Diksha Mission Economics No.
1
Public Finance
Public Debt, Fiscal Federalism
PUBLIC DEBT
Why Public Debt
1. Public Debt is used to finance public expenditure when revenue is not enough.
2. Public Debt is also taken to create social overhead capital.
3. It can be beneficial in expanding the education and health services in an economy.
4. It is used to finance the development plans.
Internal Vs External Debt
Internal Debt: It means raising money from within the country. The effect of internal debt simply
leads to the redistribution of money within the economy. There is no extreme impact.
External Debt: It is to be paid back in foreign currency hence it is more harmful for the economy.
It is usually voluntary in nature.
To join Diksha NET JRF Paper 2- Economics Preparation, Send “JOIN” to 7306721731
Productive Vs Unproductive Debt
Productive Debt: The debt is taken for financing the productive motives and therefore it is self-
liquidating. According to Dalton, productive debts are those which are fully covered by assets of
equal or greater value.
Unproductive debt: The debt is unproductive in nature and are not necessarily self- liquidating.
Unproductive debt doesn’t lead to rise in growth rate in future. Therefore, it is more harmful for
the economy.
Short, Medium and Long term Debt
Short term Debt: It matures within 3 to 9 months. The rate of interest is low on such debt.
In India, the most common example of short term debt is the treasury bills (91 days, 182 days, 364
days).
Medium term Debt: Debt taken up to five years. They are usually taken from the market.
Long term Debt: Debt taken for ten or more years. Rate of interest is very high on long term
debt. These type of loans are usually taken to undertake developmental activities.
To join Diksha NET JRF Paper 2- Economics Preparation, Send “JOIN” to 7306721731
Redeemable Vs Irredeemable Debt
Redeemable Debt: It is the debt which the government promises to pay off at some future pre-
decided date. Under this, interest and principle amount both are paid.
Irredeemable Debt: It is also known as “Perpetual Debt”. There is no pre-decided maturity date
for irredeemable debt. Under this regular interest payments are made but doesn’t guarantee
about the principle amount.
Effects of Public Debt
1. On consumption: The consumption is curtailed and hence has harmful consequences like
deterring growth of the economy, etc. It is because people buy securities from their personal
disposable income which reduces the consumption.
2. On Investment: Public debt leaves less finance for appropriate amount of investment activity
to take place. If the government borrows from the central bank of the economy, then the public
debt would not have any effect on the investment levels in the economy. However, if debt is
borrowed from individuals or investment houses, it reduces the investment.
To join Diksha NET JRF Paper 2- Economics Preparation, Send “JOIN” to 7306721731
3. On distribution: Inequalities increase due to public debt. It leads to unjustified transfers and
government’s liquidity increases. For example, if public debt is taken for importing luxuries in the
economy (which poor cannot afford); it will only lead to rise in inequalities.
4. On Private Sector: If the government uses the public debt to purchase goods from the private
sector, it will lead to rise in demand and hence boost the economy.
Public Debt Management
Public Debt Management means managing the debt and repayment of loans in such a way that
such debt should not affect the economic situation of the country in an adverse manner.
Its principles are: 1. Cost of debt servicing should be minimum.
2. Bonds/securities should be on attractive terms.
3. Public debt servicing should be in sync with monetary and fiscal policy.
4. The debt should be repaid as soon as possible.
5. Period of maturity should be wisely chosen.
To join Diksha NET JRF Paper 2- Economics Preparation, Send “JOIN” to 7306721731
Remedies to Manage Public Debt in India
1. Reduction in primary deficit:
The reduction in primary debt should be done in two steps:
1. Slow down the growth rate of debt ratio.
2. Revenue generation should be increased so that the public debt should only be taken
for productive purposes.
2. Reduction in Growth of Current Expenditure:
R.J. Chelliah suggested the following changes in expenditure policy:
1. Reduction in expenditure on the government’s staff.
2. Reduction in subsidies.
3. Liquidation of public debt
4. Reduction in subsidy to public enterprises.
5. Reduction in government civilian employment.
To join Diksha NET JRF Paper 2- Economics Preparation, Send “JOIN” to 7306721731
FISCAL FEDERALISM
Fiscal Federalism implies the division of public sector functions and finances among different
layers or tiers of the government and no layer is completely sovereign.
One way of fiscal federalism is that all matters of regional nature should be given to the
regional/state government.
Fiscal federalism leads to better fiscal discipline and efficiency and avoids double taxation.
Principles of Federal Finance
1. Independence and Responsibility
2. Adequacy and Elasticity
3. Administrative Economy and Efficiency
4. Integration and Co-ordination
5. Accountability
To join Diksha NET JRF Paper 2- Economics Preparation, Send “JOIN” to 7306721731
Forms of Inter-Governmental transfers
1. Supplementary levies:
Principle levy by the Central authority and over and above that the state also levies a
supplementary tax.
2. Grants-in-aid:
Grants given from the centre to the states should be able to fill the gap between revenue and
expenditure of the states to reduce inter-state disparities and to bring about balanced
development.
On the basis of tax collection, there exist three Lists
1. Union List: Powers of Union government/ tax levied by the Centre.
2. State Lists: Powers of the state government/tax levied by the state.
3. Concurrent Lists: Powers with both Centre and states, that is, taxes which are levied by both
centre and states. For example, Education is a part of the concurrent list.
To join Diksha NET JRF Paper 2- Economics Preparation, Send “JOIN” to 7306721731
There are 12 items of taxation under the Union Lists, however revenue from these items do
not go to the Union alone.
Taxes under the Union list are divided into four categories:
1. Taxes levied and collected by the Union and the proceeds of which are retained by the
Union.
• Custom Duty
• Corporation Tax
• Tax on Capital value of assets except agricultural land
2. Taxes levied and collected by the Union and the proceeds of which are shared with the
states in a prescribed manner.
• Taxes on Income other than agricultural income.
• Duties on tobacco and other goods manufactured in India except liquor and narcotics.
• Excise duties
To join Diksha NET JRF Paper 2- Economics Preparation, Send “JOIN” to 7306721731
3. Taxes levied and collected by Union, the proceeds of which go wholly to states
• Terminal Tax, Taxes on railway freight
• Succession and Estate duty one property except agricultural land.
• Taxes on transactions and stock exchanges and futures market.
• Taxes on the sale and purchase of newspapers and advertisements therein.
4. Taxes levied by Union but collected and appropriated by States
• Stamp duty
• Excise duty on medical and toilet preparation (all items containing alcohol).
List I of the Seventh Schedule of the Constitution is the Union List which contains
following items.
1. Income tax, other than agricultural income.
2. Custom duties.
To join Diksha NET JRF Paper 2- Economics Preparation, Send “JOIN” to 7306721731
3. Excise duties except on liquor, alcohol, opium, narcotics.
4. Corporation tax
5. Taxes on Capital value of assets exclusive of agricultural land of individuals and
companies.
6. Terminal taxes on goods and passengers carried by railway, sea, air.
7. Estate duty on property except agricultural land.
8. Succession duty on property other than agricultural land.
9. Taxes other than stamp duties or transactions in stock and futures market.
10. Rates of stamp duty on financial documents.
11. Taxes on sale and purchase of newspapers and advertisements therein.
12. Taxes on sale and purchase of trade in the course of inter-state trade.
List II of the Seventh Schedule gives State Tax
1. Land Revenue
2. Taxes on agricultural income
To join Diksha NET JRF Paper 2- Economics Preparation, Send “JOIN” to 7306721731
3. Succession and Estate duty duties with respect to agricultural land
4. Taxes on entry of goods into a local area. 5. Taxes on land and buildings
6. Taxes on mineral rights
7. Excise duties on Alcoholic, liquor goods for human consumption, Opium, narcotics
8. Tax on consumption and sale of electricity
9. Tax on sale and purchase of goods other than newspapers
10. Tax on motor vehicles, animals and boats 11. Toll taxes
12. Taxes on luxuries including betting, etc. 13. Capitation fee
14. Tax on advertisement other than those in newspapers
15. Stamp duties except those on financial documents.
16. Taxes on goods and passengers carried by board or inland water ways.
17. Taxes on professions , trades, callings and employment.
To join Diksha NET JRF Paper 2- Economics Preparation, Send “JOIN” to 7306721731
Problems in fiscal federalism can be due to following reasons:
1. Horizontal Imbalance: When equals are not treated equally, it leads to horizontal imbalance.
2. Vertical Imbalance: When non-equals are treated equally, it leads to vertical imbalance.
Problems in Fiscal Federalism are as follows:
1. Over dependency of states on centre.
2. State’s taxes are not as buoyant and elastic as compared to the centre’s taxes.
3. Discrimination in giving grants-in-aid.
4. Centre can borrow unlimited amount from RBI unlike the states.
5. Appointment of Finance Commission members is biased towards the centre.
To join Diksha NET JRF Paper 2- Economics Preparation, Send “JOIN” to 7306721731
QUESTIONS FOR THE DAY
To join Diksha NET JRF Paper 2- Economics Preparation, Send “JOIN” to 7306721731
106. If the supply of the commodity is perfectly inelastic and the demand is relatively elastic, the
burden of the tax will be -------------
A) Upon the buyer
B) Upon the seller
C) Equally divided between buyers and sellers
D) In higher proportion upon the sellers than upon the buyers.
107. The modern theory of tax shifting was advanced by
A) Mansfield and Canard B) Hobson and Stein
C) Mrs. Ursula Hicks and Prof Cannon D) E.R.A. Seligman and F.Y. Edgeworth
109. Penalties imposed by the courts for the failure of individuals to appear in courts to complete
contracts as stipulated.
A) Fees B) Escheats C) Fines D) None of these
To join Diksha NET JRF Paper 2- Economics Preparation, Send “JOIN” to 7306721731
115. Free riding means
A) There is incentive to pay for public goods because people can be excluded from consumption
B) There is no incentive to pay for public goods because people cannot be excluded from
consumption
C) There is incentive to pay for private goods because people can be excluded from consumption
D) There is no incentive to pay for private goods because people can be excluded from
consumption
110. Revenue which is derived by the State from eminent domain, penal power and taxing power.
A) Gratuitous Revenue B) Contractual Revenue
C) Compulsory Revenue D) None of these
Answers:-
1) B 2) D 3) D 4) B 5) C
To join Diksha NET JRF Paper 2- Economics Preparation, Send “JOIN” to 7306721731
