Principles of Financial Administration
Principles of Financial Administration
Principles of Financial Administration
SYLLABUS
Resource Mobilization
Public Debt Management and Role of Reserve Bank of India, Deficit Financing, Sources of Revenue: Tax and
Non-Tax
Financial Control
Executive Control, Legislative Control, System of Financial Committees
Suggested Readings:
STRUCTURE
Learning objectives
Centre-state financial relations-II
Centre-state financial relations — I
Mixed economy
Nature and scope of financial administration
Objectives and principles of financial administration
Review questions
LEARNING OBJECTIVES
After going through this unit, you should be able to:
Explain the constitutional provisions concerning the division of
functions and possessions and other financial powers flanked by the
Union and the States.
Explain the meaning of the concept of federation.
Trace the development of mixed economy in India through examining several
Industrial Policy Resolutions.
Discuss the meaning, importance of financial administration.
Explain the nature of financial administration.
Discuss the objectives of fiscal policies aimed at securing sure social
and economic goals as envisaged in modern public policies.
Federation or Union
The vital characteristic of a federation is that the powers are so divided
that the central and state governments are each within its sphere coordinate
and independent. India is a federation of States. The Constitution of India
which came into force in 1950 provided for a clear-cut division of functions
and revenue possessions flanked by Union and States. The Seventh Schedule
of the Constitution contains a detailed sharing of functions flanked by the
central and state governments in the form of three lists i.e., union, state and
concurrent lists. The functions of the central government are specified in the
Union list which comprises defense, atomic energy, foreign affairs, railways,
national highways, posts and telegraphs, currency and coinage, foreign
exchange, inter-state trade and heavy and vital industries.
The functions assigned to the states as enumerated in the state list contain
law and order, police, administration of justice, education, medical and public
health, agriculture, irrigation, power, forests, fisheries, cooperatives, rural and
community development and slum clearance. Separately from the union and
state lists, there is a third list recognized as the concurrent list. Functions of an
inter-state nature, such as commercial and industrial monopolies, labour
disputes, social legislation, social security, and economic and social planning
have been placed under the concurrent legislative powers of the central and
state governments. In the event of a conflict flanked by the laws of the central
and state governments over a concurrent area, the former i.e. the central law
prevails.
The Drafting Committee thought that it was better to create it clear at the
outset rather than to leave to speculation or to dispute.
Financial Powers
In effecting a division of possessions, the Constitution gives for a strong
centre. The Constitution ensures the supremacy of the action of the Union
Government over the fairly comprehensive Union list as also over concurrent
jurisdiction. Allocation of the heads of taxation flanked by the union and the
states is based on the broad principle that taxes which are location-specific and
relate to subjects of local consumption have been assigned to the states.
Those taxes like for instance Income tax which are of inter-state
significance and where the place of residence is not a correct guide to the true
incidence of tax have been vested in the union. This clear-cut division of heads
of taxation flanked by the union and the states has minimized the scope for
conflicts and litigation flanked by them. The taxes over which the union has
legislative jurisdiction can be classified as follows:
Taxes which are to be levied and composed through the Union and the
whole proceeds there from are to be retained through it. These contain
corporation tax and customs duties.
Taxes which are levied and composed through the Union but proceeds
are shared with the States. These are income tax, and excise duties.
Taxes which are levied through the Union but composed and retained
through the States. These are estate duties and terminal taxes on goods
and services.
Taxes which are levied through the Union but composed and retained
through the States. These are excise duties on medicinal and toilet
preparations (containing alcohol), opium, etc.
In addition, there are exclusively state taxes, i.e., taxes levied and composed
through the states and appropriated through them. This category comprises
land revenue, taxes on Article 286 of the Constitution forbids taxation through
states of
Imports into or exports from the territory of India;
Inter-state trade; and
Sale of goods declared through the Parliament through law to be
essential for the life of the community.
The property of the union is exempt from state taxation. The property and
income of the states are exempt from the union taxation. In addition to the
provisions for tax-sharing, Article 275 of the Constitution gives for both
general purpose and specific grants. Though, it has been left to the Parliament
to decide which states are in need of grant assistance and to what extent
subject to the recommendations of the Finance Commission.
The borrowing powers of the central and state governments are regulated
through Articles 292 and 293 of the Constitution. The central government can
borrow on the security of the Consolidated Fund of India within and outside
the country subject to the limits, if any, specified through the Parliament. The
state governments can borrow usually only within the territory of India with
the consent of the central government. The central government may also
provide loans to the state governments, subject to such circumstances as are
laid down in a law of Parliament.
If the President of India is satisfied that a situation has arisen where the
financial stability or credit of India or any part of the territory thereof is
threatened, the President may declare financial emergency under Article 360
of the Constitution. In these abnormal and emergent circumstances, both
collection and sharing of revenues in state governments are made through the
central government or state governments as decided through the Parliament.
The Approach
In India, so far ten Finance Commissions have been set up and they
adopted a common approach with regard to fiscal transfers from centre to
states. Some uniform principles or thoughts have been kept in view through
the Finance Commissions in creation their recommendations. The first Finance
Commission laid down sure principles as follows: Firstly, the additional
transfer of possessions from the centre necessity is such as the centre should
bear without undue strain on its possessions taking into account its
responsibility for such vital matters as the defense of the country and the
stability of the economy. Secondly, the principles of sharing of possessions
flanked by the states and the determination of grants-in-aid necessity are
consistently applied to all. Thirdly, the scheme of sharing should attempt to
lessen the inequalities flanked by the states (First Finance Commission
Report).
The First Finance Commission further observed: “It is not the purpose of
any system of grants-in-aid to diminish the responsibilities of the State
governments to balance their own budgets. The method of extending financial
assistance should be such as to avoid any suggestion that the Central
Government had taken upon themselves the responsibility for helping the
states to balance their budgets from year to year.”
Resource Transfers
Share of Income Tax: Article 270(1) of the Constitution gives for sharing
of taxes on income flanked by the union and the states, in such manner as may
be prescribed through the President after considering the recommendations of
the Finance Commission. The First Finance Commission fixed the state‟s
share of the divisible pool at 55 per cent which earlier was 50 per cent. This
was progressively raised to 60 per cent, 66 per cent, and 75 per cent through
the second, third and fourth Commission respectively. The sixth and seventh
commissions raised it further to 80 per cent and 85 per cent respectively. The
eighth and ninth Finance Commissions have retained it at that stage.
The states‟ share in divisible pool of excise duties was 40 per cent of only
three commodities. The share was raised through the second and third
commissions and fourth commission raised the share to 20 per cent of all
commodities. The fifth and sixth finance commissions maintained the stage,
seventh commission raised it to 40 per cent of all commodities, eighth raised it
to 45 per cent of all commodities. Ninth Commission retained it at that stage.
Grants-in-aid
Under Article 280 of the Constitution, the Finance Commissions have
been given the right of creation recommendations concerning the payment of
grants-in-aid of the revenues of the states out of the Consolidated Fund of
India. Article 275 gives for the payment of such funds to the states which are
actually. in need of assistance. But the controversies that arise with regard to
grants-in-aid are because the term „need‟ has not been clearly defined in the
Constitution. The first Finance Commission listed six principles of grants-in-
aid which have been followed through later Finance Commissions also with
varying degrees of emphasis. These are:
Budgetary needs;
Tax efforts;
Economy in expenditure
Standard of social services.
Special obligations; and
Broad purpose of national importance.
The seventh Finance Commission took the view that grants-in-aid should
only be a residuary means of assistance and should be used not merely to fill
in the uncovered revenue gaps but should be used to narrow down the
disparities in the standards of administrative and social services of the states.
The eighth Finance Commission broadly agreed with the views of the seventh
Finance Commission. The successive Finance Commissions have, so, broadly
followed the residuary financial assistance approach in recommending the
grants-in-aid.
Some of the states have made suggestions for improving the working of the
Finance Commission. These have been summarized through the Sarkaria
Commission as follows:
The functions of the Finance Commission are enlarged. It should also
consider plan and other transfers and/or undertake comprehensive
annual/periodical reviews of the financial performance of the Union
and State Governments.
The Finance Commission should be made a permanent or standing
body to cope with enlarged responsibilities.
The coordination flanked by the Finance Commission and the Planning
Commission should be improved so that an integrated view of the flow
of Central assistance to the States becomes possible.
It should be provided with a permanent and well-equipped secretariat
to carry out studies and maintain operational stability for the benefit of
the subsequent Finance Commissions.
From the very beginning, the Prime Minister has been the Chairman of the
Commission. The Deputy Chairman is an eminent person, usually a politician,
holding the rank of a Cabinet Minister. There are two kinds of members of the
Planning Commission in addition to the Minister for Planning. There are a few
full-time members who are eminent public persons, economists, social
scientists, technical experts or administrators. In addition, the Commission has
as its members, a few Cabinet Ministers like the Finance Minister, Defense
Minister, etc., who attend only very significant meetings of the Commission.
A large secretariat has been recognized to assist the Planning Commission in
its work.
The Planning Commission has Advisers (State Plan) who perform a very
significant role vis-à-vis the States. On the one hand, they assist the Planning
Commission in finalizing the state plans and on the other, in monitoring the
progress of several development programmes in the states. They also interact
with the state governments and assist them in resolving these troubles in
implementation of the plan. They are therefore expected to function as an
active link flanked by the Planning Commission and the state governments.
The third category of transfers is given for several purposes through the
union government. These are in the form of grants and loans for relief of
natural calamities, improvement of roads, upgrading salaries of teachers, etc.
Throughout 1951-85, such transfers amounted to 19 per cent of the transfers.
Central assistance is a significant instrument for reducing local inequalities
and augmenting finances particularly of less developed states for meeting their
developmental needs. Plan assistance has always been crucially significant for
state plans and presently about 50 to 60 per cent of state plan outlays are met
from central assistance. The amounts given as plan assistance in the form of
grants (30 per cent) and loans (70 per cent) has always been determined on the
basis of prescribed criteria. Nevertheless, in actual practice stronger states
could get absent with a larger slice than what was their due. ‟
It is often alleged that in as much as only 40 per cent of the total transfers
from the Union have been effected on the recommendations of the Finance
Commission, the transfers through the Planning Commission and the Union
Ministries (for Centrally Sponsored Schemes) have been discretionary in
character (implying subjectively arbitrary). Firstly, the Plan assistance is not
mandatory on the union government. Secondly, allocation of Central
assistance is subject to the approval of the National Development Council on
which all Chief Ministers are represented. Thirdly, bulk of central assistance
(grants and loans) is decided according to prescribed criteria, population being
a major criterion, backwardness of the states, other special troubles also being
other significant criteria. This is done under what is recognized as the Gadgil
Formula or modified Gadgil Formula. Fourthly, in the case of centrally
sponsored schemes, the pattern of financing, viz. Central assistance vis-à-vis
States own contribution for several schemes is determined and recognized well
in advance. As Sarkaria Commission has observed: “It is not humanly possible
to derive foolproof formula which would create the totality of central transfers
confirm fully to the ideal of automatic and free-from interference devolution.
Some amount of flexibility and room for subjective judgment will have to be
left to the concerned institutions to deal with the specific situations as they
arise. What is really significant is that the institutions involved should function
in a fair and non-partisan manner and take decision with due discernment and
expertise which are implicitly acceptable to the states”
The centre-state relations in a new federation like India are quite complex.
In older federations like USA, Canada, and Australia, a general acceptance of
the financial relations flanked by the federal governments and the states
creates for a far more smooth relationship. The general complaint against the
financial relations flanked by the union and the states concerns the division of
possessions.
The states have a grievance that through and large the taxes with the
Union are quite elastic whereas those left with the states are inelastic
and their tax base is also narrow. Of the several taxes levied through
them, only Sales Tax and to some extent the State Excise Duties have
shown a degree of elasticity. Land Revenue has lost its importance. In
1951-52, it acquiesced Rs. 49 crore, comprising 21 per cent of their
own tax revenue. In 1984-85, it was about Rs. 300 crore, constituting
only 2.6 per cent of their own tax revenue. The states and some of the
critics maintain that the Constitution has assigned to them the
responsibility for development works, rural and social uplift, and
structure of social overheads. Additionally, the responsibility for the
maintenance of law and order, the expenditure on general
administration has also gone up through leaps and bounds. Therefore
there are gaps flanked by the revenue and expenditure.
Extending the above criticism, it is held that there is inadequate
devolution of taxes levied and composed through the central
government, thereby reducing the finances accessible for state
activities, within their sphere of responsibility.
The heavy dependence of the states on the union for financial
possessions has resulted in progressive erosion of the jurisdiction,
authority, and initiative of the states in their own constitutionally
defined spheres.
The states have also to depend on the union for their share of the
enormous financial possessions. These contain the banking sector and
other financial institutions, foreign aid and in the last resort deficit
financing supported through the Reserve Bank.
The states are obligated to submit their five year plans, including the
items within the sphere of their own responsibility to the Planning
Commission created through the central government and there is
interference and control through the letter over the plans of individual
States. There is also a gradual decline in the relative share of State‟s
Plan outlay in the total, rising outlay of the union on state subjects, and
proliferation of centrally sponsored schemes. Therefore, the intrusive
planning procedure beside with inadequate and inelastic tax base
leading to resource constraints and dependence on the Union,
constitute the bulk of the criticism through the states of actual
operation of fiscal federalism in India.
The variation flanked by the states own possessions and their revenue
expenditures over a period of years is not an infallible measure of the extent of
their dependence on the resource transfers from the Union. The main snag is
that the quantum of revenue expenditure of a state carries a substantial
component relatable to revenue received through transfer from the union. This
component is a variable factor which has an incremental effect on the stage of
the state‟s revenue expenditure. The so-described narrow tax-base of the
states, so, cannot be related quantitatively to the stage of their revenue
expenditure as the latter itself depends upon their total revenue possessions
including revenue transfers from the Union. A state government has in fact
conceded after a quantitative analysis that the state‟s indirect taxes (Sales Tax
on Passengers and Goods, Electricity Duty and Stamp Duties and Registration
Fees) are fairly elastic to prices and income, but their direct taxes such as Land
Revenue and Profession Tax, are highly inelastic.
The major cause for the rapid rise in state‟s indebtednesses due to
investment under the plans, but more recently to the states resort to cover part
of revenue expenditure. As far as market borrowings are concerned, under
each five year plan, each state is allocated a share on a net basis, i.e. of
repayments due in the year. The states find that their repayment obligations to
the centre are absorbing a large and ever-rising proportion of fresh loans.
These cut into plan possessions to a substantial extent.
The states' representation to the Ninth Finance Commission, in the middle
of others, was in regard to reduction of repayment burden, write-off loans used
for social infrastructure, the pattern of central plan assistance to be changed to
have a higher proportion of grants, e.g. 50:70 proportions of grants to loans,
etc. In channeling market loans, allocation of capital funds through the centre
favors the weaker states. Had the moneys been borrowed through all the states
directly from the market, the richer states would have gained in competition.
The Ninth Finance Commission points out that if the centre is asked to bear
the cost of borrowing funds, the amounts accessible for direct transfers to the
states would be reduced. The “Central Government is not acting merely as a
financial agent on behalf of the States in order to reap economies of scale in
obtaining funds from the market, but also aims to fulfill sure national purposes
such as promoting development and helping weaker States”. It felt that the
solution to the government debt problem lay in using borrowed funds
efficiently and productively for capital expenditure instead of revenue
expenditure. It held that, in future, scheduling of loans should be avoided and
that the conditions on which the funds were lent through the centre to the
states necessity be reasonable and equitable. It recommended sure debt relief
measures for the states.
FEDERALISM — MEANING
All political systems have people with differing and often conflicting
demands and dissimilar abilities to achieve them. Several groups of people in
such systems have, though, common and shared concerns. On the one hand,
these groups of people have separate identities and would like to retain their
internal autonomy; on the other hand, their deeper socio-economic and
cultural interests get articulated through the participative political processes
and institutions. The function of government is to mediate flanked by
dissimilar interest groups within a legal and organizational framework which
binds them together. The distinctive characteristic of such a political system is
that public policy decision-creation and its implementation are divided flanked
by a multi-tier system consisting of two governments, i.e., a central
government and a set of unit governments. The central government is
recognized as the federal government and the unit governments are recognized
as the state governments. The political system which is characterized through
multi-stage governments is recognized as a federation. Sir Robert Garson
defined a federation as: “a form of government in which sovereignty or
political power is divided flanked by the central and local government so that
each of them within its own sphere is independent of each other.” Likewise
according to K.C. Where, “Through federal principle, I mean the method of
dividing powers so that the general and local governments are each within its
sphere coordinate and independent.” Therefore the powers of the government
are divided considerably according to the principle that there is a single
independent authority for the whole country (federal government) in respect of
some matters and that there are independent local authorities for other matters
(state governments).
There is a continual shift in the relative powers of the centre and the units.
This shift is not peculiar to federations. The unitary forms of governments had
also to contend with the dilution of their powers because of changes in
political and economic fields. Whether a nation would like to adopt a federal
or a unitary government would depend on several factors. The rationale for
decentralization of powers and functions is very great in large countries,
particularly if such countries have sizeable groups of population with
dissimilar languages, cultures, religions etc. Small countries can manage well
enough with a unitary form of government. Socially, culturally and politically
small countries are usually very compact systems. Even in unitary states, quite
a few functions are delegated to local bodies which are best suited to
collecting - local taxes assigned to them through the central government. This
delegation is, though, quite limited. Decentralization of powers, functions, and
responsibilities has been necessitated through the rising complexity of modern
life, the need to associate local people in solving their troubles and providing
local services. Decentralization gives the conceptual as well as the operational
underpinning of federations.
Economic Determinants
Decentralization of powers and possessions through federalism is regarded
as a better solution to achieve economic take-off, optimal resource use, and
removal of local economic disparities and strengthening of bargaining power
in the global market. In developing countries, it is possible to enhance
allocation of possessions on health, education, poverty alleviation, and social
services. The objectives of equity and balanced local development may,
though, not be served at least in the short run. Theoretically, with the breaking
down of barriers to trade and free movement of labour and capital being
allowed, the factors of production will move to regions where returns are the
highest. In the USA, though, the territorial expansion of the federation
intensified the conflict of economic interests flanked by the Northern and the
Southern States. The South feared a situation of permanent economic
inferiority to the North and hence the attempt to secede from the federation.
The formation of the federation in the first place was prompted through the
desire to protect their farming, trading, and the need for integrated market
serving the primary interests of the rising industrial and commercial classes.
The Commonwealth of Australia was a later creation through a similar
procedure of aggregation and integration promoted through more or less
similar thoughts. The dominance of maritime provinces has also accounted for
a strong centre in Canada. In the case of India, the extreme centralization
which characterized Indian administration under the British rule was intended
to sub serve the British economic interests. But centralizing characteristics
were slowly modified in response to the nationalist thrash about.
Efficiency
The system of sharing of functions should conform to the necessities of
efficiency and economy. “No matter how well intentioned a scheme may be or
how totally it may harmonies with the abstract principles of justice, if the tax
does not work administratively, it is doomed to failure”. Two factors
determine the effectiveness of dissimilar taxes, namely, nature of the tax and
the character of administration. A land tax for instance, may be expected to be
administered best through local authorities because “it is, after all, the local
assessors who may be presumed to possess the mainly exact knowledge of the
local circumstances upon which the value of the land depends”. One of the
reasons for the formation of a federation is that a government at the federal
stage will be efficient for the nation as a whole: The division of sources is, so,
based on the principle of relative interest and efficiency. Taxes which have an
inter-state base, like customs, income and wealth tax are assigned to the
federal government and those which have a local base, like sales tax and
entertainment tax, are assigned to the states. Costs of collection of taxes, the
feasibility of levying taxes at the nationwide stage rather than at the local stage
are significant thoughts in the allocation of powers and functions.
Equity
Fiscal federation is viewed within the framework of welfare economics.
Equitable sharing of wealth and income of the community are the proper
concerns of a welfare state. Experts argue that the whole system of federal and
state taxation and expenditure should be so framed as to impose equal burdens
and confer equal benefits upon likewise placed persons irrespective of their
residence. From the point of view of the nation, there is a separate advantage
in taxing the richer states more and spending that revenue in poorer states
since the sacrifice in extra taxation in richer states is less than the benefit that
will be derived if that money were spent in poorer states. The ideal is to
maximize national benefit from the state and federal expenditure. This would
necessitate a reduction of welfare generating expenditure in richer states and
an augmenting such expenditure in poorer states. Federal fiscal operations
have an equalizing role in respect of tax burdens and benefits from public
expenditure as flanked by the affluent and less fortunate states.
This devolution scheme was criticized on the ground that the possessions
assigned to the provinces did not have adequate growth potential and was
insufficient for their rapidly rising needs, whereas the central revenues were
capable of expansion, although its needs were relatively stationary. The
working of the financial relations, was, so, reviewed through a number of
expert committees, particularly, in early 1930‟s. The provisions incorporated
in the Government of India Act, 1935, were based on these reviews. The
Government of India Act, 1935: This Act constitutes the after that landmark in
the country‟s financial administration. It divided the revenue sources into three
categories:
Exclusively Federal.
Exclusively Provincial.
Taxes levied through the Federal government but shared with the
provinces or assigned to them.
Taxes levied through the Federal Government but composed and
retained through the Provinces.
The scheme also envisaged grants-in-aid from the Centre to the provinces
in need of assistance as approved through the former. The Government of
India Act, 1935, laid foundations for a system of elaborate but flexible
financial arrangements flanked by the centre and the provinces. The long
history of the development of public finance in India shows very complex
factors at work. Though, one clear discernible trend is that while it is wholly
possible to divide the taxation powers and allocate possessions, it is hard to
establish a balance flanked by need and possessions. The several stages of
development helped confirm the maxims:
That no decentralized government can be recognized without
allocating to it enough financial powers; and
That the central government is the appropriate
authority to levy a tax where uniform rate is
significant and locale is not a guide to its true
incidence.
MIXED ECONOMY
At times, it is held that every economy is a mixed economy and that the
concept of mixed economy is neither precise nor worthwhile. It has, though, to
be appreciated that the concepts of planned economy and market economy
have definite ideological and operational profiles. The concept of mixed
economy represents a middle position flanked by these two extremes. This
concept is flexible and has its own means and methods of approaching
economic, political, and social issues. To achieve clarity in the understanding
of the concept of mixed economy, let us discuss the meaning and features of
Capitalism, Socialism.
Capitalism
Capitalism has been defined as an economic system stressing individual
initiative with a central role for a market economy, the profit motive, and
ownership of means of production, through private individuals and
corporations. Under capitalism, all means of production such as farms,
factories, mines, transport are owned and controlled through private
individuals and firms. Those who own these means of production are free to
use them as they like in order to earn private profit. The State or government
takes least part in the economic activities of the people. The government looks
after only such matters as defense, foreign affairs, currency and coinage and
some significant civil works such as the construction of roads and bridges
because private individuals may not find it profitable to undertake such works.
Adam Smith was of the opinion that interests of individuals and those of the
society coincide. The government, so, has no role in economic activities. In
fact, the State was inherently incapable of undertaking such activities. State
undertaking would mean wastage of society‟s possessions. Things should be
allowed to take their own course and there was, so, no need for planning or a
pre-determined framework for guiding the economic activities of the people.
Essentials of Capitalism
Capitalism has an ugly face also — it divides the society into those who
are vulgarly rich and indulge in ostentatious consumption, and those who are
the wretched of the earth and do not have even two square meals a day. The
incentive system is also vitiated through the inequalities of income which get
aggravated. Consumers‟ sovereignty is a myth. In fact large corporation
controls the market which it is supposed to serve and “even bend the
consumers to its needs financial costs which capitalism imposes on the society
are in the form of inflation, unemployment, and cyclical fluctuations.
Features of Socialism
As early as the First Five Year Plan, the Indian policy makers decided that
the State necessity not only assume the responsibility of providing the
infrastructure facilities and the social overheads, but should" also undertake
direct promotional work. It was recognized that the government should
intervene in the industrial field and accordingly the development of vital and
strategic industries was earmarked to the public sector. It was also recognized
that the task of economic development of the country was so large that the
initiative of both the private and public sectors had to be harnessed for optimal
growth. The concept of mixed economy was evolved so that both the private
and public sectors could contribute to the procedure of growth. It was
measured that individual enterprise and initiative would be the best catalysts
of change in the sphere of agriculture, organized industries, small scale
industrial units, trade and construction. With the announcement of the
Industrial Policy Resolution, 1956, the concept of mixed economy was given a
definite shape and policy direction. Even before that, the Industrial Policy
Resolution of 1948 had sought to establish mixed economy, with both private
and public sectors, rising controls in government hands for regulating all
industries. The two main instruments of industrial policy were the Industries
(Development and Regulation) Act of 1951 and the Companies Act of 1956.
These two Acts conferred on the government, through licensing procedure, the
power of regulating location, production, and expansion of major industries in
the country.
In the middle of other things, the resolution emphasized that fair and non-
discriminatory treatment would be given to private sector industries and their
development, encouraged through developing transport facilities and through
providing financial assistance. The regulation recognized that the private
sector through itself could not bring about rapid industrialization of the
country. It, so, provided vital and expanding scope for public sector industries.
At the same time, private sector was assured of a significant place in the
industrial structure of the country. The resolution also acknowledged the
significant role of village, cottage, and small scale industries. The resolution
accorded a prominent role to the public sector. The apprehensions of and
Objectives the private sector that the public sector would develop at their cost
did not turn out to be correct and private sector found ample scope for its
expansion.
Private Sector
The concept of mixed economy adopted through India implied the
rejection of the thought of immediate nationalization of the private sector. It
further implied a regulated private sector and the fast expanding public sector,
especially in vital and heavy industries such as steel, engineering, fertilizer,
power, and transport. The private sector is dominant in agriculture and allied
activities in retail and mainly of the wholesale trade, cottage, rural and small
scale industries, mainly of consumer goods industries like textiles, jute,
cement, sugar, radio receivers, and numerous other consumer goods industries.
A number of capital goods industries such as engineering, chemicals.
electronics, etc., are also in the private sector. Mainly of the professional
services are in the private sector. It can be said that private sector in India
including agriculture and trade, contributes almost 80 per cent to the national
income whereas the public sector contributes the balance 20 per cent of the
national income.
Private sector in India can be divided into two parts: (a) the organized
sector and (b) the unorganized sector. The organized sector is modernized,
adopts capital rigorous methods of production, and has easy access to the
capital markets and banks. It uses modern means of communications, and
adopts all methods to manipulate demand to suit its needs. Profit motive is the
basis of all the activities of this sector. The main method of planning for this
sector is to so organize the economy that the producers get enough facilities
and inputs, and find it mainly profitable to so conduct their activities as to
reach the plan production targets. T* more risky, and long-term gestation
projects and infrastructure are left to the public sector.
Unorganized private sector is spread over a vast area and it has been hard
to enforce policy interventions. Secondly, due to lack of awareness, education,
and training, and the absence of catalytic agencies, this sector has not been
able to take full advantage of the facilities extended to them. Thirdly,
organized sector often competes and also complements the unorganized sector.
Managing these interrelationships has been hard. For instance, incentives
planned for handloom sector have often been siphoned off through the power
loom sector. The unorganized sector often is a poor-technology, poor-
remuneration sector and is often exploited in trading, credit, etc. Radical
policy changes are, so, described for to create this sector viable.
Public Sector
Prior to Independence, there was practically no such thing as the public
sector in India. Railways, posts and telegraphs, ordnance factories and a few
assorted factories constituted the public sector. Only after the Industrial Policy
Resolutions of 1948 and 1956, the government made concerted efforts to
create the public sector the dominant sector in the Indian economy. It was
Supposed to have control over “the commanding heights” of the economy. In
the middle of the significant objectives assigned to the public sector are:
To help in the rapid economic growth and industrialization of the
economy and make the necessary infrastructure for economic
development
To earn return on investment and therefore generate possessions for
development
To promote redistribution of income and wealth
To make employment opportunities
To promote balanced local development
To assist the development of small-scale and ancillary industries; and
To promote import substitution, save and earn foreign exchange for the
economy.
Some of the factors which are responsible for the poor performance of the
public sector are as follows:
Administered pricing policy of the government in respect of urban
transportation, coal, fertilizer industries, etc. is fully responsible for
non-recovery even of costs of production. The concerned public
enterprises can hardly be described inefficient, even though they are
unprofitable.
The nature of a large number of enterprises is such that they have long
gestation periods and quite often there are heavy cost overruns because
of the gestation periods and intervening inflation.
Excessive manpower recruitment due to political decisions.
Under utilization of capability.
Excessive government controls in the matter of investment decisions,
fixation of selling prices, wages and income policies, location
decisions and personnel policy.
The failures of the public sector are largely rooted in the political and
bureaucratic controls clamped on the enterprises. Unless genuine autonomy is
given to the professional management of the public sector in all matters which
are properly speaking business decisions, there is hardly any future for the
public sector.
Basics Now let us get to know some more accurate definitions of Financial
Administration. According to L.D. White, “Fiscal Management comprises
those operations intended to create funds accessible to officials and to ensure
their lawful and efficient use." According to Jaze Gaston “Financial
Administration is that part of government organisation which deals with the
collection, preservation and sharing of public funds, with the coordination of
public revenue and expenditure, with the management of credit operations on
behalf of the State and with the general control of the financial affairs of
public household.”
Traditional View
Advocates of this view conceive financial administration as a sum total of
activities undertaken in pursuit of generation, regulation, and sharing of
monetary possessions needed for the sustenance and growth of public
organisations. They emphasize upon that set of administrative functions in a
public organisation which relate to an arrangement of flow of funds as well as
to regulating mechanisms and processes which ensure proper and productive
utilization of these funds. When one looks at this view from systems
perspective, it represents an integral sub-system of supportive system. A
financial administrator shoulders responsibility for ensuring adequate financial
backing for running public organisation in the mainly efficient manner.
His/her job is to plan, programme, organize, and direct all financial activities
in public organisations so as to achieve efficient implementation of public
policy. The participants of this system are measured as financial managers and
they discharge managerial functions of financial nature. Further, this view
reflects the stand taken through pure theorists of public finance like Seligman.
The central thesis of pure theory of public finance is that public finance should
deal with the troubles of public income, public expenditure, and public debt in
an objective manner without any relation to a set of values and premises of the
political party in power. Accordingly, theorists of financial administration
subscribing to this view take a value-neutral stance. For instance, Jaze Gaston
reflects this view when he says that financial administration is that part of
government organisation which deals with the collection, preservation and
sharing of public funds.
Modern view
The modern view considers financial administration as an integral part of
the overall management procedure of public organisations rather than one of
raising and disbursing public funds. It comprises all the activities of all
persons engaged in public administration, for quite obviously approximately
every public official takes decisions which are bound to have some direct or
indirect consequences of financial nature. Further, it rejects the value-neutral
stand of the traditional theory. It combines in itself three prominent theories of
public finance, viz., the socio-political theory as expounded through Wagner,
Edge worth, and Pigou, the functional theory of Keynesian perspective and
activating view of modern public finance theorists. According to this view
financial administration has the following roles.
Equalizing Role
Under this role financial administration seeks to demolish the inequalities
of wealth. It seeks, through fiscal policies, to transfer income from the affluent
to the poor.
Functional Role
Under normal circumstances the economy cannot function on its own.
Under this role, financial administration seeks to ensure, through taxation,
public expenditure and public debt, and proper functioning of the economy. It
evolves policy instruments to maintain high economic growth and full
employment.
Activating Role
Under this role financial administration involves the revise of such steps
that will facilitate a smooth and rapid flow of investment and its optimal
allocation to augment the volume of national income.
Stabilizing Role
Under this role, the objective of financial administration is the
stabilization of price stage and inflationary trends through fiscal as well as
monetary policies.
Participatory Role
According to this view, financial administration involves formulation and
execution of policies for creation the state a producer of both public and
private goods with the objective of maximizing social welfare of the
community.
Gaston Jaze‟s definition, quoted in that context, points out that the
government organisation which deals with the following four characteristics
constitutes financial administration. These contain:
The collection, preservation and sharing of public funds.
The coordination of public revenues and expenditure.
The management of credit operations on behalf of the State.
The general control of the financial affairs of the government.
In modern governments all the above characteristics are dealt with through
the Finance Department and its subordinate agencies. Though the Finance
Department may be measured as central financial agency of modem
governments, it cannot be equated with financial administration. Its role
constitutes financial management rather than financial administration. As a
financial manager it deals with the systems, tools, and techniques contributing
to economic decision creation in government. These processes are, in fact, the
integral part of financial administration. The scope of financial administration
is much wider than what these processes suggest.
Yet another view advocates a budget oriented outline for the scope of
financial administration. According to them the scope of financial
administration is limited to the preparation of budget, the enactment of budget
and execution of budget. Though the budget is the core of financial
administration, sure operations which precede budget preparation are equally
significant. There is a pertinent need to contain planning procedure as an
integral part of financial administration. In the ultimate analysis, there is a
need to adopt an integrated approach so that all the above views are
incorporated into the scope of public administration. As an outcome of such an
approach, the following characteristics emerge as the core areas of financial
administration.
Financial planning
Budgeting
Resource mobilization
Investment decisions
Expenditure control
Accounting, Reporting and Auditing
Financial Planning
In a restrictive sense one may consider budgeting as planning since its vital
concern is to facilitate the formulation and adoption of policies and
programmes with a view to achieving the goals of government. But planning,
in a broad sense, comprises the concerns in conditions of whole range of
government policy and it demands a time frame and a perception of the inter
relationships in the middle of policies. It looks at a policy in the framework of
long-term economic consequences. There is a need to coordinate planning and
budgeting. The concept of Planning-Programming- Budgeting System (PPBS)
represents an attempt in this direction. Financial Administration, under this
stage, should consider the sources and forms of finance, forecasting
expenditure needs, desirable fund flow patterns and so on.
Budgeting
This area is the core of financial administration. It comprises examination
and formulation of such significant characteristics as fiscal policy, equity, and
social justice. It also deals with principles and practices associated with
refinement of budgetary system and its operative processes.
Resource Mobilization
Imposition of taxes, collection of rates and taxes etc. are associated with
resource mobilization effort. Due to the ever rising commitments of
government, budgetary deficits have become regular characteristic of
government finance. In this context deficit financing assumes greater
importance. But deficit financing, if used in an unrestrained manner, may
prove to be a dangerous problem for a nation‟s economy for it can cause
galloping inflation. Another challenge faced through administration is tax
evasion and growth of parallel economy. Finally public debt constitutes yet
another element of state possessions. The proceeds of debt mobilization effort
should be used only for capital financing. Therefore, modern financial
administrator has to be fully conversant with all the dimensions of resource
mobilization efforts.
Investment Decisions
Financial and socio-economic appraisal of capital expenditure constitutes
what has come to be recognized as project appraisal. Since massive
investments have been made in the public sector a thorough knowledge of the
concepts, techniques, and methodology of project appraisal is indispensable
for a financial administrator.
Expenditure control
Finances of the modem governments are becoming quite inelastic.
Approximately every government is suffering from resource crunch. Further,
the society cannot be taxed beyond a sure point without doing a great damage
to the economy as a whole. Therefore, there is an imperative need for careful
utilization of possessions. Executive control is a procedure aimed at achieving
this ideal. Legislative control is aimed at the protection of the individual tax
payer‟s interest as well as public interest. There is also the need to ensure the
accountability of the executive to the legislature.
Accounting, Reporting, and Auditing
These characteristics are intended to aid both the executive control and
legislative control. In India, the Comptroller and Auditor General (C & AG)
and the Indian Audit and Accounts Department over which the C & AG
presides ensure that the accounting and audit functions are performed in
accordance with the provisions of the Constitution.
Since financial administration concerns itself with public finance and deals
with the principles and practices pertinent to the proper and efficient
administration of the state finances, the thinkers of financial administration
have incorporated the administrative characteristics in the scope of financial
administration. Some other thinkers, taking clue from Luther Gulick, have
tried to project POSDCORCs view wherein:
P— Stands for Financial Planning
O— Stands for Financial Organisation such as Finance Ministry
S— Stands for financial Personnel
D— Stands for Direction such as Financial advise
CO — Stands for Coordination of Income and Expenditure R —
Stands for Financial Reporting such as accounting C — Stands for
control which comprises executive control, audit control and
legislative control.
The above exposition does not reveal the exact picture related to the elements
of financial administration. An organizational system consists of the following
vital elements:
The People
Work and structure
Systems and procedure
The principle of primacy of public interest, public choice, and public policy
Professor Adams, in his “Science of Finance”, stated that the Science of
Finance treats of the wants of the State and the means of their supply and
hence the fiscal policy should not impair the patrimony of the State. He
measured this dictum as a significant axiom of fiscal policy and
administration. The patrimony, according to him, consists in a flourishing
private industry. But this concept of the State‟s patrimony has undergone a
drastic change and at present it is public interest which can be measured as
locus as well as focus of the State activity. Public interest can be interpreted in
several ways such as the common good, the general welfare, and the overall
quality of life of modern and subsequent generations, the communal
realization of social values, rights, and privileges. For, fiscal policy and
administration, it is imperative to concentrate on those kinds of activities
which create a definite and justifiable contribution to the accomplishment of
public interest and public satisfaction as expressed in public policies. It is
quite essential to realize that fiscal policy is expected to sub serve the broad
aims as spelt out in public policies. One should be clear about the meaning of
public choice. Some erroneously try to identify the public choice with the
choice of the greatest number or the aggregation of individual and group
interests. Public choice is a choice which encompasses common life and is
shared through all.
This dictum does not mean centralized decision creation and decentralized
implementation. Experiences of developing countries have exposed the
inadequacy of centralized decision creation. Now, the need of the hour became
centralized direction and decentralized decision creation and decision
implementation. The concept of administrative financial control has given way
to the concept of management of results. Under this changed context, this
principle should be taken to mean centralized guidance for facilitating
decentralized decision creation with a view to securing optimum production as
well as optimum utility. The concept of national planning is a good instance.
Historical Perspective
Financial administration, as a practice, is not new to India. In Ramayana,
there is a reference concerning balanced budgeting. Financial administration
reached an advanced stage of development as early as 4th century B.C.
Kautilya‟s Arthasastra was a treatise on financial administration. It contained
many sound principles of public finance and financial administration.
Mauryan administration accepted out its fiscal functions in conventionality
with these principles. Land revenue was a principal source of revenue and it
was based on land yields. Taxes were also imposed on commodities such as
gold, cattle, etc. Income from public works constituted a major source of non-
tax revenue. Public borrowing and deficit financing were unknown. There was
a well organized financial structure which incorporated offices of the Collector
General, the Treasurer General, and the Accountant General. Fiscal decisions
were influenced through royal whims and fancies and there was no sound
system of financial accountability. Gupta‟s period had more or less a similar
system of financial administration. Mughal period saw an elaborate and
systematic financial system. Land revenue sustained to stay as the main source
of revenue. It was being levied after a systemic procedure recognized as
survey and settlement. The vital structure of revenue administration was
intended in India through Shershah.
Though the aforesaid heritage has left their indelible foot prints on fiscal
history of India, a beginning for the modem financial system was made
throughout British rule. Throughout this period, financial administration has
passed through many separate stages of development. One can broadly divide
financial administrative history of India into following four separate stages:
Period I (1765-1858) ... Creation of structure and concretization
thereof. _
Period II (1860-1919) ... Development of Systems and Procedures.
Period III (1919-1947) ... Democratization and Decentralization
Period IV (1950-till date) ... Development orientation.
It held the property as trust for the Crown. The Act vested the
superintending and controlling authority in the Governor-General of India.
The Governors lost their authority as they could not make any new office, or
grant any salary or allowance or gratuity without sanction from the Governor-
General. The Finance Secretary to the Government of India was charged with
the responsibility of conducting and co-coordinating financial operations such
as preparation of estimates, provisions of ways and means, negotiation of
loans, and supervision of accounts. He was to review all proposals for new
expenditure.
The Finance Member was to preside over and direct the Finance
Department. He performed a number of duties with regard to India‟s finances.
He prepared annual financial statement, watched the progress of income and
expenditure so as to ensure soundness of the financial system supervised and
administered monetary system and supervised and controlled Provincial
Finance Departments. The Finance Department under the leadership of the
Finance Secretary had to ensure that the restrictions imposed through the
Secretary of State for India were adhered to and that the rules and regulations
were observed. It had dual power, namely pre-budget scrutiny and expenditure
sanction.
To sum up, throughout period I the vital thrust had been on the formulation
of financial organisation with the aim of creating centers of control and
direction in the form of Secretary of State and Governor-General. Period II
was characterized through efforts to evolve a sound budgetary system and its
practice. Period III saw responses to freedom movement and as a result of
which gradual induction of popular element was attempted. It also saw
decentralization of authority and creation of federal structures. The last stage
is characterized through orientation towards people and their well-being and
development.
New Emerging Trends
There is a rising feeling that the inequalities of income and wealth may get
accentuated and that the poor and weaker sections of society may be left to
tend for themselves. This unfortunate trend can be largely redressed through
increased expenditure on social services and rural development programmes.
There is already proof that the government is taking policy initiatives like
strengthening of public sharing system and other means to ensure that growth
is not achieved at the cost of equity.
To sum up, these new trends are planned to liberate market forces from
bureaucratic control. These trends were found to be quite in conventionality
with the necessities of underdeveloped countries. In fact, some countries have
registered astonishing breakthrough with similar policy packages. So, the
government did not face any major resistance against its approach. A major
failure though expected, has been the inability of the government to contain
price rise. The government is seeking a period of two to three years to show
concrete outcomes. One has to wait and see if the new policies can pull the
country out of economic stagnation and the price paid for such is also
affordable.
REVIEW QUESTIONS
Describe the structure, functions and status of the Finance Commission
and the role played through it in respect of Centre-State financial
relations.
What do you understand through the term federation? How are federations
shaped?
Describe the respective roles of private sector and the public sector in the
Indian economy.
Explain the meaning of Financial Administration.
Why has the revise of financial administration become significant in
recent times?
What are the objectives which are reflected in the fiscal policies of the
developing countries?
What are the fundamental concerns -of financial administration which
transcend politico-economic compulsions?
CHAPTER 2
BUDGETING AND BUDGETARY SYSTEM-I
STRUCTURE
Learning objectives
Indian budgetary system
Government budgeting: principles and functions
Fiscal policy, equity and social justice
Review questions
LEARNING OBJECTIVES
After learning this Unit you should be able to:
Explain the development of budgeting system in India.
State the meaning and components of budget.
Explain the meaning and scope of fiscal policy.
Indicate the significant objectives of fiscal policy.
The accounts incorporated estimates for the coming year, and the actual
results of the year just ended. The whole Cabinet sat in a conclave, so to say,
to scrutinise them and to pronounce upon their accuracy, fullness and
satisfactory nature in all respects. And their business was not only to verify the
actual figures, to tally expenditure with outlay through vouchers and receipts,
they also had to see that full value was received for every pie spent; that the
clerks, officers and departmental heads that done their duty honestly and
efficiently. A system of fines or rewards helped to make the system very
effective. The rewards as well as punishments fell as much upon clerks as
upon the superior officers, inspectors or even the Auditor-General.
The rulers of the Delhi Sultanate and the Mughal empire also sustained a
financial system not very dissimilar from the Mauryan system. With the
advent of the British rule, the Indian financial administration came effectively
under the control of the East India Company. Till 1833, the presidencies of
Bengal, Bombay and Madras were quite independent in finance and there was
hardly any centralized financial system. This position changed with the
Charter Act of 1833 which vested the superintendence, direction and control
of all the revenues in the Governor General of India-in-Council.
The main activity of the East India Company being territorial expansion,
expenditure on costly wars mounted. Vast sums were remitted to England on
account of interest payable on Indian debt, interest on investment on Railways,
civil and military charges supposed to have been incurred in England on
behalf of India, including the expenses on the maintenance of the Office of
East India Company in India. That the Governors of the three presidencies
hardly had any powers can be seen from the fact that no governor could make
a permanent post carrying a princely salary of more than Rs. ten per month.
The Government of India Act, 1935, delivered a body blow to his powers.
Except for the control over the services, the Secretary of State gave up direct
exercise of mainly of his powers. The Governor General and the Governors
exercised special powers and prerogatives over what were described reserved
subjects which together with charged items were outside the purview of
legislative financial control. They could also restore a demand rejected or
reduced through the legislatures. Again, no expenditure could be incurred even
if it was duly authorized through the legislature unless it was incorporated in a
schedule of expenditure authenticated through the Governor-General or the
Governor.
PRINCIPLES OF BUDGETING
FINANCIAL YEAR
When the first modern budget was presented in I860, the financial year
adopted through the government was from 1st May to 30th April. Beginning
with the year 1866, though, the financial year was changed to April-March, in
conventionality with the practice in England. This practice has been the
subject of debate and several committees and commissions which examined
the issue have been critical of it. The Administrative Reforms Commission in
its Report on Finance, Accounts and Audit observed.
“The financial year starting from the 1st of April is not based on
custom and needs of our nation. Our economy is still predominantly
agricultural and is dependent on the behaviour of the principal
monsoon. A realistic financial year should enable a correct assessment
of revenue, should also synchronies with a maximum continuous spell
of working season and facilitate an even spread of expenditure. For
centuries, people in India have become accustomed to commence their
financial year on the Diwali day. This practice has its roots in their way
of life. The business community and other sections of society start the
Diwali day with the feeling that they have finished with the old period
of activity and have embarked upon a new one. It is, so, appropriate
that the commencement of the financial year should be related to
Diwali and in order to prescribe it in conditions of a date, we have
recommended that the 1st November should be the beginning of
financial year.”
The commission also thought that a budget year commencing on the 1st
November would be better suited for the transaction of Parliamentary
business. It is normally argued that the effect of south-west monsoon, which is
responsible for over 90 per cent of the total annual rainfall in India, would be
recognized through September, and the likely agricultural production
throughout the year can be estimated fairly accurately. The commercial and
industrial activities are also largely dependent on the performance in the
agricultural sector. Besides, the monsoon months can be utilized for budget
formulation and the critical fiscal parameters can be decided upon in the light
of anticipated stage of economic activity in the ensuing year.
Under the present arrangements, soon after the expenditure sanctions reach
the executing agencies, the onset of monsoon renders it hard to start
construction of the budgeted works. These works have to wait till the rains are
over. The speed of works is affected because of the intervention of monsoons
when barely the preparatory work of projects has been completed. The delayed
execution of works results in the rush of expenditure towards the end of the
year leading to surrender of funds at the secure of the financial year.
Essentially a budget year should help in performing the following functions:
Creation a fairly accurate estimates of revenue;
Creation a fairly accurate estimates of expenditure;
It should facilitate an efficient execution of projects; and
The budget calendar should be convenient to the legislators and
administrators.
Dissimilar dates have been suggested through the several experts who have
examined the question of financial year. These are 1st July, 1st October, 1st
November or 1st January. While there is a merit in each one of these
suggestions, none of these can reconcile the conflicting criteria proposed.
Considering only the criterion of better predictability of revenues, no single
budget year gives enough scope for the several states to create a realistic
assessment for both Kharif and Rabi crops. Rabi crops are very significant for
some of the states. The estimation of total agricultural production would, so,
remain a guess work.
It has, so, been argued that the balance of advantage lies in not disturbing
the present fiscal year. The database of the economy relates to the existing
financial year and any dislocation in this year will lead to statistical,
accounting and administrative troubles. One has to weigh the advantages of
changing over to a dissimilar fiscal year against the disadvantages inherent in
such a switchover. And one has to keep in mind that there is no general
agreement on the alternative fiscal year. The only practical approach, so, is to
continue with the present financial year.
THE BUDGETARY PROCEDURE
Contingency Fund
Occasions may arise when government may have to meet urgent
unforeseen expenditure pending authorization from the Parliament. The
Contingency Fund is an Imprest placed at the disposal of the President to incur
such expenditure. Parliamentary approval for such expenditure and for
withdrawal of an equivalent amount from the Consolidated Fund is
subsequently obtained and the amount spent from Contingency Fund is
recouped to the fund. The corpus of the fund authorized through the
Parliament, at present, is Rs. 50 crore.
Public Account
Besides the normal receipts and expenditure of government which relate to
the Consolidated Fund, sure other transactions enter government accounts, in
respect of which government acts more as a banker; for instance, transactions
relating to Provident Funds, small savings collections, other deposits etc. The
moneys therefore received are kept in the Public Account and the linked
disbursements are also made therefrom. Usually speaking, Public Account
funds do not belong to government and have to be paid back some time or the
other to the persons and authorities who deposited them. Parliamentary
authorization for payments from the Public Account is, so, not required.
Charged Expenditure
Under the Constitution, sure items of expenditure like emoluments of the
President, salaries and allowances of the Chairman and the Deputy Chairman
of the Rajya Sabha and the Speaker and Deputy Speaker of the Lok Sabha,
salaries, allowances and pensions of Judges of the Supreme Court and the
Comptroller and Auditor-General of India, interest on and repayment of loans
raised through government and payments made to satisfy decrees of courts etc;
are charged on the Consolidated Fund. These are not subject to the vote of
Parliament. The budget shows the charged expenditure separately in the
Consolidated Fund. Government budget comprises:
Revenue budget; and
Capital budget
Revenue Budget
It consists of the revenue receipts of government (tax and non-tax
revenues) and the expenditure met from these revenues. The estimates of
revenue receipts shown in the budget take into account the effect of the
taxation proposals made in the Finance Bill. Other receipts of government
mainly consist of interest and dividend on investments made through
government, fees, and other receipts for services rendered through
government.
Capital Budget
It consists of capital receipts and payments. The main items of capital
receipts are loans raised through government from public which are described
Market Loans, borrowings through government from Reserve Bank and other
parties through sale of Treasury bills, loans received from foreign
governments and bodies and recoveries of loans granted through Central
Government to State and Union Territory governments and other parties.
Capital payments consist of capital expenditure on acquisition of assets like
land, structures, machinery, equipment, as also investments in shares etc. and
loans and advances granted through Central government to State and Union
Territory governments, government companies, corporations and other parties.
Capital budget also incorporates transactions in the Public Account.
BUDGETARY CYCLE
Budget Preparation
In India, budget preparation formally begins on the receipt of a circular
from the Ministry of Finance sometime throughout September/October, that is,
about six months before the budget presentation. The circular prescribes the
time-schedule for sending final estimates separately for plan and non-plan, and
the guidelines to be followed in the examination of budget estimates to be
prepared through the department concerned
The general rule is that the person who spends money should also prepare
the budget estimates. Budget proposals normally contain the following
information:
Accounts classification
Budget estimates of the current year
Revised estimates of the current year
Actual for the previous year; and Proposed estimates for the after that
financial year (which is the budget proper). Budget estimates normally
involve:
o Standing charges or committed expenditure on the existing
stage of service. This can easily be provided for in the budget,
as it is more or less based on a projection of the existing trends.
New expenditure which may be due to expansion of
programmes involving expenditure in addition to an
existing service or facility; and new service for which
provision has not been previously incorporated in the
grants.
Parliamentary Approval
The estimates of expenditure prepared through ministries/departments are
transmitted to the Ministry of Finance through December where these are
scrutinized, modified where necessary and consolidated. The estimates of
revenue are also prepared through the Finance Ministry and therefore the
budget is finalized. The budget is presented to the Parliament usually on the
last working day of February. In the first stage, there is a general discussion on
the broad economic and fiscal policies of the government as reflected in the
budget and the Finance Minister's speech. This lasts about 20-25 hours.
Even after the demands for grants have been voted through the Parliament,
the executive cannot draw the money and spend it. According to the
Constitutional provisions, after the demands for grants are voted through the
Lok Sabha, Parliament‟s approval to the withdrawal from the Consolidated
Fund of the amount so voted and of the amount required to meet the
expenditure charged on the Consolidated Fund is sought through the
Appropriation Bill. The Appropriation Bill after it receives the assent of the
President becomes the Appropriation Act. Therefore, without the enactment of
an Appropriation Act, no amount can be withdrawn from the Consolidated
Fund.
Since the financial year of the government is from 1st April to 31st March,
it follows that no expenditure can be incurred through the government after
31st March unless the Appropriation Act has been passed through the secure
of the financial year. This is usually not possible as the procedure of
discussion of the budget usually goes on up to the end of April or the first
week of May. Therefore, in order to enable the government to carry on its
normal activities from 1st April till such time as the Appropriation Bill is
enacted, a Vote on Account is obtained from Parliament through an
Appropriation (Vote on Account) Bill.
Audit
The executive spends public funds as authorized through the legislature. In
order to ensure accountability of the executive to the legislature, public
expenditure has to be audited through an independent agency. The
Constitution gives for the position of the Comptroller and Auditor General of
India to perform this function. It is his/her duty to ensure that the funds
allocated to several agencies of the government have been made accessible in
accordance with law; that the expenditure incurred has the sanction of the
competent authority; that rules, orders & procedures governing such
expenditure have been duly observed; that value for money spent has been
obtained and that records of all such transactions are maintained, compiled and
submitted to the competent authority. This is the last stage in completing the
budgetary cycle.
BUDGET-MEANING
A budget is, though, not a balance sheet (exhibiting total assets and
liabilities) of the government on a scrupulous date but refers, only to
information explained above. It is a financial blueprint for action and is so, of
great advantage to government departments, legislatures and citizens.
FEATURES OF BUDGET
FUNCTIONS OF BUDGET
Accountability
In the early stage, legislative control and accountability were the primary
functions of the government budget. This arose from the legislature‟s desire to
control (impose, amend and approve) tax proposals and spending. The
executive was accountable to the legislature for spending—within limits
approved through the latter, under many heads of expenditure, and only for
approved purposes. Similar accountability was to exist within the executive on
the part of each subordinate authority to the one immediately above in the
hierarchy of delegation. Accountability continues to be a significant function
of the government budget even today owing to its usefulness in budget
execution and plan implementation.
Management
Budgeting is an executive or managerial function. As an effective tool of
management, budgeting involves planning, coordination, control, evaluation,
reporting and review. Several of the budgetary innovations such as:
Functional classification,
Performance measurement through norms and standards,
Accounting classification to correspond to functional classification,
Costing and performance audit and use of quantitative techniques
Have become significant aids to management. Several budgetary
systems like performance budgeting and zero base budgeting are
specifically management-oriented systems.
Control
Control essentially implies a hierarchy of responsibility, embracing the
whole range of executive agencies, for the money composed and expenditure,
within the framework of overall accountability to the legislature. In a
democracy, control assumes new dimensions and gives rise to exceedingly
hard troubles. The vital concern in a truly representative government is to
bring about appropriate modifications in the design and operation of the
financial system so as to ensure executive responsibility to the legislature
which is the law-creation, revenue determining and fund-granting authority.
Legislative control would mean that the legislature can meaningfully, and
not merely formally, participate in the formulation of broad policies and
programmes, their scrutiny, approval and implementation through the annual
budget. It also means that the legislature can effectively relate performance
and attainment of the executive to the objectives and policies as laid down
through it.
Members of the legislature are not always adequately acquainted with the
complexities of financial administration, nor can they always understand the
enormity of the vast scale of operations and so the stage of funds required.
Several devices are, so, used to assist legislatures in exercising their legitimate
powers over the executive. The Congressional committees of the United States
and the Parliamentary Select committees of the United Kingdom and India
help the legislature in exercising their control over the public purse.
Statutory audit also examines the accounts and other relevant records to
ensure that the moneys granted through the legislature are spent strictly in
accordance with law. Also, audit tries to ensure that the government obtains
value for the tax-payers‟ money and that the norms of economy, efficiency
and effectiveness are observed.
Planning
Budgeting gives a plan of action for the after that financial year. Planning,
though, involves the (i) determination of long term and short term objectives,
determination of quantified targets, and (iii) fixation of priorities. Planning
also spans a whole range of government policies keeping the time factor and
interrelationships flanked by policies in view. Planning envisages broad policy
choices. At the stage of projects and programmes, the choice is flanked by
alternative courses of action so as to optimize the resource utilization. The
goals of public sector, viz., (i) optimal allocation of possessions, (ii)
stabilization of economic activity, (iii) an equitable sharing of income, and (iv)
the promotion of economic growth are all pursued in an organizational
context. In the short-run, attainment of these goals has to be co-ordinate
through means of administrative and legal instruments in the middle of which
budget policy and procedure are the mainly significant. Planning in the budget
procedure reflects political pressures as well as financial pressures and
financial analysis.
CLASSIFICATION OF BUDGETS
Merits
As already stated, the rationale for this kind of classification was the
need to facilitate control and accountability. Inter-agency, inter-
organisation and interdepartmental comparison of expenditure could
easily be made. This information would also be accessible on a time-
series basis, that is, from year to year, so that the departments
concerned could be pulled up if the expenditure trends, as revealed
through this classification, were not satisfactory.
It shows clear allocation of funds. For instance, what percentage of the
expenditure is on salaries, traveling allowances, etc?
In times of financial stringency, this classification enables crossways-
the-board cuts on specific heads such as traveling allowances, foreign
travel etc.
Demerits
Functional Classification
Performance budgeting is based on a “conviction that the way in which
revenue and expenditure are grouped for decision creation is the mainly
significant characteristic of budgeting”. A functional classification of the
budget is necessary under the system of performance budgeting. The
presentation of budgeted expenditure should, so, be in conditions of functions,
programmes, activities and projects. Such a classification is an aid to the
managerial function of performance measurement relative to the costs
incurred. The output of a programme/activity in conditions of physical targets
has to be related to the inputs required. These are translated into financial
conditions and shown as the budget provision asked for the implementation of
the programme/activity. The scheme of functional classification is outlined
below:
Economic Classification
The budget of the government has an impact on the economy as a whole.
Because of its sheer magnitude, receipts and expenditure of the government
and several policies that are articulated through the budget are easily the
mainly important factors that can and do change the very nature, content and
direction of the economy. It is, so, significant to group the budgetary
provisions in conditions of economic magnitudes, for instance, how much is
set aside for capital formation, how much is spent directly through the
government and how much is transferred through government to other sectors
of the economy through way of grants, loans, etc. Economic classification
categorizes government‟s total expenditure into meaningful economic heads
like investment, consumption, generation of income, capital formation etc.
According to the Economic and Social Council of the United Nations
(Economic classification gives) “an analysis of the transaction of Government
bodies according to homogenous economic categories of transactions with the
other sectors of the economy directly affected through them”. This analysis is
contained in a separate document described Economic and Functional
Classification of the Central Government Budget, and is brought out through
the Ministry of Finance. A broad categorization is as follows:
Consumption Expenditure
o Defense
o Other Government Administration
Transfer Payments (current)
o Interest Payments
o Subsidies
o Grants to States and Union Territories
Gross capital formation of budgetary possessions
o Physical Assets
o Financial Assets
At the same time, an effort has to be made to augment the share of direct
taxes in total tax revenue over a period of time, so that the fiscal system as a
whole becomes progressive. What matters, though, are not the tax rates on
paper, but the actual collections and their incidence? Fiscal policy must, so,
ensure that taxes, as levied, are fully composed and strong action is taken to
curb tax evasion.
Control of Inflation
Currently, inflation has been described as the mainly significant problem
that the economy is faced with. A number of demand-pull and cost-push
factors have been mentioned as potential causes. The inflationary surge is led
mainly through agricultural goods. The prices of manufactured goods have not
even kept pace with average inflation, and, have lagged well behind the rise in
agricultural prices. Beside with demand-pull factors, supply factors (scarcity
or short supply) have determined the pattern of relative price changes.
Agricultural prices were increased through a rather poor kharif crop of 1990
which followed on the heels of a poor rabi crop earlier in the same year.
Imports could not be used to augment supplies and dampen prices because of
the severe balance of payments problem being faced through the economy.
The sharp increases in procurement prices for food grains have also
contributed to the inflationary pressure.
The third source for borrowings is the Reserve Bank of India. This is
directly linked to the expansion of money supply and consequently to
inflation. The monetized deficit (that is, the part of the fiscal deficit that leads
to an augment in money supply) has been rising. The monetized deficit of the
central government shows a fair degree of correspondence with the rate of
inflation. Separately from the immediate net augment in expenditure,
monetization of the deficit builds up a stage of liquidity which leads to a
general augment in demand, and hence inflation, in the succeeding years.
Therefore the government needs to reduce its reliance on all the three present
sources of funds: compulsory borrowings through the banking system, the
monetized deficit and foreign borrowings.
In order to reduce the fiscal deficit, the government has had to permit an
augment in the administered prices of some vital goods and services. It
incidentally increased input costs in the rest of the economy, thereby bringing
about cost-push inflation also. Devaluation of the rupee in July, 1991 led to an
augment in import costs. In order to combat inflation, the Government
launched a massive effort to correct the fiscal imbalance through reducing the
fiscal deficit from 8.4 per cent of Gross Domestic Product (GDP) in 1990-91
to 6.5 per cent in 1991-92 and further to about 5 per cent in 1992-93. Other
measures in this direction contain
Containing the growth of aggregate demand;
Tightening of selective credit controls; and
Revamping and extending the public sharing system.
Balance of Payments
The domestic and external sectors of an economy are interrelated. When
domestic income is equal to domestic expenditure, the external accounts are in
balance. Excess domestic demand caused through an excess of investment
over saving leads to domestic inflation. It can also result in a deficit in the
balance of payments.
India entered the decade of nineties with large internal and external
financial imbalances which made the economy highly vulnerable to external
shocks. The Gulf crisis resulted in a higher import bill and a further loss of
export markets and remittances. External commercial borrowings declined
sharply. The drying up of commercial loans was accompanied through a
substantial net outflow of deposits through Nonresident Indians. The rapid loss
of reserves prompted the government to take a number of counter measures
leading to a reduction in imports. Import reduction beyond a point would
affect the entry of the essential inputs into industry and transport, petroleum
products and fertilizers. This led to a decline in industrial production and a fall
in exports as import compression had reached a stage when it threatened
widespread loss of production and employment and verged on economic
chaos. The government, so, moved to implement a programme of macro-
economic stabilization through fiscal correction.
A key element in the stabilization effort was the attempt to restore fiscal
discipline. Both the balance of payments troubles which were structure up
over the past few years and the persistent inflationary pressure were the result
of large budgetary fiscal deficits which characterized the economy year after
year. The budget deficit was about Rs. 11,000 crore in 1990-91. A reversal of
the trend of fiscal expansionism was essential to restore macro-economic
balance in the economy. The budget for 1991-92 brought down the deficit to
about Rs. 7,000 crore. Likewise, reduction in the fiscal deficit (the overall
resource gap of the Government) was envisaged through about two percentage
points from around 8.4 per cent of GDP to 6.5 per cent of GDP. This was to be
followed through a further reduction in 1992-93 to 5 per cent of the GDP.
Cut in Expenditure
Ever since the beginning of the planning era in India, the central
government expenditure has increased enormously. The total expenditure
which was Rs. 529 crore in 1950-51 has gone up to Rs. 1,19,087 crore in
1992-93 (budget estimates), an augment of 225 times. Revenue expenditure
has grown at a faster rate. It went up from Rs. 347 crore in 1950-51 to 89,570
crore in 1992-93. Capital expenditure, though, grew at a slower pace. It
increased from Rs. 183 crore in 1950-51 to Rs. 29,517 crore in 1992-93, an
augment of 161 times. All this when the national income throughout the same
period went up from Rs. 8,938 crore to Rs. 4,25,672 crore (estimated), which
is about 48 times.
The effect of deficit financing is to cause a rise in the domestic price stage
and to generate demands for wages. This leads to an augment in prices of
input costs creation the economy non-competitive. Substitution of foreign
goods for domestic goods may lead to balance of payments troubles and
depreciation of the exchange value of the rupee. A reduction in government
expenditure, through reducing excess demand, will soften inflationary
pressure. Can government expenditure be reduced? “The newly evolving
analysis of bureaucracy through economists gives more rigorous underpinning
for an old conclusion popularly recognized as „Parkinsons Law‟. Bureaucrats
maximize their own utility and the principal variable in their “utility function”
is power. Power can be roughly measured through a proxy such as the size of
the bureaucrat's budget, or the size of the department through the number of
employees. Bureaucrats identify themselves with the stated goals of their
department and achieve their satisfaction in life in large part through
expanding their activity. They will strongly resist any attempt to dismantle a
government organisation. The governments, even when they create genuine
efforts to reduce expenditure, usually do so through slowing down the rate of
expenditure growth. Reduction in the absolute stage of expenditure is rarely
possible. Dahl and Lindblom pointed out in „Income Stabilization in a
Developing Democracy‟ (Max Milliken, ed. Yale University Press, New
Haven 1956), government expenditures usually mean that “services are
performed, values are realized, administrative organisations developed,
expectations expanded, clienteles shaped, interest groups created, pressures
mobilized, and once these are set in motion, they cannot easily be contracted”.
The balance of payments crisis that overtook the government left it with no
option but to take corrective fiscal action immediately. Containing and
reducing non plan expenditure has been the avowed policy of the government
for some years now. It is only with the budget for 1991-92 and 1992-93 that a
serious effort has been made in this direction. The significant policy initiatives
introduced in the 1991-92 budgets incorporated (i) reduction in the fertilizer
subsidy; (ii) abolition of cash compensatory scheme; and (iii) disinvestment in
some selected public sector enterprises. As a result of these adjustments, the
provision for nonplan expenditure, excluding interest payments, in 1991-92,
represented a reduction of about 5 per cent compared with the provision in the
revised estimates for 1990-91, and a reduction of approximately 15 per cent in
relation to what would have had to be provided, but for the fiscal correction.
Interest charges are the largest single item of nonplan expenditure and
account for Rs. 32,000 crore in the budget estimates for 1992-93 and account
for about 27 per cent of the total expenditure and about 38 per cent of the
nonplan expenditure. The provision for 1992-93 represented an augment of
Rs. 4,750 crore over the revised estimates for 1991-92. Interest charges are a
committed expenditure reflecting the cumulative effect of past deficits. These
charges can be controlled through reducing the reliance on borrowed funds,
and creation the debts productive and self-liquidating. In the ultimate analysis,
a reduction in revenue expenditure and hence revenue deficit can alone give a
solution of lasting nature. This indeed is a daunting task. Expenditure on
defense and subsidies are the other major components of nonplan expenditure.
In real conditions, the defense expenditure has already been contained, if not
marginally reduced. The question of subsidies is being investigated through a
Parliamentary Committee.
In any effort at reducing expenditure and hence deficits, the first casualty
usually is plan expenditure. Even though in nominal conditions, plan
expenditure is marginally higher, in real conditions it represents an important
reduction. This is in tune with the new economic philosophy of the
government which accords larger economic space to the private sector. With
this multipronged strategy, the government has been able to bring down the
fiscal deficit from 8.4 per cent of the GDP (1990-91) to 6.2 percent in 1991-92
and hopes further to reduce it to approximately 5 per cent in 1992-93. This
shows a welcome recognition of the paramount need to restore macro-
economic balance and manage the balance of payments.
FISCAL POLICY—EQUITY AND SOCIAL JUSTICE
According to the long term fiscal policy, the major contribution of fiscal
policy to poverty alleviation has to come through an effective programme for
(i) mobilization of additional possessions which can be used for financing the
anti-poverty programmes, (ii) for improving the social and economic services
on which the poor mainly, rely and (iii) for financing the heavy investments in
infrastructure, which are necessary for sustaining growth in agriculture and
industry. The anti-poverty programmes and social services have to be financed
through the government. Fiscal policy has to be so formulated that adequate
possessions are accessible to the government for funding social expenditure
which benefits the poor.
Food subsidy is a part of the system of food security for the poorer and
weaker sections of the population and is a vital element in the social policy.
This is being sustained. Fertilizer subsidy has become the largest single
subsidy in the fiscal system. There is no doubt that fertilizer is an essential
ingredient for agricultural production. Agricultural development is vital not
only for economic growth in general, but also to ensure rising stages of
income and employment in rural areas. In 1980-81, fertilizer subsidy was just
12 per cent of the total allocation in the Central and State Plans taken together,
for Agricultural Rural Development Special Area Programmes and Irrigation
and Rood Control. It increased to 33 per cent in 199192. Measures for better
targeting and containing it are under investigation. For the present, this is
being sustained.
Therefore ends of social justice and equity are being served through the
fiscal policy. Once the economy goes through the macro-economic
stabilization and structural reforms come to fruition, it should be possible to
do much more in programmes of poverty alleviation, employment generation,
public sharing systems, etc.
REVIEW QUESTIONS
Highlight the vital characteristics of the financial system in India
throughout the period 1858-1935.
Distinguish flanked by revenue and capital budget.
Explain the general features of budgeting systems.
What is the central concern of fiscal policy? What are the major
characteristics of government finance that fiscal policy is concerned
with?
Indicate the significant objectives of fiscal policy.
CHAPTER 3
BUDGETING AND BUDGETARY SYSTEM-II
STRUCTURE
Learning objectives
Zero base budgeting
Performance budgeting
Public expenditure: theories and growth
Classification of government expenditure
Review questions
LEARNING OBJECTIVES
After learning this unit, you should be able to:
Explain the concept and meaning of zero base budgeting.
Explain the concept and objectives of performance budgeting.
Evaluate the several theories and approaches through dissimilar
schools of thought concerning the determination of public expenditure.
Explain the several classifications of government expenditure.
Evaluate the present system of classification of government
expenditure.
The origin of the concept of ZBB can be traced back to the year 1924
when Hilton Young, the noted English budget authority stressed the need for
annual re-justification of budget programmes. Later in 1960 the US Defense
department introduced the Programme, Planning and Budgeting System
(PPBS). It was based on cost-benefit analysis and was very much similar to
ZBB. But the final attempt to introduce ZBB was made through the US
Department of Agriculture in 1962, when the budget director suggested that
each programme be justified from zero and in 1964, this department prepared
the budget.
Though, it was Peter Pyhrr who intended its logical framework and
implemented it successfully in the private industry in 1969 while working as a
staff control manager in Texas Instruments USA. In 1968, Pyhrr reviewed the
speech given through Authur F. Burns on the control of government
expenditure which advocated that government agencies should start from
ground zero, as it were, with each year‟s budget and present their
appropriation in such a manner that all funds can be allocated on the basis of
cost- benefit analysis, resulting in substantial cost savings. Therefore Pyhrr
formulated this concept in order to reduce staff costs. He developed this
system as a tool for planning budgeting and control. He first applied it to
research and development divisions of the company. Finding it successful, he
extended it to other divisions of Texas Instruments. Based on this experience
he published an article which caught the attention of the then Governor of
Georgia -Jimmy Carter who invited Pyhrr to apply the approach to the State of
Georgia.
ZBB was introduced for the first time in a government system and was
adopted for the formulation of the budget for the fiscal year 1973-74. Jimmy
Carter was so much, influenced with its success that when he was elected
President of the USA, he introduced the concept of ZBB in Federal Budgeting
Control Systems and also made it mandatory through the legislation for the
year 1979. President Carter claimed that an effective ZBB system will benefit
the Federal Government in many ways e.g. it will:
Following the memo, the office of Management and Budget (OMB) issued
Bulletin No. 779 on April 18, 1977 providing budget guidelines and
instructions to the agencies on the use of ZBB for the preparation and
justification of 1979 budget requests. It stated ZBB as a management
procedure that gives for systematic consideration of all programmes and
activities in conjunction with the formulation of budget requests and
programme planning. The principal objectives of ZBB were to:
Involve managers at all stages in the budget procedure.
Justify the resource necessities for existing activities as well as the new
activities.
Focus the justification of the evaluation of discrete programmes or
activities of each decision unit.
Establish, for all managerial stages in an agency, objectives against
which accomplishments can be recognized and measured.
Assess alternative methods of accomplishing the objectives.
Analyze the probable effects of dissimilar budget amounts or
performance stages on the attainment of objectives; and
To give a credible rationale for re-allocating possessions, especially
from old activities to new activities. Though the conversion from
conventional budgeting to ZBB did pose some troubles, yet the
implementation procedure proceeded smoothly. Therefore in the USA
ZBB achieved an unprecedented goal without going for a pilot
experiment and the Federal government agencies became the
experimental laboratory of ZBB.
Since 1973, in the USA ZBB has become a popular management tool in
both public and private organisations. A dozen states, 36 municipalities and
500 corporations have used it with a great degree of success as compared to
government agencies.
The ranking is done on an ordinal scale (i.e. 1st, 2nd and 3rd etc.) in order
of priority. Because of the vast numbers involved the ranking procedure takes
place at a number of stages depending on the size, geographical dispersion,
stages of management, volume of decision packages, unit managers, budget
staff or through ranking committee.
Cut off stage of funding
Ranking of decision packages in large organisations is more problematic
as compared to smaller organisations. In large organisations identifying each
discrete activity with many stages of effort could make a number of troubles.
If management has to review in detail and rank every decision package with
conflicting needs, it may take valuable time and effort of the top management.
This problem could be reduced to some extent through:
Concentrating management review on lower priority discretionary
packages around which the funding stages or cut off stages will be
determined.
Limiting the number of consolidation stages through which the
packages will be processed.
All packages presented for funding usually would fall into three categories
Those with higher priority and high probability of funding.
Those with marginal priority and which may be funded or not funded
depending on the possessions accessible; and
Those with low priority and low probability of funding.
The concept of ZBB has been in use in Indian private industry since long.
For instance Britannia Industries Ltd. and Union Carbide have been using it
since 1977-78 without calling it Zero base budgeting. Though in government
context, it is of recent origin. The first application of the system was in the
Department of Science and Technology in 1983. In view of the severe
resource crunch for the seventh plan, many alternative steps were
recommended to the government through the Eighth Finance Commission and
the Planning Commission to prune the wasteful public expenditure and
inefficiencies in implementation of government programmes.
The Finance Ministry had recognized around 150 redundant and low
priority schemes with the estimated outlays over Rs. 1000 Crore which the
Ministry wanted to eliminate. In the middle of the State governments,
Maharashtra has been implementing ZBB in 42 departments. The budget for
1987-88 reflected a saving of Rs. 50 crore. Many. redundant and duplicative
and low priority schemes have either been eliminated or merged. Likewise
Karnataka Government experimented with ZBB in Public Health and
Agriculture Sections and also had plans to apply it to all 45 departments. In
the middle of the public sector undertakings, Madras Refineries Ltd., HMT,
BHEL, BEL, Indian Telephone Industries, Indian Oil, Neyveli Lignite Corp., a
few steel plants and nationalised banks have planned to implement ZBB.
The implementation of ZBB has sure benefits and some troubles too. Let
us now discuss these:
Benefits of Zero Base Budgeting
The major benefits of the use of zero base budgeting can be the following:
Zero base budgeting examines all existing and new programmes and
activities. It also creates the managers analyze their functions, establish
priorities and rank them. This exercise helps in identifying inefficient
or obsolete functions within the area of responsibility. In this way
possessions are allocated from low priority programmes to high
priority programmes.
This system facilitates identification of duplication of efforts in the
middle of organizational units. Such inefficient activities are
eliminated and some other activities are merged.
All expenditures, under this system are critically reviewed and justified
and all operations/activities are evaluated in greater detail in conditions
of their cost- effectiveness and cost-benefits. This requires managers to
find alternative ways of performing their activities which may result in
more efficient procedures.
ZBB promotes the tendency to initiate studies and improvements
throughout the period of operation as the persons at the helm of affairs
know that the procedure would be exercised after that year and their
knowledge and training would enhance efficiency and cost-
effectiveness.
ZBB gives for quick budget adjustments throughout the year. If
revenue falls short in this procedure, it offers the capability to quickly
and rationally modify goals and expectations to correspond to a
realistic and affordable plan of operations.
ZBB ensures greater participation of personnel in formulation and
ranking processes. This helps in promoting stage of job satisfaction
and therefore resulting in better control and operational efficiency in
the organisation.
Zero base budgeting is a flexible tool that can be applied on a selective
basis. It does not have to be applied throughout the whole organisation
or even in all the service departments. Keeping in view the limitations
of time, money and persons accessible to install, operate and monitor it
the management therefore can select priority areas to which zero base
budgeting may be applied.
Troubles in Implementation
PERFORMANCE BUDGETING
The financial system of our country throughout the British period was
characterized through high degree of centralization, adherence to rigid
financial rules and procedures, integration of accounts and audit etc. After
independence, attempts have been made to create the financial administration
performance-oriented, with a view to bringing about efficiency and economy
in the implementation of plans, programmes and activities. Efforts were made
to create the budget an efficient tool of plan implementation. The result has
been the introduction of the performance budgeting system in the government.
Objectives
Performance budgeting seeks to:
Correlate the physical and financial characteristics of programmes and
activities;
Improve budget formulation, review and decision-creation at all stages
of management in the government machinery;
Facilitate better appreciation and review through the legislature;
Create possible more effective performance audit;
Measure progress towards long-term objectives as envisaged in the
plan; and
Bring annual budgets and developmental plans together through a
common language.
The need for performance budgeting in India was felt ever since India
entered into planning era. The then existing budgeting and control system was
found inadequate as no input-output relationship could be recognized flanked
by financial outlays and physical targets. The first revise concerning the
relevance of performance budgeting to our institutional set-up and needs was
made through Dean Appleby in 1953. At that stage, though, the system of
performance budgeting was still incipient in the federal government and Dean
Appleby was not very sure of the outcome of the system. The Estimates
Committee of the Lok Sabha, in its 20th report recommended that “... the
Performance-cum-Programme System of budgeting would be ideal for a
proper appreciation of the schemes and outlays incorporated in the budget,
especially in the case of large scale developmental activities. The Performance
Budgeting should be the goal which should be reached slowly and through
progressive stages without any serious budgeting dislocation.” The
recommendation was primarily made to strengthen the parliamentary control
over expenditure.
The Estimates Committee raised the issue again in their 73rd report in
1960 and suggested that the recommendation concerning performance
budgeting be implemented at the earliest possible. These recommendations
brought results. In 1961, the Union Finance Ministry accepted the
recommendations of the 73rd report of the Estimates Committee and issued
instructions exhorting the public enterprises to adopt performance budgeting.
Though due to operational troubles, no undertaking implemented the
instructions.
Several theories have been formulated throughout the last three decades to
explain dissimilar characteristics of public expenditure. In spite of all these
attempts, no comprehensive theory of public expenditure has been developed.
Let us now discuss some of the significant theories which seek to explain the
factors that determine rising public expenditure.
Public Choice
The recognition of the importance of the political processes in revealing
public preferences has, in due course, contributed to the growth of “public
choice” theories. Anthony Downs offered useful analysis of these political
processes. Downs‟ theory, which was based primarily on the US systems,
provided a general framework for explanation of public expenditure. In
democratic societies, it is held; governments determine revenues and
expenditure to maximize their chances for winning the election. The budgeted
expenditure is determined not with reference to overall spending and taxation
but through a series of separate policy decisions based on estimates of gains
and losses of votes. According to Downs, government will give what voters
want and not necessarily what is beneficial. Therefore the central reality for
governments is the citizen‟s vote and not his welfare. In order to fulfill voters‟
demands, promises made at election time, their aspirations for projects or
services, the expenditure has to expand creation for larger government, larger
bureaucracies, better budgets and more troubles in trying to find possessions
for financing the budgeted expenditure.
Positive Approaches
The earliest theory advanced is that of Adolph Wagner in 1876 which
came to be recognized as “Wagner‟s law”. He propounded the “Law of rising
expansion of public and particularly state activities” which is referred to as the
“law of rising expansion of fiscal necessities”. The law suggests that the share
of the public sector in the economy will rise as economic growth proceeds,
owing to the intensification of existing activities and extension of new
activities. According to Wagner, social progress has led to rising state activity
with resultant augment in public expenditure. He predicted an augment in the
ratio of government expenditure to national income as per capita income rises.
It is the result of rising administrative and protective actions of government in
response to more complex legal and economic relations, increased
urbanization, and rising cultural and welfare expenditures. Another cause is
the decentralization of administration and the augment in the expenditure of
local bodies.
Large scale social disturbances, like wars, influx of refugees change the
tolerance limit of people to the burden of taxation which arises as a result of
increased spending. The result is described a “displacement effect” which
shifts expenditures and revenues to new higher stages. So a displacement
effect is created when the earlier lower tax and expenditure stages are
displaced through new and higher budgetary stages. Even after the event is
over, new stages of tax tolerance change and the society feels capable of
carrying a heavier tax burden. The stage of public expenditure does not return
to the low stage it was before the event.
Production
The roles of private and the public sectors are complementary. The public
sector gives the infrastructure, transport and communications, power,
education and public health programmes. In the absence of goods and services
provided through the government sector, private sector can hardly create any
meaningful contribution towards production and development; According to
Dalton, other things being equal, taxation should not adversely affect
production and public expenditure should augment it as much as possible.
Public expenditure can affect (i) the skill to work, save and invest, (ii) the
desire to work, save and invest, and (iii) allocation of possessions as flanked
by dissimilar uses. Public expenditure can influence these factors either
favorably or unfavorably.
Sharing
In Dalton‟s words, “other things being equal, that system of public
expenditure is best, which has the strongest tendency to reduce the inequality
of incomes?” A system of grants and subsidies is equitable in the measure in
which it is progressive. This leads to maximum social benefit. An
approximation to this principle would be provided through a system of grants
which would bring all incomes below a sure stage to that stage (say, above the
poverty line), without adding anything to incomes above that stage. A public
sharing system which creates accessible essential commodities at subsidized
prices to the poor, will also achieve the same result. Free provision of services
to all members of the society e.g., free health service or free education,
“narrows the area of inequality”. Social security measures and social insurance
schemes, which are helped partly or wholly from public funds, e.g. old age
pensions, sickness and maternity benefits, unemployment relief, industrial
injury compensation, widow‟s pension etc., improve sharing through reducing
inequality of incomes.
Economic Stabilization
Business activity in an economy is usually characterized through
fluctuations of a cyclical nature. A boom in the economy may burst and lead
to a depression. While throughout boom, prices rise beyond the reach of
common person, spelling misery. Throughout depression, employment and
production stages fall drastically causing colossal damage. Throughout
depression, when employment, production and national income start declining,
government can undertake compensatory spending. This may imply heavy
public works programmes so that employment and incomes may pick up
leading to economic recovery. Throughout boom, public expenditure should
be strictly curtailed, leading to surplus budgets. Throughout depression, public
expenditure policy would lead to heavy outlays on public works; expenditure
would therefore be in excess of revenues, leading to deficit budgets. Therefore
public expenditure, if properly planned and conscientiously undertaken, will
have the favorable effect of raising employment, production and national
income, after pulling the economy oat of depression and therefore bringing
about greater economic stability.
The total expenditure of the Central government has grown from Rs. 529
crore in 1950-51 to Rs. 1,19,087 crore in 1992-93 (budget estimates) (225
times). Of this revenue expenditure grew even faster. It went up from 347
crore in 1950-51 to Rs. 89,570 crore in 1992-93 (B.E.) (258 times). But capital
expenditure grew at a slower rate. It increased from Rs. 183 crore in 1950-51
to Rs. 29,517 crore (161 times). It is, though, clear that the total expenditure of
the Central government has grown at a much faster rate than the growth rate in
national income which went up from Rs. 8,938 crore in 1950-51 to Rs.
4,25,672 crore (estimated) in 1991-92 (48 times). One can say that the total
expenditure has been rising at a rate about 5 times higher than the growth rate
of national income Gross National‟ Product.
Recent Trends
Throughout the two years (1991-92 & 1992-93) (BE) the pace and
direction of expenditure have changed radically. The revenue expenditure in
1991-92 increased through 13.8 per cent over that in 1990-91 whereas capital
expenditure actually declined through seven per cent. In 1992-93 (BE), while
the revenue expenditure increased through only seven per cent (down from
13.8 per cent augment in 1991-92), there was a standstill in respect of the
capital expenditure. There are two reasons responsible for the downward trend
in the rate of augment in government expenditure. Firstly, the fiscal crisis
faced through the country beginning with the year 1990-91, deepened in 1991-
92. The government initiated corrective measures to restore fiscal discipline in
the economy. Some of the key elements in this structural adjustment were
containment of non-plan expenditure including defense expenditure and
subsidies. Secondly, the economic philosophy of the government has
undergone a revolutionary change. The investment programme of the
government is no longer aimed at rising investment in public sector
enterprises. With the liberalization of the economy — changes in industrial
and trade policy, financial sector reforms etc., are all aimed at less government
intervention rather than more. Hence, the relative decline in government
expenditure. This is every cause to consider that this trend will continue in the
foreseeable future.
Since the latter part of the 19th century and earlier part of the 20th century,
mainly of the capitalistic and socialistic countries switched over to the concept
of welfare state. Throughout this period, mainly governments of independent
countries concentrated their energy on economic development. To achieve
speedy economic development, governments had stepped up their
expenditures. Nature of Government Expenditure: Public expenditure is
incurred in the form of purchases of goods and services, transfer payments and
lending. Purchase of goods and services is planned to carry out governmental
activities through the direct utilization of economic possessions for instance,
purchase of articles from the market right from paper clips to military aircraft.
Transfer payments and lending are planned to give enterprises and households
with purchasing power to enable them to buy goods and services in the
market. In several developed countries, transfer payments for social welfare
constitute a sizeable portion of government budgets. In developing countries,
some of the functions of transfer payments are performed through subsidies to
consumers in the form of below cost sales through state enterprises. Examples
of such subsidies are supply of bread, food grains, cooking oils, sugar and tea
to public below the normal cost. '
Economic Classification
Economic classification refers to the possessions allocated through
government to several economic activities. It involves arranging the public
expenditures and receipts through important economic categories,
distinguishing current expenditure from capital outlays, spending for goods
and services from transfers to individuals and institutions, tax receipts through
type from other receipts and from borrowing and inter-governmental loans,
grants etc. This classification brings out such significant aggregates as public
expenditure of the consumption type, public investment and the draft of public
authorities on public savings for financing the development oulays in the
public sector. In short, this classification analyses the total governmental
transactions and records government‟s influence on each sector of the
economy.
Accounting Classification
Accounting classification of government expenditure can be analyzed
under (i) Revenue and Capital (ii) Developmental and Non- Developmental
and (iii) Plan and Non-Plan. Each classification of expenditure serves one
objective or other of the government. For instance, Revenue and Capital
expenditure classification designates how much government expenditure
results in creation of assets in the economy and how much expenditure is
unproductive. Again, developmental and non-developmental classification
designates how much government expenditure is spent on social and
community services and economic services as against general services.
Likewise, the Plan and Non-Plan expenditure classification helps the Planning
Commission and Finance Commission in determining the pattern of central
assistance on plan schemes to state governments, and union territories.
Therefore, each classification of government expenditure serves one objective
or other in government.
REVENUE AND CAPITAL EXPENDITURE
Capital budget consists of capital receipts and payments. The main items
of capital receipts are loans raised through government from public which are
described market loans, borrowings from Reserve Bank of India and other
parties through sale of Treasury Bills, loans received from foreign
governments and loans granted through Central government to state and union
territory governments and other parties.
REVIEW QUESTIONS
Discuss the troubles and benefits in implementation of zero base
budgeting system.
Discuss the performance budgeting system in India.
Explain how public expenditure policies and measures affect dissimilar
characteristics of the economy.
Explain the meaning of Government expenditure. Distinguish flanked
by 'revenue' and 'capital' expenditure.
Explain the significance of Economic and Cross Classification of
government expenditure.
CHAPTER 4
RESOURCE MOBILIZATION
STRUCTURE
Learning objectives
Public debt management and role of reserve bank of India
Deficit financing
Sources of revenue: tax and non-tax
Review questions
LEARNING OBJECTIVES
After learning this unit, you should be able to:
State the meaning and causes of public debt.
Explain the meaning of deficit financing.
State the concepts and classification of tax revenue.
Explain trends in resource mobilization over the years...
Having discussed the concept of public debt, now let us highlight the
causes for public borrowing.
A considerable portion of the public debt is attributable to the sharp
increases in government outlays in public sector projects. Structure up
the economic infrastructure like railways, roads, bridges, power plants
etc. that give the base for economic development, requires vast
investments which the government cannot finance just through
taxation.
Another cause for the growth in public debt is due to both the Central
and state governments lending important amounts of capital funds to
the private sector for investment in planned development projects.
Public borrowing is resorted to for meeting temporary as well as long-
term deficits. It is required to meet the current deficits in budget when
the revenues are insufficient to meet the expenditure. Also in times of
war, or economic crisis, or other unexpected emergencies, the augment
in governmental activities result in rising expenditure that create the
government resort to public borrowing.
As said earlier, one method through which a public authority may obtain
income is through borrowing. The proceeds or whatever is composed from
such borrowing form part of public receipts. On the other hand the payment of
interest on and the repayment of the principal of the public debts therefore
created form part of public expenditure. Public debt can be classified in
several ways. Let us now discuss some significant classifications.
Public debt occupies the minds of politicians, editorial writers, citizens and
economists. Intuitions tell us that we would be better off without the debt just
as we would wish to be free of personal debts. Yet to sort out the real burden
from the fancied requires the mainly careful economic analysis. It is all the
more significant because the burden of public debt can be shifted wholly or in
substantial part from the present to the future generation. The burden of public
debt is not something which can be thrown backwards and forwards through
time and made to fall, at will, wholly on one generation or wholly on another.
Can large public debt lead to default or bankrupt the government? Default
occurs when a borrower fails to meet its financial commitments. Bankruptcy
exists when a borrower‟s debt far exceeds its skill to meet obligations. The
government will neither default nor face bankruptcy since it has the power to
tax and print money. Suppose the government has no tax revenue to meet
interest payment on its debt, it can secure whatever funds it needs through
raising taxes. Alternatively, since it is the sole issuer of paper currency, it can
print additional paper currency and use it to meet its interest payments.
Therefore with virtual unlimited sources of funds, the government is not prone
to default or bankruptcy.
In practice, as a portion of debt falls due each month, government does not
usually cut expenditure or raise taxes to give funds to retire or repay the
maturing bonds. Rather, the government basically refinances the debt, i.e. it
sells new bonds and uses the proceeds to pay off holders of the maturity
bonds. Hence public debt management becomes a crucial task or responsibility
of the government. Public debt management refers to the task of determining,
through the fiscal and monetary authorities, the size and composition of debt,
the maturity pattern, interest rates, redemption of debt etc.
The subsistence of a large public debt does Dose real and potential
troubles. Externally held debt is obviously a burden. The payment of interest
and principal require the transfer of a portion of real output to other nations.
When a developing economy borrows abroad to build a dam or when a state
issues bonds to build a school, it acquires an external debt that has to be repaid
at some future date. Just as in the case of an individual, the borrowing
increases the total possessions accessible initially, but reduces the possessions
accessible in the future. To meet the interest and repayment charges owed to
the outside world, the government necessity reduce future public spending or
raise taxes and thereby reduce private spending. In each case, it cuts total
internal resource use. In effect, the borrowing basically creates the possessions
that were accessible earlier in exchange for the commitment to pay interest.
The initial augment in total accessible possessions is made possible through
borrowing done outside the community. Likewise, interest and repayment
means that the community gives up possessions to the outside world later.
The average citizen fears the debt mainly as a source of inflation. The debt
represents past outlays that were not matched through taxes, hence it measures
past government claims to possessions that it could not pay for. If government
engages in debt financing when the economy is already at full employment,
subsistence of a large public debt tends to shift the consumption schedule
upward. This shift will be inflationary. Furthermore, government bonds can be
converted into money easily and will have little or no risk of loss. Government
bonds, so, constitute a potential backlog of purchasing power which can add
materially to inflationary pressures. Throughout periods of inflation, it is very
tempting for consumers to utilize this reserve of purchasing power in an
attempt to beat rising prices. Such an attempt to tackle inflation will cause
more inflation.
Until now we have seen only one side of the coin. There is another side to
the public debt i.e., the positive role of public debt in economic development.
Both public and private debts play a positive role in a prosperous and rising
economy. As economy expands, so does saving. Modern employment theory
and fiscal policy tell us that, if aggregate demand is to be sustained at a high
stage of employment, this expanding volume of saving or its equivalent
necessity be obtained and spent through the consumers, business houses or
government. The procedure through which saving is transferred to spenders is
debt creation. Whenever government issues bonds, since these are highly
liquid and risk free securities, they create an excellent purchase for small and
conservative savers. To the extent that the availability of bonds encourage
saving, more possessions are freed for investment and economic growth tends
to be enhanced,
External debt
The economic implications of the external public debt are quite dissimilar.
India owes this external public debt to foreign governments, foreign banks and
international lending institutions such as the World Bank and the International
Monetary Fund. External public debt is a liability for the Indian people as tax
payers and an asset to foreign lenders. So, retirement of the external public
debt would involve Indian households and business houses paying higher
taxes and the government would then pay out these tax receipts to lenders
abroad. This obviously means a transfer of income and wealth from Indian
families and business to foreigners. Therefore, retirement of the external
public debt would entail a leakage of real purchasing power out of the
economy and a decline in the standard of living of the Indian people.
The compound growth rate of aggregate debt stock from 1980-81 to 1989-
90 has been 20% in rupee conditions and 10% in conditions of U.S. Dollars.
There has been a notable change in the composition of debt stock. At the
beginning of Sixth Five Year Plan, external debt stock consisted mainly of
external assistance which constituted approximately 90% of debt stock. Since
then, the share of external assistance in debt stock has declined to less than
70% in 1989-90. External commercial borrowing has registered the fastest
growth and accounts for 27% of debt stock in 1989-90.
World Bank‟s latest debt tables reveal that India‟s external debt which
stood at $62.50 billion in 1989 rose to an estimated $70,953 billion in 1990. It
shows a rise of 13.5% throughout the year and therefore India has become the
third mainly indebted country in the world after Brazil and Mexico. This vast
debt burden only underlines the fact that in future years interest payment
burden is likely to be much larger and India may have to borrow further to
fulfill its debt service obligations or we can say that our country is in serious
debt trap.
India faced a severe resource crunch in 1991 and contacted the IMF for a
loan of $5-7 billion besides the loans contacted from other sources so that the
country is bailed out of current foreign exchange crisis. The total debt burden
will be in range of $76-78 billion. The vital factor responsible for debt trap is
the deteriorating balance of payment (BOP) on current account. The deficit in
balance of payments on current account which was of the order of Rs. 2852
crore in 1984-85 has risen to Rs. 10,410 crore in 1988-89.
The Reserve Bank of India and its several offices and representatives have
the responsibility to assist the economy in achieving sustained economic
growth without inflation through its monetary policy. Monetary policy
consists of altering the economy‟s money supply for the purposes of attaining
rising stages of output and employment on the one hand and stability in the
price stages on the other. More specifically, monetary policy entails achieving
two inter-related goals. First, it necessity expand the supply of money in the
long run to meet the demand for money in a rising economy and, second, it
necessity adjust the money supply to curb economic fluctuation, i.e.,
throughout recession to stimulate spending and, conversely, restrict the money
supply throughout inflation to constrain spending.
DEFICIT FINANCING
In the West, the phrase “Deficit financing” has been used to describe the
financing of a deliberately created gap flanked by public revenue and
expenditure or a budgetary deficit. This gap is filled up through government
borrowings which contain all the sources of public borrowings viz., from
people, commercial banks and the Central Bank. In this manner idle savings in
the country are made active. This increases employment and output. But
according to Indian budgetary documents government resorting to borrowing
from the public and the commercial banks does not come under deficit
financing. These are incorporated under the head of 'Market Borrowings‟ and
government spending to the extent of its market borrowings does not result in
or lead to deficit financing.
The magnitude of actual budget deficit throughout the seventh plan had
been of the order of Rs. 29,503 crore (at 1984-85 prices) which was more than
double the estimate of Rs. 14,000 crore. The Budget for 1990-91 laid stress on
limiting the size of the budget deficit through containment of expenditure
growth and better tax compliance. The budget programmed a deficit of Rs. 1,
10,592 crore in 1989-90. The revised estimates for the year 1990-91 placed the
budgetary deficit at Rs. 10,772 crore which is almost 50% higher than the
budget estimate. Proper financial management demands that the revenue
receipts of the government, which are in the shape of taxes, loans from the
public, earnings of the state enterprises etc., should not only meet the revenue
expenditure but also leave a surplus for financing the plan. Contrary to this
deficits on revenue account are rising year after year. For instance the revised
estimates place the deficit on revenue account throughout 91 at Rs. 17,585
crore as against the budget deficit of Rs. 10,772 crore. A higher revenue
deficit implies higher borrowed possessions to cover the deficit leading to
higher interest payments therefore creating a sort of vicious circle.
But if the public investment is on capital goods, then the increased demand
for the consumer goods will not be satisfied and prices will rise. Even if the
outlay is on the production of consumption goods the prices may rise because
the monetary incomes will rise immediately while the production of consumer
goods will take time and in the meanwhile prices will rise. Though investment
is being continuously raised (through taxation, borrowing and external
assistance), mainly of it goes to industries with long gestation period and for
providing vital infrastructure. Though there is effective demand, possessions
lie under or unemployed. Lack of capital, technical ability, entrepreneurial
skills etc. are responsible in several cases for unemployment or
underemployment of possessions in a developing economy. Under such
circumstances, when deficit financing is resorted to, it is sure to lead to
inflationary circumstances.
Deficit financing as a tool for covering the financial gap in India was
introduced at the time of formulation of first five year plan. Throughout the
first plan deficit financing was of the order of Rs. 333 crore and the money
supply with the public increased through about 22 per cent. Since this
expansion in the supply of money fell short of the augment in output, the
general price stage came down through about 18 per cent. Throughout second
plan, actual deficit financing was less than the targeted amount. The third plan
was very abnormal (adverse weather circumstances, 1962 Chinese aggression,
1965 Pakistan war). Deficit financing throughout the third plan amounted to
Rs. 1333 crore — more than double the target. Money supply with the public-
increased more rapidly.
In the fourth plan (1969-74), the amount of deficit financing stood at Rs.
2060 crore about two-and-a-half times the target. Money supply increased
from 6387 crore to Rs. 11,172 crore at the end of 1973-74. Prices increased
through 47% almost. No doubt there were sure factors beyond the control of
the government such as war with Pakistan in 1971, substantial expenditure on
account of Bangladesh refugees, oil price hike etc. Besides, the reluctance on
the part of the states to mobilize adequate possessions, their general financial
indiscipline and overdrafts from the Reserve Bank also compelled the
government to take resort to deficit financing.
There were several other factors like mismanagement of the war economy,
excessive dependence on monsoon, power shortage, labour strikes, augment in
the rates of commodity taxation, rise in wage rates, black money, rise in the
international price of petroleum products which have been responsible for
price rise in India. Though, experience shows that the augment in money
supply has led to a rise in prices. There has been a secure relationship flanked
by the rate of augment in prices and the rate of growth in money supply and
prices have a tendency to rise to new heights at every successive augment in
money supply resulting from deficit financing.
Factors that affect deficit financing can be put under two categories: (a)
factors related to demand for money and (b) factors related to supply of
money. If the demand for money is low in the economy, the safe limit of
deficit financing will be low. Then creation of new money or deficit financing
necessity be kept at a low stage otherwise evil consequences will follow.
Reverse will be the case when demand for money is high. On the supply side
of money, if due to some factors the supply of money or purchasing power
with the public increases, other things being equal, it will have an inflationary
tendency and the safe limit of deficit financing will be low. Though, safe limit
will be high in the opposite situation.
The concept of „safe limit‟ of deficit financing can be reduced to the age
old theory of demand and supply. The point at which demand for and supply
of money are equal is the point of safe limit of deficit financing. Unluckily
circumstances in a developing country are not so simple. Several factors
simultaneously exert contradictory effects on each side.
Above all these policies, what is more required is that the government
should try to seek full public cooperation and people should have full faith in
the policies of the government so that government policies can be successfully
implemented. Deficit financing or no deficit financing, the procedure of
economic development itself is inflationary. Whenever new investment is
financed through taxation or borrowing, the result is an augment in monetary
incomes, augment in demand for consumption goods, and price rise. With this
background the significant question, in a developing country, is not whether
deficit financing should be resorted to or not for economic development, but,
rather, how far inflation can be pushed without upsetting the productive
procedure. Therefore deficit financing is a necessary and positive instrument
to accelerate the rate of economic growth in countries suffering from acute
shortage of the capital, though it is necessary to emphasize here that it
necessity be undertaken with an efficient and well executed plan for economic
development.
Direct Taxes
Income Tax, Corporation Tax, Capital Gains Tax, Estate Duty, Gift Tax,
Wealth Tax come under the category of direct taxes. In the case of direct taxes
the liability is determined with direct reference to the taxpayer‟s tax-paying
skill, while in the case of indirect taxes, this skill is assessed indirectly. For
instance, in case of income tax which is a direct tax, the amount of tax to be
payable through a person, is determined on the basis of that person's income.
Income-Tax
This is the tax which is levied on the total income of the tax payer after
reducing prescribed deductions. In India, the first Income Tax Act was passed
in 1886. Later in 1922, a comprehensive act was passed. In 1961, this Act was
repealed and a new Income Tax Act was passed. Under the Income Tax Act,
income comprises salaries, interest on securities, profits and gains of business
and professions, capital gains, value of any benefit or perquisite, any winnings
from lotteries, other games etc. But income derived from agricultural activities
is exempted from income tax till date.
There are changes made in the rates of income tax from year to year. Also
under the Indian Income Tax Act sure incomes are totally exempt from tax.
Some of these contain, accumulated balance of recognized provident fund,
death-cum-retirement gratuity, house-rent allowance upto a sure limit,
scholarships granted to meet educational costs, post-office savings etc.
The budget 1991-92 proposed sure major changes in the rate structure of
income-tax. The exemption limit for personal income tax was raised from Rs.
18,000 to Rs. 22,000 i.e. income tax will be levied only on annual incomes
exceeding Rs. Any person getting an annual income upto Rs. 22,000 need not
pay any income tax. The lowest tax rate of 20% has been extended from the
existing limit of Rs. 25,000 to Rs. 30,000. Under the new system introduced
for 1991-92, a person contributing to provident fund, Life Insurance
Corporation etc., can now be entitled only to a tax rebate calculated at the rate
of 20% on such savings.
Corporation tax
In India, the companies are subjected to tax on their incomes which is
described Corporation tax. Separately from this, the companies deduct tax at
source from the dividends of shareholders and deposit them with the
authorities. Hence whatever dividend a shareholder gets is the amount
received after deduction of tax. The Corporation tax which is levied on the
income of the Company is dissimilar from this. This is levied at a flat rate and
subject to a number of rebates and exemptions. These rebates and exemptions
vary according to activities, criteria, kinds of corporate income.
The Budget of 1991-92 reduced the tax rate for widely held domestic
companies from the existing rate of 50% to 40%. As a measure of relief the
deduction for setting up new industries was raised from 25% to 30% in the
case of companies and from 20% to 25% in the case of others. This benefit can
now be availed of for 10 years as against 8 years.
Wealth Tax
The Wealth Tax Act, 1957 gives for levy of a tax on the net wealth of
every individual, Hindu Undivided Families and companies which are closely
held. Agricultural property is not incorporated in the net wealth of an
individual. But possession of amount of wealth to a sure limit is exempted
from wealth tax. The Finance Act of 1985 enhanced the vital exemption under
the Wealth Tax Act from Rs. 1.5 lakhs to Rs. 2.5 lakhs in respect of
individuals and Hindu Undivided Families. The maximum rate of tax was also
lowered from 5% of the taxable wealth to 2% if the assessable wealth exceeds
30 lakhs in respect of individuals and Hindu Undivided Families.
Estate Duty
The estate duty was introduced in India in 1953. It was levied on the total
property passing or deemed to pass on the death of a person. The duty was
leviable on all property belonging to the deceased who incorporated cash,
jewellery, household goods etc. A slab system was fixed according to which
tax was levied. Later several changes were brought about under several acts in
the rate of tax. The Estate Duty (Amendment) Act 1984, discontinued estate
duty on agricultural land. The levy of estate duty in respect of property (other
than agricultural land) passing on death occurring on or before 16 March,
1985 has also been abolished under the Estate Duty (Amendment) Act, 1985.
Gift Tax
Gift tax was introduced in India in 1958. It is a tax imposed on gifts made
through individuals, Hindu Undivided Families, Corporations, on the value of
the taxable gifts made through them throughout the year. It is paid through the
person giving the gift. Initially gifts upto Rs. 10,000 were exempted from the
tax. Later changes were brought about in the exemption limits. According to
the 1991-92 Budget, gift tax is levied on gifts exceeding a value of Rs. 20,000,
subject to sure exemptions. These exemptions contain gifts to charitable
institutions, female dependents on the occasion of marriage, gifts to spouse
etc.
The direct taxes as discussed above are the sources of revenue to the
Central Government. The proceeds of some of the above taxes though
composed through the Union Government are distributed flanked by the Union
and states. The direct tax revenues of the State governments contain the
State‟s share of income tax, estate duty; land revenue, urban immovable
property tax etc.
Indirect Taxes
Having dealt with the several kinds of direct taxes, which form the source of
revenue to the Central government, let us now discuss about the indirect taxes.
In our taxation system a heavy reliance is laid on indirect taxes which amount
to around 83%. Indirect taxes contain sales tax, excise duties, entertainment
tax, customs duties etc. One of the significant reasons for rising revenue from
indirect taxes is with rising financial necessities of revenue, it is easier to
impose and revise the indirect taxes than direct taxes.
Customs Duty
These are taxes imposed on goods entering (import duties) or leaving
(export duties) a customs area. Taxes imposed on goods imported from abroad
are import duties while those levied on goods exported from the country are
export duties. There are broadly three kinds of customs duties - import duties,
export duties and cesses on exports.
Import duties
These are levied according to the rates of duty prescribed under Schedules
I and II of the Indian Tariff Act 1934. A commodity schedule prescribes the
dissimilar rates of import duties leviable on dissimilar commodities. Usually
luxury items are charged the highest with a view to discouraging their import
while low rates are charged for essential items.
The net customs revenue has been estimated at Rs. 20,800 crore
throughout 1990-91 and Rs. 26,410 crore in 1991-92 after taking into account
the changes brought under the Finance Act 1990. As against the original
estimate of Rs. 21,213 crore, revised estimate for 1990-91 with regard to
import duties, is placed at Rs. 20,562.65 crore. The estimated decrease in
gross revenue is mainly on account of less revenue realization from project
imports, electrical machinery, iron and non-alloy steel, stainless steel, non-
ferrous metals, motor vehicles and parts thereof, organic and inorganic
chemicals, glass and glassware etc. This decrease in estimated revenue
realization is likely to be balanced to a great extent through increased
collection of import duties from crude oil and other petroleum products,
machine tools, plastics, rubber products, railway locomotives and materials
etc.
Export duties
Export duties before World War II, were levied with the prime objective of
mobilizing revenue. Later, throughout the post war period, they have been
levied for other purposes. According to the Report of Taxation Enquiry
Commission (1953-54), “many duties have been imposed for preventing the
impact on domestic markets of inflationary circumstances abroad, or for
stabilizing domestic prices, while other duties have been imposed for
protective purposes.”
In the initial years of planning, the share of export duty in the total indirect
taxes was quite high as throughout that time India had a foreign market
monopoly for the staple products. But later, due to decline in India‟s
monopoly in staple products, it became essential to reduce the rates of duties
on several commodities like jute, tea, textiles and through the end of the third
plan, these duties had to be practically abolished. Later again in 1966, these
export duties were reemployed on several items due to competitive position of
goods in international market.
Other Interest Receipts: The estimates under „other interest receipts‟ are in
respect of interest on loans advanced to public sector enterprises, port trusts
and other statutory bodies, cooperatives etc. and on capital outlays on
departmental commercial undertakings.
As a result of evaluation of Fund‟s holdings of Indian currency as on April
30, 1991 the budget estimates for 1991-92 give Rs. 1,805.03 crore as
expenditure for this purpose with corresponding credit under securities
account. India is a participant in the Special Drawing Rights (SDRs)
Department of the IMF. Throughout the year 1990-91 the net cumulative
allocation of SDRs to India remained at SDR 327.00 million as there was no
fresh allocation of SDRs. As in the case of Union Government, the non-tax
revenues of the state governments contain administrative receipts, net
contribution of the public sector undertakings grants-in-aid and other
contributions. /
Though some taxes are levied through the central government, the
responsibility to collect them is on the state government. For instance, stamp
duties other than those incorporated in the Union list and excise duties on
drugs and cosmetics have been incorporated in this category. There is need for
decentralization of functions for encouraging local initiative, for securing
promptness in decision-creation and efficiency in its implementation, and for
allowing for a diversity of experiments to suit varying needs, tastes and
temperaments this is implied in the federal nature of the Constitution which
ensures immediate effective resource mobilization and maintenance of
national perspective.
Central Government should not create directly any loans to states. State
Governments should be encouraged to borrow directly from the public as
much as they can. A significant development in the sphere of centre-state
financial relations in the recent years relates to the states taking recourse to
unauthorized overdrafts with the RBI. Two factors, namely, temporary
difficulties because of the uneven flow of receipts and expenditures and
chronic imbalances flanked by their functions and possessions have been
behind this trend. Of late repayment of and interest on debts falling due every
year are causing a great drain on the state governments‟ budgetary
possessions. Mainly of the projects on which the state governments invested
capital through borrowing from the centre are not yielding the desired rate of
returns. This calls for more determined efforts to improve the performance of
public sector projects. But some of the non-plan loans have become dead
weight debts which need to be remitted. Centre-state financial relations need
review and readjustment. States should learn to live within their means and
should use their possessions fully.
India has done very well in conditions of tax effort. In 1950-51 when the
planning procedure was initiated, the Tax-Net National Product (NNP) ratio
was as low as 6.4%. Since then it has been rising steadily and stands at 25%
(almost) today. For a developing country like India which started its
development effort with a very low per capita income and has recorded a very
modest rate of growth (i.e. around 7o per annum augment in NNP per capita),
this record in mobilizing tax revenue is extraordinarily good through any
standard. In India all the major taxes, except personal income tax and land
revenue, have recorded buoyancy greater than unity. In recent years buoyancy
of excise duty and sales tax has been as high as 1.51 and 1.41 per cent
respectively. This has enabled far greater mobilization of possessions through
taxation. There still remains some scope for raising additional tax revenue in
the country. This can be done if the government decides to show the required
political will to tax agricultural incomes which presently remain outside the
taxation net.
The Railway Budget for 1990-91 proposed hikes in the rates of goods
traffic, passenger fares, parcel and luggage rates. These proposals are
estimated to yield additional revenue of Rs. 892 crore. Revision in the postal
and telecommunication tariffs were estimated to result in additional revenue of
Rs. 645 crore. The total additional revenue changes in tax rates, through
revisions in railway fares and freights and through revisions in postal and
telecommunication tariffs was therefore estimated at Rs. 3327 crore in 1990-
91.
REVIEW QUESTIONS
Explain the significant elements of public debt management.
Discuss the role of deficit financing as an aid to financing economic
development.
What do you understand through direct taxes? State the kinds of direct
taxes levied through the Union Government?
What is Corporation Tax?
Distinguish flanked by specific and ad valorem excise duties.
CHAPTER 5
INVESTMENT OF PUBLIC FUNDS
STRUCTURE
Learning objectives
Economic and social appraisal
Financial appraisal
Review questions
LEARNING OBJECTIVES
After reading this unit, you should be able to:
Highlight the need for an economic analysis through governments.
Discuss the role of Cost Benefit Analysis in project development,
evaluation and implementation.
Bring out the differences flanked by financial and economic analysis.
The techniques of financial and cost benefit analysis are employed in three
of the six identifiable stages of project formulation and evaluation viz., 2, 3
and 6 given below: At this stage, the initiating agency, such as a government
department or utility, defines the initial concept of project and outlines the
objectives that the government wishes it to achieve. These may contain the
provision of health, transport or education services, for instance. The first
major issue that necessity be investigated is the subsistence of market
opportunities. In the case of social services, the analyst necessity determine
the anticipated demand for the project‟s output and the benefits that the public
is expected to derive from these services. An initial assessment of the best
technology to employ, given local factor prices, as well as the appropriate
scale and timing of the project is also necessary. Engineers, health specialists,
educationalists, environmental scientists, agricultural specialists, market
analyst and several other professionals will contribute to this stage of the
project‟s development. Economists may also be involved in a preliminary
assessment of the viability of alternative technology given the relative prices
of capital and labour in the country concerned. This procedure yields the basis
concept of the project and background information, which enables the
government to progress to the pre-feasibility revise stage.
Pre-feasibility Revise
At this stage, the analyst obtains approximate valuations of the major
components of the project‟s costs and benefits: input and output quantities and
prices. More precise estimates necessity be made of the demand for the
project‟s output, the technical capability and cost of the plant or technology
envisaged, and the project‟s manpower necessities. In several cases this data
will be provided through the technical professionals involved in the original
project identification stage. Using this preliminary data, financial and
economic analyses of the project will then be undertaken through the
economic analyst, to determine whether the project appears to be financially
and economically viable. A preliminary financing schedule may also be drawn
up to identify the source and costs of funds. If the project appears viable from
this preliminary investigation, it will be worthwhile proceeding to the full
feasibility revise stage.
Feasibility Revise
At this stage, more accurate data necessity be obtained on all project costs
and benefits, but particularly those that risk analysis designates are crucial to
the project‟s viability. The financial and economic viability of the project is
then assessed again. If the project is still found to be viable, approval should
be sought to proceed to the project design stage.
Project Design
This involves undertaking the detailed engineering design work of the
project, based on the technology envisaged at the feasibility stage. Manpower
necessities, administration and marketing procedure are all finalized at this
point.
Implementation
At this stage, tenders are let and contracts signed to facilitate the
appointment of the project manager, who will oversee the construction and
perhaps the operation of the project.
Ex-post Evaluation
The final stage of a project is essential, yet regularly overlooked in project
appraisal and implementation. This evaluation is intended to determine the
actual contribution that the project has made to national welfare, after man-
years of project operation. Its primary purpose is to help to identify the major
sources of project success and failure, so that future project development,
analysis and operation procedures can benefit from past experience.
Financial analysis whether used in the public or the private sector, implies
the notion of the agency maximizing its net financial surplus over time. This
will usually differ from the maximization of the economic surplus generated
for the community as a whole whenever prices do not reflect the benefits or
costs associated with an activity (in some case there may not even be any
prices because benefits and costs are not traded).
When considering benefits and costs which either cannot be valued or cannot be
quantified there can be a tendency to concentrate on the benefits and ignore the costs.
This should be resisted. Where valuation is possible, two key concepts need to be
kept in mind.
The Opportunity Cost Principle: The use of possessions (manpower, finance
or land) in one scrupulous area will preclude their use in any other. Hence the
basis for valuing the possessions used is the “opportunity cost” of committing
possessions; i.e. the value these possessions would have in the mainly
attractive alternative use.
The adoption of this principle reflects the fact that the economic evaluation of
public sector projects should be mannered from the perspective of society as
a whole and not from the point of view of a single agency.
Commonly, the price paid for new capital, labour or inputs will reflect the
opportunity cost of the possessions. The position may be less clear in the case
of the existing land owned through the agency. Though, in general it is
measured that a cost equivalent to its maximum market value or likely land
use zoning should be placed on such land.
The general principle applies even where the public sector may have access
to an input at a cost dissimilar from its market value. For instance, coal
supplied from an electricity generator‟s own collieries should be priced at the
market price for comparable coal rather than the costs of supply, reflecting
the fact that the coal has an alternative use.
Willingness-to-pay Principle: In valuing the benefits of a project the aim is to
place a monetary value on the several outputs of the project. Typically such
outputs will contain:
o Benefits for which a price is paid; and
o Benefits for which no price is paid.
Where the services are bought and sold it is usually presumed that the
price paid is a reasonable proxy for the values of the service to the consumer.
This principle will hold mainly closely where the changes in output and price
stages associated with the investment are relatively small. Where output
changes are important then it may be desirable to take account of changes in
consumer surplus (an excess over the market price which the consumer would
have been willing to pay). This will require knowledge of the price elasticity
of demand (i.e. sensitivity of demand to changes in price). Though, where the
service is not freely traded or there is no price charged, or where the benefits
fall broadly on the community rather than individual users, more indirect
measures of the willingness to pay for the benefits need to be derived. A
diversity of techniques are accessible including:
The use of data on expenditure through consumers in seeking to participate in
benefits (e.g. Costs incurred in visiting a national park);
Price data from related goods and services (e.g. Variations in house prices
due to the impact of noise stages to assess the cost of airport noise); and
Choice experiments (e.g. experimental choice flanked by a diversity of
existing and new amusement/recreation amenities to infer a value for a new
amenity).
Specific Issues
Treatment of Inflation
Due to inflation, costs and benefits which occur later will be higher in cash
conditions than similar costs or benefits which occur earlier. There are two
dissimilar ways to tackle this issue. Either nominal values can be used for each
time period and then discounted with a nominal discount rate, or real cash
flows can be used discounted through a real discount rate. In practice it is
measured that the use of real cash flows and discount rates may simplify the
forecasting and calculation processes.
Sunk Costs
In an evaluation, all costs necessity relate to future expenditures only. The
price paid 10 years ago for a piece of land or a plant item is of no relevance; it
is the opportunity cost in conditions of today‟s value (or price) which
necessity be incorporated. All past or sunk costs are irrelevant and should be
excluded.
Depreciation
Depreciation is an accounting means of allocating the cost of a capital
asset over the years of its estimated useful life. It does not directly reflect any
opportunity cost of capital. The economic capital cost of a project is incurred
at the time that labour, machinery and other inputs are used for construction,
or in the case of an existing asset, when it diverted from its current use to use
in the project being evaluated. These project inputs are valued at their
opportunity cost. Hence, depreciation should not be incorporated in the
economic evaluation.
Interest
As future cash flows are discounted to present value conditions in
economic evaluations, the choice of the discount rate is based on several
factors which contain the rate of interest. The discounting procedure removes
the need to contain interest rate in the cash flows.
The first two concepts of the discount rate relate to the opportunity cost of
the possessions used in the public sector investment projects. Possessions
could be used elsewhere and the discount rate attempts to measure such
opportunities foregone. In principle the social time preference rate and the
opportunity cost of capital should be the same. Though, for several reasons
such as private sector profit and capital constraints in the public sector, the two
will differ. Typically the opportunity cost of capital will be greater than the
social time preference rate.
Possessions devoted to public investment will be at the expense of current
consumption or private sector investment. In a rising economy with rising
living standards, a rupee's consumption today will be more valued than a
rupee's consumption at some future time for, in the latter case, the rupee will
be subtracted from a higher income stage. This so-described marginal social
rate of time preference is, of course, not easy to measure. If alternatively,
public investment takes place at the expense of private investment then, from
an economic efficiency viewpoint, public investments of an economic nature
should not be sanctioned if they are expected to earn significantly lower rates
of return than those same possessions might earn (before tax) in the private
sector (the so-described marginal social opportunity cost).
This concept is also hard to measure accurately. The concern is not with
the average rate of return in the private sector, but with the marginal rate - that
is with the rate which would be earned through the private sector if additional
capital allowed further private investment to occur. In theory a perfectly
competitive capital market will see equality of the consumer's marginal rate of
time preference, the investor's rate of return on the marginal project and the
market rate of interest. In practice interest rates give limited guidance to the
estimation of discount rates on these bases. In the face of the difficulty of
measuring discount rates on these bases, it has sometimes been argued that the
appropriate rate of return or discount rate should be derived from the interest
rate at which government borrows funds in the market. But given the
dominant position of government in the capital market, the variability of
interest rates and the wide range of factors which impact on interest rates this
is quite an inadequate way of deriving the appropriate discount rate.
Benefit-Cost Ratio
The Benefit-Cost Ratio (BCR) is the ratio of the present value of benefits
to the present value of costs. In algebraic conditions it can be expressed as
follows:
Sensitivity Analysis
Sensitivity Analysis is used to assess the possible impact of uncertainty. It
illustrates what would happen if the assumptions made about some or all of
the key variables proved to be wrong and shows how changes in the values of
several factors affect the overall cost or benefit of a given investment project.
A key practical role of sensitivity analysis is to incorporate dissimilar views
about one or more key assumptions which can reasonably be held through the
dissimilar people involved in the assessment procedure.
Post-Implementation Review
A selection of the major projects undertaken through an agency should be
subject to ex-post evaluations. In addition, major ongoing programs which
may involve a series of smaller projects should be subject to such ex-post
evaluations. These evaluations would involve:
Re-evaluation of the benefits and costs of the selected option to assess
whether the anticipated benefits were realized and the forecast costs kept to;
Reconsideration of alternative options; and
Examination of the project design and implementation to assess the scope for
improvement to the option adopted.
Distributional Weights
One of the mainly commonly used methods of undertaking a social cost
benefit analysis is to introduce distributional weights in to the cash flow.
Distributional weights are attached to changes in income, costs and benefits,
received through dissimilar income groups, ensuring that a project‟s impact on
the income of low income groups receives a higher weight than the same
dollar impact on the income of high income groups. The introduction of these
distributional weights enables projects to be assessed on the basis of
distributional as well as efficiency objectives.
Project A‟s costs are borne through the rich and its benefits are received
through the poor, while project B is the opposite. Its costs are borne through
the poor and its benefits are received through the wealthy. Since the two
projects are mutually exclusive the project wit the highest NPV should be
selected. If an economic analysis were undertaken and distributional weights
of unity were applied to the costs and benefits of the two projects, project B
would have an NPV of $L80 and project A an NPV of $L50. Hence, project B
should be selected. Though, if the government decides that it values income
going to the poor more highly than income going to the rich and applies a
distributional weight of, for instance, d=2 to the low income group‟s income,
project A would have a social NPV of $L200 and project B would have a
social NPV of $L0. Project A would then be selected on the basis of a social
cost benefit analysis.
The second problem with the use of distributional weights relates to how
the government or project analyst can objectively determine the appropriate
set of weights to employ. Even if the distributional impacts of a large project
can be traced, the marginal utility of income of these dissimilar groups may be
very hard to determine.
Economists such as Harberger and Amin have opposed the formal
inclusion of distributional objectives into cost benefit analysis. They claim
that, through necessitating comparisons of the welfare that individuals receive
from rising their income through a fixed amount, say $ 1, social cost benefit
analysis compromises the objectivity of project appraisal. Instead, Jenkins and
Harberger recommend merely which groups benefit and which lose from a
project, leaving it to decision-makers to determine implicit, rather than
explicit, distributional weights.
FINANCIAL APPRAISAL
WHEN TO UNDERTAKE A FINANCIAL ANALYSIS?
The financial benefits of a project are just the revenues received and the
financial costs are expenditures that are actually incurred through the
implementing agency as a result of the project. If a project is producing some
good or service for sale, the revenue that the project implementers expect to
receive each year from these sales will be the benefits of the project. The costs
incurred are the expenditures made to establish and operate the project. These
contain capital costs, the cost of purchasing land, equipment, factory structure,
vehicles and office machines, and working capital, as well as its ongoing
operating costs, for labour, raw materials, fuel and utilities. In a financial
analysis, all these receipts and expenditures are valued as they appear in the
financial balance sheet of the project, and are so measured in market prices.
Market prices are just the prices in the local economy, and contain all
applicable taxes, tariffs, trade mark-ups and commissions. Since the project‟s
implementers will have to pay market prices for inputs they use and will
receive market prices of the output they produce, the financial costs and
benefits of the project are measured in these market prices.
Often, constant (say 1990) prices, rather than current prices, are used in a
project‟s cash flow. A project‟s cash flow is merely the costs and benefits paid
and produced through the project over its lifetime in the years that they occur.
The use of constant prices simplifies the analysis, as it relieves the analyst of
the need to create projections about the anticipated inflation rate in the country
over the life of the project. This procedure is quite appropriate if input and
output prices in domestic currency are expected to augment at almost the same
rate over the life of the project.
Though, there are many situations where the use of constant prices may
not be appropriate. The first is when the analyst is drawing up project
financing plans. In this situation, the analyst will need to estimate expenditures
in nominal conditions to ensure that planned sources of finance will be enough
to cover all project costs. The second is a situation where the investment is
privately operated and will pay company tax. The financial analysis will need
to be accepted out in both nominal and real conditions because the rate of
inflation will affect the interest payments, depreciation allowance and the cost
of holding stocks. All these will influence the firm‟s tax liability. Working
capital necessities will also be affected through the stage of inflation. Finally,
if input prices are expected to rise at dissimilar rates over the life of the
project, and vary from year to year, it will usually be simpler to contain all
prices in current conditions.
In the case of project outputs, they should so be valued at the market price
received for them at the project gate. Transport costs from the project to
market should be subtracted from the wholesale price received in the market.
Project inputs should also be valued at their market cost at the project gate.
This price will contain the transport and handling cost of getting them there...
In order to separate the cash flow into local and foreign prices, and also to
predict the future price of a project‟s tradable inputs and outputs, it may be
necessary to create projections about future exchange rates. To do this it will
be necessary to assess, inter alia, if local inflation rates are likely to diverge
from average international inflation rates, and particularly those of the host
country‟s major trading patterns. If local inflation is expected to be higher than
the average for major trading partners, devaluation of the local currency could
be anticipated, rising both the costs of imported inputs and the local currency
value of exported outputs. If local inflation is expected to be lower than that of
the country‟s major trading partners, it is likely that the local currency will
appreciate over the life of the project. If this is a real appreciation, it will have
the effect of lowering imported input prices as well as lowering the local
currency receipts from exported outputs and/or reducing the international
competitiveness of these exports.
Project Life
Early in the procedure of constructing a project‟s financial cash flow it will
be necessary to determine the length of the project‟s economic life. This will
be the optimal period over which the project should be run to maximize its
return to the project implementer. The project‟s life is regularly set equal to
the technical life of the equipment used. Though, several factors, such as the
technological obsolescence of equipment, changing tastes, international
competitiveness or the extent of a natural resource or mineral deposit, may
result in the economic life of the project being shorter than the technical life of
the equipment employed. If the project is expected to have long term
environment impacts, it may be necessary to extend the length of the cash flow
so that these costs (or benefits) can be measured.
Capital Costs
The capital costs of a project can be divided into fixed capital costs, or the
cost of acquiring fixed assets like plant and equipment, start-up costs, and
working capital, which finances the operating expenses of the enterprise. In a
financial analysis, all forms of capital expenditure should be entered in the
financial cash flow in the years in which the project actually has to pay for
them. For instance, if the project receives a soft loan from the supplier of its
equipment, which involves a grace period before repaying the loan, the cost of
this equipment will not be incorporated in the cash flow until it necessity be
paid for through the project.
Operating Costs
The project‟s operating costs cover its recurrent outlays on labour services
(wages and salaries), raw materials, energy, utilities (water, waste removal,
etc,), marketing, transport, insurance, taxes and debt service over the life of
the project. Each operating cost is entered in the cash flow in the year (month
or quarter) in which it is incurred. Total operating costs may also be expressed
in conditions of costs per unit of output. As was mentioned previously, unit
operating costs are likely to be somewhat higher in the first year or two of a
project, so the variation flanked by start-up costs under capital costs, and
steady state operating costs will be incorporated as operating costs.
Project Benefits
In a financial analysis, the project‟s benefits equal the cash receipts
actually received through the project from the sate of goods or services it
produces, or the market value equivalent of home consumed output in the case
of non-marketed output. This can be the revenue from sales, rent or royalties,
depending on the nature of the project. Other revenue earned from, for
instance, bank deposits, the sale of fixed assets or insurance claims, will also
be incorporated as separate items under project receipts or benefits.
Net Benefits
The project‟s net benefit stream is calculated as the variation flanked by
the total revenue (or benefit) stream and its expenditure (costs) stream.
In project analysis, any costs and benefits of a project that are received in
future periods are discounted, or deflated through some factor, r, to reflect
their lower value to the individual (or society) than currently accessible
income. The factor used to discount future costs and benefits is described the
discount rate and is usually expressed as a percentage. For instance, suppose
the project is expected to yield a stream of benefits equal to BO, Bl, B2,.... Bn
and to incur a stream of costs equal to CO, Cl, C2, Cn in years 0, 1, 2,... n.
Then in each period the net benefits (benefits minus costs) of the project will
be:
(B0-C0), (Bl-Cl), (B2-C2),... (Bn-Cn)
This is basically the project‟s net benefit flow. Assuming that the discount
rate, r, is constant, then the discounted cash flow of the project can be
represented as:
Once future net income streams have been discounted in this way,
expenditures and revenues from all the dissimilar time periods will be valued
in units of similar value - present day units of currency. They will then be
directly comparable with each other and can be added together. Adding the
discounted net benefits from each year of the project‟s life, its discounted net
benefit flow, gives a single monetary value described the project‟s net present
value, NPV. For, the previous instance, the project‟s NPV is:
The net present value criterion of a project is the single mainly significant
measure of the project‟s worth. If a project‟s NPV is positive (i.e. its
discounted benefits exceed its discounted costs), then the project should be
accepted. If its NPV is negative (its discounted costs exceed its discounted
benefits), then the project should be rejected.
The bottom line of the table shows that the NPV comes to $L10.4 million
if an 8% discount rate is used. A NPV greater than zero designates that the
discounted benefits of the project are expected to be greater than its discounted
costs and the project will so be worth undertaking.
This instance illustrates how crucially the estimation of a project‟s NPV
depends on the discount rate employed. A lower discount rate would have
deflated future income through less and increased NPV of the project. A
higher discount rate would have deflated future income more heavily and
decreased the NPV of the project, perhaps changing it from positive to
negative. The selection of the appropriate discount rate is so a very significant
issue in project appraisal.
If the project implementer is a net borrower, the interest rate at which the
enterprise can borrow is the opportunity cost of funds employed. This market
borrowing rate should be used as the financial discount rate for any project
appraisal undertaken through the enterprise. If the project implementer intends
to draw some funds from its own financial possessions and some from market
borrowings, the weighted cost of the capital it obtains from these dissimilar
sources will be the appropriate financial discount rate.
The NBIR so shows the value of the project‟s discounted benefits, net of
operating costs per unit of investment The decision rule for the net benefit
investment ratio is that all projects that have a net benefit investment ratio
greater than unity should be selected. This selection criterion is totally
compatible with those for the net present value and the internal rate of return
of a project.
REVIEW QUESTIONS
Highlight the role of cost benefit analysis in the project development,
evaluation and implementation.
Discuss the differences flanked by financial analysis and economic
analysis?
Explain the steps in preparing a full economic evaluation.
Discuss the purpose of social cost benefit analysis.
CHAPTER 6
FINANCIAL CONTROL
STRUCTURE
Learning objectives
Executive control
Legislative control
System of financial committees
Review questions
LEARNING OBJECTIVES
After reading this unit, you should be able to:
Explain the development of Executive Control over expenditure and
the growths in the area of financial administration.
Discuss the organisation of Ministry of Finance.
Explain the concept of legislative control.
Explain the concept of Financial committees.
EXECUTIVE CONTROL
DEVELOPMENT OF EXECUTIVE CONTROL OVER
EXPENDITURE
The broad functions and structure of finance department at the centre and
in the states have remained more or less the same even after Independence.
Legislative control over the executive, especially in financial matters, is
sought to be achieved through (1) its approval of the detailed expenditure and
tax proposals and (2) as well as through its scrutiny of executive‟s
irresponsibility and irregularities committed in the course of implementation
of the budgets. The formal characteristic of accountability to the legislature
requires that the executive conducts its affairs in such a way that it is not
exposed to adverse criticism. Hence the executive as well as the top layers of
the administrative hierarchy are interested in exercising such control over the
several stages of administration to prevent irregularities and ensure efficiency
and economy in operations.
It is the control at the first and the third stages that usually engages much
of the time of the Finance Ministry and that impinges on the day-to-day
working of the administrative ministries. A control at these stages, if too rigid
or detailed involving much time and effort, can slow down the pace of work,
delay the implementation of projects—particularly developmental,
commercial or industrial and thereby cause loss of national effort or income.
While the need for control or scrutiny is not denied, it necessity be
constructive, purposeful, imaginative and not narrow in outlook or cramping
in effect.
Grants are voted and appropriations are made through the Parliament to
the executive. It is the duty of the executive to spend the money as voted
through the Parliament. The maxims of honesty, efficiency, and economy
should guide the conduct of the Executive officials while they spend public
money. Parliament is the sole authority under the Constitution empowered to
sanction funds to the executive for all expenditures. It is the duty of the
Parliament to ensure that an adequate machinery exists to see that no money is
spent out of the consolidated funds through the executive beyond the
appropriations provided through law or the Parliament.
Under the traditional system, the Treasury, down to the heads of the units,
assumes responsibility for the efficient and economical expenditure of the
funds entrusted to them as soon as the budget is approved through the fund-
granting authority. But in the modern times financial administration defines
budgetary control as the establishment of departmental budgets relating to the
responsibilities of executives, to the necessities of a policy and the continuous
comparison of actual with budgeted results. This comparison aims at securing,
through individual or communal action, the objectives of the policy or to give
a basis for its revision.
These powers were further enhanced in 1954 and 1955. A.K. Chanda, the
then Comptroller and Auditor General of India, who undertook the task of
preparing a plan for delegation of financial powers and for a reorganization of
the system of financial control, submitted his proposals for the consideration
of the Public Accounts Committee of Parliament While pinpointing the defects
in the existing system, he recommended that, to avoid delays in the issue of
expenditure sanctions, the particulars of the proposals referred through the
administrative ministry to the Ministry of Finance at the prebudget review
stage should be furnished in greater detail to enable the Finance Ministry to
carry out a better and more systematic prebudget scrutiny. A breakthrough, of
key importance, came in 1958, when the Government of India sought to
delegate financial powers to the administrative Ministries.
LEGISLATIVE CONTROL
CONCEPT OF LEGISLATIVE CONTROL (h1)
Parliament exercises control over revenue, expenditure, borrowing and
accounts. Legislative sanction is required for the levy of new taxes or for the
augment in the, rates of existing taxes, for the withdrawal of money from the
Consolidated Fund for public expenditure, and for raising of loans. Public
Accounts are scrutinized through the Public Accounts Committee and are
audited through a statutory authority which is independent of the executive. In
Indian context, the following four principles of financial control are being
followed:
The executive, acting through Ministers cannot raise money through
taxation, borrowing or otherwise without the authority of Parliament;
proposals for expenditure requiring additional funds necessity emanate
from the cabinet.
The second principle is the Control that vests in the Lok Sabha which
has the exclusive control of the Money bills. These necessity originate
in the Lok Sabha which has the sole power to grant money through
way of taxes or loans and to authorize expenditure. The Rajya Sabha
may reject a grant but not add to it.
The demand for grants necessity come from the Government. Neither
the Lok
Sabha nor a State Assembly may vote a grant except on a demand for
grant from the Government.
Likewise, the proposal for a new tax or for an augment in the rate of an
existing tax necessity come from the Government.
Question Hour
The first hour of every Parliamentary day is reserved for questions, which
give an effective form of control. Questions asked can keep the whole
administration on its toes. A question is an effective device of focusing public
attention, in a striking manner, on dissimilar characteristics of administration‟s
policies and activities. Any administrative action can provoke a question,
though the member cannot compel the Minister to provide the answer. The
Speaker, too, may disallow sure questions. A question is asked with a view to
getting information, obtaining ministerial opinion on a subject or basically
hammering the government on alleged weak points. Several of the questions,
may be trivial, but some do cause tremendous harm to the Government—the
Life Insurance Corporation episode of 1956 resulting in the resignation of
Finance Minister arose from an answer to a question.
This is a widely recognized, popular and commonly employed method of
ensuring accountability. From time to time members have been raising matters
of great importance through their questions.
Adjournment Debates
The device of adjournment motion is a tool of day-to- day control, and
may be utilized for raising a discussion in the House on any specific question
of urgent nature and of public importance. If allowed through the presiding
officer, an immediate debate takes place on the matter raised, therefore
suspending the normal business of the House. In practice, it has been seen that
the Speaker has shown a constant tendency not to interpret the term „urgent
nature and of Public importance‟ liberally.
Budget Discussion
Since the introduction of the Budget on Account Parliament has greater
opportunity of discussion on the budget proposals. The members of Parliament
have several opportunities of discussing the budget, on the following
occasions:
After the presentation of the budget, general discussion takes place. On
this occasion the discussion relates to the budget as a whole or any
question of principles involved therein.
Voting on grants gives the second opportunity. Discussion at this stage
is confined to each head of the Demand, and, if cut motions are moved
to the specific points raised therein, the discussion is sufficiently
pointed and may be focused on specific points.
Discussion on the Finance Bill gives an endless opportunity to discuss
the whole administration. In the words of G. V. Malinger, “It is an
acknowledged principle that any subject can be discussed on the
Finance Bill and any grievance ventilated. The principle being that the
citizen should not be described upon to pay, unless he is given, through
Parliament the fullest latitude of representing his views and conveying
his grievances.”
President’s Speech
The President addresses both the Houses of Parliament assembled together
at the commencement of the Budget session. The address is prepared through
the Government and each Ministry is responsible for the portion pertaining to
it. The President‟s Speech broadly spells out the major policies and activities
with which the executive would be pre-occupied in the period immediately
ahead. The members of Parliament have an opportunity to criticize the whole
realm of administration for its alleged acts of commission and commission.
Parliamentary Committees
Parliamentary Committees—Public Accounts Committees, Estimates
Committee, Committee on Public Undertakings, Committee on subordinate
legislation and Committee on assurances—are also tools of control over
administration. The first three committees exercise detailed and substantial
control, and the Committee on assurances undertake a scrutiny, of promises,
assurances, undertakings, etc., given through the Ministers from time to time,
on the floor of the House and it reports on:
the extent to which such assurances, promises etc., have been
implemented and
where implemented, whether such implementation has taken place
within the minimum time necessary for the purpose. The subsistence of
such a committee creates Ministers more careful in creation promises.
Audit
Parliament exercise control over Public expenditure through the
Comptroller and Auditor General who audits all Government accounts to
ensure that the money granted through Parliament has not been exceeded
without a supplementary vote and money expended conforms to rules. The
accountability of Government to Parliament in the field on financial
administration is therefore, secured through the reports of the Comptroller and
Auditor General who has rightly been described as the guide, philosopher and
friend of the Parliament.
Though full legislative control over the budget is a concept of this country,
historically the concept of budget began to develop in the late middle ages
when the revenue was to be composed from the king‟s domain. Hence the
budget was a statement of revenue and expenditure. Throughout the wars and
other emergencies when the King required a lot of money for running the
affairs of the state, he had to consult the nobility to know their views on the
taxes. The expenditure still remained a prerogative of the king. Only after the
1688 revolution, the Principle of No revenue without representation' got
recognized. The control over expenditure had still not acquired the
conventions of legislative approval.
•The system of legislative control over Public finance first arose in
England and it was more a growth than a creation. The first step that was taken
in this direction throughout the reign of King John was towards the control of
receipts and revenues rather that of expenditure. The Stuart autocracy made
the Parliamentarians more exacting and they began to claim a share in the
control of Public expenditure as well. But this did not come about suddenly or
according to any concerted plan or design it was a very gradual development.
The establishment of the accounting and reporting system in 1787, the
audit system under the Exchequer and Audit Department Act of 1866, and the
constitution of a Standing Committee of Public Accounts in the House of
Commons in 1866 were important historical growths in the arena of
Legislative Control.
Therefore was built up the modern system of Audit and Report through
which the Legislature controls the finances of the state. The system of
legislative control in India is more or less based on the system prevailing, in
England.
As per Article 116(1), the House of the People shall have power:
to create any grant in advance in respect of the estimated expenditure
for a part of any financial year pending the completion of the
procedure prescribed in Article 113 for the voting of such grant and the
passing of the law in accordance with the provisions of Article 114 in
relation to that expenditure.
to create a grant for meeting an unexpected demand upon the
possessions of India when on account of the magnitude or the
indefinite character of the Service, the demand cannot be stated with
the detail ordinarily given in an annual financial statement;
to create an exceptional grant which forms no part of the current
service of any financial year, and the Parliament shall have power to
authorize through law the withdrawal of moneys from the
Consolidated Fund of India for purposes for which the said grants are
made.
As per Article 117 (1) A Bill or amendment creation provision for any of
the matters specified under Article 110 shall not be introduced or moved
except on the recommendation, of the President and a Bill creation such
provision shall not be introduced in the Council of States. No such
recommendation shall be required for moving an amendment creation
provision for reduction or abolition of any tax. Article 117 (b) also gives that a
Bill which, if enacted and brought into operation, would involve expenditure
from the Consolidated Fund of India shall not be passed through either House
of Parliament unless the President has recommended to that House the
consideration of the Bill.
The function of the legislature does not end with the voting of grants for
public expenditure. Is has also to see that the funds granted are spent faithfully
and economically according to its direction. The Parliament has to satisfy
itself that the
funds have been applied to purposes approved (2) within the amounts
appropriated and (3) that waste and extravagance have been avoided. For this
purpose, there is an independent audit of all the departmental accounts through
the Comptroller and Auditor General of India followed through an
examination of his report through a Parliamentary sub Committee.
Joint responsibility of the political executive to the Parliament is an
essential characteristic of Parliamentary democracy. The mainly significant
control exercised through the Parliament over the executive is its control on
the purse strings. The executive can not spend any money without
authorization from the Parliament.
State legislatures also have similar committees though all of them do not
have separate committees on public undertakings.
In India, the Public Accounts Committee was first created at the centre in
1923 with the coming into force of the Montford reforms in 1921. It became a
major force in the legislative control of Public expenditure. Despite the
limitations of its constitution and the restrictions on its authority, it exercised
enormous influence in bringing to bear upon government the need to enforce
economy in the expenditure of public money. Committee of Parliament,
described the Public Accounts Committee. A committee of Parliament is
preferred because the Parliament does not have the time to undertake detailed
examination of the report. Secondly, the scrutiny being technical, can best be
done through a committee and, lastly, the non-party character of the
examination is possible only in a committee but not in the house.
Composition
Under the provisions of the Constitution, the Public Accounts Committee
at the Centre is constituted of members from both the Houses of Parliament; it
is composed of 22 members, 15 from the Lok Sabha and 7 from the Rajya
Sabha. The members are elected through a system of proportional
representation through single transferable vote. Approximately every sizeable
party or group is represented on the Committee. Although the committee is
elected annually, there is a convention that there should be a two year tenure
of the membership to ensure stability. The Chairman of the Committee is
nominated through the Speaker from amongst the members of the Committee.
Till 1966-67, the chairman belonged to the ruling party. Since then, a member
of the opposition has been named the Chairman.
The committee also reviews the form and details in which the estimates are
prepared in order to arrest any tendency to reduce the number of votes or to
contain large lump-sum provisions since these are regarded as diminishing the
control of Parliament over the estimates. It goes into the technical accounting
procedure, in order to find out its adequacy or otherwise to control
departmental extravagance.
Working of the Committee
The Public Accounts Committee can organize itself into sub-committees
and working groups. When approved through the committee, the reports of the
subcommittees are deemed to be the reports of the Public Accounts
Committee. The Committee may send for persons, papers and records. The
conclusions of the committee are submitted to Parliament in the form of a
report. To create the work of the committee more effective, the Comptroller
and Auditor General now submits interim reports to it. The committee is
therefore able to reach the conclusions and finalize its recommendations. It has
at its disposal the services of the Comptroller and Auditor General, who is the
guide, philosopher and friend of the committee.
ESTIMATES COMMITTEE
The Estimates Committee was first created in April, 1950 and its functions
were enlarged in 1953. There had been a predecessor or Estimates Committee,
described the Standing Finance Committee, which was first constituted in
1921 and attached to the Finance Department of the Government of India.
This committee depended on the will of the executive. It had no statutory
status. Its functions were not clearly defined and its deliberations were not
satisfying to the elected representatives of the legislative assembly.
Composition
The Estimates Committee, constituted in 1950 had 25 members; in 1956
the membership was revised to 30. It is a select committee elected through the
members of the Lok Sabha from amongst themselves according to the
principle of proportionate representation based on single transferable vote. The
term of office of the members is one year. But according to conventions, two-
thirds of the members are re-elected for another year. The Chairman of the
Committee is nominated through the Speaker. If, though, the Deputy Speaker
is a member of the Committee he automatically becomes the Chairman.
Ministers cannot be appointed on the Estimates Committee. Its functions,
methods of appointments and other relevant matters are laid down in the Rules
of Procedure and conducting of Business in the Lok Sabha.
Functions
The committee examines such of the estimates as it may deem fit or are
specifically referred to it through the Lok Sabha or the Speaker to:
Report what economies, improvements in organisation, efficiency and
administrative reforms, constant with the policy underlying the
estimates, may be affected;
Suggest alternative policies in order to bring out efficiency and
economy in
Administration;
Look at whether the money is well laid out within the limits of policy
implied
In the estimates; and
Suggest the form in which the estimates shall be presented to the
Parliament.
Till April 1964 the affairs of Public Enterprises in India used to be looked
after through the two Committees: namely the Estimates Committee and
Public Accounts Committee. But in view of vast investments and manifold
augment in the activities of public enterprises it was felt that there should be a
separate agency which should look into the working of public enterprises in
detail and report to the Parliament. In 1964, on the recommendation of the
Krishna Menon Committee, a separate committee on Public Undertakings was
constituted. This committee, which started functioning from May 1, 1964 took
over the work relating to autonomous Public Enterprises from the other two
Committees viz the Estimates Committee and the Public Accounts Committee.
Composition
Earlier there used to be 15 members in the Committee, with 10 members
from the Lok Sabha and 5 members from the Rajya Sabha. With effect from
April 1974, the number of members has been increased to 22.... 15 members
of COPU are drawn from the Lok Sabha and 7 members are drawn from the
Rajya Sabha. The members of COPU are elected every year in accordance
with the principles of proportional representation through means of single
transferable vote.
Functions of COPU
The Committee asks the ministry and the enterprises to furnish necessary
material relating to chosen subjects. The committee often visits chosen
enterprises for informal discussions. After the revise tours, and after getting
formal memorandum and other information from concerned parties, non-
official and official witnesses are invited to provide proof at formal sittings of
the committee held at Parliament House. All proof given before the
Committee is treated as confidential. The committee gives a whole lot of real
and useful information on Public Enterprises operations. The enterprises are
studied in some detail covering significant characteristics of their working
with a view to creation an evaluation of their performance.
REVIEW QUESTIONS
Trace the development and development of executive control over
expenditure in India.
Discuss the duties of the Finance Ministry.
Outline the organisation and functions of Ministry of Finance.
Describe the historical background and constitutional provisions of
legislative control.
Explain and evaluate the legislative control over public expenditure.
When did the thought of Public Accounts Committee originate in
India? What was its rationale?
What are the vital functions of Public Accounts Committee?
CHAPTER 7
ACCOUNTS AND AUDIT
STRUCTURE
Learning objectives
Role of the comptroller and auditor general (CAG)
Accounting system in India
Auditing system in India
Review questions
LEARNING OBJECTIVES
After reading this unit, you should be able to:
Understand the origin and constitutional position of CAG.
Explain the differences flanked by Commercial and Government
Accounting.
Explain the meaning and importance of audit.
Describe the differences flanked by Internal and Statutory audit.
Origin
Finance, Accounts and Audit are as old as history itself. History bears out
that a good accounts and audit organisation existed in ancient India. Kautilya
in his well-known Arthasastra gives an elaborate account of the accounting
system that existed in the Mauryan period. According to the Arthasastra, “In
the Mauryan policy, the final authority, in the matter of Finance, was the King;
one of whose daily duties was to attend to the accounts of receipts and
expenditure. Each Minister was responsible for the finance of his department
and each department had its own accountant, treasurer and others. The
Collector General was the head of the Finance Department. Below him was
the special commissioner (Pradeshtara), who was a type of Government
Auditor checking District and Village group account, in addition to being in
charge of collecting sure types of revenue. The accounting and financial year
closed on the last day of Ashadha”.
Accounting Duties
The duties and powers of the Comptroller and Auditor General have been
prescribed through the Comptroller and Auditor General‟s (Duties, Powers
and Circumstances Service) Act 1971 as required through Article 149 of the
Constitution of India. Under the Act, it is the responsibility of the Comptroller
and Auditor General to audit all expenditure and receipts of the Government
of India, the State Governments and of the Union Territories. He is also
empowered to audit the expenditure and receipts of bodies or authorities
considerably financed from Union or State revenues in the form of grants or
loans.
As per Section 10 of the CAG (DPC) Act 1971, it is the responsibility of
the Comptroller and Auditor General to compile the accounts of the Union and
of each (CAG) State, and prepare the Finance Accounts. Again, it is the duty
of the Comptroller and Auditor General to prepare, from the accounts,
Appropriate Accounts, showing under the respective heads, the annual receipts
and disbursements for the purpose of the Union, of each State and of each
Union Territory having a Legislative Assembly. These accounts (i.e. Finance
Accounts and Appropriation Accounts) are to be submitted to the President or
Governor of a State or Administrator of the Union Territory, as the case may
be.
He also gives the necessary information to the Union and States in the
preparation of their Budgets (i.e. Annual Financial Statement). The functions
of the Comptroller and Auditor General, in brief, in so far as accounts are
concerned, are mainly:
the prescription of forms in which accounts are to be kept in the Union
and of the States;
preparation and submission of Finance Accounts and Appropriation
Accounts to the President/Governor/Administrator of Union Territory
as the case may be, and
providing information to Union/State Governments for preparation of
their annual budgets.
Auditing Duties
The real duty of the Comptroller and Auditor General is that of an auditor.
The primary audit function is to verify the accuracy and completeness of
accounts; to secure that all financial transactions viz., receipts and payments
are properly recorded in the accounts, correctly classified and that all
expenditure and disbursements are authorized and vouched and that all sums
due, are recorded regularly in accordance with the demands and brought into
account. He/She acts as a watchdog to see that the several authorities under the
Constitution function in regard to financial matters, in accordance with the
Constitution and the laws of Parliament and appropriate Legislatures and
Rules and Orders issued thereunder. As per the CAG (DPC‟s) Act, 1971 the
auditorial functions of the Comptroller and Auditor General are as follows:
To audit all receipts into and expenditure from the Consolidated Fund
of India and of each State and of each Union territory, having a
Legislative Assembly and to ascertain whether the money shown in the
accounts as having been disbursed were legally accessible for and
applicable to the service or purpose for which they have been applied.
To audit all transactions of the Union and of the States relating to
Contingency Funds, and Public Accounts.
To audit all trading, manufacturing, profit and loss accounts and
balance sheets and other subsidiary accounts kept in any department of
the Union or of a State; and in each case to report on the expenditure,
transactions or accounts so audited through him.
To audit receipts and expenditure of bodies or authorities considerably
financed from Union or State revenues.
To audit the accounts of Government, Companies and Corporations
recognized
Through or under the Law of Parliament, or in accordance with the
provisions of respective Legislations.
To audit account of bodies or authorities through request.
Besides the duties and functions relating to the auditing and reporting upon
the accounts of the Union, of the States and of the Union territories with
Legislature, the comptroller and Auditor General may be entrusted with duties
and functions in relation to the accounts of any other authority or body, as may
be prescribed through or under any law made through Parliament. The
Comptroller and Auditor General‟s additional duty at present, is to undertake
audit of companies, the Comptroller and Government companies. In the case
of Government companies, the Comptroller and Auditor General may
comment upon or supplement the report of the professional auditors. Also,
his/her duty involves rendering assistance to the Public Accounts Committee
in its functions.
ROLE OF CAG: AN APPRAISAL
Conditions of Appointment
The Constitution guarantees his/her salary and other circumstances of
service, which cannot be varied to his/her disadvantage after his/her
appointment. Also, the salary, and allowances of the Comptroller and Auditor
General, shall be charged on the Consolidated Fund of India. Interference with
the Comptroller and Auditor General‟s function is likely, if the salary and
conditions of circumstances of service are left to the discretion of the
Executive. Again, even in the event of Parliamentary displeasure with a
Comptroller and Auditor General, his/ her salary, pension or age of retirement
will not remain within the competence of Parliament to change, if it so wishes
to penalize him/her. On his/her retirement, resignation or removal, the
Comptroller and Auditor General is prohibited from holding any office under
the Government of India or under the Government of the State. The purpose is
to keep the incumbents immune from allurement of getting favors from
executive, who in turn might influence his/her actions or decisions in office,
prior to retirement. Indirectly, this provision strengthens the hands of the
incumbents in creation fearless assessment of executive actions. In actual
practice, the spirit of this provision does not appear to have been strictly
followed. The Constitution has provided that salaries, allowances and
administrative expenses of the Comptroller and Auditor General be charged
upon the Consolidated Fund of India. Unlike the other expenses of the
Government, his/her expenses will not be notable in the budget. Hence, his/her
action and official conduct is planned to be excluded from the scope of
Parliamentary discussion and vote. The Constitution has therefore accorded a
very strong protection against Parliamentary interference with the working of
the Comptroller and Auditor General‟s organisation.
Audit Reports
The Constitution has prescribed the procedure to be followed through the
Comptroller and Auditor General for presentation of his/ her reports. His/ her
reports, in regard to the Union Government accounts, shall be submitted to the
President. And the accounts of the State Government shall be submitted to the
Governor of the State. His/ Her responsibility thereafter ceases. But it
becomes obligatory for the President/ Governor to cause them to be laid before
the House of Parliament/ State Legislature respectively. He/She submits three
Reports viz., Audit Report, on Finance Accounts, Audit Report on the
Appropriation Accounts, and Audit Report on the Commercial and Public
Sector Enterprises and Revenue Receipts on Union and State Governments
respectively. The Constitution does not prescribe any form or guidelines for
the contents of the Audit Report of the Comptroller and Audit General. It has
therefore been left with the Comptroller and Auditor General, the complete
freedom and discretion to decide the form, the materials and the contents of
the reports.
Limitations
Inspite of the several safeguards provided through the Constitution to
maintain the independence of Comptroller and Auditor General from the
Executive and Parliament, his/her independence appears to be limited through
four factors viz., (a) restraint of the Executive on his/ her budgetary autonomy
(b) block of control over staff (c) indirect accountability to the Finance
Ministry of the Union and the Finance Department of the State Government
for handling accounting duties (d) absence of direct access to Parliament
(unlike the Attorney General) in defense of his/her official conduct, if and
when questioned on the floors of Parliament.
To conclude, notwithstanding these limitations, the Comptroller and
Auditor General plays a unique role in Indian democracy, through upholding
the Constitution and the laws in the field of financial administration. He/ She
is neither an officer of Parliament nor a functionary of Government. He/She is
one of the mainly significant officers of the Constitution and his/her functions
are as significant as that of Judiciary.
The word accounts in the financial sense, has been defined as statements
of facts relating to money or things having money value. The facts that are
incorporated in the early stages of civilization, the number of transactions to
be recorded was so small that each businessman was able to record and check
for himself/herself all the transactions. But with the growth of trade, it became
hard for him/ her to know from the records, how she/he stood in relation to
his/her customers and whether her/ his business was profitable or not. This
gave rise to the maintenance of accounts on a double-entry basis, which was
helpful in the preparation of profit and loss account and balance sheet of the
business. The procedure through which these ends are effected is described
“accounting.”
Section 10 of the Act empowered the President, after consultation with the
CAG, to relieve the Comptroller and Auditor General from the responsibility
of compiling the accounts of any department of the Union Government. A
scheme for the separation of accounts from audit was approved through the
Government of India in June 1975. An ordinance was issued through the
President, which was followed through passing an Act, which amended the
Comptroller and Auditor General‟s (DPC) Act 1971, thereby relieving him
from the responsibility of compiling accounts of Ministries/Departments of
Government of India. He, though, still performs the accounts and audit
functions in each state.
The disadvantages listed out above are not so great as to justify opposition
to the separation for all times to come. The mere fact that separate accounts
organisations of Defense, Railways, Lok Sabha/Rajya Sabha Secretariat and
the separated Ministries of Works, Housing and Supply etc. are functioning
with efficiency, it dispel the fears enumerated. In fact, the disadvantages
arising out of combined accounts and audit organisations are more than the
advantages accruing out of it.
Separation of Accounts
Realising the rising need for separation of accounts from audit, the
Government of India decided to departmentalize the accounts of the
Central/Ministries/ Departments, which had been with the Comptroller and
Auditor General of India. All Ministries of the Government of India including
the Posts and Telegraphs Department were brought under the Scheme of
departmentalization of accounts flanked by 1st April to 31st December, 1976.
DEPARTMENTALISATION OF ACCOUNTS
The accounting system introduced through the British in the early years of
this century remained more or less unchanged till April 1974. The
classification in the accounting system introduced through the British, was
mainly to facilitate financial and legal accountability of the Executive to the
Legislature and within the Executive of the spending agencies to the
sanctioning authorities. Again, the classification had secure relationship to the
department in which the expenditure occurred than to the purposes for which
the money was spent. The vital concern was the item on which money was
spent rather than the purposes served through it. This system served well so
long as the functions of the Government were limited. But with a change in
the role of Government, i.e. undertaking developmental programmes for the
socio-economic development of the country under the successive Five Year
Plans, need was felt for bringing in necessary reforms in the system of
accounts, so as to meet the challenges of development administration.
The team mentioned that the new classification would facilitate a link
flanked by budget outlays and functions, programmes and activities. It would
also ensure itemized control of expenditure. Also, the classification would
facilitate introduction of performance budgeting. The Government of India
accepted the recommendations of the team on reforms in the structure of
Budget and Accounts.
The world Audit is derived from the Latin word Audile to hear. Originally,
the accounting parties were required to attend before the auditor, who heard
the accounts. In the early stages of civilization, the methods of accounts were
so crude and the number of transactions to be recorded so few that each
individual was able to check for himself/herself all his/her transactions. But
soon with the establishment of empires, a system was recognized to record
account transactions and audit them. The person whose duty, it was to check
such accounts came to be recognized as the Auditor.
An audit is an examination of accounting records undertaken with a view
to establishing, whether or not they correctly and totally reflect the
transactions to which they purport to relate. Its purpose is to see that
expenditure has been incurred with the sanctions of the competent authority
and applied for the purpose for which it was sanctioned. It should be duly
supported through vouchers, as a safeguard against fraud and
misappropriation.
Audit is one of the four pillars of democracy viz., (i) Parliament (ii)
Judiciary (iii) Press and (iv) 'Audit. Firstly, Parliament is the mainly
significant organ of democracy. It is composed of people‟s representatives,
elected on the basis of adult franchise. The members belonging to the majority
party in Parliament form the Government. All laws necessary for the running
of the Government have to be passed through the Parliament. Again, it votes
taxes which give government the possessions, necessary for running the
administrative machinery and also vote‟s funds for meeting the expenses.
Secondly, judiciary and the press are the other two pillars which are necessary
for administration of justice and functioning of a healthy democracy.
In the post-war era, the welfare state had to undertake many socio-
economic, commercial and industrial programmes to speed up development
and improve the quality of life of the people. Correspondingly, audit had to
shift its emphasis so that it was in a position to report to Parliament, whether
or not these programmes/activities had achieved their objectives. New areas of
audit had to be sheltered and new techniques had to be developed. With rising
activity, government departments and agencies had to build up their own
systems of internal control.
The transition from the traditional kind of audit to the audit of economy,
efficiency and effectiveness of activities (the three E‟s audit) was achieved,
through an intermediate stage of value for money audit, which sheltered the
economy and efficiency characteristics. Broadly, it can be said that economy
audit is aimed at ensuring that the activities are undertaken and completed at
the lowest possible cost.
Statutory Audit
Statutory audit refers to the audit mannered through the Comptroller and
Auditor General, through the agency of the Indian Audit and Accounts
Department. As per the Constitution as well as through the CAG (DPC) Act,
1971, it is the function of the Comptroller and Auditor General to (i) audit all
expenditure from the Consolidated Fund of India of the Union, of each State
and of each Union Territory, having a Legislative Assembly and to ascertain
whether the money shown in the accounts as having been disbursed were
legally accessible and applicable to the service or purpose to which they have
been applied or charged and whether the expenditure conforms to the authority
who governs it and (ii) to audit all transactions of the Union and of the states
relating to the contingency funds and public accounts. The Comptroller and
Auditor General has been given, under the Constitution, access to the accounts
of expenditure incurred against appropriations granted through Parliament.
The CAG is empowered to inspect any office linked with the transactions to
which his/her authority extends. -
Internal Audit
Internal audit, on the other hand, is internal to the organisation. Internal
audit is mannered through an agency or department created through the
management of the organisation. It is an integral part of the organisation and
functions directly under the Chief Executive. It is in the nature of an internal
service to the Executive for smooth and efficient functioning and for
reviewing and improving its performance. The common objectives of an
internal audit, inter-alia are to (i) check the adequacy, soundness and
applicability of the systems of internal controls (Accounting, financial and
other operating controls); (ii) prevent and detect frauds (iii) check on the
performance-cum-efficiency audit of an operation/programme/activity of an
entity as a whole, or its parts intended to dissimilar stages for any of the
objective, set through the management.
Internal audit, in any organisation, does not possess the same type of
independence as is accessible to the external audit, mannered through the
Indian Audit and Accounts Department. There is, though, no disagreement
flanked by internal and external or statutory audit. Where internal audit is
adequate, the extent of statutory audit is limited to test checking of internal
audit work.
KINDS OF AUDIT
The broad aim of audit is to safeguard the financial interests of the tax
payer and to assist the Parliament/State/Union territory legislatures in
exercising financial control over the executive. It is the function of the
Comptroller and Auditor General to ensure that the several authorities set up
through or under the Constitution, act in regard to all financial matters, in
accordance with the Constitution and the laws of Parliament and appropriate
legislatures and rules and orders issued thereunder. In order to discharge the
auditorial duties entrusted through the Constitution to him/ her, the
Comptroller and Auditor General (CAG) conducts several kinds of audit viz.,
Financial audit, Regularity audit, Receipts audit, Commercial audit, Audit of
stores and stock, Performance audit etc. In the performance of this stupendous
task, the CAG is assisted through the accounting authorities in several
ministries and through the Principal Accounts Officers functioning in several
states. Some of the characteristics of Financial audit, Regularity audit,
Receipts audit, Performance audit are explained in the following paragraphs.
Financial Audit
Financial audit is the audit mannered through the Indian Audit and
Accounts Department to see whether the administrative action of the executive
is not only in conventionality with prescribed law, financial rules and
procedures, but it is also proper and does not result in any extravagance.
Financial audit does not concern itself with the audit of administrative
organisations and procedures and is dissimilar from administrative audit. It is
the duty or the function of the executive government to frame rules,
regulations and orders, which are to be observed through its subordinate
in waste, extravagance or improper expenditure, it is certainly the duty of audit
to call specific attention to matters of that type and to bring the facts to the
notice of Parliament. For instance, in a canal project construction, audit would
not concern itself with the administrative set-up for the actual construction of
the canal and whether it should pass through a scrupulous part of the country
or not. These are matters of administration and no scrutiny of these processes
will be done through the audit. But if it is found that the alignments had been
drawn up on insufficient data, necessitating a subsequent change involving
additional expenditure or that the financial results were less than what had
been anticipated, then it is the duty of audit to look at the circumstances which
resulted in the wrong alignments resulting in loss or avoidable expenditure to
the tax payer. Audit interferes only when administrative action has serious
financial implications and is not in conventionality with prescribed law,
financial rules and procedures. Financial audit also comprises audit against
propriety or broad principles of orthodox finance. Therefore, financial audit
safeguards the interests of tax-payer through bringing to the notice of
Parliament, wastage in government expenditure.
Regularity Audit
Regularity audit consists mainly in checking that the payments have been
duly authorized and are supported through proper vouchers in the prescribed
form. Its main purpose has been to ensure conventionality with the relevant
administrative, financial budgetary and accounting rules and regulations
provided for in the Constitution or the laws made through Parliament.
The objectives of audit against regularity as specified in the Audit code,
inter-alia, are to ensure:
That there is provision of funds for the expenditure, duly authorized
through competent authority;
That the expenditure is in accordance with a sanction properly
accorded and is incurred through an officer competent to incur it;
That the claims are made in accordance with the rules and in proper
form;
That all prescribed preliminaries to expenditure are observed, such as
proper estimates framed and approved through competent authority for
works expenditure, a health certificate obtained, where necessary,
before disbursement of pay to a government servant;
That the expenditure sanctioned for a limited period is not admitted in
audit beyond that period without further sanction;
That the rules regulating the method of payment have been duly
observed through the disbursing officer;
That payment has been made to the person and that it has been
acknowledged and recorded 50 that a second claim against government
on the same account, is not possible; and
That the payments have been correctly brought into account in the
original documents.
Receipts Audit
Receipts audit involves the audit of income-tax and custom and excise
receipts at stage. From the late fifties, receipts audit has been mannered
through the Indian Audit and Accounts Department.
In receipts audit, the function of audit department is to ensure that
adequate regulations and procedures have been framed and are being observed
through the revenue department, to secure an effective check on assessment,
collection and proper allocation of revenue. Since the assessments in a revenue
department are of a quasi-judicial nature, audit should ensure that the
discretion used has been exercised in a judicious manner.
Performance Audit
Financial audit and Regularity audit usually involve scrutiny of individual
transactions. They do not focus on the evaluation of a scheme or a programme
to which these transactions relate. So, both kinds of audits have been found
inadequate for an evaluation of the performance of an organisation in
conditions of its goals or objectives. Ever since the Government launched
Five-Year Plans, investment on a large scale has been made on developmental
activities for acceleration of socio-economic development of the country. In
several cases, the investments did not provide the expected returns. So, public
has a right to know whether the results achieved had been commensurate with
the possessions invested. The public concern has found expression in the
introduction of performance budgeting in government.
The change in the thinking of government, in recent times, about the need
to relate expenditure to corresponding physical accomplishments made it also
to think about the functions of audit. It has been accepted that Regularity
audit/Propriety audit is essential for parliamentary control of expenditure.
Though, in view of the rising developmental expenditure, under the successive
Five Year Plans, audit should look at the achievements of specific
programmes, activities and projects in conditions of their goals or objectives.
It has been felt that audit should bring out those cases where utilization of
possessions has been sub-optimal. This has resulted in a serious thought being
given to the need for performance audit which is also described efficiency
unit.
Performance audit seeks to find out whether the possessions have been
utilized efficiently through deploying them in an optimum manner. It
highlights the extent to which possessions are put to productive uses. It also
highlights as to what extent quantified benefits could be expected from such
deployment of possessions. Although the technique of performance audit is
sound and useful, there are several troubles in conducting such an audit.
Firstly, performance evaluation of an activity can be made only in the light of
the objectives, which is expected to achieve. Objectives spell out the results
desired from an activity. Whereas inputs are easy to measure for an activity,
tremendous effort is required to quantify and measure the resulting output,
particularly when this output has a social context.
INDEPENDENCE OF AUDIT
Secondly, the Constitution gives that the Parliament shall have exclusive
power to create laws on the subject of audit of the accounts of the Union and
of the States. At the same time, the Constitution has not made the Comptroller
and Auditor General of India an officer of Parliament or of the House of the
People. In practice also, the States do not regard him as an officer of the Union
but a functionary created through the Constitution for purposes of both the
States and the Union Government. Therefore, the Comptroller and Auditor
General of India occupies a unique place. He certifies the share of the States of
the taxes composed through the Union and the amounts so certified are
accepted through the State Governments without demur. He certifies the
expenditure incurred through the States on public expenditure programmes
initiated and financed through the Union and the Union Government accepts
the figures without question. The Comptroller and Auditor General of India,
therefore plays a fiduciary role in the sensitive Union-State relations.
The details of these are contained in the accounts and audit reports
presented through the Comptroller and Auditor General for both Union and
State governments. It is impossible for parliament and legislatures to look at in
detail, the accounts and audit reports thereon which are technical and
voluminous documents. The Houses are unable to spare the time that a proper
examination requires. Parliament (Lok Sabha) and state legislatures have, so,
set up a Committee recognized as the Committee on Public Accounts and have
entrusted to it the detailed examination of accounts (appropriation and
Finance) and audit reports thereon.
REVIEW QUESTIONS
Describe the duties of CAG in respect of Accounts and Audit.
Discuss the advantages and disadvantages of the separation of accounts
from Audit and its present position in Government.
Explain the main characteristics of Departmentalization of Accounts.
Explain the meaning and importance of audit in a democracy.
Explain the variation flanked by Statutory audit and Internal audit.
CHAPTER 8
FINANCIAL ADMINISTRATION OF
PUBLIC ENTERPRISES
STRUCTURE
Learning objectives
Financial autonomy and accountability of public enterprises
Financial administration of public enterprises
Review questions
LEARNING OBJECTIVES
After reading this unit, you should be able to:
Explain the concept of financial autonomy and accountability in Public
Enterprises (PEs).
Describe several tiers of financial autonomy and accountability in PEs.
Discuss the methods of ensuring financial autonomy and accountability
in PEs.
Explain the meaning 'and importance of financial administration in
public enterprises (PEs)
FINANCIAL AUTONOMY AND ACCOUNTABILITY OF
PUBLIC ENTERPRISES
The PEs since they are recognized with public funds, are accountable to
the public i.e. through the parliament. Autonomy in simple conditions means
freedom to take decisions and function accordingly while accountability refers
to rendering of accounts to some higher authority. The financial autonomy
given to PEs means empowering them to take decisions on their own in the
areas of investment management, financing of investments and monitoring the
financial performance of respective enterprises based on sound business
principles and the wisdom of the financial administrators. Insofar as
investments are concerned, other things remaining the same, PEs should have
- freedom in identifying the projects, preparing the detailed feasibility project
reports, appraising the projects, creation investment choices, and
implementing and monitoring them. They should also be free to decide the
optimal stage of investments in the several items of inventory book debts and
floating stock of cash. Through the same principle they should be free to peg
the stage of current liabilities to any proportion of the current assets. The
financial decisions in the normal run may be made through these enterprises as
guided through the cost of capital. They should possess the freedom to choose
in the middle of the several debt-equity propositions. They should be at liberty
to select bankers, financial institutions and the channels of money and capital
markets for financing their working fund necessities. Subject to the social
constraints imposed on them through the government, these enterprises should
be vested with the autonomy to develop their own costing and pricing systems,
norms of profitability -and monitoring mechanism to ensure the desired
financial status alike any business firm in the private sector.
There has of late, been a lot of discussion about the question of autonomy
and accountability of PEs, its relationship with the government. The Arjun
Sengupta Committee set up through the Government of India in 1984, went
into several characteristics of public enterprise management like relations
flanked by government and PEs, managerial autonomy of PEs, financial
powers in regard to their investments and capital budget and so on. It
recommended that the government should be primarily concerned with overall
strategic planning and policy rather than day-to-day functioning of PEs which
should be left to the enterprises concerned. The responsibility of the
government is to ensure that public money invested in the enterprises earns an
appropriate rate of return and that their functioning is constant, with plan
objectives including those related to employment, fair pricing, efficient use of
scarce possessions etc. The Committee was of the opinion that enterprises
functioning in the core sectors like power, steel coal and lignite etc. have to
interact with the ministries with regard to matters like investment planning,
price fixation and financial management. Their plans will have to be integrated
with the national plans. But financially viable non-core public enterprises can
finance their necessities, through raising funds from the public through
deposits or debentures or borrowing from, the financial institutions, without
being subjected to any procedure of governmental clearance.
There are, though, definite limits to debt financing. Debt involves financial
risks which need to be commensurate with the business risks. The business
risks arise 'from likely changes in demand for the product, emergence of
competition or imposition of controls over prices, imports, exports etc. The
financial risk grows in proportion to the debt component in the capital
structure. It is essential to set definite limits to debt financing.
The government follows the policy of asking PEs to obtain their credit
necessities from the nationalised banks. In those cases where the enterprises
are short of margin money, the government extends a guarantee to cover the
deficit. When they find it impossible to obtain their total necessities of
working capital from the banks, the government gives, short-term loans for a
specific period.
Short-Term Investments
Major investment decisions may be subject to external pressures on the
enterprise. But the decisions on current asset-holdings fall well within the
scope of internal management. Investments in inventory can be regulated to
ensure that excess stocks and stock-outs are avoided. Likewise, efficient
management of trade credit helps in keeping the investments in sundry debtors
to the absolute minimum. Better management of cash offers scope for
reducing the interest burden on the enterprise. The techniques of ABC
analysis, economic order quantity, re-ordering stage, value analysis, etc., help
managing the current assets more efficiently.
Planning Systems
The planning procedure in the enterprise comprises strategic planning,
long-term corporate planning and annual performance budgeting. It also
covers economic and financial analysis needed for short-term decisions.
Strategic planning refers to planning of major strategies concerning expansion,
diversification, taking up manufacture of new products, entering new markets,
etc. The financial administrator plays a crucial role in marshalling the relevant
costs and benefits and in advising the management on the long-term financial
implications in conditions of outlays and cash flows expected. He/She works
closely with the team engaged in the strategic planning procedure. The criteria
for investment decisions mentioned earlier are integral to the procedure of
strategic planning.
Operating Decisions
There are very few decisions at the enterprise stage which do not affect its
funds. It is, so, logical for the financial administrators to have a say in those
decisions. Leaving aside the investment decisions mentioned earlier the
operating decisions cover a wide range of troubles such as capability
utilization, pricing, overtime working, shift-working, product-mix, credit
policy and incentives.
Control Systems
Budgetary control and standard costing systems give the basis for
monitoring enterprise performance at all stages. They introduce a participative
element in the target-setting exercise. The financial administrator is expected
to develop an integrated system which incorporates financial accounting as
well as management accounting systems. The system has to be so intended as
to generate data for compiling periodical reports to be sent to the
administrative ministry, Finance Ministry and Planning Commission etc. It
should also give information to enterprise managers at all stages about their
achievements vis-à-vis plans and targets. These managers need assistance in
identifying and analyzing cost variance as well as profit variance.
There are several sources of financing PEs. These mainly constitute equity
and grants received from the government, public participation in equity,
borrowings from the open market in the form of public deposits and issue of
bonds, foreign investment and cash credit advances. The government is the
main provider of funds to PEs. It finances PEs through equity grants and
borrowings. The borrowings are provided at a rate of interest of 14-16 per cent
per annum for long-term funding. The equity is provided for long-term
funding at no cost. Therefore, the equity represents the perpetual interest-free
capital. To check the misuse of cost-free funds, the government has initiated a
scheme of disinvestment of equity in PEs from 1991-92 in which year Rs.
3,000 crore was received from the sale of PE shares through mutual funds.
The government‟s total equity in the Central PEs was of the order of Rs.
38,634 crore as on March 1,1990. The long-term loans provided through the
Government to PEs amounted to Rs. 24,585 crore as on the same date. The
central government provided about 68 per cent of the total financing needs to
these enterprises in 1989-90. The foreign participation in conditions of equity
and debt amounted to Rs. 14,221 crore as on the same date which amounted to
about 14 per cent of the total financing needs in 1989-90. The equity and loans
provided through the financial institutions amounted to Rs. 5,213 crore and
constituted about 5 per cent of the total financing needs as on March 31,1990.
The private participation through way of bonds, equity and public deposits
amounted to Rs. 60,496 crore which represented roughly 16 per cent of the
total financing needs as on March 31, 1990.
The working capital requirement of PEs are usually met through cash
credits and advances arranged with the State Bank of India and nationalised
banks. The total amount of outstanding cash credit drawn through the central
PEs stood at Rs. 13,973 crore as on March 31, 1990. In special cases nonplan
loans also are arranged through the central government to some enterprises to
meet their working capital necessities. As on 31 March 1990 an amount of Rs.
14.40 crore was due from these enterprises under this head. Despite the
recommendations made through many expert committees/commissions such
as the Krishna Menon Committee (1959), Administrative Reforms
Commission (1967) and Committee on Public Undertakings (1971), these
enterprises did allow public participation in their equity. The internal
financing through generation of internal funds through way of depreciation,
write-offs and retained profits constitute another significant source of
financing PEs. Internal financing is a cost free source of finance. Flanked by
1985-86 and 1989-90 internal possessions generated through these enterprises
stood at Rs. 37,677 crore. Not only the volume of internal generation of
possessions increased flanked by 1985-86 and 1989-90 from Rs. 5,067 crore
to Rs. 10,779 crore, respectively, but the number of PEs generating internal
possessions also increased from 126 to 150 throughout the same period. The
generation of internal possessions reduces the dependence of PEs on the
government and thereby acts as an significant measure of autonomy.
REVIEW QUESTIONS
What do you understand through financial autonomy of PE?
Point out the areas of financial accountability of PEs.
Discuss the methods of ensuring financial accountability of PEs.
Look at troubles pertaining to financial autonomy and accountability in
PEs.
Discuss the functions of financial administration in PEs.
Explain the investment management and financing of PEs;
CHAPTER 9
LOCAL FINANCE
STRUCTURE
Learning objectives
Financial administration of rural governments
Financial administration of urban governments
Review questions
LEARNING OBJECTIVES
After reading this unit, you should be able to:
Describe the machinery concerned with financial administration in
rural governments.
Discuss the concept of rural development and the principles of rural
local finance.
Explain the several characteristics of rural fiscal management.
Explain the major divisions and the machinery concerned with
financial administration.
Discuss the ecology and principles of urban local finance.
The Secretary of the Zila Parishad prepares the budget every year and
places it before the Standing Committee for finance and taxation. After having
measured the estimates of receipts and expenditure, the standing committee
submits the budget to the Zila Parishad for approval. As soon as it is passed
through the Zila Parishad, it is sent to the government so that it can be
scrutinized with a view to pointing out any misuse or abuse of funds placed at
the disposal of the Zila Parishad. Therefore, it is clear that the budget as
passed through the Parishad is final. Separately from this, it is significant to
note that the departments concerned prepare the District-wise statement of
funds to be placed at the disposal of the Zila Parishads and the Panchayat
Samitis and pass on the same to the State Government before the prescribed
date each year. The Government communicates to each Zila Parishad the
allocation of funds for schemes earmarked to the Zila Parishad as well as
Panchayat Samitis. The Zila Parishad then meets immediately and decides
block-wise allocation of funds and conveys its recommendations to the
government. Keeping in view the recommendations of the Zila Parishad, the
government communicates to each Panchayat Samiti the allocation of funds
allotted to it for the schemes to be executed through it throughout the after that
financial year. On receipt of the intimation of the allocation of funds, the
Panchayat Samiti prepares its budget and submits it to Zila Parishad for
approval as mentioned earlier.
Stores
The term „Stores‟ comprises all articles and materials purchased or
otherwise required for the use of or in the service of Panchayat Samiti or Zila
Parishad, whether these are Consumable like articles of stationery etc., or non-
consumable like instruments, furniture etc. Detailed rules have been framed
for the procurement, custody and issue of stores.
In all the states, detailed accounting procedures have been laid down in
matters pertaining to itemization of receipts and expenditure, custody and
disbursement of funds, stores, periodical scrutiny of accounts through the
appropriate authorities, and so on. Besides, the accounts are also subject to
government audit which is an significant instrument through which control
and supervision is exercised, deficiencies located and loopholes plugged to
ensure financial discipline.
A review of the working of Panchayati Raj shows that it has not come up
to the expectations of the people. There are several troubles that have made
Panchayati Raj Institutions ineffective in accomplishing their vital purpose. It
is usually the view that part of the inability of these institutions in performing
their functions satisfactorily lay in their weak financial possessions. The
troubles of Panchayati Raj finance are of varied character. In the first place, it
has been noticed that in spite of wide taxation powers, Panchayati Raj
Institutions have not utilized them fully. The Asoka Mehta Committee‟s
findings reveal that these institutions have rarely utilized their taxation
powers. It observes: “In spite of all the exhortations on the need to raise their
own possessions through way of taxation, there is a general resistance through
the Panchayati Raj Institutions to imposing taxes. This reluctance is visible not
only in the case of Panchayats which are in face-to-face get in touch with the
people but also in the case of the Zila Parishads even in such states as
Maharashtra where they are performing a diversity of developmental functions
and need additional possessions”. This unwillingness to mobilize the
possessions is due to the unpopularity of the measure and the representatives
fear of their being unseated at the after that election. There is no exaggeration
that the minimum that an elective body can do to alienate the sympathies of its
constituents and to ensure the defeat of its sitting members at the after that
polls is to provide the people heavier doses of taxation. Several committees
which have examined, from time to time, the problem of local finance, have
drawn pointed attention to this factor. Hence, the Asoka Mehta Committee
recommended that some of the local taxes should be made compulsory. It
observed, “The thesis „no taxation, only representation‟ should be
discouraged. Representation involves inescapable responsibility of raising
possessions for development and welfare work”. Further, the borrowing
facilities accessible to Panchayati Raj units are too restrictive. The Local
Authorities Loans Act, 1914 under which these units can raise loans is not
much suited to the needs of the modern times and requires a complete
overhaul. It has been suggested that the scope of the purposes for which loans
can be raised, the period and other circumstances of repayment should be
liberalized keeping in view the rural poverty. The establishment of a new
financing body like a Panchayati Raj Finance Corporation in the states of Uttar
Pradesh and Bihar to give loans to Panchayati Raj Institutions to enable them
to take up dissimilar kinds of remunerative enterprises has not been favored
through Asoka Mehta Committee. The Committee was of the opinion that it is
not likely to add to the total availability of the credit.
Separately from this, the present system of grants-in-aid suffers from sure
shortcomings. The grants are unrelated to the needs, these are irregular,
uncertain and their release is sometimes based on political thoughts. To fill up
the gap flanked by revenue and expenditure, the grants should be made
accessible to these institutions on time and their release on political thoughts
should be avoided.
Though there is a provision for government audit of Panchayati Raj
Institutions, yet there are serious gaps in actual practice. It has been noticed
that the accounts, especially, of Village Panchayats, have remained unaudited
for years at times. Panchayati Raj units have not cared to consider or remove
the audit objections within the stipulated period. Hence, audit should be
mannered regularly and the impression of its dispensibility should not be
allowed to gain ground. The persons found guilty of misuse of funds should be
given exemplary punishment and shown no leniency. In order to ensure that
weaker sections of the society derive maximum benefits from the several
plans, the Asoka Mehta Committee suggested that there should be an
independent authority to carry out „Social Audit‟ of the funds and programmes
earmarked for the Scheduled Castes and Scheduled Tribes and to ensure that
projects intended for them are implemented in a way that the desired impact is
not diluted. Improper sharing of sources of income flanked by the state and
rural local bodies, limited financial autonomy, undeveloped trading
enterprises, increased population pressure and functions etc., are some of the
reasons for inadequate financial possessions of Panchayati Raj Institutions. To
improve the financial circumstances of local bodies, creation of a separate tax-
zone was strongly recommended through the Local Finance Enquiry
Committee (1949-51) and the Taxation Enquiry Commission (1953-54).
The form of local polity, size and stage of local units, local functions,
government control and the economic circumstances of local inhabitants are
significant factors which contribute to determining the ecology of local
finance. The financial position of the local government is significantly
determined through the form of local polity. A decentralized pattern of local
government helps the local authority to determine its financial position
because it enjoys greater degree of financial independence to levy, assess and
collect taxes beside with enough freedom to formulate legislate and execute
budgetary proposals. Whereas, a deconcentrated pattern of local government
may not help the local government to augment its financial possessions
because it allows a lesser degree of financial autonomy in regard to several
facets of its financial activities. In this kind of local polity, local government
heavily depends on the government for finances. It may also not command
better public image and enjoy better position in relation to government when
compared with local government in a decentralized polity.
Last but not least the general poverty of our people is undoubtedly a potent
factor in the matter of local finance. People in our country have very little
taxable capability. A simple revise of the annul national per capita incomes of
countries like — UK, USA, Canada and Japan and that of India will amply
prove the point. Therefore, general poverty of people may not help to
contribute much towards local revenues.
The principles which should govern urban local finance are discussed
briefly as under: Independence and Responsibility. The principle of
independence means that urban government‟s necessity have freedom of
financial operations for fulfilling their obligations. The cannon of
responsibility which flows from independence implies that the responsibility
for raising and spending money should be with the same authority. The
authority which has the pleasing job of spending money should also do the
unpleasant job of raising it. Taxing autonomy and spending autonomy
necessity go hand in hand.
Public Accountability
In a democratic system, the principle of public accountability means that
government should be accountable to the elected representatives who
represent the citizens of the country, or the state or the locality as the case may
be, for its taxing and spending decisions. After executing the budget, there
should be an audit of it through an independent authority and all acts of
omissions and commissions through administrative agencies or the executive,
if there be any, should also be dealt with severely.
Simplicity
It means procedures concerning preparation, enactment, execution,
custody and disbursement of funds, accounts, audit, etc., should be simple and
understandable for taking timely action which is essential for efficiency and
economy. The absence of simplicity, promptness with caution, regularity of
working affects the vitality of financial administration.
Fiscal Access
The fiscal arrangements should be such that they provide to urban
governments an access to new financial possessions. There should be no bar in
developing new sources of income within their own prescribed fields to meet
the rising financial needs. The possessions should grow as the responsibilities
increase, hence, the need for exploiting new sources of revenue.
Non-tax Revenue
It comprises receipts from rents of municipal property, interest on
investments, profit from public utility undertakings like—water supply,
passenger transport, electricity supply, fee for issuing licenses or permits, fines
realised for offences against municipal bye-laws, rules, regulations etc. For
instance in Punjab and Haryana this source of revenue fetches about 30 per
cent of revenue. The national average of the proceeds from this source is a
little above 30 per cent.
Grants-in-Aid
It is another significant source of income of urban governments in India.
Grants represent subsidies given through the state government in aid of sure
services rendered through urban governments. Grants can broadly be divided
into two categories, namely, recurring and non-recurring. The former are
provided through the State Government to meet the gap in their recurring
expenditure. The latter are given to municipalities to meet the initial cost of
some specific projects such as water supply, school structures, health centre
etc. The amount of grant is determined on the basis of the matching formula,
per capita income and expenditure etc.
Loans
Urban governments also meet their needs of capital expenditure such as
purchase of land, heavy machinery and long-term projects through raising
loans. Borrowings are regulated through the central law recognized as Local
Authorities Loans Act, 1914. Loans are raised with prior sanction from the
state government. In sure cases, the permission of the central government is
also needed. The urban governments are permitted to borrow loans from
banks, Life Insurance Corporation and other financial institutions. All
proposals concerning loans from open market or LIC are required to be
cleared, through the Reserve Bank of India. For all practical purposes, urban
governments except municipal corporations have to depend largely upon loans
from their respective state governments. Every loan has its own rate of
interest, term, mode of repayment, measures of utilization etc.
Public Education
The responsibility of providing free and compulsory education for children
until they complete the age of fourteen years is as a matter of fact to be borne
through the state governments. (Article 45 of the Constitution of India). But in
some states, like Punjab, Bihar, Haryana, Uttar Pradesh, this is being shared
through urban governments. These states extend financial aid to urban
governments to meet the expenditure. The expenditure on public education
falls under two heads, viz., (1) running schools, and (2) setting up and
operating public libraries and reading rooms.
Medical and Public Health
Protection of public health is one of the primary functions of urban
governments. The public health activities are divided into two parts:
Provision for medical relief and administration of preventive medicines
and
Maintenance of public health.
Water Supply
Pure drinking water is essential for good health. The provision of pure,
clean and adequate water supply is, so, an significant function of urban
governments. Expenditure on this head is usually quite heavy because tanks,
reservoirs, engines, pipes, taps and other works may have to be constructed
and maintained. Besides, the water is supplied at no-profit no-loss basis, in
other words, the water is supplied at a less rate than the cost of production.
Municipal Works
It is one of the significant items of the municipal budget. Under this head,
the urban government‟s maintenance of roads, bridges, markets, slaughter-
houses, lanes and bye-lanes and any such other works concerning with the
physical beautification and development of the city or a town, are sheltered.
Stores
Urban Government‟s stores are divided into two parts, namely, (a) Special
stores and (b) General Stores. Special stores consist of article required through
a scrupulous department. These are purchased directly according to the
necessities of the department. General stores consist of articles which are of
general use and are required through general departments. Such stores are
purchased through the central stores department. In this way the purchase of
wholesale quantity is made at the lowest rate
Municipal Accounts and Audit
Accounts mean a record of money transactions. It may be described as a
procedure through which a local body puts all its business transactions on
record to coordinate the data in these records, so that they may be used
intelligently. Accounts not only enable the local bodies to regularize its
administration but also help them in the exercise of proper control over the
finances. In Punjab the general methods, the structure of accounts and the
manner in which the accounts are to be kept are prescribed in the Municipal
Accounts Code, 1930. The instructions of the Examiner, Local Fund Accounts
are to be complied with, in respect of details to be furnished through the urban
government.
Urban local bodies are not sovereign bodies. As mentioned earlier, local
government is a state subject and as such state government is empowered to
legislate on several characteristics of local bodies. It determines their structure,
powers, functions, financial possessions etc. In fact, urban local bodies are
regularly controlled, supervised, directed and occasionally penalized through
the State Government for their acts of omission and commission. In India, the
forms of government control over urban bodies are several and varied. Such
control is of four broad diversities, namely, (a) legislative, (b) judicial, (c)
administrative, and (d) financial. In this unit, we are mainly concerned with
financial control. Government control over the finances of urban governments
may be grouped under the following heads.
Besides, the state government can direct a municipal body to impose octroi
on a scrupulous items at a scrupulous rate instructed Ludhiana Municipal
Corporation in 1986 to levy octroi on man-made fibers like nylon and terrene
and hand knitting yarn made out of nylon fiber at the rate of rupees 2.10 per
100 rupees. State government may allow urban bodies to add supplementary
rates to the existing government taxes. For instance, in India, when state
governments had abolished octroi, they permitted the urban governments to
impose a surcharge on the sales tax which is a state tax.' Besides, a local tax
may be administered through the government, although it is actually enjoyed
through the urban governments. For instance, in Andhra Pradesh
entertainment tax which is basically a local tax is imposed through the
government but the whole proceeds are given to urban governments after
retaining the collection charges amounting to Rs. 5 per unit of the collections.
Likewise, from motor vehicle tax, which was formerly a local tax in India,
sure percentage of the collections are made over to the urban authorities
through the state governments.
The borrowing powers of the urban local bodies in India are also limited.
The term of re-payment and the rate of interest on loans are unfavorable in
comparison to developed countries of the World. Further, mainly of the
sources assigned to municipal bodies for taxation are inelastic and cannot give
the required services for the rising activities of these bodies. For instance,
taxes like octroi, terminal and property which constitute the backbone of
municipal finance are quite inelastic as the proceeds from them do not grow in
proportion to the growth in financial necessities. The rules and procedures
governing the imposition of taxes etc. are very elaborate, cumbersome, time
consuming and leave very little financial independence to municipal bodies.
Besides, the powers of the Indian local bodies to levy is limited through the
Constitution of India. For instance, Art. 285(2) of the Constitution exempts the
Central Government properties from the levy of local tax through
municipalities.
Separately from the above mentioned causes for the unsatisfactory position
of municipal possessions the other reasons are: underdeveloped trading
enterprises, increased population pressure, general poverty in India, increased
responsibilities, increased cost of municipal services because of ever soaring
prices of the material and enhanced wages of the municipal personnel, and so
on. If the municipal government is to play its role commensurate with the
expectations and aspirations of the people, a serious effort is to be made to
ensure its financial soundness so that the gap flanked by the municipal
services and possessions is reduced. A number of committees and
commissions have examined the question of the adequacy of municipal
possessions in India since independence. It has been suggested that the
prevalent reluctance of municipalities to introduce taxes has to be overcome.
REVIEW QUESTIONS
What operations are involved in financial administration of rural local
government? How are these performed?
Discuss the significant principles that govern rural local finance.
Point out the sources of revenue of Panchayati Raj Institutions.
Discuss the significant factors which contribute for determining the
ecology of local finance.
Describe briefly the principles which should govern the local finance.
Explain the sources of income of urban government.
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