Canons/Principles of Public Expenditure

The main principles or canons of public expenditure are as follows:

(i) The Principle of Maximum Social Advantage: The government expenditure should be incurred in such a way that it should give benefit to the community as a whole. The aim of the public expenditure is the provision of maximum social advantage. If one section of the society or one particular group receives benefit of the public expenditure at the expense of the society as a whole, then that expenditure cannot be justified in any way, because it does not result in the greatest good to the public in general. So we can say that the public, expenditure should secure the maximum social advantage.

(ii) The Principle of Economy: The principle of economy requires that government should spend money in such a manner that all wasteful expenditure is avoided. Economy does not mean miserliness or niggardliness. By economy we mean that public expenditure should be increased without any extravagance and duplication. If the hard-earned money of the people, collected through taxes, is thoughtlessly spent, the public expenditure will not confirm to the cannon of economy.

(iii) The Principle of Sanction: According to the principle, all public expenditure should be incurred by getting prior sanction from the competent authority. The sanction is necessary because it helps in avoiding waste, extravagance, and overlapping of public money. Moreover, prior approval of the public expenditure makes it easy for the audit department to scrutinize the different items of expenditure and see whether the money has not been overspent or misappropriated.

(iv) The Principle of balanced Budgets: Every government must try to keep its budgets well balanced. There should be neither ever recurring surpluses nor deficits in the budgets. Ever recurring surpluses are not desired because it shows that people are unnecessarily heavily taxed. If expenditure exceeds revenue every year, then that too is not a healthy sign because this is considered to be the sign of financial weakness of the country. The government, therefore, must try to live within its own means.

(v) The Principle of Elasticity: The principle of elasticity requires that public expenditure should not in any way be rigidly fixed for all times. It should be rather fairly elastic. The public authorities should be in a position to vary the expenditure as the situation demands. During the period of depression, it should be possible for the government to increase the expenditure so that economy is lifted from low level of employment. During boom period, the state should be in a position to curtail the expenditure without causing any distress to the people.

(vi) No unhealthy effect on Production and Distribution: The public expenditure should be arranged in such a way that it should not have adverse effect on production or distribution of wealth in the country. Public expenditure should aim at stimulating production and reducing inequalities of wealth distribution. If due to unwise public spending, wealth gets concentrated in a few hands, then its purpose is not served. The money really goes waste then.

? Meaning of Public Expenditure:

? Public expen-diture consists of expenditure by central government, state governments and local authorities (such as municipalities and public corporations), with central government accounting for the major portion of such expenditure

 Effect on Production

? In order to have a correct view of the effects of public expenditure on production, according to Dalton, it is necessary to consider

(i) effects upon ability to work and save,

(ii) effects on desire to work and save, and

(iii) effects on diversions of economic resources as between different uses and localities.

The use of progressive taxes is generally advocated as a means of influencing income distribution; it renders post-tax income distribution less unequal. Hugh Dalton has stated that like the taxes, public spendings too can be made progressive.

? Effect on Economic Development

? There are two principal channels, through which government spending may influence economic growth and development. First, government spending, particularly investment, may provide such goods that enter directly into private sector production.

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Adverse/ Bad effect of Public Expenditure.

1. Unnecessary Assistance to Industries and Business

? 2. Excessive Expenditure on Defence

? 3. Tendency of gaining Political Influence

? 4. Advantage to a Particular Community

? 5. Rapid Increase in Taxation

? 6. Government expenditure is Misue of Scarce and Limited Resources and also Unproductive

? 7. Fear of Minority Political Parties

? 8. Dominance of Public Sector Reduced the Authority of Private Sector

The Main items of  government spendind are the following:

Social services such as education, health and welfare and social security; defence, that is the cost of maintaining the armed forces; environmental services, that is, spending on roads, transport services, law and order, housing and the art; national debt interest, that is, interest payments on money borrowed by the government. At present, public expenditure is about one-third of India’s national income.

Principles of Public Expenditure

? 1. Principle of Maximum Social Benefit: ? It is necessary that all public expenditure should satisfy one fundamental test, viz., that of Maximum Social Advantage. That is, the government should discover and maintain an optimum level of public expenditure by balancing social benefits and social costs.

2. Canon of Economy: ? Although the aim of public expenditure is to maximize the social benefit, yet it does not exonerate government from exercising utmost economy in its expenditure.

? 3. Canon of Sanction: ? Another important principle of public expenditure is that before it is actually incurred it should be sanctioned by a competent authority. Unauthorised spending is bound to lead to extravagance and over-spending.

 4. Canon of Elasticity: ? Another sane principle of public expenditure is that it should be fairly elastic. It should be possible for public authority to vary the expenditure according to need or circumstances.

? 5. No Adverse Influence on Production or Distribution: ? It is also necessary to ensure that public expenditure should exercise a healthy influence both on production and distribution of wealth in the community. It should stimulate productive activity so that income and employ-ment of the living.

? 6. Principle of Surplus: ? It is considered a sound or orthodox principle of public expenditure that as far as possible public expenditure should be kept well within the revenue of the State so that a surplus is left at the end of the year.

What is Public Debt ?

Public debit or public borrowing is considered to be an important source of income to the government. If revenue collected through taxes & other sources is not adequate to cover government expenditure government may resort to borrowing. Such borrowings become necessary more in times of financial crises & emergencies like war, drought, etc. ? ? Public debt may be raised internally or externally. Internal debt refers to public debt floated within the country; while external debt refers loans floated outside the country.

Types of Public Debt

Public debt can take various forms, but we can distinguish between two major types: ?Internal ?External

? In India, public debt refers to a part of the total borrowings by the Union Government which includes such items as market loans, special bearer bonds, treasury bills and special loans and securities issued by the Reserve Bank. It also includes the outstanding external debt.

The State generally borrows from the people to meet three kinds of expenditure: ? (a) to meet budget deficit, ? (b) to meet the expenses of war and other extraordinary situations and ? (c) to finance development activity.

When we shift attention from external to internal debt we observe that the story is different.

1. Efficiency and Welfare Losses from Taxation: ? When the government borrows money from its own citizens, it has to pay interest on such debt. Interest is paid by imposing tax on people. If people are required to pay more taxes simply because the government has to pay interest on debt, there is likely to be adverse effects on incentives to work and to save.

? 2. Capital Displacement (Crowding-Out) Effect: ? Secondly, if the government borrows money from the people by selling bonds, there is diversion of society’s limited capital from the productive private to unproductive public sector. The shortage of capital in the private sector will push up the rate of interest. ? In fact, while selling bonds, the government competes for borrowed funds in financial markets, driving up interest rates for all borro-wers.

? 3. Public Debt and Growth: ? By diverting society’s limited capital from productive private to unproductive public sector public debt acts as a growth-retarding factor. Thus an economy grows much faster without public debt than with debt. ? When we consider all the effects of government debt on the economy, we observe that a large public debt can be detrimental to long-run economic growth.

? To conclude with Paul Samuelson and W. D. Nordhaus: “A large government debt tends to reduce a nation’s growth in potential output because it displaces private capital, increases the ineffi-ciency from taxation, and forces a nation to service the external portion of the debt.”

Principles of Public Debts

?First principle: the allocation of credit to desired aims ? ?Second principle: priorities setting before scarcity of resource and time ? ? Third principle: debt structure on sustainability criteria ? ?Fourth principle: sound legal framework ? ?Fifth principle: best management practices ?Sixth principle: operational transparency ? ? Seventh principle: thorough process auditing

Methods of Debt Redemption 

? (i) Utilization of Surplus Revenue: ? This is an old method and badly out of tune with the modern conditions. Budget surplus is not a common phenome-non. Even when there is a surplus, it is so insignificant that it cannot be used for making any substantial reduction in the public debt.

(ii) Purchase of Government Bonds: ? The government may buy its own stock in the market, thus wiping off its obligation to that extent. This may be done by the application of surplus revenues or by borrowing at low rates, if the condi-tions are favourable.

? (iii) Terminable Annuities: ? When it is intended completely to wipe off a permanent debt, it may be arranged to pay the creditors a certain fixed amount for a number of years. These annual payments are called annuities. It will appear that, during the time these annuities are being paid, there will be much greater strain on the government finances than when only interest has to be paid.

(iv) Conversion: ? This is a method for reducing the burden of the debt. A government may have borrowed when the rate of interest was high. Now, if the rate of interest falls, it can convert a high-rated loan into a low-rated one.

Important of Subsidies

? Subsidies include all grants on current account made by the government to depress the price of any good or service below its economic cost. ? Subsidy has been defined as the “money granted by state, public body, etc., to keep down the prices of commodities, etc.”

Type of Subsidies

Direct Subsidies – Direct subsidies are given in terms of cash grants, interest-free loans and direct benefits. For example- Direct farm subsidies are the kinds of subsidies in which direct cash incentives are paid to the farmers in order to make their products more competitive in the global markets. 

Indirect subsidies – Indirect subsidies are provided in terms of tax breaks, insurance, low-interest loans, depreciation write-offs, rent rebates. For example- Indirect farm subsidies: These are the farm subsidies which are provided in the form of cheaper credit facilities, farm loan waivers, reduction in irrigation and electricity bills, fertilizers, seeds and pesticides subsidy as well as the investments in agricultural research, environmental assistance, farmer training etc.

The benefit of subsidy as a policy are :

1. Inducing higher consumption/production.

2. Achievement of social policy objectives including redistribution of income, population control etc.

3. It helps in controlling the prices to maintain stability.

4. Especially in case of agriculture where food is basic right of all, you cannot leave everything to market.

5. Offsetting market imperfections including internalization of externalities.

INTRODUCTION

Public expenditure is expenditure incurred by the government (e.g. central government, state governments, lower level governments like district office, gram panchayat, etc.). Such expenditures are made for social welfare of people and to run the government administration. The importance attached to public expenditure has varied between different schools of thought. During the laissez-faire polices of 19th century, the role of government was minimum. Over time, with the evolution of theories of public expenditure, the importance of public expenditure has come into limelight as an important tool of fiscal policy. The failure of market mechanism to ensure social welfare, income equality and full employment has contributed to the insights developed into the potentials of public expenditure. In view of these, the role of the government in public expenditure is considered crucial across the globe.

CONCEPT OF PUBLIC EXPENDITURE

World-wide, there has been a continuous increase in public expenditure. The range of activities performed by the governments span areas like national defence, police and internal security, development of education and health sectors, policies to remove poverty, etc. Several theories have attempted to explain the reasons behind the growth in public expenditure. You have already studied about them in detail in your previous Unit 13. However, we shall briefly make reference to some of the important ones below and then proceed to study the ‘trends in public expenditure in India’. 

German economist, Adolph Wagner (1883), gave a law called the ‘law of ever increasing state activity’ based on the historical facts (studied primarily for Germany and some other countries). The law states that there is a persistent tendency for the scope of the government to expand because of three main factors: (i) the higher level of economic development, (ii) higher level of administrative and protective actions of the state, and (iii) due to welfare functions. The different layers of the government (e.g. Central, State and Local bodies) have a tendency to grow, both intensively and extensively (i.e. vertically as well as horizontally). By intensive growth of expenditure is meant the recurring type of expenditure such as law and order, police, defence, etc. Extensive expenditure, on the other hand, refers to the welfare related programmes and capital creation activities such as creation of schools, hospitals etc. Likewise, Peacock and Wiseman (1961) studied the growth path of public expenditure of United Kingdom from 1890-1955. They concluded that public expenditure does not increase in a smooth and continuous manner but increases in a step-like manner. They postulated three important hypotheses from their analysis. First is known as the ‘Displacement Effect Hypotheses’. This states that public expenditure is caused by growth in revenue. Large scale and unavoidable disturbances such as wars, influx of refugees, etc. force the government to undertake higher expenditure in the economy thereby placing higher taxation burden on the people. Thus, such events shift the earlier low level of expenditure and taxation to new and higher level. There is thus a ‘displacement effect’. The second one is termed as the ‘Inspection Effect Hypothesis’. Due to new level of expenditure and taxation created by the displacement effect, the economy does not go back to the earlier lower levels of expenditure and taxation even after these major disturbances are over. People develop higher tolerance towards higher taxation and as a result become habitual in course of time due to which the general level of expenditure and taxation goes up. Such big and unavoidable disturbances therefore force the government (and the people) to find out solutions to the problems which were neglected earlier. The third hypothesis is termed as ‘Concentration Effect Hypothesis’. This effect occurs when the central authorities have higher tendency (than sub-national or local governments) to grow faster during the periods of high growth level.

Factors of Influence Several factors of demographic, political and public significance influence public expenditure. These may be stated as follows.

Growth of Population: A large and growing population is one of the main reasons behind growing public expenditure. A country with large population will have to create more schools, hospitals, transport facilities, roads and other amenities to meet the needs of its large population as compared to countries with smaller population. In order to control the population growth, the government intervenes with policies on family planning creating necessary infrastructure to administer such policies.

Growth of Democracy: The structure of the democratic form of the government is such that it will require more public expenditure. It requires regular and continuous maintenance of the political institutions. For instance, periodic conduct of elections would be required at all levels of the government. Countries with a democratic form of government will always therefore have a higher level of public expenditure. Additionally, to increase their chances of re-election local politicians will be more responsive to demands of the people in their jurisdiction. This requires the setting up of large scale ‘public goods’ in all jurisdictions which require funds on regular basis for their maintenance (called non-plan or revenue expenditure). Therefore, the political and governing structure of country always serves as a significant factor behind a large scale public expenditure. 

Welfare State: The role of the state during the laissez-faire policies of 19th century was termed as a ‘police state’ where the role of public expenditure in the economic life of the people and community remained neglected. Various positive effects of public expenditure on increasing production and employment, reducing income inequality, etc. were ignored. In successive decades, the understanding of the term ‘modern state’ evolved over time. This changed the concept of ‘police state’ to ‘welfare state’ under which large emphasis is placed on the welfare related measures required to uplift the social welfare of the marginalised sections of people. For instance, creation of employment opportunities, social security measures, creation of welfare related infrastructure, etc. would all require greater role by the government. The ‘theory of public expenditure’ has therefore recognised distortions created by ‘market mechanism’ in ensuring full employment of job seeking population. Due to these factors and increased sensitisation for the welfare of people, the extent of public expenditure incurred has increased enormously over the years.

Defence Expenditure: In modern society, every country wants to protect its borders. The possibility of wars require the nations to equip themselves with arms. This process, in turn, requires large scale public expenditure to equip their defence sector.

Expansion of Public Sector and Administrative Set up: Creation of large scale administrative set up requires large scale public expenditure. This is more likely for countries with large geographic area with decentralised government systems (e.g. Canada, Australia, India). This entails expenditure on large scale police and public services machinery in every nook and corner of the country to maintain internal security, public administration, public sector enterprises, etc. 

Poverty Alleviation Programmes: Countries which have chronic poverty have to incur large scale expenditure in the form of poverty alleviation programmes. This is especially so for countries like India (and other developing countries) which rely heavily on public programmes to improve the well-being of their poorest so as to bring them up to join and benefit from the mainstream development process of the country.

Urbanisation: Countries with a larger, and especially growing, urban population also require growing public expenditure to expand their urban amenities (such as establishment of better quality schools, drainage system, hospitals, drinking water facilities, better law and order condition in the society, etc.).

Income Re-distribution: Policies targeted for income re-distribution collect taxes from richer states and spend them in poorer states leading to transfer of funds. For instance, government collects taxes from richer areas with proceeds from certain taxes earmarked to be spent for the development of poorer regions. This is needed because such regions cannot raise enough funds from their own jurisdiction due to lower level of development. The extent of public expenditure is therefore large in such a federal set up. 

CANONS OF PUBLIC EXPENDITURE

Public expenditure should satisfy certain canons (or principles) of public expenditure. These are the guiding principles about how the public expenditure policy of the governments should be administered. Professor Alfred G. Buchler made some guidelines for expenditure by the public authorities. These are: (i) public expenditure should promote the welfare of the society; (ii) careful judgement should be exercised to ensure that the advantages of the public expenditure exceed the costs; (iii) the fund utilised by the governments should be more conducive to social welfare (than when the same funds were utilised for private welfare); and (iv) public expenditure should be utilised in the order of priority of welfare i.e. the services which will bring about maximum welfare gains should be undertaken first. Prof. Findlay Shirras specified these as canons in terms of four principles of public expenditure as follows. 

Canon of Benefit: The ideal of this is maximum social advantage. If a particular group in a community gets more benefit from public expenditure at the expense of the whole society then that cannot be justified by the principle of ‘maximum social advantage’. Hence, public expenditure should be planned in such a way that it yields maximum social benefit in terms of the social welfare of the community as a whole and not of a particular group. Public expenditure must therefore be spent in those directions which will maximise utility. It should aim to increase production, reduce income and wealth inequality in the society, enhance quality of social life, etc.  

Canon of Economy: The canon implies that the government should be economical in spending money. By economical means, the expenditure should avoid extravagance and wastage of public money. Government should not spend more than the necessary amount required because any such activity can lead to wastage of public fund and corruption. Additionally, the social benefit can be maximised when resources are not wasted. The canon of economy therefore calls for efficient public finance authorities.

Canon of Sanction: According to this canon, no expenditure should be incurred without the proper approval of the sanctioning authority. This ensures that the money is spent on authorised heads of expenditures allowing for a smooth auditing of public accounts at the end of each financial year. As a rule, therefore, money must be spent on the purpose for which it is sanctioned by the authority and accounts maintained must be properly audited. Since unauthorised spending leads to extravagance and over-spending, this canon acts as a check on arbitrary, unwise and reckless spending of public funds.

Canon of Surplus: This canon believes in the avoidance of deficit in public expenditure. In other words, government should aim at achieving balanced budget where public expenditure is lower than or at most equal to public revenue. If public expenditure exceeds public revenue by a large gap it will lead to government debt and might impact the fiscal sustainability of the government. Besides the above four canons, there are also some other canons of public expenditure. These are as follows.

Canon of Productivity: Public expenditure should be incurred in such a way that promotes production and creates employment opportunities in the economy. It should lead to capital formation and increase the working efficiency of the people. Development activities should be given priority in the government budget. In other words, the aim of public expenditure should be maximum production, employment and income.

Canon of Elasticity: This canon requires that the government should not spend public money in a rigid manner; rather, it should be flexible. This means that the government should be able to vary the amount of expenditure as per the need of the situation. For instance, government should be able to increase public expenditure during periods of emergency such as war, flood, drought, etc. or during economic depression when the economic growth is low. An increase in government expenditure during the time of depression ensures that the economy is lifted from low levels of production and employment. The multiplier effect of the public spending will pave the way for economic recovery. The opposite is the case during the period of boom and high inflation when government should reduce public expenditure. In other words, public expenditure should be elastic which can be used as a fiscal policy instrument to stabilise the economy during the time of high inflation or depression.

Canon of Equality: This canon implies that public expenditure should be incurred in such a way as to reduce inequality in the distribution of income and wealth. It should not lead to accumulation of income and wealth by a small segment of the society. In order to achieve equality of income, government should direct its public expenditure towards the welfare and economic progress of those sections of the society who are lagging behind on economic front.

Canon of Neutrality: The canon of neutrality states that public expenditure should have a desirable impact on the economy and not any un-desirable impact. This means that public expenditure should increase production and productivity and not reduce it. Similarly, it should reduce income inequality and not increase it. In other words, public expenditure should not worsen the production-distributionexchange relationship but improve it.

Canon of Certainty: The public authorities should be clear about the purpose and extent of public expenditure to be incurred. The canon requires the preparation of public budgets with the government taking into account both the short term and long term impacts of public expenditure with the modes of spending clearly spelt out.