Module 3: GOVERNMENT

The government plays an important role in the economy through its fiscal policy.
The policy of taxation and public expenditure affects the economic development of the
country. Hence in this module we study the various aspects of role of government in the
economy.

I. Public Goods

Economists have a strict definition of a public good, and it does not necessarily
include all goods financed through taxes. To understand the defining characteristics of a
public good, first consider an ordinary private good, like a piece of pizza. A piece of
pizza can be bought and sold fairly easily because it is a separate and identifiable item.
However, public goods are not separate and identifiable in this way. A public good is one
for which the market mechanism fails, either completely or in part. Since public goods
cannot be provided by the market mechanism it is argued that the government must
provide them. In other words, this example of market failure is corrected by the
government making a direct provision of the good. One role of government is, therefore,
to provide public goods. Public goods are defined as products where, for any given
output, consumption by additional consumers does not reduce the quantity consumed by
existing consumers. There are very few absolutely public goods, but common examples
include law, parks, street-lighting, defence etc. As there is no marginal cost in producing
the public goods, it is generally argued that they must be provided free of charge, because
otherwise the people who benefit less than the cost of using the public good, will not use
it. That will lead to a loss of welfare.

Difference between Private goods and Public goods: Private goods are goods that are
both rivalrous and excludable. This means that consumers compete with each other to
enjoy the benefits of the goods. If someone consumes a good, then another person cannot
have it. An example would be a car. The preferences of consumers for private goods are

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expressed through demand schedules. In other words, for private goods there is a
relationship between the quantity demanded and the price charged. Consequently, the
market mechanism can operate to determine the equilibrium price and quantity. There is
no demand schedule for a pure public good - one that is entirely non-rivalrous and non-
excludable.

Public goods are goods that will either not be supplied by the market or if supplied will
be supplied in insufficient quantity for e.g. defense. Public goods have the following
characteristics or properties:
1) Non Rivalry in Consumption and
2) Non- Excludability.
1) Non-Rivalry in Consumption: This means that additional consumption of the good
does not add anything to the costs of production. It costs nothing for an additional
individual to enjoy their benefits also zero marginal cost for the individual enjoying the
good. For example, an additional pedestrian on a well-lit street does not add to the cost of
providing the street lighting. Other examples are defense, public roads, dam etc. This is
called as principle of non-rivalry in consumption. For allocative efficiency anyone
wishing to consume a good should be able to do so. However, charging for a public good
(in this sense, for a good, like street-lighting that is non-rivalrous) means that some
people wishing to consume that good will not choose or be able to do so. Hence, for
maximum welfare the price of a public good should be zero. This means that public
goods cannot be produced privately, since any profit is incompatible with allocative
efficiency.
2) Non-Excludable: This means that it is not practical to exclude people who do not pay
for a good from the benefit of receiving the good. It is in general difficult to exclude
individuals from enjoying public goods; for example street lighting, defense and clean-
streets. All of these are provided for everyone, and everyone benefits from them
regardless of who pays for it. Also the goods are mostly non-excludable, that means that
if once provided everybody can use them, which when charged will lead to "free-riding".
So these goods will not be provided by free markets as there is no way to charge for the
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usage, the solution is, that state must provide these goods and finance them from taxes
collected from everybody.A free-rider is someone who wants the benefit of a good but is
not prepared to pay for it. Further examples of public goods are law and order, flood
protection, roads, national parks, medical and other research.

Nevertheless it is important to bear in mind that there can be different degrees of public
goods. We can distinguish between pure public goods which are perfectly non-rival and
non-excludable and between impure public goods which are rival and/or excludable to
some extent. While pure public goods perfectly follow the non-rival and non-excludable
condition, impure public goods are rival and/or excludable to some extent. Normally
these goods have to be provided by the public sector as the private sector is not interested
in them due to the lack of profits. National defense, justice and public transportation, are
just some examples. Thus, in the case of public goods, there are two basic forms of
market failure-(a) under supply because the private sector would be unwilling to supply
them and (b) their non-excludability makes them non-marketable, because non-payers
cannot be prevented from enjoying the benefits of consumption, and therefore prices
cannot be attributed to particular consumers. This involves the free-rider problem, which
arises when it is impossible to provide a good or service to some without it automatically
and freely being available to others who do not contribute to its cost.

One must remember that State ownership does not make a good into a public good. For
example, postal services are sometimes owned by the state, but they are private goods, in
the sense of being both rivalrous and excludable.

II. Merit Goods

Merit goods are the opposite of demerit goods - they are goods which are deemed to
be socially desirable, and which are likely to be under-produced and under-
consumed through the market mechanism. Merit goods are those goods and services that
the government feels that people will under consume and which ought to be subsidized or

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provided free at the point of use so that consumption does not depend primarily on the
ability to pay for the good or service. Examples of merit goods include education, health
care, welfare services, housing, fire protection, refuse collection and public parks.

Merit goods have the following characteristics:

1) Net private benefit to the consumer is not fully recognized at the time of consumption
e.g. education, a poor person does not value the gains of education in long run and so will
not seek it. There is significant Information failure in terms of expected benefits.

2) Consumption of merit goods also generates an external benefit to others from which
society gains, this is not known at the point of consumption for e.g. benefits of education,
health care etc. Merit goods and services thus create positive externalities when
consumed and these third party spillover benefits can have a significant effect on social
welfare.

3) Merit goods confer benefits on society in excess of the benefits conferred on individual
consumers; in other words, there is a divergence between private and social costs and
benefits, as the social benefits accruing to society as a whole from the consumption of
such goods tend to be greater than the private benefits to the individual. This divergence
means that the private market cannot be relied upon to ensure an efficient allocation of
society's scarce resources.

4) There is positive marginal cost of supplying to additional users. Thus they are limited
in supply due to potentially high opportunity cost of supply.

5) A merit good is a product that society values and judges that people should have it
regardless of their ability to pay. In this sense the government is acting paternally in
providing these goods. For e.g. health services, public libraries, education, museums,
pensions etc.

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6) Government has to provide these goods to correct market failure for e.g. subsidized
food, low cost housing, mid-day meal, fire protection, refuse collection and public parks.

Merit goods are products generally not distributed by means of the price system, but
based on merit or need, because people although having perfect knowledge would
buy the wrong amount of them. These goods can be supplied by free market, but not on
the right quantity. Merit goods are, for example, education and to some extent the health-
care. They are provided by state as "good for you". The merit goods when provided
privately are usually affordable only to the very rich. As they carry external benefits,
government thinks everybody should have them. For example if one is vaccinated it
benefits the others as it decreases the risk of epidemic diseases, whereas good education
(or investment to human capital) will increase the economic growth and the overall well-
being (the supply-side of labour) later on.In contrast to pure public goods, merit goods
could be, and indeed are, provided through the market, but not necessarily in sufficient
quantities to maximize social welfare. Thus goods such as education and health care are
provided by the state, but there is also a parallel, thriving private sector provision. Indeed,
there is considerable disagreement between economists on the right and left of the
political spectrum over the extent to which such goods should be provided by the state

Activity- Prepare a list of public goods and merit goods from the following list:
Musuems, Electricity, police services, Entertainment parks, Colleges, primary schools,
Highways, Ration shops, Film theatres , Malls, Public Libraries , Cab services, Hospitals,
Vaccination drive, Public parking, Roads, Dams, Sanitation and hygiene facilities,
Railways, Airline services, mobile phones, Public parks.

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III. PUBLIC REVENUE

The government plays a very important role in the circular flow of income in the
economy. It undertakes various kinds of expenditure in the economy which necessitates
generation of revenue to provide for the growing expenditures. Revenue and expenditure
are important aspects of government budget. Unlike individuals budget where income
decides the expenditure, in case of government budget, expenditure is given importance
and according to the expenditure income is arranged for. Hence the revenues of the
government are important.

A. Meaning of Public Revenue

Public revenue implies the income or earning of the public authorities from all the
sources in the economy. According to Dalton, however, the term Public Income has
two senses wide and narrow. In its wider sense it includes all the incomes or receipts
of the Government during a stipulated period i.e. usually one financial year. In its narrow
sense, it includes only those sources of income of the public authority which are
ordinarily known as revenue resources. To avoid ambiguity, thus, the former is termed
public receipts and the latter public revenue. As such, receipts from public
borrowings (or public debt) and from the sale of public assets are mainly excluded from
public revenue. For instance, the budget of the Government of India is classified into
revenue and capital. Public revenue would include taxes, prices of goods and
services supplied by public enterprises, revenue from the administrative activities and
gifts and grants.

I. Sources of Public Revenue: The major sources of public revenue can be classified
into two: (a) Tax and (b) Non-tax sources. Taxes are the single largest source of revenue
for any government.

a) Tax Revenue: A fund raised through the various taxes is referred to as tax revenue. In
any country taxation happens to be the most important and largest source of public
revenue. Taxes are compulsory contributions imposed by the government (central, state
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or local) on its citizens to meet its general expenses incurred for the common good,
without any corresponding benefits to the tax payer. As Taussig puts it, the essence of a
tax, as distinguished from other charges by government, is the absence of a direct quid
pro quo between the tax payer and the public authority. Seligman defines a tax thus: A
tax is a compulsory contribution from the person to the government to defray the
expenses incurred in the common interest of all, without reference to specific benefits
conferred. From these definitions we can outline the following characteristics of taxes:

1. A tax is a compulsory charge imposed by the public authority. A tax is a compulsory

payment to be paid by the citizens who are liable to pay it. Hence, refusal to pay a tax is a
punishable offence.

2. There is no direct, quid pro quo between the tax-payers and the public authority. In
other words, the tax payer cannot claim reciprocal benefits against the taxes paid by him.
However, as Seligman points out, the state has to do something for the community as a
whole for what the tax payers have contributed in the form of taxes. But this reciprocal
obligation on the part of the government is not towards the individual as such, but
towards the individual as part of a greater whole. A tax does not represent a payment for
a specific benefit enjoyed by the taxpayer.

3. A tax is levied to meet public spending incurred by the government in the general
interest of the nation; irrespective of the amount paid by each. There is no relation
between the tax liability of an individual and his share of the collectively provided
services like defense, police, health etc.

4. A tax is payable regularly and periodically as determined by the taxing authority.

5. A tax involves some sacrifice on the part of the taxpayers.

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 Taxes can be classified into two- Direct tax and Indirect tax. Taxes have macro-
economic effects. Taxation can affect the size and mode of consumption, pattern of
production and distribution of income and wealth. Progressive taxes can help in reducing
inequalities of income and wealth. Thus, taxes are used as an important instrument of
achieving socio-economic goals.

b) Non-Tax Revenue: Besides taxes, the other sources of revenue available to the
government are termed as non-tax sources and it includes the following:
(i) Profit from state enterprises (ii) Administrative revenue (iii) Gifts and grants (iv)
Special Assessment (v) Public borrowing and deficit financing.

(i) Profits or Revenue from Public or State Enterprise:

Profits of state undertakings are an important source of revenue owing to the expansion
of the public sector. Certain goods and services like transport, water, electricity etc., are
provided by public enterprises. Prices paid by the public for these goods and services
constitute revenue for the state. For instance, the central government runs railways.
Surplus from railway earnings can be normally contributed to the revenue budget of the
central budget. Likewise, profits from the state transport corporation and other public
undertakings can be important sources of revenue for the budgets of state governments. A
government may also set up certain industries like iron and steel etc. It may also
nationalize private industries for providing certain goods or services to people better than
the private sector. Earnings from state enterprises depend upon the prices charged by
them for their goods and services and the surplus derived from them. Price is the revenue
obtained from business activity undertaken by the public authorities. The prices of these
goods and services may or may not be fixed with reference to the cost involved for the
state or benefit enjoyed by the individuals. Many public enterprises like postal services
run on cost-to-cost basis. The prices are charged just to cover the cost of rendering such
services. However, in certain cases, when the state has an absolute monopoly, prices

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having a high profit element are charged. Such monopoly profits of a state enterprise are
an important source of revenue. For example Hindustan Machine Tools, Bokaro Steel
Plant, State Trading Corporation etc. which makes profits are also a support to the central
budget. The difference between price and fee is this: the former usually can never be less
than the cost of production or service, while the latter may not necessarily cover the cost
of service. Thus, the pricing policy of state undertakings should be self-supporting and
reasonably profit-oriented. Again, prices are charged with an element of quid pro quo i.e.,
directly in proportion to the benefits conferred by the services rendered.

(ii) Administrative Revenues:

Under public administration, public authorities can raise some funds in the form of fees,
fines and penalties, and special assessments.

a. Fees: Fees are charged by the government or public authorities for rendering a service
to the beneficiaries. To quote Seligman, A fee is a payment to defray the cost of each
recurring service undertaken by the government, primarily in the public interest, but
conferring a measurable advantage to the payer. Court fees, passport fees, etc., fall
under this category. Similarly, license fees are charged to confer a permission for
something by the controlling authority, e.g., driving license fee, import license fee, liquor
permit fee, etc. Fees are to be paid by those who receive some special advantages.
Generally the amount of the fee depends upon the cost of services rendered. Fees are a
bye- product of the administrative activities of the government and not a payment for a
business. Sometimes a fee contains an element of tax when it is charged high in order to
bring revenue to the exchequer e.g., a license fee.
b. Fines and Penalties: Fines and penalties are levied and collected from offenders of
laws as punishment. Here the main object is not so much to earn an income as to prevent
the commitment of offences and infringement of laws of the country. Fines and penalties
are arbitrarily determined and have no relation to the cost of administration or activities
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of the government. Hence, collections from such levies are insignificant as a source of
public revenue.

c. Special Assessments: A special assessment, as Seligman points out, is a

compulsory contribution levied in proportion to the social benefits derived to defray the
cost of a specific improvement to property undertaken in the public interest. That is to
say, sometimes when the government undertakes certain types of public improvements
such as construction of roads, provision of drainage, street lighting etc., it may confer a
special benefit to those possessing properties nearby. As a result, values of rents of these
properties may rise. The government, therefore, may impose some special levy to recover
a part of the expenses so incurred. Such special assessment is levied generally in
proportion to the increase in the value of the properties involved. In this respect, it differs
from a tax. In India, these special assessments are referred to as betterment levy.
Betterment levy is imposed on land when its value is enhanced by the construction of
social overhead capital such as roads, drainage, street- lighting, etc. by the public
authority in an area.

iii) Gifts and Grants:

These form generally a very small part of public revenue hence not a significant source.
Quite often, patriotic people or institutions may make gifts to the state. These are purely
voluntary contributions. Gifts can also be made for specific purposes such as relief funds
or defense fund during war time or an emergency like floods, droughts etc. In modern
times, however, grants from one government to another have a greater importance. Local
governments receive grants from state governments and state governments from the
Centre. The central government gives grants- in-aid to state governments in order to
enable them to carry out certain specific activity such as highway or power plant or dam
construction etc. When grants are made by one countrys government to another
countrys government it is called foreign aid. Usually poor countries receive such aid
from developed countries, which may be in the form of military aid, economic aid, food

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aid, technological aid, and so on. Funds acquired in form of grants are not significant and
sometimes it may also be conditional.

iv) Public borrowings and deficit financing: In order to cover budgetary deficit, a
government may borrow internally or externally and such loans undertaken by the
government is a source of public borrowings. However it entails burden of repayment of
principal and interest. A government may also resort to printing more currency to fill up
the deficit. However this method is inflationary and need to be cautiously used.

Thus a modern welfare state has a variety of sources of raising revenue. However
taxation remains the important source of revenue. Taxes are classified into Direct and
Indirect tax.

A. Direct Tax
A direct tax is one, which is paid by a person on whom it is legally imposed and the
burden of which cannot be shifted to any other person. According to Dalton A direct tax
is really paid by the person on whom it is legally imposed. The person from whom it is
collected cannot shift its burden to anybody else. A tax is said to be direct
tax when impact and incidence of a tax are on one and same person, i.e., when a person
on whom tax is levied is the same who finally bears the burden of tax. For instance,
income tax is a direct tax because impact and incidence falls on the same person. Other
types of direct taxes are corporation tax, wealth and gift tax.

Merits of Direct Tax: Direct taxes possess the following merits:

(i) Equity: Direct taxes are levied on the principle of equity or equality. These taxes are
based on the ability-to-pay principle that is individuals capacity to pay. The only
standard measure of individuals capacity is his income, hence income is considered to
levy taxes. This tax is progressive in nature and hence the burden falls more on rich than
poor. They are therefore, more equitable and help to remove disparity of income.

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(ii) Economy in collection: They entail less expense on collection and as such are
economical. They may also be deducted at source (TDS) and hence their evasion would
be difficult.
(iii) Certainty: They satisfy canon of certainty. Based on the principle of certainty the tax
payer knows how much tax, when or how to pay. Even the government is certain to a
large extent about the revenue collected from these taxes.
(iv) Elasticity and Productivity: These taxes are elastic in the sense the tax payer
automatically moves from one tax bracket to another as and when his income changes.
The government can raise or reduce tax revenue by increasing or decreasing the rate of
these taxes. There is a direct relation between tax revenue generated and changes in
national income. For instance growth in GDP will result in rise in tax revenue and vice-
versa.
(vi)Convenience: These taxes are based on the principle of convenience. The payment of
these taxes has to be made mostly at a time when it is convenient for the people to pay.
For example income tax is collected when individual receives salary or after harvest.
(vii) Reduction in Income Inequalities: The progressive tax structure helps the
government to reduce income and wealth inequalities. This is because the rich pay higher
taxes while the low income groups are either exempted from tax payment or pay lower
taxes. These taxes should be utilized for providing public expenditure on education,
health etc. to the poor, which would reduce the income inequalities.
(viii) Creates Civic Consciousness: Another advantage of direct taxes is that they create
civic consciousness in people. When a person has to bear burden of tax, he takes active
interest in affairs of state. In developed countries citizens are aware of their rights and
often question the government on how the tax revenue is spent in the economy.
Demerits of Direct Tax: Despite the above merits direct taxes suffer from following
demerits:
(i) Unpopular or Pinching: Taxpayer is seldom happy when he pays tax. It pinches him
that his hard-earned money is being taken by government. They are paid in lump sum.
Direct taxes like income tax are therefore unpopular.
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(ii) Easy to Evade: It is easy to evade a direct tax than an indirect tax. People often are
unwilling to part away with their income and so they often submit false statements of
their income or hide their true income to evade taxes.
(iii) Inconvenient: Direct tax is very inconvenient because taxpayer has to prepare
lengthy statements of his income and expenditure. He has to keep a record of his income
up-to-date throughout the year. It is very laborious for taxpayer to prepare and keep these
records. In case of complications people have to take assistance from experts or CAs.
(iv) Difficult to pay : Direct tax is to be paid in lump sum every year while income which
a person earns is received in small amounts. It often becomes difficult by taxpayers to
pay large amounts in one installment.
(v) Uneconomical to collect: Some direct taxes are uneconomical to collect when an
elaborate machinery has to be set up for collecting taxes and also for checking returns. In
countries like India, government has to spend huge amounts in publicizing the benefits of
tax payment to encourage more and more people to pay taxes and also issue reminders to
public about tax payment deadlines. All this requires large expenses on tax collection.
(vi)Narrow base: Direct taxes are narrow based particularly in less developed countries
where large numbers of people having low incomes are exempted from tax payment or
people who are given concessions are also out of tax net. Further if large numbers of
people live below poverty line then they cannot be taxed. This leads to a narrow tax base
and as a consequence burden of tax is high on the taxpayer.
(vii) Arbitrary: The rates of direct taxes are arbitrarily determined by the government. No
scientific principle is involved in the determination of the ability to pay taxes and its
progression.

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 B. Indirect Taxes
Indirect taxes are those taxes which are paid in the first instance by one person and
then are shifted on to some other persons. The impact is on the taxpayer (seller or
producer) but the incidence or final burden is on the others (buyers) when it is fully
shifted on them. If impact of tax falls on one persons and incidence on the another, the
tax is called indirect, for example sales tax, excise duty, customs duties and VAT.

Merits of Indirect Tax: Indirect taxes have following merits-

(i) Convenience: These taxes are convenient to collect from governments point of view
because they are collected in lump sum by government from the producers/sellers or
importers. They are more convenient also from buyers or taxpayers point of view because
they are wrapped in prices of goods in small amounts. Consumers pay these taxes while
purchasing the goods and are often not aware of it so it is not pinching.
(ii) Difficult to evade : It is not possible to evade indirect tax since they are included in
the prices of the commodities. The only way to avoid this tax is not to buy the taxed
commodities. However some may be able to evade these taxes by submitting false
accounts of sale or production. Taxes can also be evaded by purchasing goods from grey
market or smuggling.
(iii) Broad based: Indirect taxes have broad tax base. Since these taxes fall on all income
groups, they cover the entire population even those who are exempted from direct taxes.
Through indirect taxes every member of society contributes something towards revenue
of state.
(iv)Progressive and Elastic: Indirect taxes are said to be progressive as high taxes are
imposed on luxuries while necessities are exempted from these taxes. It is also elastic to a
certain extent as state can increase its revenue within limits by increasing rates of taxes.
(v) Social Value: Indirect taxes are considered to have high social value. They are used
for discouraging consumption of intoxicants and harmful drugs etc. This is a great social
advantage which a community can achieve from tax.

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(vi) Productive: The revenue yield from these taxes can be high as no separate or
additional machinery is required to collect them hence large revenue is collected with
minimal cost. The government can impose few taxes yielding high revenue for e.g.
imposing taxes on inelastic goods.
(vii) Capital formation and Re-allocation of resources: Indirect taxes discourage
consumption of non-essential/ harmful goods and thus divert resources for investment
and production of essential goods which increases the rate of capital formation and
efficient allocation of resources.

Demerits of Indirect Tax: Indirect taxes suffer from following demerits-

(i) Regressive: A very serious objection leveled against indirect taxation is that it is
regressive in character. It is inequitable. Burden of tax falls more on poor people than on
rich. They are not based on the ability-to-pay principle.
(ii) Administrative cost: Indirect tax is also uneconomical. State has to spend large
amounts of money on collection of small amounts of taxes from millions of people.
(iii) Uncertain: Revenue from indirect tax is uncertain. State cannot correctly estimate as
to how much money it will receive from this tax because it is not possible to foresee the
volume of demand for the goods taxed.
(iv) Civic consciousness: As tax is wrapped up in prices; therefore, it does not create
civic consciousness.
(v) Inflation and fall in saving: A major criticism of indirect taxes is that since they are
imposed on goods they increase their prices thus leading to inflationary pressure. As a
consequence of inflation people are required to spend more on the same commodity to
maintain their consumption standards. This reduces the savings which also adversely
affects capital formation in the economy.
After discussing merits and demerits of the two types of taxes, we come to the
conclusion that for reducing inequality of income and raising sufficient funds for state,

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both these taxes are essential, a country should not place exclusive reliance on any one
type, but should have a judicious mix of both taxes.

Activity: Identify which of the following are direct and which are indirect taxes
and list them:

Sales tax, Excise duty, Customs duty, Gift tax, Property tax, Service tax,
Corporate tax, Dividend tax, Education cess, luxury tax, Stamp duty

IV. Impact, Shifting and Incidence of Tax

When a tax is imposed on some person, it is quite possible that it may be transferred by
him to a second person, which may be ultimately borne by this second person or yet
transferred to other by whom it is finally borne. Thus the person who originally pays the
tax may not be actually bearing its money burden in the ultimate analysis. The problem is
to determine who bears the tax ultimately. According to Dr. Dalton, incidence is the
ultimate money burden of the tax.

Impact of a Tax: By impact of a tax we mean the person who pays the tax to the
government.
Shifting the Burden of a Tax: Shifting is a legal process of transferring the money
burden of a tax from one person over to the other. The burden of the tax can be
transferred to others through a process of shifting. It may be noted that the whole burden
of the tax may not be shifted to others. It may be that a part of the tax may be shifted to
others and a part be borne by the one who initially pays the tax. As a matter of fact, a part
of the tax burden rests on all the persons to a larger or smaller degree in the chain of
transferring the burden so that at the ultimate end only a small burden rests. The process
of shifting the burden of a tax goes on so long as different persons who come in the chain

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are able to pass on the burden to others till it ultimately rests on a person or a group of
persons who cannot shift this any further.

Meaning of Incidence: Incidence of a tax means the ultimate money burden of the tax. It
is possible for an individual to shift the burden of a tax over to any other individual.
According to Dalton, the problem of incidence is mainly of finding out the direct money
burden of the tax. Incidence is the result of shifting. The incidence of taxation refers to
this question of who and in what proportion bears the final burden of a tax. It is not
necessary that a person or a firm who pays a tax to the Government or, in other words,
bears the initial burden of a tax will also be the one on whom the final burden of the tax
rests. This is because a tax can be shifted or transferred to others. Therefore, in
economics, we distinguish between the impact and incidence of a tax. Whereas the
impact of a tax is said to be resting on the person or firm who pays the amount of the tax
and thus receives the initial burden, the incidence of the tax rests on the person or firms
who ultimately bears the money burden of the tax. If a person or a firm who pays the tax
to the Government is also one who ultimately bears it, then the impact and incidence of
the tax rests on the same person or firm. In such a case, there is no shift.
Theories of incidence of tax studies in what proportion the burden or incidence of a tax
is shared among different persons. The person who initially pays the tax can pass it on to
the other either in the form of higher prices of goods he sells or in the form of lower
prices of factors he buys. Whether shifting can take place or if it does so how much tax
burden can be shifted depends on a number of factors.

a. Factors Determining Incidence of Indirect (Commodity) Taxes:

The question of tax shifting especially arises in the case of indirect taxes, that is, taxes
on the production and sale of goods such as excise duties and sales tax. In this regard,
whether and to what extent a tax on commodity can be shifted depends on the price
elasticity of demand for and supply of a commodity. It is this elasticitys of demand and
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supply that determine the bargaining strengths of the sellers and buyers of the taxed
commodity. Sellers can shift the tax burden to the buyers if they are able to reduce the
supply of the commodity and thereby raise its price. Thus, the power to shift the tax
depends on the elasticity of supply of the taxed commodity. The elasticity of reducing
supply of a commodity will be relatively smaller if there is excess capacity in the industry
producing it. Further, the elasticity of supply of a commodity will be larger in the long
run than in the short run.

Apart from the elasticity of supply, power to transfer the tax burden depends on the-
elasticity of demand for a commodity. The greater the elasticity of demand of the buyers,
the smaller the extent to which the tax will be shifted to them. As shall be shown below,
under conditions of perfect competition the incidence of a commodity tax is shared
between the sellers and buyers in the ratio of the elasticity of demand and supply. The
following figure1 illustrates the incidence of an indirect tax under conditions of perfect
competition.

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 Fig.1 Incidence of Indirect tax under Perfect Competition

DD is the demand curve for a commodity and SS is its supply curve before the
imposition of tax on it. Interaction of these demand and supply curves determines price
OP of the commodity and OM is the quantity sold and purchased. Suppose a unit sales
tax, that is, sales tax per unit of the commodity equal to SS or LQ is levied by the
Government on the commodity in question. This will raise the supply price of the
commodity by the sellers as the unit tax SS will now be included by the sellers in their
supply price. As a result, the supply curve of the commodity will shift to the left by the
magnitude of the tax SS. The new supply curve SS intersects the demand curve DD at
the point Q and determines the new price OP and quantity exchanged OT. It will be seen
from Fig.1, that price for the buyers have risen by PP or RQ whereas the tax per unit is
SS or LQ which the buyers will bear. It may be noted that the buyers will bear the
burden of a tax to the extent that they have to pay the higher price than before. Thus the
incidence of the tax borne by the buyers will be equal to RQ. The remaining part of the
tax RL will be borne by the sellers. Thus, of the tax SS or LQ per unit, RQ is incidence
of the tax on the buyers and RL is the incidence on the sellers. Now, we can show that the
incidence of the tax RL and RQ on the sellers and buyers respectively is equal to the ratio
of the elasticity of demand and the elasticity of supply. To conclude, to what extent the
burden of the tax will be shifted and the proportion in which the buyers will share the
incidence of a commodity tax depends on the elasticitys of demand and supply.

b. Incidence of Tax under Monopoly

One is tempted to believe that since a monopolist enjoys complete control over the
supply of the product he will shift the entire burden of tax on to the buyer. To analyze the
incidence of tax we consider two types of taxes: the specific tax on units of output
produced and the lump sum tax on monopoly profits.
19
(i) Incidence in case of a Specific tax: The aim of the monopolist is to maximize profits;
and the condition of monopolist equilibrium is that the monopolist will restrict the output
at the point where MR=MC. The following figure 2, explains the incidence of specific tax
under monopoly condition:

Figure 2- Specific Sales tax and Monopoly

In the above fig.2 we assume that AR, MR, AC and MC curves are given before any
tax is imposed. Point E is the equilibrium point where MR=MC. Output is OM, price is
shown by the AR curve. Thus OP is the price when output is OM. Now let us assume that
a specific tax is imposed on commodity X. Thus the AC and MC will be affected and
imposition of tax will cause new average and marginal cost curves i.e. AC1 and MC1 .
The new equilibrium point will be E when the MR curve cuts the marginal cost curve
20
after tax (MCt). New output is OM1 and new price is OR. The price thus changed by PR
and hence this much amount of tax burden is shifted over to the buyer and the remaining
will be borne by the seller. The amount of tax imposed is shown by the distance between
the cost curves before and after tax; of this an amount equal to PP1 will be shifted over to
the buyer. The extent to which the burden of tax will be shifted over to the buyer will
depend upon the position and slope of demand curve (AR curve).

(ii) Incidence of a Lump sum tax: Let us study the incidence of a lump sum tax on
monopoly profits with the help of the following figure 3:

Fig.3- Incidence of lump sum tax on monopoly profit

Let us assume that a lump sum tax is imposed on the monopolists profits irrespective
of the number of unit of output sold. If TR is the total revenue and TC is the total cost
curve faced by monopolist before tax. The aim is to maximize profits; and thus
monopolist will be producing the output up to the point where the vertical distance
21
between TR and TC is maximum. The output is OM. Lets say a lump sum tax is
imposed on the monopolist. Then the new cost will be TCT. At this stage if the
monopolist tries to shift the burden of tax on to the buyers, then perhaps the demand for
his product will fall below OM. The distance between TR and TC will not remain
maximum. Thus to retain the maximum profits he should continue to produce OM units.
Before tax his maximum profit was PSQN. After tax, his profit is reduced to PSQN1, but
that is yet the maximum possible after payment of the lump sum tax. Thus to enjoy
maximum profits the monopolist after lump sum tax prefers to bear the entire burden of
tax himself instead of disturbing the demand for his product by resorting to price change.
Thus we can conclude that under monopoly, imposition of specific tax will lead to shift
of burden on the buyer but in case of lump sum tax a monopolist will prefer to bear the
burden of tax himself. There are many factors influencing incidence of tax like- form and
nature of tax, nature of goods, income level, time element and cost structure.
________________________________________________________________

V. Public Expenditure

I. Meaning of Public Expenditure: Expenses incurred by the public authorities

central, state and local self- governmentsare called public expenditure. Such
expenditures are made for the maintenance of the governments as well as for the benefit
of the society as whole.

II. Types of Public Expenditure:

Public expenditure may be classified into - Developmental and Non-developmental

expenditures. Former includes the expenditure incurred on social and community
services, economic services, etc. Non-developmental expenditure includes expenditures
made for administrative service, defense service, debt servicing, subsidies, etc. Public
expenditure is classified into revenue expenditure and capital expenditure. Revenue
expenditure includes civil expenditure (e.g., general services, social and community
22
services and economic services), defense expenditure, etc. On the other hand, capital
expenditure comprises expenditures incurred on social and community development,
economic development, defense, general services, etc.

Public expenditure may also be classified as plan expenditure and non-plan expenditure.
Expenditures on agriculture, rural development, irrigation and flood control, energy,
industry and mineral resources, etc., are included in plan expenditure. Non-plan
expenditure falls under two broad heads, viz., revenue expenditure and capital
expenditure. The former comprises interest payments, defence expenditures, subsidies,
pensions, other general services (like health, education), economic services (like
agriculture, energy, industry, transport and communication, science, technology and
environment, etc.)

III. Causes of Rising Public Expenditure

There was a misbelief in the academic circles in the nineteenth century that public
expenditures were wasteful. Public expenditures must be kept low as far as practicable.
This conservative thinking died down in the twentieth century, especially after the
Second World War. As a modern state is termed a welfare state, the horizon of
activities of the government has expanded in length and breadth. The public expenditure
has been continuously increasing everywhere. This is because of the growth of an
economy. Major causes responsible for the growth of public expenditure are as follows:

(1) Wagners law and expenditure: A major economist Adolph Wagners, writing in
1883 gave a law called the law of ever increasing state activity. He based his law on
pressure for social progress. Hence the government sector tends to grow causing an
increase in the expenditure as a proportion of national income. This implied that there is a
persistent tendency towards an increase in the intensive and extensive functions of the
central and local governments. The old and traditional functions are been undertaken
more satisfactorily and efficiently than before. At the same time, new functions are being

23
undertaken on an increasing scale. Many of the wants of the people which were satisfied
through private expenditure in the earlier periods are now been satisfied collectively
through the government e.g. transport, lighting, water, supply, sewage, health services,
etc. This is mainly because of an improvement in the efficiency of the government. This
tendency towards an increase in the state activities and expenditures was observed by
Wagner in the 19th century, Nitti, an Italian economist, had also observed this tendency.
A.T.Peacock and Jack Wiseman in their publication the growth of public expenditure in
the united kingdom, 1961, have found that Wagners law is still working. But according
to them, the expenditure grows because revenue grows. There is always a tendency to
provide more social amenities to people such as free education, free medical aid,
unemployment benefits, health insurance etc. This requires more and more money.
Further the cost of providing public services grows with nation.

(2) Increase in per capita income: With a rise in the national income and per capita
income, the revenue yield would rise. Hence there is a rising share of the public
expenditure in national income. Rising per capita income leads to rising demand for
consumption of public goods. Hence government has to spend more on provision of
public goods.

(3) Effects of war and requirements of defense expenditure: The defense expenditure is
on increase. This is due to wars and threats of war. It takes various forms such as
expenditure on war equipment, salaries of army, navy and air force personnel,
maintenance expenses during and between wars, expenditures on military research and
new weapons like atom bombs, pensions to retired army, navy and air force personnel,
interest on war loans, expenditures to provide benefits to men and their families injured
by a war, in the form of rehabilitation, education, etc. Even when there is no actual war,
the expenditures for military preparation increases because of the international tensions.
Thus the cost of expenditure arising out of war or as a result of the result of the
preparation of war has increased enormously.

24
(4) Civil expenditure- Maintenance of police and administration: With the growth of
cities and concentration of population, the expenditure on the police force and equipment
has increased. This is because the urban complexity requires highly specialized and
expanded police department. Likewise the expenditure on courts, prisons etc. is on
increase. This is because with the growth of cities, there has also been an increase in the
incidence of crimes.

(5) Growth of population in towns: The growth of population in urban areas has
necessitated increasing per capita expenditure in cities. This is because of various
complexities. The expenditure on more and better street lightning, schools, water supply,
sewage system, traffic control, maintenance of public health through hospitals, clinic
services, housing, family planning, playgrounds, etc., has been increasing continuously.

(6)Infrastructure growth: Infrastructural services are prerequisites for a countrys

economic growth and development at the same time these services are not affordable by
the private sector hence the state has to create these services. The state has to spend more
and more on providing infrastructural services like roadways, railways, highways,
transport and communication, construction and maintenance power plant etc. For
example in India creating infrastructure was important for industrialization and growth of
service sector. Over the years state expenditure on these activities has been rising.

(7)Education: In order to achieve higher levels of literacy, government may provide

educational facilities to the masses at the primary and secondary level, higher education
and technical education. These lead to rising government expenditure on providing
quality education and in opening and maintaining schools, colleges and universities (free
education, rising salaries of teacher etc.)

(8) Democracy: Democracy is an expensive form of government as the entire process of

selecting the government is through elections. Conducting free and fair elections in
highly populated countries like India is an expensive state of affairs. Further maintaining

25
the heads of each states, large number of ministries MPs and MLAs increases the
expenditure greatly

(9) Inflation: Rising inflation leads to both direct and indirect increase in public
expenditure. Inflation necessitates hike in salaries and dearness allowances to the
government employees, increases the cost of projects undertaken by the government.
Indirectly as the government is a welfare state, it has to provide basic necessities like
food grain to the masses at subsidies price which is procured through open market at
inflationary prices or at time through imports , all these cause public expenditure to rise
in monetary terms.

(9) Rural and Agricultural development: In countries like India where 60% of
population resides in rural areas and depends on agriculture for its livelihood, the
government has to intervene to develop agriculture to improve farmers income and their
standard of living. The government may provide them with loans, subsidized farm inputs,
MSP etc. Further government has too create rural infrastructure, create employment
opportunities and provide various welfare schemes like better roads, healthcare,
sanitation etc. for rural development.

(10) Industrial development: Government may have to encourage industrialization

through provision of cheap loans, subsidized industrial inputs, promoting exports etc. The
government may also have to setup important basic capital good industries in public
sector and promote private sector industries by providing infrastructure facilities thus
public expenditure may rise for fast growth of industrialization process in the economy.

(11) Regional balance development to achieve overall economic growth: It is necessary

to remove regional disparities in the economy. Public expenditure can correct regional
disparities. By diverting resources in backward regions, government can bring about all-
round development there so as to compete with the advanced regions of the country. For
example in a country like India, geographical locations of states has led to lopsided
development causing regional imbalances, hence the government has to provide tax
26
incentives, create infrastructure facilities, development of industrial estates and provide
attractive schemes to private sector for undertaking investment activities in backward
regions and states. Thus monetary and non-monetary benefits need to be provided for
achieving regional balance development.

Activity: Name some of the rural and urban welfare schemes implemented by the
Government of India to alleviate poverty and generate employment.

VI. Types of Deficit

A deficit refers to excess of spending (expenditure) over earnings (revenue). Here we

discuss some of the basic fiscal concepts related to the different types of deficits that arise
in a budget.

1. Revenue Deficit

Revenue deficit is the difference between current or revenue receipts and current or
revenue expenditure of the government. The revenue receipts consist of tax and non-tax
sources. Revenue expenditure is constituted of subsidies, interest payment, expenditure
on tax collection, administrative expenses etc. Revenue deficit is a basic concept of
deficit because all other types of deficit is found in revenue deficit only. Government has
to resort to public borrowing to meet this deficit. Hence it is urgently necessary to
regulate this deficit properly.

2. Budgetary Deficit

This is a traditional concept of deficit. This concept is wider than the revenue deficit. It
takes into account the total receipts (revenue + capital) and total expenditures (revenue +

27
capital). Budget deficit is the difference between total expenditure and total receipts of
the central government. Thus

Budgetary deficit= total receipts - total expenditure

Budget deficit is also sometimes referred to as overall deficit. Continuous and large
budgetary deficit is a cause of concern.

3. Fiscal deficit

This is an important, wider and internationally accepted concept of deficit. This concept
is given importance by IMF. It reveals the true extent of government borrowing. In
contrast the concept of budgetary deficit indicates government borrowing only from RBI.
Hence the significance of the concept. Fiscal deficit is obtained by subtracting total
receipts (excluding government borrowings) from the total expenditure. Thus

Fiscal deficit = Budgetary deficit + Public borrowing (internal + external) +

Small savings + provident fund + other liabilities

4. Primary deficit

This is a new concept of deficit introduced by the Ministry of Finance. Primary deficit is
obtained by subtracting net interest payments from the fiscal deficit. Thus

Primary Deficit = Fiscal deficit Interest payment

This concept is an expanded form of fiscal deficit. The concept throws light on the real
position of the national treasury. The net primary deficit is considered as relevant
measure to determine the stability of debt to GDP ratio.

__________________________________________________________________

28
 VII. Subsidies

I. Meaning of Subsidy

The word subsidy is derived from the Latin word subsidium, which meant "support,
assistance, aid, help, and protection". In medieval times it referred to a payment made to
the king. To most people, a subsidy means a payment from a government to a person or
company. Many subsidies are indeed provided in that form, as grants or, more
generically, direct payments. The only internationally agreed definitions of a subsidy are
those of the United Nations Statistics Division, which is used for the purpose of
constructing national accounts, and of the World Trade Organization (WTO), which is
used for the purpose of regulating the use of subsidies that affect trade. The WTO
definition is the more comprehensive of the two and can be summed up as follows: A
subsidy is a financial contribution by a government, or agent of a government, that
confers a benefit on its recipients. The most basic form of a subsidy, and the one that
still defines a subsidy in some dictionaries, is a cash payment or grant. Although few
grants are paid out in currency any more (most are paid via cheque or bank transfer), it is
still common to refer to them as "cash" grants, payments or subsidies.

II. Types of Subsidies: In general there are various types of subsidies offered in different
forms all over world:
1) Grants and other direct payments
2) Tax concessions
3) In-kind subsidies
4) Cross subsidies
5) Credit subsidies and government guarantees
6) Hybrid subsidies
7) Derivative subsidies
8) Subsidies through government procurement
9) Market price support (MPS)

29
Rationale / Role / Effects of Subsidies: Subsidies play a vital role in the economy. We
can discuss the following effects of subsidies:-

1) Subsidies are a kind of incentive which plays an important role in economic

development of developing countries. Subsidies bring out desired changes by effecting
optimal allocation of resources, stabilizing the price of essential good & services,
redistributing income in favor of poor people thus achieving the twin objective of growth
& equity of nation.

2) Subsidies are used to modify market outcomes, especially to take account of positive
externalities, and, sometimes, to subserve certain well-defined redistributive objectives.

3) Subsidies are justified in the presence of positive externalities because in these cases
consideration of social benefits would require higher level of consumption than what
would be obtained on the basis of private benefits only. Subsidies can correct for under-
consumption of goods.

4) Subsidies constitute an important fiscal instrument for modifying market- determined

outcomes. While taxes reduce disposable income, subsidies inject money into circulation.
Subsidies affect the economy through the commodity market by lowering the relative
price of the subsidized commodity, thereby generating an increase in its demand.

Subsidies in India

Subsidies are one of the quintessential attributes of any welfare state. India, at the eve
of independence was left with uphill task of socio-economic development. Markets were
almost nonexistent, masses lived in abject poverty and illiteracy, we were not producing
enough food to satiate hunger of masses, life expectancy was just 32 years; in short, there
was crisis in every sphere; be it agriculture, industry, health or education. Given such
circumstances, founding fathers of democratic India rightly envisaged Indian state to be a
welfare state. However, 70 years down the line only few problems have abated, while
new ones cropped up and poverty still stubbornly remains a pressing problem.

30
I. Classification of Subsidy in India: Subsidies are classified under following 3 heads:

Merit I: Elementary education, primary health centers, prevention and control of

diseases, social welfare and nutrition, soil and water conservation, and ecology and
environment.

Merit II: Education (other than elementary), sports and youth services, family welfare,
urban development, forestry, agricultural research and education, other agricultural
programmes, special programmes for rural development, land reforms, other rural
development programmes, special programmes for north-eastern areas, flood control and
drainage, non-conventional energy, village and small industries, ports and light houses,
roads and bridges, inland water transport, atomic energy research, space research,
oceanographic research, other scientific research, census surveys and statistics,
meteorology.

Non-Merit: All others.

In India subsidies can be classified in two categories:

I. Economic Subsidies: Power, Agriculture & Irrigation, Communication &
Industry, Transport & others, Cooperation Flood Control, Energy
II. Social Subsidies: Water Supply, Education, Health & Sanitation, Rural
Housing and others.
According to major heads of expenditure, Economic sector subsidies are nearly five and
half times as large as those of the Social sector. Heads arranged in diminishing order of
size of subsidies are: agriculture and allied services, industry and minerals, energy,
general economic services, and transport.

II. Burden of subsidies in India

When India grew in the first decade of millennium at average rate of 7.5% it was found
that this growth was jobless and unsustainable. Indias economy faced supply side
constraints, which didnt increase productivity as compared to GDP. Subsidies have been
31
 misused by politicians to create vote banks. Rationalization of subsidy regime will
improve markets in India which will then attract more investment. This in short, can turn
the wheel of a virtuous economy which creates more employment and attacks poverty at
its roots.

The proportion of subsidies in the fiscal deficit kept on rising since 2002-03 from about
31% to reaching the highest level ever of 56% by 2007-08. Some reform efforts of the
government especially in the fiscal deficit have decreased it to about 50%. But it is not
adequate considering the fact that still half of the fiscal deficit is comprised by subsidies.
The explicit subsidy of the central government comprises of primarily food subsidies,
fertilizer and fuel subsidy. It accounts for major share in the total subsidy allocation of
the government. In the year 2014-15, explicit subsidy accounted for more than 96% of
the total subsidy allocation of the central government which rose from 93% in 2002-03.
The share of food subsidy has declined to about 47% but still contributes a major share.
During the period 2002-03 and 2014-15, fertilizer subsidy increased by about six times
(from 11009 crore to 67970 crore) but the share remained same at 27% during this
period. Fuel subsidy remains at 26%. From the trend it appears that food subsidy
continues to dominate though its share has declined. It is prominent to record that fuel
subsidy is adding more fiscal pressure to the government. The following table 1 presents
a brief overview of the trends in Central government subsidies:

Table 1- Trends in Central Government Subsidies in India (Rs.in crore)

Total Share of
Food Fertilizer Fuel Interest Other Total
Year explicit explicit subsidy
subsidy subsidy subsidy subsidy subsidy subsidy
subsidy to total subsidy
2002-03 24176 11009 6265 41450 765 2379 44618 92.9
2009-10 58242 61264 14951 134457 2686 4006 141350 95.1
2010-11 63844 62301 38371 164516 4680 4223 17340 94.9
2014-15
(budget 115000 67970 63427 246397 8463 847 255708 96.4
estimates)
Source: indiastat.com

32
 Although the burden of subsidies is very high, the latest economic survey rightly points
out that despite spending as high as 3.77 lakh crore rupees annually on subsidies there is
no transformational impact on standard of living of masses. While subsidies have
helped some poor people to do firefighting in life, main allegation on a subsidy economy
is that, through subsidies, money meant for poorest is appropriated by richer sections of
the society due to mistargeting and leakages. Subsidies extended to rich are regressive.
They help in keeping poverty intact and create inefficiencies in economy which
culminates in inflation and corruption. Government has taken the initiative to ensure that
subsidies reach to the actual needy people by introducing Direct Benefit Transfer.

III. Direct Benefit Transfers (DBT) - A solution to reduce the negative effects of
subsidies is direct benefit transfers. This is likely to have the following multiple benefits.

1) Fiscal savings Assuming explicit subsidies being extended by state in current form
to remain between 3 to 4 lakh crores, DBT will curb this expenditure by around 15%,
which is a conservative estimate of current leakages. This can save government around
50,000 crore, which can be used more efficiently for developmental purposes.
2) It hits at roots of corruption It is common knowledge that subsidized fertilizer is
diverted to industrial use from agricultural sector, kerosene is mixed in diesel and PDS
food is leaked in black markets. In short, subsidy regime has nurtured a mammoth corrupt
ecosystem and black economy in India. When DBT is implemented everything will be
sold at market prices by the government. For e.g. fair price shop owner will get PDS food
in full central issue price plus margin kept by state government. Then question of giving
away PDS commodities illegitimately doesnt arise. Further, direct transfers will
eliminate intermediaries which will end system of rent seeking from beneficiaries.
Otherwise there is rampant system of illegitimate commission which is collected by
government officials where they have power to stop, deny or delay the benefit to be
passed.

33
3) It is likely to control inflation Distortions created by subsidy regimes discourage
investment in relevant sectors. This creates supply side constraints in economy. It is
expected that recent deregulation of diesel will increase production and private firms will
reopen their retail outlets. This will create competition which often results in cheaper
prices. Further, trading and purchase at market prices keeps demand in check. For e.g.
subsidy on urea encourages farmers to use it more even when there is no due benefit.
This created huge demand of urea and in turn high prices of unsubsidized urea. This
scenario has increased governments subsidy on urea manifold, which is not only waste
but a disaster in itself. Similar case is with the food grains. DBT will leave more food
grain in market and hence lower prices.
4) Better nutrition When there is cash transfer poor will be able to diversify their diet
by including more items like pulses, eggs etc. This will increase their protein intake.
However, there is risk that some households will misuse this cash in social evils like
alcohol, tobacco or gambling. For this government has made eldest women in a
household target beneficiary for cash transfers. This step is likely to empower women.

IV. Government initiatives in this direction: Direct benefits transfers intend to transfer
subsidies directly to account of beneficiaries. For this to happen efficiently there are two
separate but related issues which needs to be resolved as a pre-requisite. One is medium
of transfer and second is identification of beneficiaries. Some of the initiatives taken in
this direction by the government in recent years can be summarized as follows:
a) Government launched PAHAL scheme Pan India initiative for transfer of direct
benefits for Liquefied Petroleum Gas (LPG). Its huge success and about 3 crore fake
beneficiaries have been eliminated, which will contribute to annual saving of Rs. 15000
crore.
b) Direct Cash Transfer- It is being implemented for transfer of wages in MGNREGS
scheme. It has resulted in reduction in delayed and fake payments in relevant areas
.Further, Direct Benefit Transfer for fertilizers and kerosene is on the cards. In case of

34
fertilizers government is facing problems in determination of beneficiaries because there
is lack of clear land titles.
c) JAM Trinity Jan Dhan Yojna, Adhaar and Mobile base
Government is banking upon Pradhan Mantri Jan Dhan Yojna, under which more than 20
crore accounts have been opened. Subsidies under PAHAL scheme, pensions under
National Social Assistance Plan and wages under MGNREGS are being credit to newly
opened Jan Dhan account of the people. However, lakhs of villages do not have any brick
and mortar bank branch. In these villages mobile penetration is steadily growing. India
has more than 900 million subscribers and out of these about 370 million users are based
in rural areas. Rural subscriber base is growing at 2.8 million a year. Currently internet
penetration in India is about 40% and is expected to grow spectacularly once national
optic fiber network is in place. This all will be developed into digital mobile or internet
based cash transfer mechanism. Further, RBI has opted for differentiated banking by
rolling out licences for Payment and Small banks. RBI last year issued 11 licences for
payment banks to various corporate giants, telecoms and most importantly, India Post.
India post is having about 155000 branches mostly in rural areas. Apart from this, in-
principle licenses for Small Finance Banks have been granted to 10 entities. The aim
behind these is to provide financial inclusion sections of the economy not being served by
other banks, such as small business units, small and marginal farmers, micro and small
industries and unorganized sector entities. Accordingly, it is likely that within few years
subsidies will find way to bank accounts of all beneficiaries. To be sure about the identity
of beneficiary, Adhaar card base is being used. Biometrics captured in this card ensures
that there is no duplication and no wrong claim is made.
Apart from these initiatives, behavioral and technical remedies may be of immense
use to control and target subsidies better.

Activity (a) Do developed countries also provide agriculture subsidies?

(b) Mention subsidies given to some of the allied activities in India.

35
 IX. GST

GST stands for Goods and Service Tax. GST is a kind of indirect tax. It is a kind of
tax imposed on sale, manufacturing and usage of goods and services. Goods and Service
Tax is applied on services and goods at a national level with a purpose of achieving
overall economic growth. Currently, Indian consumers have to pay indirect tax on goods
and services such as Value Added Tax, Service Tax, Excise Duty, Customs Duty, etc.
Under the current system, each State has a right to levy their own tax on the goods
coming into their dominion for sale and consumption, while the Centre levies taxes on
manufacture of the goods. All these indirect taxes levied on the traders are passed down
to the consumer. GST is particularly designed to replace all the indirect taxes imposed
on goods and services by the Centre and States. Any person, who is providing or
supplying goods and services, is liable to pay GST.

Goods and Service Tax Definition:

Goods and Service Tax can be defined as a kind of Value Added Tax imposed on
various goods and services. GST is a consumption based tax/levy. It is based on the
Destination principle. The tax charged on goods and services may differ from country
to country. This tax is paid by the consumers of goods and services and collected and
forwarded to the government by the business entities.

GST in India

GST proposes to abolish the varying levels of taxation between States, and consider
the country as a single whole organism when it comes to taxes on goods and services
instead of a segmented creature. GST will also prevent multiple taxation occurring on
certain goods, and ensure transparency with regards to the rate of taxation and the total
amount that goes to the government as taxes on a product. Currently, a consumer is not
aware of the total amount of taxes s/he pays for a product, apart from VAT which is

36
mentioned on the bill. All the sundry taxes will be clubbed into just 2 levels Central
GST and State GST.

Application and Mechanism of GST: GST is applied on goods and services at the place
where final/actual consumption happens. GST is collected on value-added goods and
services at each stage of sale or purchase in the supply chain. GST paid on the
procurement of goods and services can be set off against that payable on the supply of
goods or services. The manufacturer or wholesaler or retailer will pay the applicable GST
rate but will claim back through tax credit mechanism. But being the last person in the
supply chain, the end consumer has to bear this tax and so, in many respects, GST is like
a last-point retail tax. GST is going to be collected at point of sale. The following chart
depicts the applicability of GST:

37
 GST is an indirect tax which means that the tax is passed on till the last stage wherein it
is the customer of the goods and services who bears the tax. This is the case even today
for all indirect taxes but the difference under the GST is that with streamlining of the
multiple taxes the final cost to the customer will come out to be lower on the elimination
of double charging in the system. The current tax structure does not allow a business
person to take tax credits. There are lots of chances that double taxation takes place at
every step of supply chain. This may set to change with the implementation of GST.

Implementation of GST in India: Indian Government is opting for Dual System GST.
This system will have two components which will be known as

Central Goods and Service Tax (CGST) and

State Goods and Service Tax (SGST).

The current taxes like excise duties, service tax, custom duty etc. will be merged under
CGST. The taxes like sales tax, entertainment tax, VAT and other state taxes will be
included in SGST. Heres a list of taxes that GST is likely to replace:

Service Tax
Cesses and surcharges related to supply of goods or services
Central Excise Duty
Excise Duties on medicinal and toilet preparations
Additional Excise Duties on textiles and textile products
Additional Excise Duties on goods of special importance
Additional Customs Duties (CVD)
Special Additional Duty of Customs (SAD)

These are the taxes that could be absorbed into the GST regime:

Central Sales Tax

State VAT
Entry Tax
38
 Purchase Tax
Entertainment Tax (not levied by local bodies)
Luxury Tax
Taxes on advertisements
State cesses and surcharges
Taxes on lotteries, betting and gambling
The exact rates of GST have not been decided yet. This will be done only after repeated
consultations on the reports made by the GST Council. The rates being discussed as of
now hover around 18%, which may be higher than the current system for certain goods
and services, and lower for the others. There might be CGST, SGST and Integrated GST
rates. It is also widely believed that there will be 2 or 3 rates based on the importance of
goods. For instance, the rates can be lower for essential goods and could be high for
precious/luxury items.

Advantages or Benefits of GST: GST would be beneficial for all stake holders in the
economy. It would benefit business and industry, government and the consumers. Let us
look at the various advantages of implementing GST in India:

This is a federal law, which means that the states will no longer have the right to make
new laws on taxation towards goods and services.

The tax structure will be made lean and simple. For the government it would be
simple and easy to administer as well as cheaper to implement at various levels. They
would be able to better control revenue leakages thus leading to higher revenue
efficiency.
The entire Indian market will be a unified market which may translate into lower
business costs. It can facilitate seamless movement of goods across states and reduce
the transaction costs of businesses.
It simplifies the tax system and makes it easier to understand. Tax evasion at various
stages will be eliminated as tax offsets can be collected only if taxes have been paid

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 originally. You will also be able to buy raw materials or constituent materials for
production only from those who have paid taxes, in order to claim benefits.
It will be cheaper to buy input goods and services for production from other states.
The current supply and distribution chain may undergo a change with a change in
taxation system that does away with excise and customs duties.
As of now, petroleum and petroleum products have been kept out of the GST regime
until further notice.
Sale of newspapers and advertisements are also likely to fall under the GST regime,
allowing the government to increase its revenue considerably.
While there will be central GST and state GST, the tax applicable on goods and
services being exported and imported between states in India would fall under an
Integrated GST (GST) system in order to avoid conflict of dominion.
It is good for export oriented businesses. Because it is not applied for goods/services
which are exported out of India.
In the long run, the lower tax burden could translate into lower prices on goods for
consumers.
The suppliers, manufacturers, wholesalers and retailers are able to recover GST
incurred on input costs as tax credits. This reduces the cost of doing business, thus
enabling fairer prices for consumers.
It can bring more transparency and better compliance. Number of departments (tax
departments) will reduce which in turn may lead to less corruption
For business and industry it would mean easy compliance. A robust and
comprehensive IT system would be the foundation of the GST tax regime in India.
Therefore all tax payer services such as registration, returns, payments etc. would be
made online which would make the system more transparent and easy.
More business entities will come under the tax system thus widening the tax base.
This may lead to better and more tax revenue collections.
Companies which are under unorganized sector will come under tax regime.

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 The consumer will get the end-product at cheaper rates because of elimination of
multiple taxes and the tax cascade. Most goods are expected to turn cheaper while
services will become more expensive with the introduction of the new goods and
services tax (GST) regime. For manufactured consumer goods, the current tax regime
mean the consumer pays approximately 25-26% more than the cost of production due
to excise duty and value added tax. With the GST rate expected at 18%, most goods
are expected to become cheaper.
Provision for removing imposition of entry tax/ octroi across India would result in a
smoother and quicker movements of goods across the country and bring an end to the
serpentine truck queues at state borders
The system will change from the current production-based taxation to being
consumption based

Disadvantages of GST:
GST is not good news for all sectors. In the current system, many products are
exempted from taxation. The GST proposes to have minimal exemption list. Currently,
higher taxes are levied on fewer items, but with GST, lower taxes will be levied on
almost all items.
GST is not applicable on liquor for human consumption. So alcohol rates will not get
any advantage of GST.
Stamp duty will not fall under the GST regime and will continue to be imposed by
states.
Services could get costlier. The effective service tax rate at present is 15% and it
applies to almost all services other than essential ones such as ambulance services,
cultural activities, and certain pilgrimages and sports events. If GST is implemented,
this rate will increase to 18% making services more expensive. Consequently, eating
out, staying at hotels and air travel will turn costlier. Similarly, insurance premiums
and investment management which attract a service tax currently will also become
costlier with the higher rate of GST.
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Challenges for implementing Goods & Services Tax system in India:

France was the first country to introduce this system in 1954. Nearly 140 countries are
following this tax system. The Bill was first introduced in the Lok Sabha in March 2011
and reports were submitted around it regularly. In India, the Goods and Service Tax Bill
was officially introduced in 2014 as the Constitution (One Hundred and Twenty-Second
Amendment) Bill, 2014. The GST Bill in India proposes the implementation of
nationwide Value Added Tax on sale, manufacturing and the use of different goods and
services. The Constitution Amendment Bill for Goods and Services Tax (GST) was
cleared by the Rajya Sabha on August 3, 2016. After Rajya Sabhas clearance of the Bill,
the Lok Sabha will ratify the Bill again. At least 15 other states also have to support the
Bill to go forward with its implementation as an Act. Once the ratifications are received,
the President will constitute a GST Council comprising the Finance Minister, Minister of
State in charge of Revenue, Minister in charge of Finance/Taxation, and other ministers
nominated by states. This Council will make recommendations on the taxes to be
absorbed and done away with, exemptions to GST and their threshold, laws governing
the GST levies, actual GST rates and discounts, etc. A draft of the Bill is already
available in the public domain. Once the changes are made and the final draft is ready it
will be put up in public again and comments sought. Once all legislations have been
passed as Acts, a synchronized implementation of the Acts will be negotiated among the
states and Centre, and Goods and Services Tax will be officially active. The Goods and
Service Tax act is expected to be operative in India from April, 2017.There are several
challenges in the implementation of this bill:

To implement the bill (if cleared by the Parliament) there has to be lot of changes at
administration level, Information Technology integration has to happen, sound IT
infrastructure is needed and the state governments will have to be compensated for the
loss of revenues (if any) and many more..

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 GST, being a consumption-based tax, states with higher consumption of goods and
services will have better revenues. So, the co-operation from state governments would
be one of the key factors for the successful implementation of GST

GST could be the next biggest tax reform in India. This reform could be a continuing
process until it is fully evolved. We need to wait few more months for more details about
Goods & Services Tax system.

Activity: Explain the supply chain of GST shown in the following chart:

X. Sources of Data

There are various sources of data available in India. Depending on the nature of data
sought, an individual can access any of the official government data portals for finding
the respective information. Some of the important data sources are listed below:

Directorate of Economic and Statistics

(Website providing state/district level data)
CMIE
NSSO
Handbook of Statistics in India
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 CSO publications
RBI publications
Economic survey
Agricultural Statistics
EPWRF
Handbook of Industrial Policy and Statistics
Planning Commission
Some of these data portals may need subscription for accessing the data.

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