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Principles of Federal Finance: In the case of federal system of finance, the following main principles must be applied:

1. Principle of Independence. 

2. Principle of Equity. 

3. Principle of Uniformity. 

4. Principle of Adequacy. 

5. Principle of Fiscal Access. 

6. Principle of Integration and coordination. 

7. Principle of Efficiency. 

8. Principle of Administrative Economy. 

9. Principle of Accountability.

1. Principle of Independence: 

(i) Under the system of federal finance, a Government should be autonomous and free about the internal financial matters concerned.

(ii) It means each Government should have separate sources of revenue, authority to levy taxes, to borrow money and to meet the expenditure.

3. The Government should normally enjoy autonomy in fiscal matters.

2. Principle of Equity: From the point of view of equity, the resources should be distributed among the different states so that each state receives a fair share of revenue.

3. Principle of Uniformity: In a federal system, each state should contribute equal tax payments for federal finance.

4. Principle of Adequacy of Resources:

1. The principle of adequacy means that the resources of each Government i.e. Central and State should be adequate to carry out its functions effectively.

2. Here adequacy must be decided with reference to both current as well as future needs. 

3. Besides, the resources should be elastic in order to meet the growing needs and unforeseen expenditure like war, floods etc.

5. Principle of Fiscal Access: 

(i) In a federal system, there should be possibility for the Central and State Governments to develop new source of revenue within their prescribed fields to meet the growing financial needs.

(ii) In nutshell, the resources should grow with the increase in the responsibilities of the . Government.

6. Principle of Integration and coordination:

1. The financial system as a whole should be well integrated. 

2. There should be perfect coordination among different layers of the financial system of the country. 

3. Then only the federal system will survive. 

4. This should be done in such a way to promote the overall economic development of the country.

7. Principle of Efficiency:

1. The financial system should be well organized and efficiently administered. 

2. Double taxation should be avoided.

8. Principle of Administrative Economy:

1. Economy is the important criterion of any federal financial system. 

2. That is, the cost of collection should be at the minimum level and the major portion of revenue should be made available for the other expenditure outlays of the Governments.

9. Principle of Accountability: Each Government should be accountable to its own legislature for its financial decisions i.e. the Central to the Parliament and the State to the Assembly.

(a) Fiscal deficit

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.

(I) Taxation: 

1. Taxes transfer income from the people to the Government. 

2. Taxes are either direct or indirect. 

3. An increase in tax reduces disposable income. 

4. So taxation should be raised to control inflation. 

5. During depression, taxes are to be reduced.

(II) Public Expenditure:

1. Public expenditure raises wages and salaries of the employees and thereby the aggregate demand for goods and services. 

2. Hence public expenditure is raised to fight recession and reduced to control inflation.

(III) Public debt:

1. When Government borrows by floating a loan, there is transfer of funds from the public to the Government. 

2. At the time of interest payment and repayment of public debt, funds are transferred from Government to public.

Primary Deficit: 

1. Primary deficit is equal to fiscal deficit minus interest payments. 

2. It shows the real burden of the government and it does not include the interest burden on loans taken in the past.

3. Thus, primary deficit reflects borrowing requirement of the government exclusive of interest payments. Primary Deficit (PD) = Fiscal deficit (PD) – Interest Payment (IP)

Scope of Public Finance: The subject ‘Public Finance’ includes five major subdivisions, viz., Public Revenue, Public Expenditure, Public Debt, Financial Administration and Fiscal Policy.

(I) Public Revenue: Public revenue deals with the methods of raising public revenue such as tax and non-tax, the principles of taxation, rates of taxation, impact, incidence and shifting of taxes and their effects.

(II) Public Expenditure: This part studies the fundamental principles that govern the Government expenditure, effects of public expenditure and control of public expenditure.

(III) Public Debt: 

1. Public debt deals with the methods of raising loans from internal and external sources. 

2. The burden, effects and redemption of public debt fall under this head.

(IV) Financial Administration:

1. This part deals with the study of the different aspects of public budget. 

2. The budget is the Annual master financial plan of the Government.

3. The various objectives and steps in preparing a public budget, passing or sanctioning, allocation evaluation and auditing fall within financial administration.

(V) Fiscal Policy: Taxes, subsidies, public debt and public expenditure are the instruments of fiscal policy.

(b) Public revenue

(d) Fiscal policy

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.

(I) Sinking Fund:

1. Under this method, the Government establishes a separate fund known as “Sinking Fund”.

2. The Government credits every year a fixed amount of money to this fund. 

3. By the time the debt matures, the fund accumulates enough amount to pay off the principal along with interest. 

4. This method was first introduced in England by Walpol.

(II) Conversion:

1. Conversion of loans is another method of redemption of public debt. 

2. It means that an old loan is converted into a new loan.

3. Under this system a high interest public debt is converted into a low interest public debt. 

4. Dalton felt that debt conversion actually relaxes the debt burden.

(III) Budgetary Surplus:

1. When the Government presents surplus budget, it can be utilised for repaying the debt. 

2. Surplus occurs when public revenue exceeds the public expenditure. 

3. However, this method is rarely possible.

(IV) Terminal Annuity:

1. In this method, Government pays off the public debt on the basis of terminal annuity in equal annual instalments. 

2. This is the easiest way of paying off the public debt.

(V) Repudiation:

1. It is the easiest way for the Government to get rid of the burden of payment of a loan. 

2. In such cases, the Government does not recognise its obligation to repay the loan. 

3. It is certainly not paying off a loan but destroying it. 

4. However, in normal case the Government does not do so; if done it will lose its credibility, (vz) Reduction in Rate of Interest:

5. Another method of debt redemption is the compulsory reduction in the rate of interest, during the time of financial crisis.

(VII) Capital Levy:

1. When the Government imposes levy on the capital assets owned by an individual or any . institution, it is called capital levy. 

2. This levy is imposed on capital assets above a minimum limit on a progressive scale. 

3. The fund so collected can be used by the Government for paying off war time debt obligations. 

4. This is the most controversial method of debt repayment.

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.

(I) Sinking Fund:

1. Under this method, the Government establishes a separate fund known as “Sinking Fund”. 

2. The Government credits every year a fixed amount of money to this fund. 

3. By the time the debt matures, the fund accumulates enough amount to pay off the principal along with interest. 

4. This method was first introduced in England by Walpol.

(II) Conversion:

1. Conversion of loans is another method of redemption of public debt. 

2. It means that an old loan is converted into a new loan. 

3. Under this system’a high interest public debt is converted into a low interest public debt. 

4. Dalton felt that debt conversion actually relaxes the debt burden.

(III) Budgetary Surplus:

1. When the Government presents surplus budget, it can be utilised for repaying the debt. 

2. Surplus occurs when public revenue exceeds the public expenditure. 

3. However, this method is rarely possible.

Public debt deals with the methods of raising loans from Internal and External sources.

Causes for the Increase in Government Expenditure: The modem 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.

(I) Population Growth: 

1. During the past 67 years of planning, the population of India has increased from 36.1 crore in 1951, to 121 crore in 2011.

2. The growth in population requires massive investment in health and education, law and order, etc. 

3. Young population requires increasing expenditure on education & youth services, whereas the aging population requires transfer payments like old age pension, social security & health facilities.

(II) Defence Expenditure:

1. There has been enormous increase in defence expenditure in India during planning period. 

2. The defence expenditure has been increasing tremendously due to modernisation of defence equipment. 

3. The defence expenditure of the government was ? 10,874 crores in 1990-91 which increased significantly to ? 2,95,511 crores in 2018-19.

(III) Government Subsidies: 

1. 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.

2. Because of the massive amounts of subsidies, the public expenditure has increased manifold.

(IV) 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.

(V) Development Projects: 

1. The government has been undertaking various development projects such as irrigation, iron and steel, heavy machinery, power, telecommunications, etc.

2. The development projects involve huge investment.

(VI) Urbanisation: 

1. There has been an increase in urbanization. 

2. In 1950 – 51 about 17% of the population was urban based. 

3. Now the urban population has increased to about 43%. 

4. There are more than 54 cities above one million population.

5. The increase in urbanization requires heavy expenditure on law and order, education and civic amenities.

(VII) Industrialisation: 

1. Setting up of basic and heavy industries involves a huge capital and long gestation period. 

2. It is the government which starts such industries in a planned economy. 

3. The under developed countries need a strong of infrastructure like transport, communication, power, fuel, etc.

(VIII) Increase in grants in aid to state and union territories:

There has been tremendous increase in grant-in-aid to state and union territories to meet natural disasters.

(b) External public debt

(d) Terminal Annuity

(a) Both (i) and (ii) are tme

(d) Fiscal policy – Micro economic policy

(b) A (iii) B (i) C (iv) D (ii)

“Public finance is one of those subjects that lie on the border line between Economics and Politics.

The compulsory charge levied by the government is Tax.

Financial  institutions like UTI, LIC, GIC, etc. also buy the Government bonds. 

(b) Both (i) and (ii) are false

(c) Union budget

(c) Kinds of taxes

(a) Gifts and grants – Non tax Revenue

GST is an Indirect tax levied on the supply of goods and services. 

(c) Public debt

Budget is prepared and submitted Every year.

(b) Indirect Tax

(b) Non – Tax Revenue

Income Tax is an example of Direct Tax.

(c) (i) is true but (ii) is false

(c) Agricultural Income Tax

(b) convenient

(d) Loans from other countries – External revenue

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 taxpayer 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.

(c) Development

GST is equivalence of Sales tax.

(d) Modem state – Technology

(a) Canons of taxation – Adam Smith

According to Adam Smith, there are four canons or maxims of taxation. 

They are as follows: Canons of Taxation:

1. Economical 

2. Equitable

3. Convenient 

4. Certain 

5. (Efficient and Flexible)

1. Canon of Ability: 

1. The Government should impose tax in such a way that the people have to pay taxes according to their ability. 

2. In such case a rich person should pay more tax compared to a middle class person or a poor person.

2. Canon of Certainty: 

1. The Government must ensure that there is no uncertainty regarding the rate of tax or the time of payment. 

2. 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: 

1. The method of tax collection and the timing of the tax payment should suit the convenience of the people. 

2. The Government should make convenient arrangement for all the tax payers to pay the taxes without difficulty.

4. Canon of Economy:

1. The Government has to spend money for collecting taxes, 

for example, salaries are given to the persons who are responsible for collecting taxes. 

2. The taxes, where collection costs are more are considered as bad taxes. 

3. Hence, according to Smith, the Government should impose only those taxes whose collection costs are very less and cheap.

(d) A (iv) B (i) C (ii) D (iii)

(d) All the above

Correct Answer is : (b) ii only

(d) Canon of simplicity

(c) An excess of government’s total expenditure over its total revenue

(a) Social Welfare

“Public finance is one of those subjects that lie on the border line between Economics and Politics. It is concerned with income and expenditure of public authorities and with the adjustment of one to the other”. – Huge Dalton “Public finance is an investigation into the nature and principles of the state revenue and expenditure”. – Adam Smith

Public Revenue: Public revenue deals with the methods of raising public revenue such as tax and non-tax, the principles of taxation, rates of taxation, impact, incidence and shifting of taxes and their effects.

Tax:

• A tax is a compulsory payment made to the government.
• People on whom a tax is imposed must pay the tax.
• There is no quid pro quo between a taxpayer and public authorities. This means that the tax payer cannot claim any specific benefit against the payment of a tax.

Fee:

• Fees are another important source of revenue for the government.
• A fee is charged by public authorities for rendering a service to the citizens.
• The government provides certain services and charges certain fees for them.

For example, fees are charged for issuing of passports, driving licenses, etc.

Zero Base Budget: 

1. The Government of India presented Zero-Base Budgeting (ZBB first) in 1987-88.

2. It involves fresh evaluation of expenditure in the Government budget, assuming it as a new item.

3. The review has been made to provide justification or otherwise for the project as a whole in the light of the socio economic objectives which have been already set up for this project and as well as in view of the priorities of the society.

Direct taxes are progressive i.e. rate of tax varies according to tax base. 

For example, income tax satisfies the canon of equity.

Certainity: Canon of certainty can be ensured by direct taxes. For example, an income tax payer knows when and at what rate he has to pay income tax.