Public Finance
WHAT IS PUBLIC FINANCE?
In simple layman terms, public finance is the study of finance related
to government entities. It revolves around the role of government income and
expenditure in the economy.
Prof. Dalton in his book Principles
of Public Finance states that “Public Finance is concerned with income and
expenditure of public authorities and with the adjustment of one to the other”
By this definition, we can understand that public finance deals with
income and expenditure of government entity at any level be it central, state
or local. However in the modern day context, public finance has a wider scope –
it studies the impact of government policies on the economy.
Let’s understand the scope of public
finance to understand how public finance impacts the economy.
THE SCOPE OF PUBLIC FINANCE
Prof. Dalton classifies the scope of
public finance into four areas as follows –
PUBLIC INCOME
As the name suggests, public income refers to the income of the
government. The government earns income in two ways – tax income and non-tax
income. Tax income is easy to recognize, it’s the tax paid by people of the
country in the form of income tax, sales tax, duties, etc. On the other hand
non-tax income includes interest income from lending money to other countries,
rent & income from government properties, donations from world
organizations, etc.
This area studies methods of
taxation, revenue classification, methods of increasing government revenue and
its impact on the economy as a whole, etc.
PUBLIC EXPENDITURE
Public expenditure is the money spent
by government entities. Logically, the government is going to spend money on
infrastructure, defence, education, healthcare, etc. for the growth and welfare
of the country.
This area studies the objectives and classification of public
expenditure, effects of expenditure in different areas, effects of public
expenditure on various factors such as employment, production, growth, etc.
PUBLIC DEBT
When public expenditure exceeds
public income, the gap is filled by borrowing money from the public, or from
other countries or world organizations such as The World Bank. These borrowed
funds are public debt.
This area of public finance explains the burden of public debt, why it
is necessary and its effect on the economy. It also suggests methods to manage
public debt.
FINANCIAL ADMINISTRATION
As the name suggests this area of public finance is all about the administration
of all public finance i.e. public income, public expenditure, and public debt.
Financial administration includes preparation, passing, and implementation of
government budget and various government policies. It also studies the policy
impact on the social-economic environment, inter-governmental relationships,
foreign relationships, etc.
FUNCTIONS OF PUBLIC FINANCE
There are three main functions of public finance as follows –
THE ALLOCATION FUNCTION
There are two types of goods in an
economy – private goods and public goods. Private goods have a kind of
exclusivity to themselves. Only those who pay for these goods can get the
benefit of such goods, for example – a car. In contrast, public goods are
non-exclusive. Everyone, regardless of paying or not, can benefit from public
goods, for example – a road.
The allocation function deals with the allocation of such public goods.
The government has to perform various functions such as maintaining law and
order, defence against foreign attacks, providing healthcare and education,
building infrastructure, etc. The list is endless. The performance of these
functions requires large scale expenditure, and it is important to allocate the
expenditure efficiently. The allocation function studies how to allocate public
expenditure most efficiently to reap maximum benefits with the available public
wealth.
THE DISTRIBUTION FUNCTION
There are large disparities of income and wealth in every country in the
world. These income inequalities plague society and increase the crime rate of
the country. The distribution function of public finance is to lessen these
inequalities as much as possible through redistribution of income and wealth.
In public finance, primarily three measures are outlined to achieve this
target –
§ 1) A tax-transfer scheme or using progressive taxing, i.e. in simpler words
charging higher tax from the rich and giving subsidies to the low-income
§ 2)Progressive taxes can be used to finance public services such as
affordable housing, health care, etc.
§ 3)A higher tax can be applied to luxury goods or goods that are purchased
by the high-income group, for example, higher taxes on luxury cars.
THE STABILIZATION FUNCTION
Every economy goes through periods of
booms and depression. It’s the most normal and common business cycles that lead
to this scenario. However, these periods cause instability in the economy. The
objective of the stabilization function is to eliminate or at least reduce
these business fluctuations and its impact on the economy. Policies such as
deficit budgeting during the time of depression and surplus budgeting
during the time of boom helps achieve the required economic stability.
Now that we understand the study of public finance, we must look into
its practical applications. So let us understand the career opportunities in
public finance .
Difference Between Private and Public Finance
these are the differences between the private and public finance.
- Adjustment of income and expenditure: a government first prepares and estimate of expenditure and then means of raise that sum and the individual must adjust his expenditure to his income.
- Budgeting: the unit for the public budget is one year but an individual needs not balance his budget during a given period.
- Deficit financing: deficit financing is a peculiar privilege of government but an individual cannot do it, unless he is prepared to go behind the bars.
- Different Objectives: an individual tries to maximize his satisfaction or profit from a given amount of resources but the objective of government expenditure is to maximize social benefit.
- Publicity of finance: budgets are published and the widest publicity is given to them. On the other hand, the secrecy surrounds individual finance.
- Coercion: a government has to pass a law and compel the citizen to pay a tax while an individual lacks the coercive authority
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