KISII UNIVERSITY

BCOM 333: PUBLIC FINANCE

LESSON NOTES

TOPIC ONE: BASIC CONCEPTS & SCOPE OF PUBLIC FINANCE

1.1 Basic Concepts

1.1.1 Concept of Public Finance
 Public finance can be defined as the study of government activities, which may
include spending, deficits and taxation. The goals of public finance are to recognize
when, how and why the government should intervene in the current economy, and
also understand the possible outcomes of making changes in the market. In addition,
public finance can involve issues outside of the economy, including accounting, law
and public finance management.
 Public finance is the management of a country’s revenue, expenditures, and debt load
through various government and quasi-government institutions. This guide provides
an overview of how public finances are managed, what the various components of
public finance are, and how to easily understand what all the numbers mean. A
country’s financial position can be evaluated in much the same way as a business’
financial statements.
 Public finance refers to the activities carried out by the government associated with
raising of finances and the spending of the finances raised (it is the study of how
government collects revenue and how it spends it)
 Public finance is related to the financing of the state activities and a narrow definition
of the public finance would try to say that public finance is a subject which discusses
the financial operation of the fiscal or of the public treasury.
 Public finance has been held as a science which deals with the income and
expenditure of the government’s finance. It has been held as a study of principles
underlying the spending and raising of funds by the public authorities. The various
theories which form the basis of the collection; maintenance and expenditure of the
public income constitute the subject and matter of finance.
 Public finance is the study of the role of the government in the economy. It is the
branch of economics that assesses the government revenue and government

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 expenditure of the public authorities and the adjustment of one or the other to achieve
desirable effects and avoid undesirable ones.
 In public finance we study the finances of the Government. Thus, public finance deals
with the question how the Government raises its resources to meet its ever-rising
expenditure. As Dalton puts it, public finance is concerned with the income and
expenditure of public authorities and with the adjustment of one to the other.
 Accordingly, effects of taxation, Government expenditure, public borrowing and
deficit financing on the economy constitutes the subject matter of public finance.
Public Finance is the study of the effects of budgets on the economy, particularly the
effect on the achievement of the major economic objects growth, stability, equity and
efficiency.

1.1.2 Meaning of Public Finance:

Public finance is the branch of economics. It is made of two words as public and finance. The
term public means government and finance means science of management of money. So
literally public finance means the study of allocation of economic resources for achieving the
goals of public affairs.

Thus, public finance is the study of allocation and management of resources and technology
for achieving the goals of public organization. However, literally it seems to have narrow
meaning but its scope and definition has been widening and changing through the time. In
public finance we study the finances of the Government.

Thus, public finance deals with the question how the Government raises its resources to meet
its ever rising expenditure. Public finance is the study of the role of the government in the
economy. It is the branch of economics which assesses the government revenue and
government expenditure of the public authorities and the adjustment of one or the other to
achieve desirable effects and avoid undesirable ones.

As Dalton puts it, “public finance is “concerned with the income and expenditure of
public authorities and with the adjustment of one to the other.”

Accordingly, effects of taxation, Thus, Prof. Otto Eckstein writes “Public Finance is the
study of the effects of budgets on the economy, particularly the effect on the
achievement of the major economic objects—growth, stability, equity and efficiency.”

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Further, it also deals with fiscal policies which ought to be adopted to achieve certain
objectives such as price stability, economic growth, more equal distribution of income.
Economic thinking about the role that public finance is expected to play has changed from
time to time according to the changes in economic situation.

Before the Great Depression that gripped the Western industrialized countries during the
thirties, the role of public finance was considered to be raising sufficient resources for
carrying out the Government functions of civil administration and defense from foreign
countries. During this period, the classical economists considered it prudent to keep
expenditure to the minimum so that taxing of the people is avoided as far as possible. Further,
it was thought that Government budget must be balanced. Public borrowing was
recommended mainly for production purposes. During a war, of course, public borrowing
was considered legitimate but it was thought that the Government should repay or reduce the
debt as soon as possible.

Government expenditure, public borrowing and deficit financing on the economy constitutes
the subject matter of public finance.

1.1.3 Importance of Public finance:

Thus, it is evident public finance is very important for the growth and development of a
country. It is obvious that the government of a country can push up the industrial and
economic development of the country, provide more employment opportunities, encourage
investments and savings in the desired direction and increase social benefits through public
expenditure. It therefore, affects the overall economic and social system of the country. The
major importance of public finance are:

1. Steady state economic growth: Public finance is important to achieve sustainable

high economic growth rate. The government uses the fiscal tools in order to bring
increase in both aggregate demand and aggregate supply. The tools are taxes, public
debt, and public expenditure and so on.
2. Price stability: The government uses the public finance in order to overcome form
inflation and deflation. During inflation it reduces the indirect taxes and genera
expenditures but increases direct taxes and capital expenditure. It collects internal
public debt and mobilizes for investment. In case of deflation, the policy is just
reversed.

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 3. Economic stability: The government uses the fiscal tools to stabilize the economy.
During prosperity, the government imposes more tax and raises the internal public
debt. The amount is used to repay foreign debt and invention. The internal
expenditures are reduced. During recession, the case is just reversed.
4. Equitable distribution: The government uses the revenues and expenditures of itself
in order to reduce inequality. If there is high disparity it imposes more taxes on
income, profit and properties of rich people and on the goods they consume. The
money collected is used for the benefit of poor people through subsidies, allowance,
and other types of direct and indirect benefits to them.
5. Proper allocation of resources: The government finance is important for proper
utilization of natural, manmade and human resources. For it, on the production and
sales of less desirable goods, the government imposes more taxes and provides
subsidies or imposes taxes lightly on more desirable goods.
6. Balanced development: The government uses the revenues and expenditures in order
to erase the gap between urban and rural and agricultural and industrial sectors. For it,
the government allocates the budget for infrastructural development in rural areas and
direct economic benefits to the rural people.
7. Promotion of export: The government promotes the export imposing less tax or
exempting form the taxes or providing subsidies to the export oriented goods. It may
supply the inputs at the subsidized prices. It imposes more taxes on imports and so on.
8. Infrastructural development: The government collects revenues and spends for the
construction of infrastructures. It has to keep peace, justice and security too. It has to
bring socio-economic reformation too. For all these things it uses the revenues and
expenditures as fiscal tools.

1.1.4 Role of Government in the Economy:

a. Provision of Public Goods: Governments often provide public goods such as
national defense, infrastructure (roads, bridges, etc.), and public services that benefit
society as a whole but are not adequately provided by the private sector due to market
failures.
b. Regulation: Governments enact regulations to ensure fair competition, consumer
protection, and the stability of markets. They may also regulate certain industries or
sectors to address issues such as environmental concerns or public health.

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 c. Macroeconomic Stabilization: Governments intervene in the economy to stabilize
fluctuations in economic activity, such as managing inflation, unemployment, and
promoting economic growth. They may use fiscal policies (taxation and government
spending) and monetary policies (interest rates, money supply) to achieve these
objectives.
d. Redistributive Policies: Governments implement policies to redistribute income and
wealth in society, aiming to reduce inequality and provide social safety nets. This may
involve progressive taxation, welfare programs, and other forms of income
redistribution.
e. Market Failure Corrective Measures: Governments intervene when markets fail to
allocate resources efficiently. Examples include addressing externalities (such as
pollution), monopolies, and asymmetric information to ensure economic efficiency
and protect public interests.

1.1.5 Key Principles of Public Finance:

1. Efficiency: Public finance aims to allocate resources efficiently by ensuring that
government expenditures generate the maximum benefit for society given the
available resources. This principle emphasizes cost-effectiveness and minimizing
waste.
2. Equity: Public finance strives for equity or fairness in the distribution of resources
and the tax burden. It involves designing tax policies and government expenditures to
reduce income and wealth disparities and promote social justice.
3. Adequacy: Public finance aims to generate sufficient revenue to fund government
expenditures effectively. Adequacy relates to the government's ability to finance
public goods, services, and programs without creating excessive debt or resorting to
unsustainable fiscal practices.
4. Certainty: Public finance seeks to provide certainty and predictability to individuals
and businesses regarding tax policies, government regulations, and fiscal plans. This
principle helps facilitate economic planning, investment decisions, and overall
economic stability.
5. Neutrality: Public finance should strive to be neutral and avoid distorting economic
behavior or market outcomes. This means designing tax policies and regulations that
do not introduce unnecessary biases or distort incentives for individuals and
businesses.

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1.1.7 Scope of public finance
The scope of public finance encompasses the following key areas:

1. Public Revenue: This involves the collection of funds by the government through
various means, primarily taxation. It includes the design of tax systems, determining
tax rates, and implementing tax policies to generate revenue. Other sources of public
revenue may include fees, fines, tariffs, and income from government-owned
enterprises.
2. Public Expenditure: This refers to the government's spending of the collected funds
to finance public goods and services, such as infrastructure development, education,
healthcare, defense, social welfare programs, and administrative expenses. Public
expenditure also includes transfer payments to individuals or groups, such as
pensions, subsidies, and grants.
3. Public Debt: Public finance also deals with government borrowing and debt
management. Governments may borrow funds from domestic or international sources
to finance budget deficits or fund long-term investments. Public debt management
involves strategies to ensure the sustainability of debt, minimize borrowing costs, and
manage the risks associated with debt repayment.
4. Fiscal Policy: Public finance plays a crucial role in formulating and implementing
fiscal policies. Fiscal policy refers to the use of government spending and taxation to
influence the overall economy. It includes decisions on budget deficits or surpluses,
the level of government expenditure, tax rates, and other fiscal measures aimed at
achieving macroeconomic stability, promoting economic growth, and addressing
socio-economic challenges.
5. Public Financial Management: This involves the efficient and effective
management of public funds, encompassing budgeting, accounting, auditing, and
financial reporting processes. It includes ensuring transparency, accountability, and
integrity in financial operations, as well as monitoring and evaluating the performance
of public expenditures.

Overall, public finance encompasses the study of how governments generate revenue,
allocate resources, and manage their finances to promote economic stability, social welfare,
and sustainable development. It provides the framework for understanding the economic role
of the government and how it influences the overall functioning of the economy.