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CHAPTER ONE

BASICS OF PUBLIC FINANCE

12/29/2023
 1.1. Definitions of Public Finance
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 Public finance is a very old science and different economists

have defined it in their own ways.
1) “Public finance is concerned with the income and
expenditure of public authorities and with the
adjustment of one to the other.” Huge Dalton
2) “Public finance is the study of the principles
underlying the spending and raising of funds of
public authorities.” Findley Shiras
3) “Public finance deals with expenditure and income
of public authorities of the state and their mutual
relations as also with the financial administration
and control.” 12/29/2023
 Cont’d
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 All of them say that it is a study of income

and expenditure of the central, state, and
local governments.
 Therefore, rising of funds for the
expenditure and their disbursement
constitutes the subject of Public finance.

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 Public Finance and Private Finance
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 Finance in general means public as well

as private finance.
 Public finance: relates to the money-
raising and income-expenditure functions
of the government.
 Private finance: refers to the income-
expenditure phenomenon of an individual
or private business firm.

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 Similarities and Dissimilarities
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Similarities
(1) Satisfaction of Human Wants: Both the
public and private finance have the same
objective, i.e., the satisfaction of human wants.
(2) Maximum Advantage: Both the public
finance and private finance try to secure
maximum advantage or maximum benefit.
 Tries to obtain maximum advantage from
there expenditure
(3) Balancing of Income and Expenditure: Both
individual and Government have incomes and
expenditures and trying to balance each other.
12/29/2023
 Cont’d
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(4) Borrowings: Both have to be obtained

from the market in the form of borrowings
whenever the expenditure exceeds their
income/revenue.
(5) Engagement in Similar Activities: Both
the private and public sectors are
engaged in activities that involve lots of
purchases, sales and other transactions.
 Similarly, they are engaged in production,
exchange, saving capital accumulation,
12/29/2023
 Cont’d
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(6) Scarcity of Resources: They have

unlimited objectives, whereas the
resources are limited.
(7) Problem of Adjustment of Income and
Expenditure: Both face the problem of
adjustment of income and expenditure.
Dissimilarities
(1) Motive: The motive of private finance is
personal interest or benefit, whereas the
motive of public finance is social benefit
12/29/2023
 Cont’d
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(2) Adjustment Approach of Income and

Expenditure: Every individual tries as far
as possible to adjust his expenditure to
his income because his expenditure
depends on his income.
 Conversely, the government first prepares
its budget. In other words, the government
first determines its expenditure and then
devises ways and means to raise the
requisite revenue to meet its expenses.
12/29/2023
 Cont’d
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(3) Nature of Resources: The resources of

an individual (private finance) are more or
less limited, whereas the resources of the
government (public finance) are
enormous.
 Government can raise resources from tax
sources as well as non-tax sources. The
government can borrow from internal as
well as external sources.
12/29/2023
 Cont’d
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(4) Coercive Methods: An individual (private

finance) cannot use coercive methods to
raise his income, whereas the government
(public finance) can use forceful methods
to collect revenue.
(5) Secrecy of Budget (Publicity): Public
finance is an open affair as the
government gives utmost publicity to its
budget by publishing it in newspapers and
by showing it on television.
 Cont’d
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(6) Long/Short-term Consideration (Nature

of Perspective): private finance has a
short-term perspective whereas the public
finance has a long term perspective.
 But, the Government is a permanent
organization and is the caretaker of the
present and the future as well.
 In private finance, the individual strives for
immediate or quick return.
12/29/2023
 Cont’d
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(7) Influence (Deliberate) on expenditure: The

expenditure pattern of private finance is
influenced by various factors such as
customs, habits, culture, religion, business
conditions etc.
 But the pattern of expenditure of public
finance is influenced and controlled by the
economic policy of the Government.
(8) Elasticity of Finance: Public finance is
elastic in nature-as compared to private
12/29/2023
 Cont’d
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(10) Right to Print Currency: The government

has a right to print currency which is legal,
whereas private individual does not enjoy
such a right.
(11) Postponement of Expenditure: In private
finance, the individual can postpone or even
avoid certain expenditure, as he likes. But in
the case of public finance, the Government
cannot avoid certain commitments like social
welfare measures and thus cannot postpone
12/29/2023
 Cont’d
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(12) Nature of Benefit: The private finance

aims at individual benefit i.e. the benefit of
individual household. But the public finance
aims at collective benefit, i.e. the benefit of
the nation as a whole.
(13) Audit: In the case of private finance,
auditing of the financial transactions of the
individuals is not always necessary. But the
accounts of the public authorities are
subject to audit and inspection.
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 Economic and Social Significance of
Public Finance
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Economic Significance: According to R.J.

Chelliah, “Public Finance has a positive and
significant role in the context of economic.
1) Capital Formation: For rapid capital
formation, the government should incur
expenditure on the establishment of basic
and heavy industries, infrastructural
development, such as power projects,
transport sector, means of communications
etc. 12/29/2023
 Cont’d
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2) Economic Stabilization: Public finance

(revenue and expenditure process of the
government) may be used to secure economic
stability or to remove economic fluctuations in
the economy.
3) Full Employment: It is the function of public
finance to provide employment opportunities.
 To generate employment, public expenditure
should be incurred on setting up new industries,
encouraging small-scale and cottage industries
through financial subsidies, expenditure on
training schemes etc.
12/29/2023
 Cont’d
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4) Balanced Regional Development: Balanced

regional development is possible by setting
up private industries in backward areas
instead of in urban areas.
 The government should provide fiscal or tax
concessions in the form of 5 year tax
holiday, communication facilities should
also be provided, industries fail to divert to
backward regions should be taxed heavily.
12/29/2023
 Cont’d
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5) Reduction in Economic Inequalities: To bring

about equitable distribution of income and wealth,
the government should follow the system of
progressive taxation.
 The government should impose heavy taxes on the
richer section of society
6) Mobilization of Resources: The government can
mobilize or raise resources by imposing taxes on
the people and industries, by encouraging savings
through various saving schemes, surplus of public
enterprises and borrowings and making them
available for investment for the rapid economic
development of the underdeveloped country.
12/29/2023
 Cont’d
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7) Optimum Utilization of Resources: In a

developing country it is not uncommon to find
non-utilization or destruction of scarce
resources.
 The state can direct the flow of consumption,
production and distribution in the right
direction by adopting balanced budgetary
policy.

12/29/2023
 Cont’d
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Social Significance
 Social justice or equitable distribution of
income and wealth is another responsibility
of the government in its public finance
operations.
 luxury items purchased mainly by the rich
should be subjected to higher rates of
taxation, and necessary items should be
exempted from taxation.
 Social justice also requires investment
expenditure on the establishment of
enterprises in the public sector.12/29/2023
 Satisfaction of Social Wants and Merit Wants
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 Another significant point of public finance is the
satisfaction of social or collective wants and merit
wants.
 Wants are divided under three heads:

a. Private Wants
b. Social Wants or Collective Wants and
c. Merit Wants
Private Wants
 Private wants are those wants which are satisfied by
individuals according to their personal incomes.
 Degree of satisfaction depends upon their
12/29/2023
 Cont’d
Social Wants or Collective Wants
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 Social or collective wants require public goods which

are demanded by all members of society equally
whether the people have the capacity to pay or not.
 Wants like defense, education, public health, flood
control provisions, weather forecasting bureaus,
research centers, police protection, social overhead
capital like roads, bridges, etc. are collective wants
which must be available to all the people irrespective
of whether they are rich or poor, whether they can
afford to have them or not.
 Public expenditure on these heads is necessary to
satisfy social or collective wants. 12/29/2023
 Cont’d
Merit Wants
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 Merit wants are essential private such as food, clothing,
housing etc., which are satisfied by the government at low
prices for the poor due to their low level of income.
 Merit wants are, thus, provided by the government for the
benefit of the poor.
 These wants are satisfied by the government for the
upliftment and progress of the poor.
 Such wants are food, clothing, low cost housing (eg.
condominium), free nutritious means to school children, free
education to the children of the poor, low priced milk to the
poor, old age pensions and social security measures,
maternity benefits etc.
 Satisfaction of these wants for the poor increases their
productivity efficiency and there by their income.
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 Fiscal Policy to Prevent Undesirable Wants
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 Another important aspect of public finance is that

the government not only satisfies social wants and
merit wants, but also discourages and control
certain undesirable wants of the people from the
social point of view.
 Undesirable wants are cigarette-smoking, liquor
drinking, chewing of opium and tobacco etc.
 Such harmful wants are discouraged and controlled
by imposing heavy taxes and spending large
amount on publicity, health measures for the
affected people, etc.
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 1.2 Scope of Public Finance
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 The subject matter or the contents of the

science of public finance are divided into
five categories of financial activities of the
government:
1. Public Revenue,
2. Public Expenditure,
3. Public Debt,
4. Financial Administration and Control,
and
5. Economic Stability and Growth.
12/29/2023
 Cont’d
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1. Public Revenue
 Revenue includes all incomes irrespective
of the source they are obtained from.
 Thus, in the wider sense, we can include
taxes as well as borrowings under public
revenue.
 public revenue include only those
incomes which do not carry the obligation
of repayment for the state.
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 Cont’d
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Thus, public revenue implies raising income

by way of taxation.
A. Tax Revenue: Taxes are compulsory
payments to government with no expectation
of direct return or benefit to tax payers. It
imposes a personal obligation on the
taxpayer.

12/29/2023
 Cont’d
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B. Non-Tax Revenue: This includes the

revenue from government or public
undertakings, revenue from social
services like education and hospitals, and
revenue from loans or debt service. To
sum up, non-tax revenue consists of:
i. Interest receipts
ii. Dividends and profits
iii. Fiscal services and others.
12/29/2023
 Cont’d
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2. Public Expenditure: Expenditure is the end and

aim of the collection of revenues.
 The term “Public Expenditure” is used to
designate the expenditure of government-
central, state and local bodies.

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 Current and Capital Expenditure
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most governments classify public
expenditure into two:
(i)Current expenditure, and
(ii) Capital expenditure
Current expenditure
All sorts of administrative and defense
expenditure and debt services are called
current expenditure.
They are also referred to as non-
developmental expenditure.
They are intended for continuing the existing
flow of goods and services and maintaining
the capital of the country intact.12/29/2023
 Capital expenditures
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 Contribute to increased productive

capacity of the nation and therefore, are
known as development expenditure.
 Expenditures on construction of dams,
public works, state enterprises,
agricultural and industrial development
etc., are instances of capital expenditure.
 Public expenditure is a means of
maintaining the capital of the country.
12/29/2023
 Cont’d
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3. Public Debt : A public authority can obtain

income through loans and public
borrowings.
 The study public debt also includes:

i. Methods and objectives of public

borrowings;
ii. Management of public debt; and
iii. Burden of public-internal and external
4. Financial Administration and Control
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 Cont’d
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Without a study of relevant dimensions of

financial administration the subject of public
finance remains incomplete.
 This category includes the preparation of
financial budget, the control and
administrations of the budget relevant
problems, auditing etc.

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 Cont’d
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5. Economic Stability and Growth: The

study of public finance includes fiscal
policy of the government in dealing with
inflationary and deflationary situations,
stability of the price level, promotion of
full employment, growth of economy,
welfare of the people, etc.
 It studies the use of financial policies of the
Government from the view of economic
development. And it frame and look after the
implementation of various policies required for
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 Fiscal Federalism
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 Concerns the division of public sector

functions and finance among different tiers of
government.
 Financial relations between units of
governments in a federal government system.
 The term was introduced by the German born
American economist Ricared in 1959.
 the theory of fiscal federalism assumes that a
federal system of government can be efficent
and effective at solving problems government
face today. 12/29/2023
 Cont’d
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 Such as just distribution of income, efficient

and effective allocation of resources and
economic stability.
 Economic stability and just distribution of
income can be done by federal government
because of its flexibility in dealing with these
problems.
 Because states and locality are not equal in
their income, federal government intervention
is needed.
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