The Distribution Function of Budget Policy

The Distribution Function of Budget Policy:

The allocation function of securing an efficient provision of social goods may be considered the classical function of budget policy. Since classical economists were of the view that the provision of public services is the only legitimate function of the government and hence of the budget policy. It was argued that “the fiscal problem pure and simple” should not be confused with “alien considerations of social and economic policy.” Subsequently, however, most people came to recognize that the revenue expenditure process of the Government is bound to have social and economic effects and that these may be aimed usefully at purposes not directly connected with the immediate objectives of satisfying public wants. It means that modern economists (Prof. Musgrave, etc.) are of the view that the revenue-expenditure process of the government (i.e., budget policy) should not confine itself to the immediate objective of satisfying public wants but should be usefully employed to secure adjustments in the distribution of income and wealth. In other words, it should be used to secure an equitable distribution of income and wealth also.

Assumptions:

Prof. Musgrave, while explaining the distributive functions of budget policy, made the following assumptions.

• The State of distribution is given.
• The satisfaction of public wants is determined correctly by the Allocation Branch.
• Full employment and price stability are maintained by the Stabilization Branch.
• It is the task of the Distribution Branch to determine and secure the proper State of distribution.

Determinants of Distribution:

The distribution of income and wealth in a market economy depends on a number of factors including the laws of inheritance, the distribution of innate talents, the availability of educational opportunities, social mobility, and the structure of the market. As a result of these factors, a State of distribution, with a given degree of equality or inequality, comes about. This state will seem appropriate to some, while others will prefer a greater, and still others a lesser, degree of equality. The distribution of income may or may not be in line with what society considers fair or just.

Optimum Distribution:

Let us now consider, what constitutes a fair or just State of distribution. Modern economic analysis has steered shy of this problem. The essence of modern welfare economics has been to define economic efficiency in terms that exclude distributional considerations. A change in economic conditions is said to be efficient, (i.e., improve welfare) if, and only if, the position of some person, say A, is improved without that of anyone else, including B and C, being worsened. This criterion cannot be applied to a redistributional measure which by definition improves A’s position at the expense of B’s and C’s. Thus it contributes little to solving the basic social issues of distribution and redistribution.

The answer to the question of fair distribution involves considerations of social philosophy and value judgement. Hence, it is difficult to decide, what the proper State of distribution should be. To some, equality may imply actual equality in economic welfare at any given time, to others it may imply a quite different concept of equality or opportunity, and still others may interpret equality in terms of maximum welfare to all members of society. The choice among these criteria is not simple, nor it is easy to translate any one criterion into the corresponding ‘correct’ pattern of distribution. Fiscal policies aimed at greater equality in the one sense of the term may interfere with other aspects of equality, thus, requiring a careful weighing of the various objectives.

In view of these reasons, Prof. Musgrave said that it is tempting to interpret the concept of equality (or degree thereof) as outright equality of objectively measurable income and wealth rather than as subjective equality of welfare. Thus, equality means an equal amount of income and wealth.

Proper Definition of Income:

However, he further pointed out that while the most accepted criterion is income, but this is not only possible one; since it is by no means obvious how income is defined. Thus, according to Prof. Musgrave, if income is to be taken as the criterion, a proper definition of income should also be given.

A proper definition of income is important, not only to establish equity in a vertical sense- that is to plan taxes and transfer so as to adjust relative positions; it is important also to establish equity in a horizontal sense- that is to give equal treatment to people in equal positions. The complexity of a modern economic organization is such that income may accrue in a variety of forms and through many different channels. Thus, there arises the problem of designing the text and transfer structure so as to give equal treatment to people who are basically in equal positions but who differ regarding the form in which their income accrues.

Notwithstanding these difficulties, the current discussion emphasizes the prevention of poverty, setting what is considered a tolerable cutoff line or floor at the lower end rather than putting a ceiling at the top as was once the popular view.

However, social philosophies or personal predictions with regard to equality or inequality differ. Yet, it is agreed in our society that babies should not go short of milk, that old people should be cared for, that cases of extreme poverty should be taken care of, and so forth. But, there are situations also where interference in the state of distribution is called for.

Instruments of Distribution Policy:

Tax and Transfer Mechanism for Proper Distribution:

Prof. Musgrave pointed out that the tax and transfer system of the budget policy is one of the methods by which correction in the state of distribution can be made. Taxes and transfers are designed to shift resources from the disposal of one individual to that of another. The budget must be balanced in real terms. It means that the amount of real resources that is withdraw from X will be placed at the disposal of Y. This balance in real terms need not exclude the use of loan finance as a means of accomplishing distributional objectives. 

Among various fiscal devices, re-distribution is implemented most directly by (1) a tax-transfer scheme, combining progressive income taxation on high-income households with a subsidy to low-income households.

Alternatively, redistribution may be implemented by (2) progressive income taxes used to finance public services, especially those such as public housing, which particularly benefit low-income households.

Finally, redistribution may be achieved by (3) a combination of taxes on goods purchased largely by high-income consumers with subsidies to other goods which are used chiefly by low-income consumers.

Finally, it is now concluded that the pattern of distribution which results from the existing pattern of factor endowment ownership of factors of production and from the sale of factor services in the market is not necessarily on which society considers fair. Hence, distributional adjustments may be called for, and tax-transfer policies offer an effective means of implementing them. This may be called as the distributive function of the budget policy.

Limitations:

In choosing among alternative policy instruments, allowance must be made for resulting efficiency costs, i.e., costs that arise as consumer or producer choices are interfered with. However, redistribution via an income-tax transfer mechanism has the advantage that it does not interfere with particular consumption or production choices. But, it has also been pointed out that it involves efficiency cost since the choice between income and leisure is affected.

Hence, it is concluded that where redistribution involves an efficiency cost, this consequence by itself establishes a conclusive case against such policies. It merely tells us that:

• Any given distributional change should be accomplished with the least efficiency cost and that
• a need exists for balancing conflicting policy objectives.