Public Economics Questions and Answers

Answer: B

Vaccination is not a negative externality.

A vaccinated person is less likely to catch and spread a disease, which protects others who were not part of the decision. That third-party benefit makes vaccination a classic example of a positive externality.

Air pollution, contamination of water and crime all impose costs on people who did not choose them, which makes them negative externalities.

Answer: C

Under equal marginal sacrifice, the post-tax marginal utility of income is the same for everyone.

The principle of equal marginal sacrifice (minimum aggregate sacrifice) arranges taxes so that the last rupee taken from each taxpayer causes the same loss of utility. With diminishing marginal utility of income, this means taking income from the richest first until their marginal utility of income, after tax, equals that of the others.

Equal absolute loss of utility for everyone is the principle of equal absolute sacrifice. Pre-tax marginal utilities differ between rich and poor, which is why taxation is needed to equalise them, and the marginal utility of commodities is not the measure used.

Answer: B

This is vertical equity.

Vertical equity means that people with different abilities to pay should pay different amounts of tax, with those more able to pay bearing more, so that the sacrifice is equalised. Progressive income tax is its main instrument.

Horizontal equity is the other half of the ability-to-pay principle: people in the same circumstances should pay the same tax. Taxable capacity is the maximum tax a people can bear, and tax avoidance is the legal reduction of one's tax liability. Neither is about taxing unequals unequally.

Answer: D

An example of built-in flexibility is unemployment insurance.

Built-in flexibility (automatic stabilisers) refers to budget items that change automatically with the business cycle, without any new policy decision. In a recession, more people become unemployed and unemployment insurance payments rise on their own, supporting incomes and spending; in a boom they fall. Progressive income tax works the same way.

Infrastructure spending and welfare grants require deliberate decisions, which makes them discretionary fiscal policy. A fiscal deficit is an outcome of the budget, not a stabilising mechanism.

Answer: A

The key's answer is Fiscal consolidation.

Vijay Kelkar has headed several committees. The one best known in the fiscal context is the Committee on Roadmap for Fiscal Consolidation (2012), which warned that the fiscal deficit was on an unsustainable path and set out a plan to bring it down, and an earlier task force (2004) on implementing the FRBM Act.

The other subjects are associated with other committees: guidelines for disinvestment and privatisation of PSUs, and power sector reform, were dealt with by different panels, and tax incidence is a concept, not the subject of a Kelkar committee.

Answer: B

The correct statements are (i), (ii) and (iv).

The diffusion theory, associated with writers such as Canard and Mansfield, holds that a tax is shifted and reshifted through exchange until its burden is spread thinly over the whole society (i). Since indirect taxes on goods are passed along through prices more easily, diffusion is greater with them (ii). The theory is about where the burden finally rests, which is tax incidence (iv).

Statement (iii) reverses the theory's conclusion: because an old tax has already been absorbed and diffused, its supporters argued that 'an old tax is no tax', making old taxes preferable to new ones.

Answer: B

The correct code is a-(ii), b-(i), c-(iv), d-(iii).

• 12th Finance Commission (2005-10): Dr. C. Rangarajan.
• 13th Finance Commission (2010-15): Dr. Vijay Kelkar.
• 14th Finance Commission (2015-20): Y. V. Reddy.
• 15th Finance Commission (2020-26): N. K. Singh.

Option A simply follows the order in which the names are listed, which pairs the 12th Commission with Kelkar; the other codes also mismatch at least two chairmen.

Answer: B

The indirect tax is service tax.

An indirect tax is collected from one person but its burden is passed on to another. Service tax was charged by the service provider on the bill and paid by the customer, so its incidence shifted to the consumer. (In July 2017 it was subsumed into the Goods and Services Tax.)

Income tax, corporation tax and interest tax are direct taxes: they are levied on the income of the person or company that pays them, and the burden cannot be passed on.

Answer: B

On the recommendation of the 15th Finance Commission, states were allowed a fiscal deficit of 4% of GSDP in 2021-22, of which 0.5% was tied to power sector reforms, so (B) is correct.

Agriculture, industrial and service sector reforms were not the sector named for the extra 0.5% borrowing room. The power distribution companies' losses were the concern behind the condition.

The 15th Finance Commission was headed by N.K. Singh and its report for 2021-26 allowed a fiscal deficit limit for the states above the usual 3 per cent in the Covid years. In the extra borrowing room, part of the limit was linked to specific reforms, and the power sector reform was one of the conditions, which makes the choice of the power sector the only one consistent with the report.

Answer: C

The motto One Tax, One Market, One Nation is associated with the Goods and Services Tax (GST), option C, which replaced many Central and State indirect taxes in 2017.

Central tax, corporate tax and State tax are single taxes and do not carry this motto.

The Goods and Services Tax, brought in on 1 July 2017 by the 101st Constitutional Amendment, subsumed many indirect taxes of the Centre and States, such as excise, service tax and VAT, into a single tax across the country. This is the meaning of One Tax, One Market, One Nation.