The principle of Maximum Social Advantage has been interpreted by economist Richard Musgrave who termed it as Maximum Welfare Principle of Budget Determination. According to Musgrave, the principle explains that taxation and public expenditure should be carried out up to that level where satisfaction obtained from the last unit of money spent is equal to the sacrifice from the last unit of money taken in terms of taxes. In other words, it should be carried out up to the point where marginal social benefit is equal to marginal social sacrifice. To illustrate his interpretation, Musgrave used Fig. in which, the size of the budget (level of taxation and public expenditure) is shown on the X-axis. On the positive part of Y-axis MSB is measured and on the negative part, MSS is measured.
The curve EE, in the first quadrant, represents the marginal social benefit (MSB) of successive units of money spent as public expenditure, allocated optimally between different public uses. It falls from left to right because as public expenditure increases, MSB declines. The curve TT, in the fourth quadrant, represents the marginal social sacrifice (MSS). As additional units of taxation are raised from the people, MSS increases. Accordingly, the curve SS slopes downwards from left to right in the fourth quadrant showing rising MSS. The curve NN measures Marginal net benefits (MNB) which is derived from successive addition to public budget. MNB is calculated by deducting MSS from MSB. The vertical distance between EE curve and TT curve measures MNB at different sizes of the budget. The optimum size of the budget is determined at OM, where MNB is zero. At this size of the budget, the marginal social benefit MP is equal the marginal social sacrifice MQ (MSB = MSS). Since MSB and MSS are measured in opposite directions, marginal net benefit is zero at M(MSB-MSS = 0). At this point the MNB curve NN cuts the X-axis. At any point to the left of M, say M1, MSB will be greater than MSS and MNB will be positive. It is beneficial to increase size of the budget as long as MNB is positive. So there will be a tendency to move from M1 towards M. If the budget size exceeds M, say M2, than MSS will exceed MSB and MNB will be negative. Therefore it will be beneficial for the government to cut down the size of the budget and move from M2 towards M. According to Musgrave the optimum size of the budget is given by the point where the marginal net benefit is zero. This point corresponds to the point of maximum social advantage, as at this point MSB = MSS
According to Musgrave the optimum size of the budget is given by the point where the marginal net benefit is zero. This point corresponds to the point of maximum social advantage, as at this point MSB = MSS
Limitations of Maximum Social Advantage.
The principle of maximum social advantage has been criticized on various grounds. The main practical difficulties in following the principle of maximum social advantage are as follows:
i) Difficulties in Measuring Social Benefits: The principle of maximum social advantage is theoretically explained with the help of the marginal utility analysis. The Marginal benefits of public expenditure and the marginal disutility on sacrifice of public revenue are concepts, the objective measurement of which is extremely difficult.
ii) Unrealistic Assumptions: It is unrealistic to assume that government expenditure is always beneficial and that every tax is a burden to society. For example, taxes on cigarettes or alcohol can provide a benefit to society, expenditure on social overheads like health care will give rise to social benefit whereas unnecessary increase in expenditure on defence may divert resource from productive activities causing loss of welfare to society.
iii) Neglect of Non – Tax Revenue: The principle says that the entire public expenditure is financed by taxation. But, in practice, a significant portion of public expenditure is also financed by other sources like public borrowing, profits from public sector enterprises, imposition of fees, penalties etc. Dalton fails to take into account all such other sources.
iv) Lack of divisibility: 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. But it is not possible practically.
v) Large Budget Size: The financial operations of the government involve collection of large sums of money from taxation and other sources and the disbursement of large amounts by way of public expenditure. The effects of small additional amounts of these on the community are difficult to measure. Therefore, in practice, the public authorities are not in a position to estimates the marginal benefits and the marginal sacrifices
vi) Change in Condition: Conditions in an economy are not static and are continuously changing. What might be considered as the point of maximum social advantage under some conditions may not be so under some other. For example, in times of war government expenditure and revenue must increase, and the increase is to the advantage of the community. What is optimum at one level of national income may not be so at a higher level. Therefore, it is difficult to determine the point of maximum social advantage.
vii) Different Periods: The impact of many public projects is felt over the long period by both the present and the future generations. In order to determine maximum social advantage it becomes necessary to calculate social benefits from public expenditure in short period and in long period.
viii) Conceptual differences: Taxes are paid by individuals and the sacrifice involved is felt at an individual or micro level. Whereas, public expenditure gives rise to public goods that are jointly consumed by all in a community. The benefits therefore are felt at a macro level. Many economists argue that it is neither possible nor desirable to compare micro and macro concepts by using the same criteria.
ix) Misuse of Government Funds: The principle of Maximum social advantage is based on the assumption that the government funds are utilized in the most effective manner to generate marginal social benefit. However, quite often a large share of government funds is misused for unproductive purposes which so not provide any social benefits.
x) Contra – Cyclical Measures: The Government has to undertake contra – cyclical measures to Control inflation, Overcome recession, Reduce increasing level of unemployment, etc. In such a situation, the concept of Maximum social advantage cannot be adopted. For instance, to control recession, the government may introduce certain measures such as reduction in taxation in order to increase effective demand. Also, during inflationary periods, the government may increase tax rate in order to reduce demand and increase interest rates, so as to encourage savings on the part of people.