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Colin Clark’s Critical Limit Hypothesis:
·
The hypothesis is
basically concerned with the tolerance level of taxation.
·
It was developed by Colin
Clark immediately after the Second World War from the empirical data drawn
from several western countries for inter-war period.
·
Clark wants to point out
that in an economy; inflation emerges when the share of the government sector,
as measured in terms of taxes and other receipts, exceeds 25 per cent of the
aggregated economic activity in the country.
·
When public expenditure
reaches 25 percent of the total economic activity or aggregate amount of
expenditure in the country, the tax payers, ability to pay more tax is
exhausted.
·
Public expenditure beyond
this limit, means, disincentive to producers and fall in production due to taxation
beyond tolerance level.
The hypothesis rest upon the
following two institutional factors:
(a) When tax collection
by government exceeds the critical limit of 25 percent of gross national
product, the income earners are badly affected by reduced incentives and
decrease in their productivity. They produce less than what they are capable
of doing. This leads to a reduced supply.
(b) On the other hand,
even if the budget remains balanced, increase in government expenditure would
constitute rising demand. Therefore inflation is generated from Dis-adjustment
between demand and supply.
In the modern world a
number of countries are incurring public expenditure much beyond their limit,
without facing worse situation of inflationary pressure. Impact of budgetary
spending on generation of inflationary situation; depend upon the manner and
nature in which public expenditure is incurred. Inflation is a complex economic
phenomenon influenced and characterized by a number of mutually exclusive and
inter-dependent factors. Hence we can only fairly conclude that in a marked
economy, increasing state activity may create inflationary pressure.
