PUBLIC FINANCE

INTRODUCTION:

Every country in the world has a system of

government that runs the affairs of the country. The
financing of the government is a matter of universal
concern; practically everyone enjoys some
advantages from the service of government and also
contributes to their support.
To run the affairs of the government effectively and efficiently the
leader’s need financial resources. Government business is the largest
single business in every advanced modern economy. Everyone whether
in Politics, Business or in Educational sector must have a sound
knowledge of public finance. The knowledge of public finance and its
practical value is critically very essential these days where corruption,
fraud and misappropriation of public funds are common.

The methods of public finance have certain effects on economic life and
can therefore be used as instruments or means for bringing about
desired social and economic changes.
MEANING OF PUBLIC FINANCE
Public is a collective term and signifies an association,
community or group of people. It refers to all members of a
community or nation. In public finance, however, the word
public is used to imply government. Finance here signifies
anything that can perform the functions of money and also
signifiers anything that has to do with money transactions. The
process of supplying the needs of the modern economy involves
the use of money medium hence the expression public finance.
DEFINITION OF PUBLIC FINANCE:
Public finance is related to the financing of state activities and can be narrowly
defined as a subject which discusses financial operation of the public/ state
treasury. Earlier writers on the subject tended to define public finance in such a
narrow manner, but this is no longer the case now. Boundaries of the subject of
public finance have undergone repeated revisions in line with developments in
state activities and corresponding economic philosophy.

Public finance is that science which deals with the income and expenditure of
the government.

Public finance is the study of the principle underlying the spending and raising
of funds by the public authorities.
 According to Prof. Lutz, Public finance deals with the provision, custody and
disbursement of resources needed for the conduct of public or government
functions.

 Public finance, also known as Public Sector Economics, focuses on the taxing
and spending activities of government and therefore influence on the allocation
of resources and distribution of income. Public finance is not a mere academic
exercise, its goal is to help understand and improve real world situations.

 According to Philip E. Taylor, Public finance deals with the finance of the public
as an organized group under the institution of government. It thus deals with
the finances of the government which includes the raising and disbursement of
government funds. Public finance is concerned with the operation of public
treasury, hence the degree that it is a science, it is a fiscal science, it is policies.
 Richard A. Musgrave says, the complex of problems that centre
around the revenue-expenditure process of the government is
referred to traditionally as Public finance, while operations of
the public household involves money flow of receipt and
expenditure, the basic problems are not issues of finance, we
must think of our task as investigation into those aspect of
economic policy that arise in the operation of the public budget.
Thus the subject matter of public finance is logically concerned
with the financial aspects of the business of government.
There seem not to be any fundamental difference in the above definitions
of Public finance. The basic ideals in all the definitions are the same.
Public finance is a science as well as an art. When we study the
principles and policies of government revenue and expenditure that
might well be the science of public finance, but when we apply these
principles for the solution of the financial problems of the government,
public finance becomes an art.

The subject matter of public finance thus deals with not only the way in
which public treasury operates, it also deals with the repercussions of
alternative policies which the treasury might adopt and accordingly deals
with question of choice of these policies and operations
Musgrave has advocated an approach in which the
state sector is viewed as a public household. Such a
public household has certain objectives which can be
grouped into categories of (i) allocation of resources
(ii) stabilization of prices and employment, (iii)
adjustments in the distribution of income and wealth.
SUBJECT MATTER OF PUBLIC FINANCE:
Since a modern government often operates at several levels (federal, state,
and local), the subject matter of public finance looks into the financial
problems and policies of the government at different levels and also
studies the inter-governmental financial relations.

The study of public finance is made up of the following:

(i). The Theory of Public Revenue.
(ii). The Theory of Public Expenditure.
(iii). Financial Administration.
(iv). Stabilization, Growth and Distributive Justice.
(v). State Finance / Fiscal Policy.
(vi). Public Debenture.
(1). The Theory Public Revenue.
This branch of public finance looks at those sources from which the government derives it
revenues. This portion deals with alternative sources of state income. It discusses and analyses
comparative advantages and disadvantages of various forms of revenue and principle which
should govern the choice between them. Of various sources of public revenue, taxation, non-tax
revenues, public debt and creation of additional currency claim are of our special attention.

In the study of taxation, various principles governing the choice of tax measures, the problems
of incidence of taxation and effects of taxation on the working of the economy are covered.

Non-tax revenue includes dividends and profits from public undertaking, grants, fees, fines and
interest receipt. Each of them is of significant importance in overall policies of the government
in general and of fiscal policies in particular.
In modern time it is helpful to study public debt problems separately. With modern government,
public debt has become an important source of revenue.
 
 
(2). The Theory of Public Expenditure:
Through public expenditure the government participates in and
contributes to financial flows of the economy and influence its demand
and supply patterns.

The main principles of public expenditure, its allocation and resulting

effects on the economy are analysed.

Along with that we also study all those ways or means through which the
government keeps a check on its expenditure. It is also a major tool for
implementing welfare, growth stabilization and policies of the
government.
(3). Financial Administration:
All financial activities involve issues of financial
administration including public budget, its passing,
implementation, auditing and other matters.
Without a study of relevant dimensions of financial
administration the subject of public finance remains
incomplete.

(4). Stabilization, Growth and Distributive Justice:

These have become leading issues in economic policies
of modern government and therefore their financial
implications deserve a separate treatment in the
discussion of public finance theory.
(5). Fiscal Policy:
This is considered to be an integral part of public finance. Fiscal policy deals
with the effects of financial operations of the government on the various
aspects of the functioning of the national economy such as prices,
employment, consumption, production and distribution of wealth.

(6) Public Debenture:

Like a private individual, the government also needs loans to meet certain
situations created by war, famine, floods, or other natural calamities. The
reason is that the government expenditure often exceeds government income.
To meet the deficit in the budget, the government borrows from the public to
promote the economic development of the country.
 
FUNCTIONS OF PUBLIC FINANCE
The main functions of the public finance are grouped
under:
1. The Allocative function.
2. The Distributive function.
3. The Stabilization function.
(1). The Allocative function:
A modern government has perform a large variety of functions such as,
maintenance of internal law and order, defence against foreign
aggression, settlement of disputes among citizens, promotion of
agriculture and industry, building up of infrastructure facilities such as
roads, railways, ports, and telecommunication, promotion of general and
technical education. etc. The performance of these functions requires
large-scale government expenditure on these items. The function of
public finance is to allocate the total expenditure to the various heads in
such a way as to maximise the social welfare of the people.
(2). The Distributive Function:
There are large disparities of income and wealth in a capitalist economy between the
‘haves’ and the’ have-nots’ which are not conducive to maintenance of peace and
tranquillity in a country. The function of public finance is to lessen or reduce
inequalities as far as possible through redistributing of income and wealth in favour
of the’ have-nots’.

(3). The stabilization function:

A capitalist economy is such that the existence of business cycle has become the
common phenomenon. The function of public function is to eliminate the business
fluctuation by correlating its taxation, expenditure and public debenture policies.
According to the Keynes the twin policies of deficit-budgeting (at a time of
depression and unemployment) and a surplus- budgeting (during inflation) will help
to promote economic stabilization in the country. Thus welfare, equity and stability
are the three main functions or goals of public finance.
SIMILARITIES AND DIFFERENCE BETWEEN PRIVATE AND
PUBLIC FINANCE

By private finance, we mean the financial problems and policies of an

individual economic unit (which does not form part of state organs) as
compared with those of the public authorities. It is a convention to look
into similarities and dissimilarities between the two so as to provide an
analytical function for the decision making aspects of public finance.
 Similarities
Modern economies are monetized. That is most of their economic activities have
financial counterparts involving creation and use of financial claims.

(1). Both private and public sectors are engaged in activities that involve purchases,
sales and other transactions.

(2). They are engaged in the production exchange, saving, capital accumulation,
investment and so on.

In order to finance these operations, the government creates money (which is also a
financial asset), raises loan and makes payment etc. Similarly a private economic unit
lends, borrows, and receives payments, make payment and so on. Both private as
well as government have to resort to borrowing when expenditure exceeds revenue.
(3). Both sectors are engaged in satisfying the wants of the society by
sharing economic activities Both have limited resources at their at the
disposal and to make their best by taking decisions such that the most
important wants are satisfied first. In that sense their problems and
decisions are similar.

(4). The objective of both is to secure the maximum advantage out of the
expenditure just as the private individual tries to secure maximum utility
out of his expenditure, in the same manner the government also wishes to
obtain the maximum social advantage out of its expenditure. That is both
are based upon the principle of rationality.
 Dissimilarities / Differences

1. A private economic unit has to live within its means. It deficit

budgeting (that is spending more than the income) can be for a limited
period and only up to a limit. That is the private economic unit can only
accumulate outstanding debt liabilities up to a certain limit and no more.
But the state can plan to add to its outstanding debt with every budget
and may also succeed in doing so. This has resulted in the public debt of
many countries becoming a high proportion of national income.
2. The distinction between private and public borrowing does not end
with only amounts of possible borrowing, but extends to their forms,
rates of interest and other terms and conditions. A private firm cannot
raise non-repayable loans, but the state may. The state can borrow both
internally and externally but a private economic unit (such as a firm)
cannot raise an internal loan, all its loans have to be external.
Furthermore, high creditworthiness of the state enables it to borrow at
rates much lower than the private economic units have to pay. It has the
support of the Central Bank of the country as an agent and as an
underwriter when it loans are floated in the market. It can draw upon the
facilities of the banking and other financial institutions more liberally. It
can also adopt indirect coercive methods to borrow at lower rates.
3. The government can create legal tender currency that is money which
the creditors cannot refuse to accept in discharge of their claims upon
their debtors. With the introduction of paper currency, the authorities
have discretionary power to add to currency supply. The government can
just create purchasing power and add to the demand side of the market. A
private economic unit cannot do so. Its obligation can never become
legal tender. A private economic unit is always expected to pay back its
obligations. In contrast, obligations of public authorities via issue of
currency need not be redeemed at all.
4. Private finance follows the market principle or the principle of
economic rationality, but the public finance follows the budget principle.
It means that, private economic units are guided by market signals and of
market mechanism and their own economic interest. In contrast, the
essence of the budget principle is that the services in this sphere are
determined not by profit expectations and the willingness of the
individuals to spend their money for the purchase of such services but by
decisions reached through political and administration procedures and
based on common social objectives.
5. The view taken in private finance is a short term one whiles the state is
expected to take a long term view in the interests of the economy as a
whole and be ready to suffer commercial losses for that purpose, both in
the short run and in the long run.

6. A private economic unit proceeds by first ascertaining its income and

then determining its expenditure, the government first decides about its
expenditure and then goes round to seek revenue for it.
 
 IMPORTANCE OF PUBLIC FINANCE
Public finance had little importance in the 19 th century. The reason was that
the governments in those days did not interfere in economic affairs. But
during the 20th century, public finance has come into the forefront on account
of the new concept of ‘welfare state’. Modern governments do not confine
themselves to maintenance of law and order only but are grossly involved
with control and involvement in economic welfare of their countries.
According to A.C Pigou, in every developed society there is some form of
government organization, which may or may not represent the members of
the society collectively, but certainly has coercive authority over them
individually. The coercive nature of government or ‘compulsory power’ refers
to the ability of government to force people to do things that they probably
will not otherwise do or value. These days the governments actively intervene
in economic matters, hence the importance of public finance has vastly
increased in recent years. Public finance is useful in the following ways;
1. Helpful in Capital Formation. The main objective of the government is to
maximize savings and invest same for productive purpose by modifying
properly its tax policies. Most governments these days give subsidies and
grants to different industries to enable them to increase the production of
essential goods in the country. These subsidies and grants have special place
in the government expenditure of under-developed and backward countries.

2. Helpful in increasing Government Activities. The government does not

confine itself only with the three functions of defending the country from
foreign aggression., maintaining law and order in the country and giving
justice to the public but also has become concerned with the management of
transport, electricity, social security, insurance and banking. It requires
finance for all these activities the management of which can be done with
the help of the principles of public finance.
3. Important in Economic Planning. Every country is launching a policy
on planning that will bring about more economic development. Public
finance therefore plays a significant role to meet this end. The success of
financial planning depends on the fiscal policy of the government.

4. Helpful in Reducing Economic Inequalities. Public finance plays a

vital role in reducing economic inequalities in capitalist countries. The
government levy heavy taxes on the richer sections and spent the income
so received on providing cheap food, cheap housing, and free medical
care for the poorer sections of the community. Thus public finance helps
the government to transfer purchasing power from the rich to the poor.
5. Helpful in raising National Income and the running of Public Enterprise.
The income of the people and their standard of living is low in developing
countries. Public finance serves as a tool of economic upliftment of such
countries by raising the level of national income. In addition, huge amount
of capital is required for running public enterprise and maintaining essential
services like water, electricity, health and education. Public finance plays a
vital role in arranging this huge amount of capital.

6. Creation of Employment: Public finance occupies a special place in the

modern theory of employment. The government obtains long-term loan and
invest it in trade and industries of short gestation period which gives
employment to many persons in the country in the ministries, departments
and agencies as well as the district, municipal and metropolitan assemblies.
7. Protection of Infant Industries and to discourage the production and
consumption of harmful commodities. The infant industries are often given
protection against foreign competition through tariff duties in developing
countries. The government often imposes taxes to discourage the production
and consumption of harmful commodities as well.

The importance of public finance has increased several folds in socialist and
communist countries. The economic and social life can be reconstructed in
these countries with the help of public finance. Public finance therefore
plays a crucial role in achieving and maintaining economic stability in a
country. The modern concept of public finance is one of functional or
compensatory finance which the government has to see that the marginal
social sacrifice does not exceed the marginal social benefit.