Comparative Importance of Taxation Borrowing and Deficit Financing

Taxation Borrowing and Deficit Financing:

Fiscal policy in a developing economy is concerned with Government’s taxing, borrowing, and spending policies to achieve rapid economic development with reasonable monetary stability. It has to serve both the objectives of capital accumulation and the maintenance of stability. Since voluntary saving is very low, the State must play a positive role in stimulating capital formulations. As Higgins observes, “The sheer poverty of under-developed countries makes the raising of the propensity to save, as well as an inducement to invest, a necessary part of fiscal policy.”

(1) Borrowing and Taxation- In an underdeveloped country that has a very low rate of voluntary savings, compulsory savings through the high rate of taxation is perhaps the best means of mobilizing resources for development. Moreover, since economic development must be achieved with minimum inflation, taxation which is the most important source of non-inflationary finance should be given high priority in mobilizing the resources.

The traditional view of public finance is that tax proceeds should be used for the normal and recurring expenditure of the State and that the loan proceeds should be used for the building of assets that yield a direct return to the economy. Prof. A. C. Pigou, in his Classic work on Public Finance, observes, “There is a general agreement that ordinary running expenses should be met out of the current taxes.”

Government expenditure devoted to producing capital equipment, the fruits of which will be subsequently sold to purchasers for fees, must be raised by loans. If this is done, violent and sudden changes in tax rates are avoided: the people who are benefitted from the service which the new capital equipment renders pay for it in proportion to their use, and provided of course, that the fees charges are sufficient to wipe out the principal of the loan during the lifetime of capital equipment, no additional taxation has ever to be raised on account of it. Upon this matter, as upon that of the proper methods of finance for normal recurrent expenditure, there is no room for controversy.

The U.N. Report on the Domestic Financing of Economic Development also observes, “As to the relative share of taxation and Government boring in the fiscal structure, few general principles can be stated. Taxation should cover at least current expenditure on normal Government services. Borrowing is particularly appropriate to finance government expenditures which results in the creation of capital assets or which is otherwise directly productive.

It should, however, be noted that in a developing economy, taxation should go beyond financing normal expenditure and supply a considerable amount of funds for investment in development projects.  The traditional view does not fit into the conditions of a developing economy. It is, however, difficult to determine the relative share of taxation and borrowing in financing economic development.

(2) Public Debt and Surpluses of Public Undertaking- Net contribution of public undertakings to the revenues of Central and States has been increasing; but it is not substantial. The Planning Commission has pointed out in the Memorandum on the Fourth Plan (1966) that by adopting a national price policy, public undertakings should be made to yield high returns on investment so that their surpluses may be utilized for resource mobilization for development. But even with the best of efforts, in the early stages of economic development surpluses of public undertakings may provide an infinitesimal part of developmental finance and even taxation supplemented by the surpluses of the public undertaking will not be adequate to finance the ambitious development efforts.

(3) Public Debt and Deficit Financing- Deficit financing has a very limited scope in a less developed economy where unemployment and underemployment are not due to a lack of effective demand but due to a lack of capital, and technical skill, etc. It should be employed only in small doses. Monetary Stability which is a sino qua non of orderly development, will be disturbed by a heavy dose of deficit financing.

A U.N. report observes, “In the short run and under certain circumstances inflation may make it possible to direct resources into particular development projects, but experience has shown that in the long run, it has serious unfavorable consequences for balanced economic growth.  Therefore in the interest of orderly development of the economy, deficit financing should be kept to the minimum. This once again emphasizes the fact that non-inflationary borrowing would be increased and to that extent, the dependence on deficit financing can be reduced.”

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