Taxation certainly has an edge over public debt but the taxable capacity of the people is not unlimited. Hence, it can be suggested that the Government should not impose taxes beyond the Capacity of the people to pay otherwise, it will adversely, affect the capacity to work and to save by the people. As a result, the production and the economy as a whole may receive setback. If Government requires money to meet the development expenditure beyond the taxable capacity of the people, it should go for public borrowings and postpone the tax burden for some time. It will not adversely affect the productivity and saving capacity of the people. As because the amount cannot be raised unlimited even through this source, it should be resort to deficit financing.
The Government of a developing country more often resorts to two major sources to raise the necessary funds for the developmental expenditure (i) Taxation, and (ii) Public borrowings which one is better is very difficult to say. Before reaching any conclusion, we are explaining, the relative merits and demerits of Taxation and Public Borrowings.
The merits and demerits of Taxation
Taxation it the main source of revenue of a Government. This is compulsory payment by the citizen of the country to the Government and the avoidance of which may lead to penalty. Tax-revenue generally determines the size or the public expenditure.
Merits of Taxation could be presented as under:
(i) Taxation is a compulsory payment which cannot be avoided by the citizen. The Government may obtain necessary funding from this source.
(ii) It automatically puts a control check on inflationary situations because it leads to withdrawal of purchasing power to the Government and leads to reduction in unnecessary consumption by the citizen.
(iii) The Government saves itself from the burden of public borrowings in future, The burden of public borrowings can only be redeemed out of proceeds or tax-revenue. So, it is a method of debt redemption.
(iv) If development expenditure is exclusively financed by taxation, there is an automatic check of wastage because taxes cannot be levied and collected in unlimited way.
(v) Taxes are not to be repaid to the public and therefore there is no question of burden of taxes on the Government.
Demerits of Taxation could be presented as under:
(i) The taxable capacity of the people is not unlimited so the whole development expenditure cannot be met through taxation alone.
(ii) Heavy taxation produces adverse effect on savings and on production because the process of capital
formation is hampered. So, the economic development is also affected adversely.
(iii) There is necessarily a time gap between the imposition of new taxes and their collection from the people. The
Government revenue, therefore cannot be increased immediately by levying fresh taxes. Any contingencies or emergencies cannot be immediately met through taxation.
The merits and demerits of Public borrowings:
Public borrowings are not compulsory levies but purely a voluntary contribution by those who have surplus. But the Government has to repay such amount of borrowings as well its interest as and when due. It is, therefore, a charge on Government’s future revenue.
Merits of Public Borrowings: The following point can be put forth in favor of public borrowing if the entire development plans ace financed through this sole source of revenue-
(i) For the people of the country, public borrowings are considered better than taxes as taxes are never returned to people whereas the amount lent to the Government will be returned by the Government along with interest as and when due.
(ii) In case heavy taxes arc levied by the Government the people have to cut down their consumption. On the contrary, public borrowings are contributed by them out of their savings and therefore their present income remains unaffected hence there is no adverse effect on their consumption.
(iii) It is in the larger interest of the nation if the development expenditure is met out of public borrowings. The reason is that public borrowings do not adversely affect the capacity of the people to work and to save and also the production and business and trade like taxation. The process of capital formation remains unaffected.
(iv) If the Government collects a sizable amount through public borrowing. it need not resort to deficit financing.
(v) Interest received on public borrowings by the people is a source of their income while there is no such income in taxation.
Demerits of Public Borrowings: The following arguments against public borrowings as sole source of development expenditure can be put forward
(i) Like taxation, there is a limit to public borrowings also. The saving capacity of the people is itself is limited. Hence, the entire development expenditure cannot be met through public borrowings.
(ii) Public debt is a burden on the people. If the entire development expenditure is met through borrowing, the size of
the debt will be greatly inflated and its burden will ultimately be borne by the tax payers.
(iii) The burden taxation is invariably on the present generation. But in case of public borrowings, the ultimate burden will be shifted on to the shoulders of future generation because public borrowing is nothing but to postpone the tax burden to the coming generations. This is contrary to justice and fair play.