Theories of Public Expenditure

In the public policy study, we find that there are many theories that explain the causes of increasing government expenditure. Among many, I  just have selected four theories and discussed herein.

A. Wagner’s Hypothesis

Wagner’s hypothesis is propounded by Adolf Wagner. He, in his comprehension comparisons of different countries at different times shows that among progressive people, public expenditure increases regularly takes place in the activity of both the central and local government. This increament by the central and local governments constantly undertake new functions while performing both old and new responsibility more efficient and complete.

This law seeks to establish a functional relationship between the rate of economic growth and government activities. It shows that the government sectors grow faster than the economic expenditure. The scope of government activities would continue to increase both absolutely and relative income for many years. In the long-run economy secures growth in the public sector. This law is “explained” and “justified” by the pressure for social progress and resulting change in the sphere of private and public economy.

Wagner emphasized long term trend rather than short term changes in public expenditure. Moreover, he didnot explain the mechanism of increasing public expenditure. His study is based on the historical experiences, the precise quantitative relationship between the increase in public expenditure and the time taken. By this, it was not fixed in any logical or functional manner. His contention was that public expenditure had been increasing over the time that could not be used to predict its rate of increase in future. 

Wagner's law is to state that the state expenditure would increase at a rate slower than the national income though it had increased in a faster rate then in the past. Thus, in the initial stage of economic growth, the state find that it has to expand its activities quite fast in several fields like education, health, civic amenities, transport and so on. But when the initial deficiency is removed then the increase in state activities may be slowed down. Wagner argues that the causes of the relative growth of government expenditure are due to the following reason:

Social Progress: One of the most influential factors that was considered by classists is the social sector. This law argue that due to maintenance of law and order in the society and due to the participation of the state in the production of “ social product”, the government needs to spend more. But what they assume that investment does not go in vain. It finally terminates into the economic growth in the long run.

Expanding of Economy: Wagner talks about the expanding economy during the period of industrialization and the economic growth, At the mean time of these both situation government expenditure increases. He discused about the role of private sector which influences public expenditure decisions, for that he has presented following factors, which makes a public expenditure to rise:

a) The Income Effect

As real income increases, the effective demand for all kinds of goods and services also increases. But there is not so straight forward reaction. Increase in real income would not automatically induce one to bear a higher rate of tax in return for improved public services. As private income increases, wealth position of the individual improves. They faces scarcity lacks of goods and services in the quantity and quality approaches. And it demands more social goods and service and it increases government expenditure result in social imbalances.

b) The Population Effect

Population is the second factor that made a public expenditure to increase. With the growth of population and increases in the flow of real income occurring to individuals, this increases the rate of government outlay on the provision of public services to the population growing up.

c) The Urbanization Effect

Increase rate of urbanization is a major factor for the growing rate of public expenditure. There is also the possibility of external effects of an expenditure becoming more and more widely diffused as a consequence of the increase in the size of the urban community.

d) Technological Effect

Technological changes add to the prevailing magnitude of external effects. Hence it tends to increase significantly the need for greater public expenditure.

To sum up, Wagner’s hypothesis established the functional relationship between economic growth and the relative growth of public expenditure. 

Contribution to Social Sector

Over to the national emergencies, and wars government increases its expenditure, results in high increase in the tax. This abruptly changes the volume of expenditure ove the time period.

Criticism

·        Lack of Interdisciplinary Approach

·        Not Analytical

·        Ignore the Influence of War

·        It is not relevant to today’s Western’s countries.

B. Colin – Clark’s Critical limit of Taxation and Expenditure

Colin-Clark forwarded his view through “Public Finance and changes in the value of Money” about the growth of public expenditure. According to them, the share of government sector exceeds 25% of the total economic activity in the economy that results to inflation even in the balanced budget. In this connection his opinions are;

'When the government’s share of the aggregate economic activities reach the critical limit of 25%, the community behaviour pattern changes and people produce less since incentives are harmed by the fact that increasing proportions of additional income that must be paid under progressive tax system.

People become less resistance to various inflationary means of financing government expenditure which in turn reduces to government “aggregate supply". On the other hand, increased purchasing power tends to expand aggregate effective demand.

Inflation results from maladjustment between demand-supply under the condition of high employment of resources. The theory holds that by increasing taxes and restricting credit it is possible to cut down the expenditure of the private sector and thereby to accommodate increased public expenditure by releasing resources for private use. Therefore when it is asserted declare to be true that public expenditure beyond a specified limit will generate inflation. It seems to imply that the reduction of private expenditure in the account of personal consumption and private investment is either impossible or undesirable. If anyone of these contentions (disagreement) is conceded (admit to being true) it will be true that additional public expenditure will cause inflation in the economy.

Critical Limit of the Taxation 

If the question is simply how much taxes a government can possibly impose? the answer could be 100% of  NT+ bonus for all taxation in kind of all privately held national wealth. 100% taxes on income and wealth do not imply that the private sector will have nothing left for its own expenditure public expenditure, in this case, may mostly transfer payment.

The desirable level of taxation may not be determined numerically. But the economic capacity of the taxation should be answered. It may not be identical on both classical finance and the modern formation of fiscal policy.

The classical model postulates the view that the level of public expenditure is the resultant of the level of taxation. It means vice versa for the level of public expenditure has been claimed to have been determined by policy.

C. Stanley Please Hypothesis

An attempt to increase domestic saving by increasing performance is frustrated by the growth of current government expenditure which is casually related to tax effort. This is referred to as please effect or please hypothesis. This means that the countries which had pushed up their tax ratios over time had not necessarily increased their saving performance and that countries with high tax ratios were not necessarily high savers.

The primary role of fiscal policy is to increase the total flow of saving in an economy and also to provide for adequate flow of government funds for meeting the current expenditure of the government for eg: defence, road maintenance, school, books and suppliers.

Increased tax effect has been accepted almost universally has the way to do this. It is assumed that MPs of the private sector. It is a law that increased taxation of government will be used entirely to reduce government deficit or to increase its surplus.

Kirshnamurti (1968) in the WB, examines the relationship between saving and taxation of 35 developing countries in the cross-section analysis and for 12 developing countries in time series analysis. Countries study showing no association between taxation and savings. Similarly, cross-section the result reveals that taxation had the effect of discouraging private consumption and that positive effect of taxation in promoting aggregate saving had been neutralized by the behaviour of current expenditure in the public sector. This research is in support of please Hypothesis.

 Dziadek (1968) examines the relationship of taxation to saving for 13 out of 18 Latine American countries in which tax/GNP ratios increased between 1961 and 1966. It was found that please Hypothesis was supported in 7 countries out of the 13 where there had been an improvement in tax performance. As such he concludes that it is not to pass to generalize the relationship between tax performance and saving performance.

Vlatio(1967) in his examination of 20 African countries found that the increased in tax has a favourable effect in mobilizing domestic resources for development. Similarly, Morss(1969) concludes from his sample of 46 developing countries that the relationship was contrary to the evidence of please effect i.e. he found that on the average savings increased by 64% of any tax increased. This is against Please's hypothesis.

Finally, Eklwd(1969) found that the additional revenue is spent on non-developmental goods and services as the tax/GNP ratio increases, expenditure on social needs and defence have a priority and not economic services.

In support of his hypothesis please presents the case of Ethiopia and Peru later in IBRD WB NO 82 titles “The please effect revisited in 1970”. In the case of Ethiopia for eg. About 2/3 of additional government revenue ever the course of the last 5 years have been used to finance expenditure on defence and internal security. Except for education, only marginal additional funds have gone to finance development services such as agriculture, health etc.

In conclusion, please puts himself positively admitting that he is not against increased tax and realizes that fiscal policy possesses high potentiality for mobilizing savings. Please shows that the governments in developing countries raised the level of tax revenue in order to increase the rate of domestic saving through a higher level of public saving. This attempt has resulted in a higher increase in government consumption and a much lower increase in public saving through increased spending on public investment. It is known as “please effect”.

D. Peacock-Wiseman Hypothesis

Peacock and Wiseman analyze the process of growth of public expenditure in terms of three different but related concepts; displacement, inspection and concentration effects. By the empirical analysis of the data of Britain on public expenditure, they were able to establish the relative growth of public sector expenditure in that country occurred on “step-like” pattern rather than on “continuous growth” pattern. They have discussed this hypothesis under three effects separately.

a) Displacement Effect

The public expenditure increases and makes the inadequacy of the present revenue. Then a movement must take place so that the older level of expenditure and taxation to a new and higher level is the displacement effect. During the period of emergency or of major social disturbances such as war and depression that most of the upward steps in public expenditure had occurred. Displacement Effect is the process by which the previous lower expenditure levels were displaced by a new and higher level of expenditure.

b) Inspection Effect 

The inspection effect refers to the phenomenon whereby a direct consequence of the social emergency, public expenditure comes to increase which may be insufficient compared to the revenue of the government, creates the inspection effects. The government and people review the revenue position and to find the solution of the important problems that have come up with gently to attain the new level of tax tolerance. They are now ready to tolerate a greater burden of taxation and as a result, the general level of expenditure and revenue goes up. In such a way the new level of expenditure and revenue comes to stabilize at a new level till the new disturbance occurs to cause the displacement effect.

 c) Concentration Effect

The concentration effect also refers to the apparent tendency for central government economic activity to grow faster than that of the state and local level government. This is found fitted therein British economy but it is not needed to verify this to other countries. This concept is the evolution of expenditure undertaken at a different level of government and their tendency to be concentrated in central government. This usually happens when the country is experiencing economic growth.

The main concentration of Peacock-Wiseman hypothesis is that factors both endogenous and exogenous to the economic system exert a force influence on public sector institutions to increase their expenditure over a secular period and this increase occurs on a step-like basis and at a faster rate than the growth in aggregate economic activities.

Thank You

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