INTRODUCTION TO

PUBLIC FINANCE

CHAPTER ONE
 CHAPTER ONE

What is public finance ?

 Outline
• Meaning of Public Finance
• Public Finance vs. Private
• Role of Public Finance
• Need for Public Finance
• The Theory of Public Finance
• Functions of Fiscal Operation
 5.1 Meaning of Public Finance
• PF is a study of the financial aspects of
government.
• The science of public finance studies
systematically and scientifically the income and
expenditure of the government and its control as
well as administration.
It lie on the borderline b/n economics &
politics.
It is concerned with the income and
expenditure authorities and with the
adjustment of the one to the other.
 5.1 Meaning of Public Finance
• In modern times it includes four major divisions:
PR, PE, PD, & certain problems of the
fiscal system as a whole, such as fiscal
administration and fiscal policy.
 1.2. Public Finance vs. Private Finance
Similarities
Rationality: both kinds of finance are based
on rationality i.e maximization of benefits.
Borrow Funds: just as an individual cannot
have enough income to cover his expenses and
fills it by borrowing from others,
Common interest: both public and private
funds may be go in to the hands of selfish
interest.
1.2. Public Finance vs. Private Finance (2)

Similarities
Both the private and the public sectors are
engaged in satisfying the wants of the society.
Both the private and public sectors have
limited resources (optimum use of their
resources.)
Both engaged in production, exchange,
saving, capital accumulation investment etc
 Differences
1. Adjustment of Income and Expenditure
(Public revenue is determined by public expenditure)
oAn Individual attempt to adjust his
expenditure to his income.
oThe government first estimate the various
items of expenditure and then devise methods
of raising the necessary amount.
 Differences
oIn the words of Dalton “while an individual
income determines his expenditure, public
authority expenditure determines its income.
oThis difference arises b/c the individual
ordinarily knows the size of his income while
the government does not know it.
 Differences
2. Welfare aspect:
the existence of the state is for the welfare the
society as a whole and not for the good of any
individual or group.
Every individual attempts to maximize his
satisfaction by distributing his limited income on d/t
G/Ses which MU’s of money spent on all goods
would be more or less the same.
But, the government spend its income in such a
way that the welfare of the community is
maximized.
 Differences
4. Long term vision (Provision Made for the Future)
oThe individual hopes to live only for a short period
and he feels the present needs far more urgently; and
hence allotted his majority income to present.
oBut the state is a permanent organization and allots a
large portion of its resources for the conservation as
well as the promotion of future interests.
oThe government spends its funds in to the projects,
which will have fruit full benefits after a
considerable time lag.
 Differences
5. Sources of income
The individual has only limited resources at his
disposal, income; saves from the past earnings and
borrowings.
However, the public authorities can draw upon the
entire wealth of the community, by using force, if
necessary. Besides tax revenue, the state borrows
from the public and foreigners, and print money
under difficult times .
 Differences
6. Secrecy and Publicity
oPrivate finance is generally shrouded in
secrecy; does not like to expose his
financial affairs to others.
oOn the other hand, the government gives
the greatest publicity to its budget
proposals and, in fact, publicity strengthens
rather than weakens pubic credit.
• Governments provide public goods —
government-financed items and services
such as roads, military forces, lighthouses,
and streetlights.
 Private Citizens would not voluntarily pay
for these services, and therefore businesses
have no incentive to produce them.
 Spillovers or externalities
Public finance also enables governments to
correct or offset undesirable side effects of
a market economy.
The roles of public sector in developing Countries
oPrivate enterprises in most of the under developed
countries focused more for private gain rather than
by public benefit, so that resources may be used in
areas with less economic importance. Direct
intervention by the government, therefore becomes
indispensable.
oDeveloping countries face also large fluctuations
in income and prices from to time. There fore it
needs government intervention through different
instruments of fiscal policy as well as direct
involvement to combat these problems.
Developing countries are characterized by
low level of income, the private sector most
of the time are incapable to invest on some
sectors, which needs huge capital, but
have lower return like electricity,
telecommunication, roads, education
health and other infrastructure. There
fore direct government involvement is a
must to brought rapid development.
• Income disparities are high in developing
countries where there is a wide difference
of income and wealth between the rich and
the poor between regions. Thus government
involvement through its budgetary program
and other fiscal instruments of taxation,
subsidy etc
Public goods are goods, which made
available, free of direct charge to the user and
are provided through budgetary mechanism to
satisfy public wants.
 Private goods are goods which go to satisfy
private wants and are financed and supplied
by the market on price pay
PRIVATE GOODS PUBLIC GOODS
 A. Allocation Function
• the public sector is used to make provision of
social wants or collective wants. i.e defense,
justice, regulation and control of public
enterprises, social and cultural welfare, railways
and roads etc.
• the expenditure and revenue process of the
government is used to divide the total resources
of the community between private and social
goods.
• used to determine the proportion in which
different social goods are produced.
 B. Distribution function
• The revenue and expenditure process of
the government may be used to reduce
disparities in the distribution of income
and wealth.
• Prof. Musgrave pointed out that among the
various fiscal devices, redistribution
might be implemented most directly
through the following measures:
 B. Distribution function
• Tax transfer scheme, combining progressive
income taxation of high-income households with
a subsidy to low income households.
• Progressive income taxes may be used to finance
public services, especially those such as public
housing which particularly benefit low income
house holds
• A combination of taxes on goods purchased
largely by high income consumers and subsidies
to other goods which are used chiefly by low
income consumers
C. Stabilization function
•The revenue and expenditure process of the
government may be used to secure economic
stability or to remove economic fluctuations
and distortions in the economy
•If involuntary unemployment prevails,
increase the level of demand i.e increase the
level of public expenditure and reduce the
level of taxation.
C. Stabilization function
•If inflation prevails, reduce the level of
demand I,e reduce level of public
expenditure and increase the level of
taxation .
•If full employment and price stability prevail,
maintain the aggregate level of money
expenditure i.e maintain the present level of
public expenditure and taxation, to prevent
unemployment and inflation.
D. To accelerate economic development
othere exists vicious circle of poverty
oTotal output in these countries is very low, and
after consumption requirements are satisfied little
remains as surplus for capital accumulation.
oBecause of the low level of real income and high
propensity to consume, the flow of saving is small.
Investment in capital goods is low on account of
low saving; and due to in adequate capital stock
the level of real income is low again.
D. To accelerate economic development
o“A poor country is poor because it is poor”
oThus, vicious circle of poverty can be broken
through heavy capital investment in the economy.
othe fiscal instruments in under developed
countries are concerned with allocating more
resources for investment and restraining
consumption.
D. To accelerate economic development
oFiscal instruments i.e taxation, borrowing, deficit
financing and public expenditure, are used for
mobilization of resources to achieve accelerated rate
of growth with reasonable stability and to remove
inequalities in the distribution income and wealth