The ‘Principle of Maximum Social Advantage (MSA)’ is the fundamental principle of Public Finance.
The Principle of Maximum Social Advantage states that public finance leads to economic welfare when pubic expenditure & taxation are carried out up to that point where the benefits derived from the MU (Marginal Utility) of expenditure is equal to (=) the Marginal Disutility or the sacrifice imposed by taxation.
Hugh Dalton explains the principle of maximum social advantage with reference to:
- Marginal Social Sacrifice
- Marginal Social Benefits
This principle is however based on the following assumptions:
- All taxes result in sacrifice and all public expenditures lead to benefits.
- Public revenue consist of only taxes and no other sources of income to the government.
- The government has no surplus or deficit budget but only balanced budget.
- Public expenditure is subject to diminishing marginal social benefit and taxes are subject to increasing marginal social sacrifice.
Marginal Social Sacrifice (MSS)
Marginal Social Sacrifice (MSS) refers to that amount of social sacrifice undergone by public due to the imposition of an additional unit of tax.
Every unit of tax imposed by the government taxes result in loss of utility. Dalton says that the additional burden (marginal sacrifice) resulting from additional units of taxation goes on increasing i.e. the total social sacrifice increases at an increasing rate. This is because, when taxes are imposed, the stock of money with the community diminishes. As a result of diminishing stock of money, the marginal utility of money goes on increasing. Eventually every additional unit of taxation creates greater amount of impact and greater amount of sacrifice on the society. That is why the marginal social sacrifice goes on increasing.
The Marginal social sacrifice is illustrated in the following diagram :
The above diagram indicates that the Marginal Social Sacrifice (MSS) curve rises upwards from left to right. This indicates that with each additional unit of taxation, the level of sacrifice also increases. When the unit of taxation was OM1, the marginal social sacrifice was OS1, and with the increase in taxation at OM2, the marginal social sacrifice rises to OS2.
Marginal Social Benefit (MSB)
While imposition of tax puts burden on the people, public expenditure confers benefits. The benefit conferred on the society, by an additional unit of public expenditure is known as Marginal Social Benefit (MSB).
Just as the marginal utility from a commodity to a consumer declines as more and more units of the commodity are made available to him, the social benefit from each additional unit of public expenditure declines as more and more units of public expenditure are spent. In the beginning, the units of public expenditure are spent on the most essential social activities. Subsequent doses of public expenditure are spent on less and less important social activities. As a result, the curve of marginal social benefits slopes downward from left to right as shown in figure below.
The Point of Maximum Social Advantage
In the above diagram, the marginal social benefit (MSB) curve slopes downward from left to right. This indicates that the social benefit derived out of public expenditure is reducing at a diminishing rate. When the public expenditure was OM1, the marginal social benefit was OB1, and when the public expenditure is OM2, the marginal social benefit is reduced at OB2.
Social advantage is maximised at the point where marginal social sacrifice cuts the marginal social benefits curve.
This is at the point P. At this point, the marginal disutility or social sacrifice is equal to the marginal utility or social benefit. Beyond this point, the marginal disutility or social sacrifice will be higher, and the marginal utility or social benefit will be lower.
At point P social advantage is maximum. Now consider Point P1. At this point marginal social benefit is P1Q1. This is greater than marginal social sacrifice S1Q1. Since the marginal social sacrifice is lower than the marginal social benefit, it makes more sense to increase the level of taxation and public expenditure. This is due to the reason that additional unit of revenue raised and spent by the government leads to increase in the net social advantage. This situation of increasing taxation and public expenditure continues, as long as the levels of taxation and expenditure are towards the left of the point P.
At point P, the level of taxation and public expenditure moves up to OQ. At this point, the marginal utility or social benefit becomes equal to marginal disutility or social sacrifice. Therefore at this point, the maximum social advantage is achieved.
At point P2, the marginal social sacrifice S2Q2 is greater than marginal social benefit P2Q2. Therefore, beyond the point P, any further increase in the level of taxation and public expenditure may bring down the social advantage. This is because; each subsequent unit of additional taxation will increase the marginal disutility or social sacrifice, which will be more than marginal utility or social benefit. This shows that maximum social advantage is attained only at point P & this is the point where marginal social benefit of public expenditure is equal to the marginal social sacrifice of taxation.
The ideal of maximum social advantage is attained by the state, if the following principles of financial operation are followed in the budget.
- Taxes should be distributed in such a way that the marginal utility of money sacrificed by all the tax-payers is the same.
- Public spending is done, such that benefits derived from the last unit of money spent on each item becomes equal.
- Marginal benefits and sacrifices must be equated.
To sum up, all fiscal operations, both as regards revenue and expenditure, should be treated as a series of transfer of purchasing power that must ultimately increase the economic welfare of the people. In this context, Dalton enunciated the principle of maximum social advantage and asserted that financial operations of the government must be in accordance with this principle in a welfare state.
Although the principle of maximum social advantage is regarded as an ideal and the best guiding principle of the state’s financial activities, it has been severely criticised on some fundamental grounds.
The theoretical considerations (of marginal utilities and dis-utilities) underlying the principle are very difficult to put into practice.
The state cannot balance the marginal utility of expenditure so easily. Because, in the first place, utilities being subjective phenomena cannot be measured very precisely.
The difficulties of measurement are much enhanced in the case of the state, which is a conglomeration of a large number of individuals. Thus, it is difficult to measure marginal benefits of expenditure accruing to each individual from each and every public outlay, owing to the difficulties involved in the interpersonal comparison of utilities enjoyed in social goods. So also, it is difficult to measure the marginal dissatisfaction caused to each individual separately from each additional unit of tax.
The problem of such measurement is further aggravated by the fact that actual spending and taxing is done by a large number of people at different places in different government departments. Secondly, when some public spending is made for the future benefits, measurement of its utility is obviously indeterminate in the present.
As such, the government may find it impossible to compare the marginal social benefits and sacrifice related to its fiscal operations. Even if the government somehow succeeds in doing so, it may become difficult to act accordingly, as governmental activities are greatly affected by many non-economic forces, and personal political considerations.
To some critics, the disutility of taxation to the taxpayer is a micro problem inconsistency relating to individuals, whereas the utility of public expenditure to the society is a macro problem-concerning all collectively. Thus, there is a serious methodological inconsistency involved in balancing the marginal sacrifice of taxation with the marginal social benefits from public expenditure.
Disutility arises in payment of taxation, but in public borrowings, no such disutility is involved. Hence, there can be no limit to public expenditure financed through public loans. The marginal equality principle (of maximum social advantage), thus, loses its grip to that extent.
4. Governmental Indifference:
When fiscal operations are adopted as a counter-cyclical measure, no consideration of equalising marginal benefits and sacrifices can be made. For, as a part of counter-cyclical measure, taxes sometimes cannot be reduced or increased beyond a limit.
Similarly, when public spending under public works projects is just to reduce unemployment and improve the level of effective demand, there can be little consideration of its marginal social benefits and sacrifice. Further, in the growth-oriented functional finance, which calls for a perpetual increase in the public expenditure, the principle of marginal social benefit is completely ignored.