting within divisions of a company.

Important Concept: Fiscal Responsibility and Budget Management (FRBM) Act, 2003 aims to maintain fiscal discipline and consolidate fiscal policy.

Fiscal Policy

Fiscal policy involves government strategies in raising revenue and deciding spending. Its objectives are:

1. Growth Enhancement: Achieved through resource mobilization and efficient allocation.
2. Social Justice: Promoted by direct taxes, welfare spending, and balanced expenditure.

Debt Management

Public debt consists of internal and external borrowings. While necessary for economic activities and smoothing tax rates, excessive debt can create financial burdens and affect private sector funds.

Debt-to-GDP Ratio

The debt-to-GDP ratio measures a country’s ability to repay its debt. High ratios suggest financial distress and risk of default.

Fiscal Imbalance and Deficit Financing

Fiscal imbalance occurs when there’s a revenue-expenditure gap. Deficit financing fills this gap by borrowing, often leading to inflation and interest burdens.

Important Note: The Vijay Kelkar Committee recommended measures to consolidate finances, reduce subsidies, and implement GST.

Actions to Reduce Deficit

• Control new schemes to limit spending.
• Adjust import duties to favor local goods and raise revenue.

Multi-Column Table: Direct vs. Indirect Taxes

Aspect	Direct Tax	Indirect Tax
Burden	On the taxpayer	Shifted to others
Examples	Income tax, Corporate tax	GST, Customs duty
Impact	Reduces income inequality	Affects consumer prices
Taxpayer’s Role	Cannot shift

burden | Shifts burden to consumers |

Concept Note: Advance Pricing Agreement (APA) scheme introduced for resolving international tax disputes, reducing litigation.

Public Debt Necessity

Public debt smoothens tax rates, funds emergencies, and promotes social sector expenditure. However, high debt levels increase interest burdens and reduce private sector funds.

One MCQ with Answer

Q: Which of the following taxes is not subsumed under GST?

1. Central Excise Duty
2. VAT
3. Entertainment Tax
4. Stamp Duty

Answer: 4. Stamp Duty