The objectives of taxation are thus about coterminous with the functions of the State. All ordinary expenditure of the State, such as is needed for the maintenance of law and order, defence etc., must be covered by tax revenue. Where the economy suffers from under-utilization of resources, deficit-financing is no doubt indicated to an extent necessary for filling in the utilization gap.
There is also a case for deficit-financing, if kept within limits so as not to engender a price rise, when the State takes upon itself the responsibility of planning economic development through public investment of a productive character. So public finance is important. But we would be deceiving ourselves if we thought that war expenditure or large defence expenditure of the sort that India, for instance, is confronted with at the moment in view of the Chinese aggression, just because it is extraordinary, could also be left to be covered by deficit. Since these expenditures are large and since there is a certain psychological resistance on the part of the taxpayers to high rates, a government may often be forced to resort to the loan method or to direct inflation in the context of war finance. But this must not lead one into thinking that the procedure is economically sound. So public finance is important.
The loan method may no doubt turn out to be a success, provided it is operated in such a way that it does not lead to a rise of prices. But, in so far as this happens, loans are seen to behave like taxes, being a mere transfer from individuals to the State; their impact upon the society distribution of income apart turns out to be the same as it would be under a system of taxation. In fact, it is possible to conceive of a system of compulsory loans to meet these expenditures which would just be a substitute of a system of taxation both from the point of view of the aggregate transfer and from the point of view of the personal distribution of income. But if that is so, why throw people off the scent by having a round-about system instead of a straight one of taxation? If a system of compulsory loans is called for in such emergencies, it should rather be confined to those whose incomes are below the tax exemption limit; for the system would carry with it a built-in process of redistribution of income in favour of the relatively poor, the rich having to bear the burden of interest payment after the period of emergency will be over.1
This at last brings us to the question of distribution of income and the role of taxation in mitigating inequality. It is generally agreed that gross inequalities are bad and that it is one of the responsibilities of the State to see that inequalities of income are reduced as far as possible without injuring national output. In fact, moral considerations apart, continuance of large inequalities is detrimental to the stability of a society, and if maintenance of social stability is recognized to be a function of the State, measures are called for which would lead to a transfer of income from the rich to the poor. Taxes and subsidies are a means of achieving this.
Even if other functions of the State were left out, a good case could be made out for a policy of taxation just for the sake of effecting such transfers. The State might step in to collect a part of the income of the relatively rich and spend it towards the provision of social amenities to the poor. Such operations indeed are a common feature of the activities of a modern State. In the discharge of its general functions, too, the State has to recognize this social responsibility.
And this it does by distributing the burden of taxation in such a way that it falls more on those who are richer than on those who are poorer. The principle of progressive taxation rests on this. In an economy where resources remain idle because of a tendency on the part of the rich to save too much, this redistribution through taxes and subsidies may, by raising the aggregate level of consumption, result in larger employment and output. Even where the problem of excess capacity does not exist, redistributive measures, if kept within proper limits, may energize the beneficiaries to an extent which would outweigh the dampening effect, if any, produced elsewhere. This is an aspect of the matter which has to be borne in mind particularly in emergencies such as wars. Measures which are regarded as too bold in the tranquil state of a society may find ready acceptance in a state of emergency. So public finance is important.
Having this in mind, one would indeed feel sympathy with a proposal which has come from some of our economists, namely, that to meet the present emergency in our country, progression in taxation should be carried to the extent of fixing a ceiling on individual incomes. A 100 per cent tax on slabs above a certain level of income deemed permissible in the present state of our economy is surely an understandable proposition. So public finance is important.