Two Aspects of Deficit Financing
Two Aspects of Deficit Financing
Two Aspects of Deficit Financing
reduce expenditures and increase revenues to achieve a cash surplus to be used in an antiinflationary manner.
(b) Taxes: It is axiomatic that during inflation the existing tax structure should be retained, that
tax cuts should be resisted, and the new taxes should be adopted or tax rates increased, if
possible to reduce the amount of spendable money in the hands of general public. But care
must be taken not to deflate the money incomes of the country via taxation so much as to
provoke a recession of economic activity.
(c) Savings: Saving is a type of public borrowing which has a deflationary effect on the money
supply and effective demand. The most effective anti-inflationary public borrowing takes the
form of compulsory saving.
(d) Debt Management: Public debt may be managed in such a way as to reduce the money
supply or to prevent further credit expansion. Anti-inflation debt management often refers to the
retirement of bank-hold debt out of a budgetary surplus. It includes the retirement of public
debts of the following categories:
(i) Retirement of public debt by central banks out of a budgetary surplus is most
deflationary
(ii) Retirement of bank-held debt (i.e., commercial banks) is neutral in its effects
(iii) Retirement of a maturing portion of debt held by the non-bank public, which has
also neutral effect.
(e) Gold Sterilisation: Whenever the gold inflow is deemed too dangerously inflationary in
effect, the government may decide to sterilise gold in order to keep bank reserves from
increasing gold acquisitions.
(f) Overvaluation: In order to control domestic inflation, a country might maintain the
overvalued exchange value of its currency, that is, an expensive currency relative to foreign
currency. An overvalued currency is anti-inflationary in effect for three reasons, namely:
(i) Because of its discouraging effect on exports and decreasing effect on domestic
money incomes
(ii) Because of its encouraging effect on imports and increasing effect on import
expenditure
(iii) Because of its cheapening effect on the price of those foreign materials which enter
into the domestic cost of product of its preventive effect on the upward-cost price
spiral.
Federal finance seeks to maximise total welfare. The economic welfare in an under-developed
region in a federation can be increased by the diversion of resources from the developed regions.
The general principle to maximise economic welfare is that each regional or state government
should try to equate marginal social benefit (MSB) with marginal social cost (MSC). The federal
government will try to do so for the whole country. Thus the principle of federal finance would
be:
MSBa =
MSBb =
MSBc =
MSCa =
MSCb =
MSCc =
Equalising of MSB and MSC would require a substantial inter-area transfer of resources in a
federation for achieving what Professor Buchanan calls inter-personal equity. Inter-personal
equity means equal treatment to equals. A transfer of resources is necessary to achieve
horizontal equity. If the same amount of expenditure were made in all states, it would mean
that the rich state would be subject to less tax than his equal income counter-part in the poor
state.
The principles of federal finance are listed below:
1. No discrimination in levying taxes among the states. It implies uniformity of
taxation.
2. Independence of federal finance to impose taxes and spend.
3. Central government and the federal units have no dependency on each other
and should carry their functions normally
4. Resources should be capable of expansion as the requirements increase.
5. Efficient economy, i.e., minimum tax evasion, effective tax collecting system,
minimum cost of tax collection, minimised adverse effects on trade and
industry, etc.
6. Provision for grants-in-aid to meet resource deficits.
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