Public Finance Overview
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Questions and Answers

What is likely a consequence of high tax rates on the wealthy?

  • Disincentive to savings and investments (correct)
  • Increased entrepreneurship
  • Higher overall tax revenue
  • Encouragement of work

What does an optimal budgetary policy aim to achieve?

  • Balancing efficiency and equity objectives (correct)
  • Encouraging economic inequality
  • Eliminating all forms of taxation
  • Maximizing government spending

Which of the following is NOT a condition of macroeconomic stability?

  • High inflation (correct)
  • Full employment of labor resources
  • Output matching production capacity
  • Total spending matching total output

What is a major reason behind the need for government intervention in the economy?

<p>To correct instabilities in the economy (D)</p> Signup and view all the answers

Which economic theory supports the need for deliberate stabilization policies?

<p>Keynesian economics (B)</p> Signup and view all the answers

What could be a negative impact of government redistribution policies?

<p>Increased deadweight losses (B)</p> Signup and view all the answers

What is an inherent characteristic of a market economy regarding employment?

<p>Tends to create business cycles (A)</p> Signup and view all the answers

How does the government generally promote price stability?

<p>Through prudent fiscal and monetary policy (C)</p> Signup and view all the answers

What is stagflation?

<p>A situation where inflation and unemployment exist side by side. (C)</p> Signup and view all the answers

Which of the following factors is NOT part of the stabilization function's performance metrics?

<p>Unregulated foreign exchange. (D)</p> Signup and view all the answers

How does monetary policy primarily work?

<p>Through controlling the supply of money and interest rates. (A)</p> Signup and view all the answers

In the context of maintaining economic stability during a recession, which action is typical for the government?

<p>Increase government expenditure or cut taxes. (D)</p> Signup and view all the answers

What does countercyclical fiscal policy aim to address?

<p>Macroeconomic fluctuations through government actions. (C)</p> Signup and view all the answers

What typically happens to effective demand if taxes are increased?

<p>It decreases due to reduced disposable income. (C)</p> Signup and view all the answers

What is the role of government intervention during periods of high inflation?

<p>Cut down on government expenditure or raise taxes. (D)</p> Signup and view all the answers

What is a consequence of the contagion effect in stabilization?

<p>It causes instability to easily spread from one country to another. (C)</p> Signup and view all the answers

What is the primary role of the Finance Commission in India?

<p>Recommend the sharing of taxes between union and states (C)</p> Signup and view all the answers

Which of the following articles facilitates the transfer of resources from the union to states?

<p>Article 270 (C), Article 275 (D)</p> Signup and view all the answers

What does vertical equity refer to in the context of the Finance Commission's recommendations?

<p>Deciding about the share of all states in the revenue collected by the center (B)</p> Signup and view all the answers

Which article provides for the establishment of the Finance Commission?

<p>Article 280 (D)</p> Signup and view all the answers

What is one of the functions of the Finance Commission related to grants-in-aid?

<p>Determine the principles and quantum of grants-in-aid for needy states (C)</p> Signup and view all the answers

What is the significance of the phrase 'any other matter referred to the Commission by the President'?

<p>It broadens the scope of the Finance Commission's responsibilities (D)</p> Signup and view all the answers

The concept of horizontal equity in the Finance Commission's work primarily addresses what?

<p>Allocation of the shares of central revenue among states (B)</p> Signup and view all the answers

Which of the following is NOT a function performed by the Finance Commission?

<p>Advising the government on individual tax rates (C)</p> Signup and view all the answers

What is the primary purpose of IGST?

<p>To collect and distribute tax revenue between the union and states. (B)</p> Signup and view all the answers

What percentage of the gross tax revenue of the union does GST account for?

<p>35 per cent (A)</p> Signup and view all the answers

Which of the following statements about the GST Council's recommendations is correct?

<p>Union and state legislatures have equal and unique powers to make GST laws. (A)</p> Signup and view all the answers

For how long was compensation provided to states for revenue loss due to GST implementation?

<p>Five years (D)</p> Signup and view all the answers

Which of the following states received the most GST compensation during the transition period?

<p>Maharashtra (B)</p> Signup and view all the answers

What is levied to provide compensation to states for GST-related revenue losses?

<p>A cess on luxury and demerit goods (A)</p> Signup and view all the answers

Which area is the central government responsible for in terms of expenditure decentralization?

<p>National defense and foreign affairs (C)</p> Signup and view all the answers

During the year 2022-23, what was the total amount of GST compensation released to states and union territories?

<p>` 1,15,662 crore (D)</p> Signup and view all the answers

What primarily causes market failures in an economy?

<p>Imperfect competition and monopolies (A)</p> Signup and view all the answers

What is one responsibility of the government in terms of market failures?

<p>To take corrective action when markets fail (A)</p> Signup and view all the answers

Which of the following is NOT an instrument by which governments can influence resource allocation?

<p>Market monopoly creation (B)</p> Signup and view all the answers

What is the main goal of the distributive function of the budget?

<p>To redistribute income for equity and fairness (A)</p> Signup and view all the answers

What do redistribution policies often incur as a cost?

<p>Deadweight losses (C)</p> Signup and view all the answers

How does a market economy ensure full employment and price stability?

<p>By government intervention and stabilization policies (C)</p> Signup and view all the answers

Which function of fiscal policy is aimed at reducing macroeconomic fluctuations?

<p>Stabilization function (B)</p> Signup and view all the answers

What does monetary policy primarily control to stabilize the economy?

<p>Money supply and interest rates (B)</p> Signup and view all the answers

What is the primary focus of the resource allocation role of government policy?

<p>To improve economic performance through expenditure and tax policies (B)</p> Signup and view all the answers

Which of the following best defines the allocative function in budgeting?

<p>Deciding how government revenue will be spent and who will be taxed (D)</p> Signup and view all the answers

Which method can the government use to influence private resource allocation effectively?

<p>Using tax concessions and subsidies to guide consumer and producer behavior (D)</p> Signup and view all the answers

What role does legislation play in resource allocation by the government?

<p>It influences allocation through regulations like bans on certain products. (A)</p> Signup and view all the answers

Which of the following is a tool for the government to influence resource allocation involving economic goods?

<p>Directly producing economic goods like public transportation (B)</p> Signup and view all the answers

How can government competition policies affect resource allocation?

<p>By promoting competition and preventing anti-competitive activities (B)</p> Signup and view all the answers

What is a potential consequence of government regulatory activities on resource allocation?

<p>They provide a framework that may promote efficient resource allocation. (A)</p> Signup and view all the answers

Which of the following best describes the reallocation of society's resources by the government?

<p>Redirecting resources from private sectors to public sectors when necessary. (A)</p> Signup and view all the answers

Flashcards

Government's Resource Allocation Role

Government policies, like expenditure and taxes, can influence economic output.

Allocative Function in Budgeting

Planning how society's resources are used for different purposes.

Government Allocation Instruments

Methods used by governments to guide resource allocation in the economy.

Direct Government Production

The government itself creates and provides goods and services, like utilities.

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Price Mechanism Influence

Government uses taxes and subsidies to modify market prices for altered consumer and producer behavior.

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Incentives and Disincentives

Rewards (incentives) and penalties (disincentives) to steer resource use, often via taxes and subsidies.

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Legislation and Force

Government using rules or mandates, such as bans, to control resource allocation.

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Regulatory Activities

Government controls, like licensing or minimum wages, to manage resource allocation.

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Stagflation?

A combination of high inflation and unemployment, making economic problems even worse.

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Contagion Effect

Financial instability in one country spreads to others due to global interdependence.

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What does the stabilization function focus on?

Maintaining a balanced economy through factors like employment, output, prices, international payments, and economic growth.

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What's the goal of the stabilization function?

To control and reduce economic fluctuations caused by inefficiencies in resource use.

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How does monetary policy stabilize?

Adjusting money supply and interest rates to influence spending, investment, and prices.

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How does fiscal policy stabilize?

Using government spending and taxes to manage demand and influence economic activity.

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Recession measures?

Government increases spending or cuts taxes (or both) during recessions to boost demand and protect income.

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Inflation control?

Government reduces spending or raises taxes during high inflation to curb demand.

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Efficiency Costs

The negative effects on economic output caused by government policies that interfere with market choices, like price controls or high taxes.

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Deadweight Loss

A reduction in economic efficiency due to government intervention, which prevents resources from being used in their most productive way.

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Equity vs. Efficiency

The trade-off between achieving fairness in resource distribution and maximizing economic output.

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Stabilization Function

The government's role in maintaining economic stability, ensuring full employment, stable prices, and matching output with production capacity.

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Keynesian View

The belief that markets don't automatically create full employment and price stability, requiring government intervention.

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Business Cycles

The natural fluctuations in economic activity, characterized by periods of growth followed by periods of contraction.

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Fiscal Policy

Government actions related to spending and taxation to influence economic activity.

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Monetary Policy

Actions by the central bank to control the money supply and interest rates to influence economic activity.

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Market Failure

Situations where free markets don't efficiently allocate resources due to factors like monopolies, public goods, or externalities.

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What is IGST?

IGST (Integrated Goods and Services Tax) combines SGST and CGST, collected by the union government. After input tax credit adjustments and verification of the goods' destination, the revenue is distributed between the union and states.

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Government's Allocation Role

Governments intervene in markets to correct market failures and achieve desired economic outcomes.

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Allocation Instruments

Tools used by governments to influence resource allocation, like direct production, incentives, regulations, and policies.

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GST Revenue Share

GST accounts for a significant portion of the union's gross tax revenue (35%) and a large share of state's own tax revenue (44%).

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Distributive Function of Budget

Government's role in determining who benefits from economic production, aiming for fairness and equity.

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GST's Impact on Revenue

The shift from production-based taxation to consumption-based taxation under GST raised concerns about revenue loss for manufacturing states.

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Redistribution Policies

Government actions, like taxes and spending, to shift income and wealth from one group to another.

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Compensation for States

To address revenue loss concerns, a five-year compensation scheme was implemented for states. A cess on luxury and demerit goods funded this compensation.

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Extended Compensation

The GST compensation period was extended beyond five years due to the economic slowdown caused by the pandemic.

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Top GST Compensation Receivers

Maharashtra, Karnataka, Gujarat, Tamil Nadu, and Punjab received the most GST compensation during the five-year transition period.

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Central Government Responsibilities

The central government handles national-level areas like defense, foreign affairs, trade, banking, and cross-state infrastructure.

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State Government Responsibilities

State governments manage local affairs like agriculture, industry, social services (health, education), police, and state infrastructure.

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Article 270

Defines the process of distributing tax revenue between the central government and the states.

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Article 275

This article enables the central government to provide financial assistance, called grants-in-aid, to states that require additional funds.

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Finance Commission

A constitutionally mandated body that plays a crucial role in India's fiscal federalism by recommending the sharing of taxes between the central government and the states.

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Vertical Equity

A principle guiding the Finance Commission, ensuring that states receive fair shares of revenue collected by the central government.

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Horizontal Equity

A principle that ensures states with similar needs and characteristics receive an equitable share of central revenue.

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Grants-in-aid

Financial assistance provided by the central government to states that face financial difficulties in providing essential public services.

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How does the Finance Commission help maintain fiscal federalism?

By recommending tax sharing between the center and states, allocating grants-in-aid to states, and ensuring equitable distribution of resources.

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Why are Articles 270 and 275 important?

They lay the foundation for the division of tax revenue between the central government and the states, promoting fiscal federalism.

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Study Notes

Public Finance Overview

  • Public finance encompasses the economic functions of government, covering allocation, redistribution, and stabilization.
  • Government intervention is crucial in market economies to improve general welfare and economic performance.
  • The government's role includes resource allocation, income redistribution, and macroeconomic stabilization.

Learning Outcomes

  • Students will be able to explain the three-branch taxonomy of the government's role in a market economy.
  • Analyse governmental economic actions and classify them based on economic functions.
  • Elucidate the nature of finances and responsibilities of the central and state governments in India.
  • Describe the mode of resource division between the union and states.

Functions of Government in an Economic System

  • The basic economic problem is scarcity, arising from unlimited wants and limited resources.
  • An economic system dictates resource allocation for production and distribution.
  • There are three economic systems: market, government, and mixed—each with varying degrees of state intervention.
  • Adam Smith advocated for minimal government intervention in a market economy.

Allocation Function

  • Resource allocation involves an efficient and optimal use of resources.
  • The private sector allocates resources using supply and demand, while the government uses fiscal mechanisms like subsidies and taxation.
  • Market failures occur in various scenarios, including monopoly power, and collective public goods.
  • A perfectly competitive market ensures efficient resource allocation.

Redistribution Function

  • The government aims to ensure an equitable distribution of income and wealth.
  • Redistribution occurs through tax policies, public expenditure, and social welfare programs.
  • Market failures lead to unequal resource distribution, and government intervention is needed to correct them.

Stabilization Function

  • Government interventions are needed to create economic stability.
  • A stable economy has full employment, low inflation, and balanced trade.
  • The government employs monetary and fiscal policies to maintain macroeconomic stability.

Centre and State Finance

  • Fiscal federalism describes the sharing of tax powers and responsibilities between states and the central government in India.
  • The Indian constitution designates three lists of powers to define the division of powers between the central government and states.
  • The Finance Commission recommends the distribution of central government taxes to the states.

Introduction of GST

  • GST (Goods and Services Tax) significantly changed tax relations between the centre and state governments.
  • GST assesses a variety of taxes on goods and services, shifting from a production-based to a consumption-based system.
  • The GST system provides compensation to states experiencing revenue loss after its implementation.

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Public Finance - Unit 1: Fiscal Functions (PDF)

Description

This quiz covers the essential functions of government in a market economy with a focus on public finance. It aims to enhance understanding of how government actions impact resource allocation, income redistribution, and macroeconomic stabilization in India. Students will explore the relationship between central and state finances.

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