PUBLIC FINANCE

DEFINITION AND EXPLANATION:

Public finance, according to the traditional definition of the subject, is that branch of Economics which deals with, the
income and expenditure of a government. In the words of Adam Smith:

"The investment into the nature and principles of state expenditure and state revenue is called public finance".

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. 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.”
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.
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.
Understanding the role of the government and how changes may affect the economy are a few important aspects of public
finance professionals. When the government intervenes and takes action within the economy, the outcomes are classified
into one of three categories: economic efficiency, distribution of income or macroeconomic stabilization.

The scope of the science of public finance now-a-days has widened too much. It is due to the fact that modern states
have to perform multifarious functions to promote the welfare of its citizens. In addition to maintaining law and order
within the country and provision of security from external aggression, it has to perform many economic and commercial
functions.

The study of public finance is split up into four parts; (1) Public Expenditure (2) Public Revenue, (3) Public Debt and (4)
Budgeting etc.

SCOPE OF PUBLIC FINANCE:

The scope of public finance is not just to study the composition of public revenue and public expenditure. It covers a full
discussion of the influence of government fiscal operations on the level of overall activity, employment, prices and growth
process of the economic system as a whole.
According to Musgrave, the scope of public finance embraces the following three functions of the government’s
budgetary policy confined to the fiscal department:
(i) The Allocation Branch,
(ii) The Distribution Branch, and
(iii) The Stabilisation Branch.
These refer to three objectives of budget policy, i. e., the use of fiscal instruments:
(i) To secure adjustments in the allocation of resources,
(ii) To secure adjustments in the distribution of income and wealth, and
(iii) To secure economic stabilisation.
Thus, the function of the allocation branch of the fiscal department is to determine what adjustments in allocation are
needed, who shall bear the cost, what revenue and expenditure policies to be formulated to fulfill the desired objectives.
The function of the distribution branch is to determine what steps are needed to bring about the desired or equitable
state of distribution in the economy and the stabilisation branch shall confine itself to the decisions as to what should be
done to secure price stability and to maintain full employment level.
IMPORTANCE OF PUBLIC FINANCE
1. Steady state economic growth:
Government 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.
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.

DIFFERENCE BETWEEN PRIVATE AND PUBLIC FINANCE

Private finance (individual) Public finance ( government)
An individual adjusts his or her expenditure according to his The public authority adjusts its income to its expenditure.
or her income.
A private individual tries to have a surplus of income over A public authority will spend all that it gets
expenditure i.e. surplus budget.
An individual can borrow money from other individual only A public authority esp a state can raised loans from both
and externally internally
Finances of individuals are limited Finances of government are flexible
Private individuals cannot use force to get their income; they The government can use coercive method to realize
cannot compel others to get income revenues

Not a single individual can print notes A state can print currency notes in order to meet its
expenditure in difficult times
Let us learn about the similarities and dissimilarities between public finance and private finance.

Similarities between Public Finance and Private Finance:

The following are the points of similarities between public finance and private finance:
(a) Same Welfare Objective:
Both kinds of finances have broadly the same objective. Private finance is concerned with the maximization of individual
welfare while public finance is concerned with the maximization of a community’s welfare from given resources.
(b) Rationality:
All kinds of finances are based on rationality. A rational individual tries to maximize his personal gain by allocating his
given income.
Likewise, the government also behaves rationally in the sense that it seeks to maximize society’s welfare from the
expenditures made in different activities. Any irrational behaviour— either on the part of the individual or the
government—may spell disaster to individuals, and to the society as a whole.
(c) Scarcity of Resources:
Both have limited resources at their disposal. Both public and private individuals are required to match their income and
expenditures in such a way that both make the optimum use of resources which are scarce.
(d) Loans are Repayable:
Both private and public loans are required to be repaid. An individual borrows money from various sources to meet
personal requirements. But that too cannot be unlimited. He has to repay his loans. Like individuals, government cannot
live beyond its means. It can temporarily postpone repayment of loans, but it is obligatory to repay the loans.
Thus, public finance may be regarded as an extension of private finance. This, however, is not true.

Dissimilarities between Public Finance and Private Finance:

There are some basic differences between private and public finance. Some of the important differences are:
(a) Objectives are Indeed Different:
The objectives are different by the very nature of public and private finance. The government has to set an objective
standard of utility from given public expenditure while an individual fixes a subjective standard of utility from his given
personal expenditure.
Private individuals or firms are mainly concerned with private consumption or profits, while the government aims at
promoting the society’s welfare. Again, an individual or a firm is mainly concerned with present profits and prospects, not
with that of the distant future. But the government has to serve society generation after generation.
In other words, government is not guided by the profit motive; it is mainly concerned with the general interest of the
society. An individual is myopic in the long run, and that is why he attaches more importance to the present period than
to the future. On the other hand, since government regards itself as a trustee for the future, it makes provisions not only
for present period but also for posterity.
(b) Public Expenditure Determines Public Revenue:
An individual adjusts his expenditure to income while the state adjusts income to expenditure.
An individual usually prepares his family budget in accordance with the income that he expects to receive. Income is, thus,
the crucial determinant of individual budget. On the other hand, the government usually prepares its budget of
expenditures and then searches wherefrom it can raise the required funds to meet the expenditures.
Thus, expenditure is the crucial determinant of public budget. In view of this difference, it is said that in private finance
the coat is cut according to the cloth available, while in public finance the opposite happens—the size of the coat is
determined first and then the authorities set out to gather the necessary cloth (through taxation, borrowing and deficit
financing).
However, there may arise some situations in which an individual may also adjust his expenditure to income—like the
government. In case of unforeseen emergencies, an individual may have to spend more than what he receives from
current income.
Under the circumstances, he will have to work harder and sacrifice leisure or to borrow money from different sources to
supplement his present income. Likewise, when government expenditure exceeds government revenue, government
borrows money. Or it may cut expenditure when its expected revenue falls short of the target.
(c) Public Budget is not Necessarily Balanced:
An individual tries to maintain a balanced budget and maintenance of a surplus budget is a virtue. Instead of a balanced
or a surplus budget it is desirable to have a deficit budget of a government so as to increase the country’s productive
power. In other words, a surplus budget may not stimulate economic activities. On the contrary, a deficit budget is often
made to finance economic development.
(d) Methods of Raising Resources are Different:
One of the important areas of differences between public and private finance lies in the method of raising income.
First, resources of the state are large compared to individuals. Secondly, a government has the power to raise revenues
from nationals as taxes are defined as the compulsory contributions to the government. An individual cannot force others
to pay him money. In order to raise money, a government can print money.
An individual does not have this right. Further, the government can raise money both from its own citizens and from
external sources like the IMF, the World Bank, foreign countries, etc. No such prerogative is enjoyed by individuals.
Government may force people to buy its own bonds to enable it to raise resources, particularly during emergencies like
war.
(e) Public Finance is Transparent:
Private finance relating to sources of revenue and spending is a secret affair. An individual tries to maintain secrecy of his
accounts. Usually, an individual does not disclose his financial standing. Nor such disclosure has any significance to other
people.
No such secrecy is maintained in the case of public finance. Government places its budget (i.e., estimated accounts of
income, expenditure, methods of financing deficit) in the parliament. All these information are available in the news media
so that transparency in public budget is maintained.
Thus, dissimilarities between public and private finance are more important than similarities. That is why we have separate
theories and tools, principles and practices relating to public finance. Public finance is not merely the study of revenue-
expenditure process of the government; it also studies how revenue-expenditure process affects macro- economic
variables of an economy like consumption, interest rate, etc.
Thus, public finance is a part of the economic system as a whole. The domain of private finance is microeconomics while
that of public finance is macroeconomics—although governmental and private activities are more complementary in
nature.