PUBLIC FINANCE
Public finance is a study of the financial aspects of Government. It is concerned with
the revenue and expenditure of the public authorities and with adjustment of the one to
the other.
Adam Smith
“Public finance is an investigation into the nature and principles of the state
revenue and expenditure”. Public Finance’ includes five major sub-divisions,
1. Public Revenue
Public revenue deals with the methods of raising public revenue such as tax and nontax, the principles of taxation, rates of taxation, impact, incidence and shifting of
taxes and their effects.
2. Public Expenditure
This part studies the fundamental principles that govern the Government
expenditure, effects of public expenditure and control of public expenditure.
3. Public Debt
Public debt deals with the methods of raising loans from internal and external
sources. The burden, effects and redemption of public debt fall under this head.
4.Financial Administration
Financial administration deals with the study of the different aspects of public
budget. The budget is the Annual master financial plan of the Government. The
various objectives and steps in preparing a public budget, passing or sanctioning,
allocation evaluation and auditing fall within financial administration.
5. Fiscal Policy
Taxes, subsidies, public debt and public expenditure are the instruments of fiscal
policy.
Public finance and Private finance similarities and dissimilarities
Public finance deals with study of income, expenditure, borrowing and financial
administration of the government And Private finance is the study of income,

expenditure, borrowing and financial administration of individual or private
companies.
SIMILARITIES
1. Rationality
Both public finance and private finance are based on rationality. Maximization of
welfare and least cost factor combination underlie both.
2. Limit to borrowing
Both have to apply restraint with regard to borrowing. The Government also cannot
live beyond its means. There is a limit to deficit financing by the state also.
3. Resource utilisation
Both the private and public sectors have limited resources at their disposal. So, both
attempts to make optimum use of resources.
4. Administration
The effectiveness of measures of the Government as well as private depends on the
administrative machinery. If the administrative machinery is inefficient and corrupt
it will result in wastages and losses.
DISSIMILARITIES
1. Income and Expenditure adjustment
The government adjusts the income to the expenditure while individuals adjust their
expenditure to the income. Private finance involves stitching coat according to cloth
available whereas public finance decides the cloth according to the need for the coat.
2. Borrowing
The government can borrow from internal and external sources; it can borrow from
the people by issuing bonds. However, an individual cannot borrow from himself.
3. Right to print currency
The government can print currency. This involves the creation, distribution and
monitoring of currency. The private sector cannot create currency.
4. Present vs Future decisions
The public finance is more involved with future planning and making long-term
decisions. These investments could include building of schools, hospitals and
infrastructure. The private finance makes financial decisions on projects with a
short-term vision.

5. Objective
The public sector’s main objective is to provide social benefit in the economy. The
private sector aims to maximize personal benefit i.e. Profit.
6. Coercion to get revenue
The sources of income of a private individual is relatively limited while those of the
Government is wide. The Government can use its power and authority.
7. Ability to make huge and deliberate changes
The public finance has the ability to make big decisions on income. For example, it
can effectively and deliberately adjust the revenue. But individuals cannot make
such massive decisions.
Public Revenue
The Government has to perform several functions for the welfare of the people. They
involve substantial amount of public expenditure which can be financed only through
public revenue. The amount of public revenue to be raised depends on the necessity of
public expenditure and the people’s ability to pay. The income of the government
through all sources is called public income or public revenue.
SOURCES OF PUBLIC REVENUE
Public revenue can be classified into two types.
1. Tax revenue
2. Non tax revenue
TAX REVENUE
A Tax is a compulsory contribution imposed by 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.
Characteristics of Tax
1. A tax is a compulsory payment made to the government. People on whom a tax is
imposed must pay the tax. Refusal to pay the tax is a punishable offence.
2. There is no quid pro quo between a tax payer and public authorities. This means
that the tax payer cannot claim any specific benefit against the payment of a tax.
3. Every tax involves some sacrifice on part of the tax payer.

4. A tax is not levied as a fine or penalty for breaking law.
Some of the tax revenue sources are
1. Income tax
Tax on personal income of the individuals, Hindu undivided family, partnership
firm.
2. Corporate tax
Levied on company profit income also called income tax.
3. Customs and excise duty
Tax on export and import of commodities & tax on production of commodities.
4.Surcharge
Surcharge is an additional charge or tax levied on an existing tax. Unlike a cess,
which is meant to raise revenue for a temporary need, surcharge is usually
permanent in nature. It is levied as a percentage on the income tax payable as per
normal rates.
5. Cess
A cess imposed by the central government is a tax on tax, levied by the government
for a specific purpose. Generally, cess is expected to be levied till the time the
government gets enough money for that purpose.
NON-TAX REVENUE
The revenue obtained by the government from sources other than tax is called Non-Tax
Revenue.
The sources of non-tax revenue are
1. Fees
Fees are another important source of revenue for the government. A fee is charged by
public authorities for rendering a service to the citizens. Unlike tax, there is no
compulsion involved in case of fees. The government provides certain services and
charges certain fees for them. For example, fees are charged for issuing of passports,
driving licenses, etc.
2. Fine
A fine is a penalty imposed on an individual for violation of law. For example, violation
of traffic rules, payment of income tax after the stipulated time etc.

3. Earnings from Public Enterprises
The Government also gets revenue by way of surplus from public enterprises. Some of
the public sector enterprises do make a good amount of profits. The profits or
dividends which the government gets can be utilized for public expenditure.
4.Special assessment of betterment levy
It is a kind of special charge levied on certain members of the community who are
beneficiaries of certain government activities or public projects. For example, due to a
public park or due to the construction of a road, people in that locality may experience
an appreciation in the value of their property or land.
5. Gifts, Grants and Aids
A grant from one government to another is an important source of revenue in the
modern days. The government at the Centre provides grants to State governments and
the State governments provide grants to the local government to carry out their
functions. Grants from foreign countries are known as Foreign Aid. Developing
countries receive military aid, food aid, technological aid, etc. from other countries.
6.Escheats
It refers to the claim of the state to the property of persons who die without legal heirs
or documented will.
CANONS OF TAXATION
The characteristics or qualities which a good tax should possess are described as
canons of taxation. It must be noted that canons refer to the qualities of an isolated tax
and not to the tax system as a whole. A good tax system should have a proper
combination of all kinds of taxes having different canons.
According to Adam Smith, there are four canons or maxims of taxation.
They are as follows:
1. Canon of Ability
The Government should impose tax in such a way that the people have to pay taxes
according to their ability. In such case a rich person should pay more tax compared to a
middle-class person or a poor person.

2. Canon of Certainty
The Government must ensure that there is no uncertainty regarding the rate of tax or
the time of payment. If the Government collects taxes arbitrarily, then these will
adversely affect the efficiency of the people and their working ability too.
3. Canon of Convenience
The method of tax collection and the timing of the tax payment should suit the
convenience of the people. The Government should make convenient arrangement for
all the tax payers to pay the taxes without difficulty.
4. Canon of Economy
The Government has to spend money for collecting taxes, for example, salaries are
given to the persons who are responsible for collecting taxes. The taxes, where
collection costs are more are considered as bad taxes. Hence, according to Smith, the
Government should impose only those taxes whose collection costs are very less and
cheap.
DIRECT TAX AND INDIRECT TAX
Comparison Chart
Basis for
Comparison
Direct Tax Indirect Tax
Meaning Direct tax is referred to as
the tax, levied on person’s
income and wealth and is
paid directly to the
government.
Indirect Tax is referred to
as the tax, levied on a
person who consumes the
goods and services and is
paid indirectly to the
government.
Nature Progressive Regressive
Incidence and Impact Falls on the same person. Falls on different persons.
Tax base Income or wealth of the
assess
Purchase/sale/manufacture
of goods and provision of
services
Evasion Tax evasion is possible. Tax evasion is hardly
possible because it is
included in the price of the

goods and services.
Inflation Direct tax helps in
controlling the inflation.
Indirect taxes push up price
inflation.
Imposition and
collection
Imposed on and collected
from assesses, i.e. Individual,
HUF (Hindu Undivided
Family), Company, Firm etc.
Imposed on and collected
from consumers of goods
and services but paid and
deposited by the assess.
Burden Cannot be shifted. Can be shifted
GST (Goods and Service Tax)
GST is an Indirect Tax which has replaced many Indirect Taxes in India. The Goods
and Service Tax Act was passed in the Parliament on 29th March 2017. The Act came
into effect on 1st July 2017; Goods & Services Tax in India is a comprehensive, multistage, destination-based tax that is levied on every value addition. Goods and Service
Tax (GST) is an indirect tax levied on the supply of goods and services. GST is one
indirect tax for the entire country. Under the GST regime, the tax will be levied at the
final point of sale. In case of intra-state sales, Central GST and State GST will be
charged. Inter-state sales will be chargeable to Integrated GST. The first state ratified
the GST is Assam and First state to pass the state GST bill is Telangana.
Destination Based
Consider goods manufactured in Tamil Nadu and are sold to the final consumer in
Karnataka. Since Goods & Service Tax is levied at the point of consumption, in this
case, Karnataka, the entire tax revenue will go to Karnataka and not Tamil Nadu.
Tax slab
Tax slabs are 0%,5%,12%,18%,28%
Components of GST
The component of GST is of 3 types. They are: CGST, SGST & IGST.
CGST: Collected by the Central Government on an intra-state sale (E.g. Within state/
union territory)
SGST: Collected by the State Government on an intra-state sale (E.g. Within state/
union territory)
IGST: Collected by the Central Government for inter-state sale (E.g. Maharashtra to
Tamil Nadu)

In most cases, the tax structure under the new regime will be as follows:
Transaction New
Regime
Old Regime
Sale within the
State
CGST + SGST VAT + Central
Excise/Service tax
Revenue will be shared
equally between the Centre
and the State
Sale to another
State
IGST Central Sales Tax
+ Excise/Service
Tax
There will only be one type
of tax (central) in case of
inter-state sales. The
Centre will then share the
IGST revenue based on the
destination of goods.
Nature of Sales tax, VAT and GST
1. Sales tax was multipoint tax with cascading effect.
2. VAT was multipoint tax without cascading effect.
3. GST is one-point tax without cascading effect.
Composition scheme
The composition scheme is an alternative method of tax levy under GST designed to
simplify compliance and reduce compliance costs for small taxpayers. The main feature
of this scheme is that the business or person who has opted to pay tax under this
scheme can pay tax at a flat percentage of turnover every quarter, instead of paying tax
at normal rate every month.
Applicable limit:
1. The manufacturers or traders whose taxable business turnover is up to ₹1.5
crore (₹75 lakh in case of North-Eastern States). The applicable tax rates under
the composition scheme are 1 per cent (0.5 per cent Central GST and 0.5 per
cent State GST) of turnover in case of manufacturers and traders.
2. A service provider can opt for the scheme if his taxable turnover is up to ₹50
lakh. But there are strings attached. The applicable tax rates under composition
scheme are 5 per cent in the case of restaurants (not serving alcohol) and 6 per
cent for other service providers. The tax is to be paid from tax payer’s own
pocket without charging it to the customer.

Not applicable:
1. Businesses with inter-State supplies.
2. Manufacturers of ice cream.
3. Pan masala and tobacco.
4. e-commerce players
Advantages of GST
1. GST will mainly remove the cascading effect on the sale of goods and services.
Removal of cascading effect will directly impact the cost of goods. Since tax on
tax is eliminated in this regime, the cost of goods decreases.
2. GST is also mainly technologically driven. All activities like registration, return
filing, application for refund and response to notice need to be done online on
the GST Portal. This will speed up the processes.
Disadvantages of GST
1. Increased costs due to software purchase
2. Being GST-compliant
3. GST will mean an increase in operational costs
4. GST came into effect in the middle of the financial year
5. GST is an online taxation system
6. SMEs will have a higher tax burden
PUBLIC EXPENDITURE
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”.
Causes for the Increase in Government Expenditure
The modern state is a welfare state. In a welfare state, the government has to perform
several functions viz Social, economic and political. These activities are the cause for
increasing public expenditure.
1. Population Growth
During the past 67 years of planning, the population of India has increased from 36.1
crore in 1951, to 121 crore in 2011. The growth in population requires massive
investment in health and education, law and order, etc. Young population requires

increasing expenditure on education & youth services, whereas the aging population
requires transfer payments like old age pension, social security & health facilities.
2. Defence Expenditure
There has been enormous increase in defence expenditure in India during planning
period. The defence expenditure has been increasing tremendously due to
modernisation of defence equipment. The defence expenditure of the government
was 10,874 crores in 1990-91 which increased significantly to 2,95,511 crores in
2018-19.
3. Government Subsidies
The Government of India has been providing subsidies on a number of items such as
food, fertilizers, interest on priority sector lending, exports, education, etc. Because
of the massive amounts of subsidies, the public expenditure has increased manifold.
The expenditure on subsidies by central government in 1990-91 was 9581 crores
which increased significantly to 2, 29,715.67 crores in 2018-19. Besides this, the
corporate sectors also receive subsidies (incentives) of more than 5 lakh crores.
4. Debt Servicing
The government has been borrowing heavily both from the internal and external
sources, as a result, the government has to make huge amounts of repayment
towards debt servicing. The interest payment of the central government has
increased from 21,500 crores in 1990-91 to 5, 75,794 crores in 2018-19.
5. Development Projects
The government has been undertaking various development projects such as
irrigation, iron and steel, heavy machinery, power, telecommunications, etc. The
development projects involve huge investment.
PUBLIC DEBT
The debt is the form of promises by the Treasury to pay to the holders of these
promises a principal sum and in most instances interest on the principal. Borrowing is
resorted to in order to provide funds for financing a current deficit.

Types of Public Debt
1. Internal public debt
An internal public debt is a loan taken by the Government from the citizens or from
different institutions within the country. An internal public debt only involves transfer
of wealth.
The main sources of internal public debt are as follows:
1. Individuals, who purchase government bonds and securities;
2. Banks, both private and public, buy bonds from the Government.
3. Non-financial institutions like UTI, LIC, GIC etc. also buy the Government
bonds.
4. Central Bank can lend the Government in the form of money supply. The Central
Bank can also issue money to meet the expenditures of the Government.
2. External public debt
When a loan is taken from abroad or from an international organisation it is called
external public debt. The main sources of External public debt are IMF, World Bank,
IDA and ADB etc. Loan from other countries and the Governments.
Causes for the Increase in Public debt
The causes for enormous growth of public debt may be studied under the following
sub-headings:
1. War and Preparation of war
Waging war has become one of the important causes for incurring debts by the
governments. In modern times, the preparation for war and nuclear defence
programmes take away the major share of the government’s revenue and so it incurs
debt.
2. Social obligations
Modern states are considered to be ‘Welfare States’ and they have to undertake
many social obligations like public health, sanitation, education, insurance,
transport and communications, etc., besides providing the minimum necessaries of
life to the citizen of the country. To finance this the state has incur heavy debt.

3. Economic development and deficit
The government has to undertake many projects for economic development of the
country. Construction of railways, power projects, irrigation projects, heavy
industries etc., could be thought of only by means of mobilising resources in the
public debt. Due to heavy public expenditure, the government always face deficit
budget. Such a deficit has to be financed only thorough borrowings.
4. Employment
Most of the governments of modern days face problem of unemployment and it has
become the duty to solve this by making huge expenditure. To solve the
unemployment problem, and to fight recession, the government has to make huge
expenditures. For this the states have to resort to public debt.
5. Controlling inflation
The Government can withdraw excess money from circulation, by raising public debt
and thus prevent prices from rising.
6.Fighting depression
During the depression phase, private investment is lacking. The Government applies
compensatory public spending by borrowing from internal and external sources.
Methods of Redemption of Public Debt
The process of repaying a public debt is called redemption. The Government sells
securities to the public and at the time of maturity, the person who holds the security
surrenders it to the Government. The following methods are adopted for debt
redemption.
1. Sinking Fund
Under this method, the Government establishes a separate fund known as “Sinking
Fund”. The Government credits every year a fixed amount of money to this fund. By
the time the debt matures, the fund accumulates enough amount to pay off the
principal along with interest.
2. Conversion
Conversion of loans is another method of redemption of public debt. It means that
an old loan is converted into a new loan. Under this system a high interest public

debt is converted into a low interest public debt. The debt conversion actually relaxes
the debt burden.
3. Budgetary Surplus
When the Government presents surplus budget, it can be utilised for repaying the
debt. Surplus occurs when public revenue exceeds the public expenditure. However,
this method is rarely possible.
4.Terminal Annuity
In this method, Government pays off the public debt on the basis of terminal annuity
in equal annual instalments. This is the easiest way of paying off the public debt.
5. Repudiation
It is the easiest way for the Government to get rid of the burden of payment of a loan.
In such cases, the Government does not recognise its obligation to repay the loan. It
is certainly not paying off a loan but destroying it. However, in normal case the
Government does not do so; if done it will lose its credibility.
FINANCE COMMISSION
Finance commission is a quasi-judicial body set up under Article 280 of the Indian
Constitution. It was established in the year 1951, to define the fiscal relationship
framework between the Centre and the state.
Aim
Finance Commission aims to reduce the fiscal imbalances between the centre and the
states (Vertical imbalance) and also between the states (horizontal imbalance). It
promotes inclusiveness.
Composition
The Finance Commission consists of a chairman and four other members to be
appointed by the president. They hold office for such period as specified by the
president in his order. They are eligible for re-appointment. The Parliament has
specified the qualifications of the chairman and members of the commission. The
chairman should be a person having experience in public affairs and the four other
members should be selected from amongst the following:

1. A judge of high court or one qualified to be appointed as one.
2. A person who has specialised knowledge of finance and accounts of the
government.
3. A person who has wide experience in financial matters and in administration.
4. A person who has special knowledge of economics.
A Finance Commission is set up once in every 5 years. It is normally constituted two
years before the period. It is a temporary Body.
The 14th Finance Commission was set up in 2013. Its recommendations were valid for
the period from 1st April 2015 to 31st March 2020.
The 15th Finance Commission has been set up in November 2017. Its recommendations
will be implemented starting 1 April 2020.
Finance
Commission
Year of
establishment
Chairman Operational
duration
First 1951 K. C. Neogy 1952–57
Second 1956 K. Santhanam 1957–62
Third 1960 A. K. Chanda 1962–66
Fourth 1964 P. V. Rajamannar 1966–69
Fifth 1968 Mahaveer Tyagi 1969–74
Sixth 1972 K. Brahmananda
Reddy
1974–79
Seventh 1977 J. M. Shelat 1979–84
Eighth 1983 Y. B. Chavan 1984–89
Ninth 1987 N. K. P. Salve 1989–95
Tenth 1992 K. C. Pant 1995–2000
Eleventh 1998 A. M. Khusro 2000–05
Twelfth 2002 C. Rangarajan 2005–10
Thirteenth 2007 Dr. Vijay L. Kelkar 2010–15
Fourteenth 2013 Dr. Y. V Reddy 2015–20
Fifteenth 2017 N. K. Singh 2020–25

Functions of Finance Commission of India
Article 280 (3) speaks about the functions of the Finance Commission. The Article
states that it shall be the duty of the Commission to make the recommendations to the
President as to:
1. The distribution between the Union and the States of the net proceeds of taxes,
which may be divided between them and the allocation among the states of the
respective shares of such proceeds.
2. To determine the quantum of grants-in-aid to be given by the Centre to states
[Article 275 (1)] and to evolve the principles governing the eligibility of the state
for such grant-in-aid.
3. Any other matter referred to the Commission by the President of India in the
interest of sound finance. Several issues like debt relief, financing of calamity
relief of states, additional excise duties, etc. have been referred to the Commission
invoking this clause.
FISCAL POLICY
The term fiscal policy refers to a policy under which the Government uses its
expenditure and revenue programmes to produce desirable effects and avoid
undesirable effects on the national income, production and employment.
Fiscal Instruments
Fiscal Policy is implemented through fiscal instruments also called ‘fiscal tools’ or fiscal
levers: Government expenditure, taxation and borrowing are the fiscal tools.
1. Taxation:
Taxes transfer income from the people to the Government. Taxes are either direct or
indirect. An increase in tax reduces disposable income. So, taxation should be raised
to control inflation. During depression, taxes are to be reduced.
2. Public Expenditure:
Public expenditure raises wages and salaries of the employees and thereby the
aggregate demand for goods and services. Hence public expenditure is raised to fight
recession and reduced to control inflation.

3. Public debt:
When Government borrows by floating a loan, there is transfer of funds from the
public to the Government. At the time of interest payment and repayment of public
debt, funds are transferred from Government to public.
Objectives of Fiscal Policy:
The Fiscal Policy is useful to achieve the following objectives:
1. Full Employment
Full Employment is the common objective of fiscal policy in both developed and
developing countries. Public expenditure on social overheads help to create
employment opportunities. In India, public expenditure on rural employment
programmes like MGNREGS is aimed at employment generation.
2. Price Stability
Price instability is caused by mismatch between aggregate demand and aggregate
supply. Inflation is due to excess demand for goods. If excess demand is caused by
Government expenditure in excess of real output, the most effective measure is to
cut down public expenditure. Taxation of income is the best measure if excess
demand is due to private spending. Taxation reduces disposable income and so
aggregate demand. To fight depression, the Government needs to increase its
spending and reduce taxation.
3. Economic Growth
Fiscal Policy is used to increase the productive capacity of the economy. Tax is to be
used as an instrument for encouraging investment. Tax holidays and tax rebates for
new industries stimulate investment. Public sector investments are to be increased
to fill the gap left by private investment. When resource mobilization through tax
measures is inadequate, the Government resorts to borrowing both from internal
and external sources to finance growth projects.
4. Equitable distribution
Progressive rates in taxation help to reduce the gap between rich and poor. Similarly,
progressive rates in public expenditure through welfare schemes such as free
education, noon meal for school children and subsidies promote the living standard
of poor people.

5. Exchange Stability
Fluctuations in international trade cause movements in exchange rate. Tax
concessions and subsidy to export oriented units help to boost exports. Customs
duties on import of non-essential items help to cut import bill. The reduction in
import duty on import of raw material and machinery enables reduction in cost and
make the exports competitive.
Questions:
1. Define Public finance. Explain the sources of revenues briefly.
2. Describes the difference between direct and indirect taxes.
3. Brief notes about GST
4. What is public expenditure? Gives details about classification of public
expenditure.
5. What is public debt? Causes for public debt and measures of redemption of
public debt.
6. State and explain instruments and objectives of fiscal policy.