1. MODULE 1: INTRODUCTION TO PUBLIC FINANCE CHAPTER 2: THE PRINCIPLE OF MAXIMUM SOCIAL ADVANTAGE

2. INDEX Sr. No. PARTICULARS 1 INTRODUCTION 2
PRINCIPLE OF MAXIMUM SOCIAL ADVANTAGE (DALTON’S VERSION) 3
PRINCIPLE OF MAXIMUM SOCIAL ADVANTAGE (MUSGRAVE’S VERSION) 4
LIMITATIONS/ CRITICISMS OF THE PRINCIPLE OF MAXIMUM SOCIAL ADVANTAGE 5
DALTON’S OBJECTIVE CRITERIA FOR SOCIAL ADVANTAGE

3. INTRODUCTION
The main aim of the government is public welfare. In order to bring about public welfare, the government has to spend on various public utilities like health, education, infrastructure, housing etc. The funds for the same are collected by the government through taxation.  
When a person pays tax to the government, he experiences certain amount of sacrifice or disutility. This is mainly because his purchasing power reduces to the extent of the amount of tax paid. In other words, the person transfers his purchasing power to the extent of the amount of tax to the government.  
The tax collected by the government is spent on various public utilities. This leads to benefit or utility on the part of the community. In other words, there is a change in distribution pattern of income and wealth.  

4. INTRODUCTION
It is very important to consider whether these changes are desirable /advantageous or not. If the changes lead to social welfare, then they are advantageous. On the other hand, if they do not lead to social welfare, then they are not advantageous.
TAX
WELFARE EXPENDITURE

5. PRINCIPLE OF MAXIMUM SOCIAL ADVANTAGE (DALTON’S VERSION)
According to Hugh Dalton, a British economist, the best system of public finance is that which secures maximum social advantage from the operations which it conducts. In simple words, “Maximum Social Advantage” is the fundamental principle on which public finance is based. In other words, public finance has to ensure maximum social advantage.
The principle of maximum social advantage states that “public finance leads to maximum economy welfare when public expenditure and taxation are carried upto that point where the benefits derived from the marginal utility of expenditure is equal to marginal disutility of the sacrifice imposed by taxation.”

6. PRINCIPLE OF MAXIMUM SOCIAL ADVANTAGE (DALTON’S VERSION)
The principle is based on the following assumptions:
All taxes result in sacrifice and public expenditure lead to benefit.
Public revenue consists only of taxes and there is no other source of income to the government.
The government has only balance budget i.e. revenue = expenditure.
Public expenditure is subject to diminishing marginal social benefit and taxes are subject to increasing marginal social sacrifice.
In order to understand maximum social advantage, the two following concepts need to be understood:
Marginal Social Sacrifice
Marginal Social Benefit

7. PRINCIPLE OF MAXIMUM SOCIAL ADVANTAGE (DALTON’S VERSION)
Marginal Social Sacrifice:
When a person pays tax to the government, he experiences certain amount of sacrifice or disutility. The tax paid by all the people is the total (aggregate) social sacrifice. The sacrifice that is experienced by people when the government levies an additional unit of tax is called as marginal social sacrifice.
Tax Marginal Social Sacrifice

8. PRINCIPLE OF MAXIMUM SOCIAL ADVANTAGE (DALTON’S VERSION)
This can be illustrated with the help of some hypothetical figures.
Tax paid
Marginal Social Sacrifice (MSS)
First unit 19
Second unit 20
Third unit 21
Fourth unit 22
Fifth unit 23 Y
MSS Curve . 23 . 22 . 21
Marginal Social Sacrifice . 20 . 19 18 17 1 2 3 4 5 X
Tax Paid (Units)

9. PRINCIPLE OF MAXIMUM SOCIAL ADVANTAGE (DALTON’S VERSION)
Marginal Social Benefit:
The tax collected by the government is spent on various public utilities. This leads to benefit or utility on the part of the community. The benefit that is derived by the community as a whole is the total (aggregate) social benefit. The benefit that is derived by people by every additional unit of public expenditure is called as marginal social benefit.
Now, when the government increases its public expenditure, the marginal social benefit derived by the community declines with every additional rupee spent (as per the law of DMU).

10. PRINCIPLE OF MAXIMUM SOCIAL ADVANTAGE (DALTON’S VERSION)
This can be shown with the help of the following hypothetical table: Y
Public Expenditure
Marginal Social Benefit (MSB)
First unit 25
Second unit 24
Third unit 23
Fourth unit 22
Fifth unit 21 23 . 22 . 21
Marginal Social Benefit 20 . 19 18 .
MSB Curve 17 . 1 2 3 4 5 X
Public Expenditure (Units)

11. PRINCIPLE OF MAXIMUM SOCIAL ADVANTAGE (DALTON’S VERSION)
Maximum Social Advantage (MSA) is achieved at a point where the Marginal Social Benefit (MSB) and Marginal Social Sacrifice (MSS) are equal.
If MSB > MSS, there is an addition to the net social advantage.
In this case, the government may levy more taxes till a point where the MSB = MSS.
If MSB < MSS, there is a reduction in the net social advantage.
In this case, the government may reduce the taxes or increase public expenditure till a point where the MSB = MSS.

12. PRINCIPLE OF MAXIMUM SOCIAL ADVANTAGE (DALTON’S VERSION)
The government has to balance the effects of taxation and public expenditure at every rupee collected and spent. The table below explains the concept of MSA with the help of hypothetical figures:
Tax / Public Expenditure
MSB
MSS
Net Social Advantage
Total Net Social Advantage
First unit 25 19 6
Second unit 24 20 4 10
Third unit 23 21 2 12
Fourth unit 22
Fifth unit -2

13. PRINCIPLE OF MAXIMUM SOCIAL ADVANTAGE (DALTON’S VERSION)
The following diagram further explains the concept of MSA:
The MSS curve slopes upward from left to right because as the government takes away more and more rupees from the community in the form of taxes, the marginal social sacrifice rises.  
The MSB curve slopes downward from left to right because as the government spends more and more money on satisfying collective wants of the community, every additional rupee spent by the government gives lesser and lesser satisfaction to the community.  
The curves MSS and MSB intersect at point P. This is the point where the MSS and MSB are equal. It is the point of maximum social advantage.

14. PRINCIPLE OF MAXIMUM SOCIAL ADVANTAGE (MUSGRAVE’S VERSION)
According to Musgrave, in order to achieve maximum welfare, the public expenditure should be pushed to a point where satisfaction derived from the last unit of money spent is equal to the sacrifice from the last unit of money collected in taxes. In simple words, the public expenditure should be pushed to a point where marginal social benefit (MSB) is equal to the marginal social sacrifice (MSS).

15. PRINCIPLE OF MAXIMUM SOCIAL ADVANTAGE (MUSGRAVE’S VERSION)
The principle can be explained with the help of the following diagram:
X – axis: Size of budget (i.e. amount of n taxation and public expenditure)
Y- axis (Positive side): Marginal Social Benefit
Y-axis (Negative side): Marginal Social Sacrifice

16. PRINCIPLE OF MAXIMUM SOCIAL ADVANTAGE (MUSGRAVE’S VERSION)
The curve EE moves downwards from left to right because as the public expenditure increases, the MSB keeps falling (law of diminishing marginal utility).
The curve TT slopes downward from left to right because as additional units of tax are raised from the public, MSS increases.

17. PRINCIPLE OF MAXIMUM SOCIAL ADVANTAGE (MUSGRAVE’S VERSION)
The curve NN represents marginal net benefit (MNB). MNB is actually the difference between MSS and MSB. The distance between EE curve and TT curve measures MNB at different sizes of the budget.
The optimum size of the budget will be at OM where the MNB is zero. At this size of the budget the MSS (measured by MP) is equal to MSB (measured by MQ).

18. PRINCIPLE OF MAXIMUM SOCIAL ADVANTAGE (MUSGRAVE’S VERSION)
At any point to the left of M
MSB > MSS and hence the government can increase the budget till the MNB is positive or zero.
At any point of the right of M
MSS > MSB and hence the government will have to reduce the size of the budget till the MNB is positive or zero.  
Thus, according to Musgrave, the optimum size of the budget is given by the point where the marginal net benefit (MNB) is zero. This point is actually the point of maximum social advantage since MSS = MSB at this point.

19. LIMITATIONS/ CRITICISMS OF THE PRINCIPLE OF MAXIMUM SOCIAL ADVANTAGE
The following are limitations / criticisms of the principle of maximum social advantage:
Measurement of MSS and MSB is difficult
Dichotomy in concept
Non-tax revenue is neglected
Time period is different
Not followed in modern economy
The assumptions are flawed
Indivisibility of public expenditure and public revenue
Government funds may be misused

20. LIMITATIONS/ CRITICISMS OF THE PRINCIPLE OF MAXIMUM SOCIAL ADVANTAGE
Measurement of MSS and MSB is difficult
The concept of MSS and MSB are explained with the help of marginal utility analysis. However, utility is a subjective concept and cannot be measured cardinally i.e. in terms of numbers. Therefore, there is a great difficult in calculating the sacrifice experienced by an individual on payment of taxes.

21. LIMITATIONS/ CRITICISMS OF THE PRINCIPLE OF MAXIMUM SOCIAL ADVANTAGE
Dichotomy Concept
Tax is paid by an individual and it is that individual who experiences the sacrifice. However, the public expenditure is incurred by the government for the entire country and the benefit is derived by all the people as a whole. In economic terms, MSS is calculated on a micro level while MSB is calculated on a macro level. These two concepts are not comparable.

22. LIMITATIONS/ CRITICISMS OF THE PRINCIPLE OF MAXIMUM SOCIAL ADVANTAGE
Non-Tax Revenue is Neglected
The government earns revenue from tax as well as non-tax sources like fines, fees, penalties, public borrowing, profits of public sector undertakings etc. This total revenue is used to finance the public expenditure. However, the principle of maximum social advantage considers that only tax revenue is used to finance public expenditure. It neglects the non-tax revenue.

23. LIMITATIONS/ CRITICISMS OF THE PRINCIPLE OF MAXIMUM SOCIAL ADVANTAGE
Time Period is Different
The marginal social benefit and marginal social sacrifice may not pertain to the same period. When an individual pays tax today, he experiences the sacrifice or disutility today. This tax collected by various individual will be used to finance public expenditure. However, the benefit of this public expenditure may not be felt immediately.

24. LIMITATIONS/ CRITICISMS OF THE PRINCIPLE OF MAXIMUM SOCIAL ADVANTAGE
Not Followed in Modern Economy
The modern economies are extremely dynamic. The government has to maintain economic stability as well as ensure economic growth. The government does not consider the marginal social benefit and marginal social sacrifice while fulfilling its objectives.

25. The Assumptions are Flawed
Almost all the basic assumptions of the principle are flawed to a certain extent.
Sr.
Assumption
How it is flawed 1
All taxes result in sacrifice and public expenditure lead to benefit.
Taxes on liquor, cigarettes, tobacco etc. may cause sacrifice to the drinker or smoker but it benefits the society as a whole.
Increasing public expenditure on defence, judiciary, ministers etc. may not lead to benefit. 2
Public revenue consists only of taxes and there is no other source of income to the government.
The government earns revenue also through various non-tax sources like fees, penalties, profits from public sector undertakings etc. 3
The government has only balance budget i.e. revenue = expenditure.
In the modern world, almost all developing countries have a deficit budget. 4
Public expenditure is subject to diminishing marginal social benefit and taxes are subject to increasing marginal social sacrifice.
This also may not be necessarily true in all cases.

26. LIMITATIONS/ CRITICISMS OF THE PRINCIPLE OF MAXIMUM SOCIAL ADVANTAGE
Indivisibility of Public Expenditure and Public Revenue
The marginal benefit from public expenditure and marginal sacrifice from taxation can be equated only when public expenditure and taxation are divided into smaller units. However, it is not practically possible since they are indivisible in nature.

27. LIMITATIONS/ CRITICISMS OF THE PRINCIPLE OF MAXIMUM SOCIAL ADVANTAGE
Government Funds May Be Misused
The public expenditure may not always be for productive purposes. A proportion of the public expenditure is spent on various unproductive purposes which lead to no benefit. Further, some funds are even siphoned off by corrupt government officials and are never used for developmental purposes.

28. DALTON’S OBJECTIVE CRITERIA FOR SOCIAL ADVANTAGE
There are certain obvious difficulties in determination of maximum social advantage. This was pointed out by various economists and even Hugh Dalton himself realized these practical difficulties. Therefore, he suggested certain objective criteria which can be applied by the government in order to achieve maximum social advantage. They are as follows:
Defence and protection of the community
Improvement in production
Improvement in distribution of income
Economic stability
Growth and full employment
Provision for future contingencies

29. DALTON’S OBJECTIVE CRITERIA FOR SOCIAL ADVANTAGE
Defence and protection of the community
One of the basic functions of the government is the defence and protection of the community from external as well as internal aggression. The government can ensure social advantage by utilizing funds for this purpose.

30. DALTON’S OBJECTIVE CRITERIA FOR SOCIAL ADVANTAGE
Improvement in Production
An increase in social benefit can take place if there is an overall improvement in production in the country. For this purpose, the government has to invest in new technology and also provide facilities for the workers which help to increase their efficiency.

31. DALTON’S OBJECTIVE CRITERIA FOR SOCIAL ADVANTAGE
Improvement in Distribution of Income
The government can bring about social benefit by reducing the prevalent inequality in the economy. This is possible by way of progressive taxation (i.e. high tax rate for rich and low tax rate for poor). Further, the government can allocate a larger part of the public expenditure in order to benefit the poor.

32. DALTON’S OBJECTIVE CRITERIA FOR SOCIAL ADVANTAGE
Economic Stability
An economy sometimes experiences extreme fluctuations which affects its functioning. One of the primary objectives of the government is to bring about stability during such times through its fiscal operations. Public expenditure and taxation can be used to reduce the impact of business cycles in the economy.

33. DALTON’S OBJECTIVE CRITERIA FOR SOCIAL ADVANTAGE
Growth and Full Employment
Every government aims at bringing about growth and full employment in the economy. It is necessary that production is boosted in order to achieve this aim. The public expenditure for this purpose can bring about social advantage.

34. DALTON’S OBJECTIVE CRITERIA FOR SOCIAL ADVANTAGE
Provision for Future Contingencies
Apart from the present advantage of the community, the government has to also consider the future advantage of the community. For this purpose, the government may have to sacrifice a present expenditure. In simple words, the government should always consider a long term perspective.