PROJECT ON

MEANING & SCOPE OF PUBLIC EXPENDITURE

SUBMITTED TO: SUBMITTED BY:

_______________ Arpit naag (L/ 73)

Assiatant Professor Scholar

School of Law School of Law

Raffles University Raffles University

MEANING AND SCOPE OF PUBLIC FINANCE

Public finance is a field of economics concerned with how a government raises money, how that
money is spent and the effects of these activities on the economy and society. It studies how
governments at all levels—national, state and local—provide the public with desired services and
how they secure the financial resources to pay for these services.
Public finance deals with the finances of public bodies – national, State or Local – for the
performance of their functions. The performance of these functions leads to expenditure. The
expenditure is incurred from funds raised through taxes, fees, sale of goods and services and loans.
The different sources constitute the revenue of the public authorities. Public finance studies the
manner in which revenue is raised; the expenditure is incurred upon different items etc. Thus,
public finance deals with the income and expenditure of public authorities and principles, problems
and policies relating to these matters. We can analyse some important definitions of public finance
given by some leading authorities in public finance.
According to Professor Hugh Dalton,the term ‘Public authorities’ refers to the Government or
State at all levels –National, State, and Local.
Harold Groves’ definition outlines the types of governments whose finances are studied in Public
finance.
According to Taylor, public finance studies the manner in which the state through its organ, the
government, raises and spends the resources required. Public Finance is thus concerned with the
operation and policies of the fisc - The State treasury.
The definition of public Finance by Mrs.Ursla Hicks highlights the satisfaction of collective wants
which in turn leads to the need to secure necessary resources.
The definition of CS Shoup enlarges the scope of Public Finance for modern governments to
include different types of expenditure and different sources of revenue.
All the definitions stated above illustrate the scope of Public Finance. From these definitions, we
can conclude that Public Finance is an enquiry into the facts, techniques, principles, theories, rules
and policies which shape, direct, influence and govern the use of scarce resources, with alternative
uses, of the government.

IMPORTANCE OF PUBLIC FINANCE

 1. Provision of public goods: -For providing public goods like roads, military services and
street lightsetc. public finance is needed. Business firms will have no incentive to produce
such goods, as they get no payment from private individuals.
2. Public finance enables governments to tackle or offset undesirable side effects of a market
economy. The side effects are called spill overs or externalities. For example, pollution.
The governments can introduce recycling programmes to lessen pollution or they can make
laws to restrict pollution or impose pollution charges or taxes on activities that bring about
pollution.
3. Public finance helps governments to redistribute income. To reduce the inequality in the
economy, the governments can impose taxes on the richer people and provide goods and
services for the needy ones.
4. Public finance provides many a programme for moderating the incomes of the rich and the
poor. Such programmes include social security, welfare and other social programmes.
5. The acceptance of the principle of welfare state, the role of public finance has been
increasing. Modern governments are no more police states as the classical economists
viewed.
6. As the scope of state participation in the economic activity is widening, the scope of public
finance has also been increasing. Generation of employment opportunities, control of
economic fluctuations like boom and depression, maintaining economic stability etc. are
some of the thrust areas of the governments

PUBLIC REVENUE:

The income of the states is referred to as Public Revenue. In this branch, we study the various
ways of raising revenue by the public bodies. We also study the principles and effects of taxation
and how the burden of taxation is shared among the various classes of society etc.
PUBLIC EXPENDITURE

It deals with the principles and problems relating to the allocation of public spending. We study
the fundamental principles governing the flow of public funds in to different channels,
classification and justification of public expenditure; expenditure policies of governments and the
measures adopted for welfare state etc.
PUBLIC DEBT

The governments borrow when its revenue falls short of its expenditure. Public debts is a study of
various principles and methods of raising debts and their economic effects. It also deals with the
methods of repayments and managements of public debts.
FINANCIAL ADMINISTRATION

It deals with the methods of Budget preparation, various types of Budgets, war Finance,
Development Finance etc. Thus, financial administration refers to the mechanism by which the
financial functions are carried on. In other words, financial administration studies the organizing
and disbursing of the finances of the State
ECONOMIC STABILIZATION AND GROWTH

The use of Public revenue and Public expenditure to secure stability in levels of prices by
controlling inflationary as well as deflationary pressures is studied.
Similarly the income and expenditure policies adopted by the government so as to attain full
employment, optimum use of resources, equitable distribution of income etc. are also studied.

FEDERAL FINANCE

Under federal finance we study the principles and policies governing the distribution of functions
and funds among the public authorities in a federal set up. In a federal set up there are different
levels of governments-centre, state and local.

PUBLIC FINANCE AND PRIVATE FINANCE

The understanding and the study of public finance is facilitated by a comparison of the public or
government finance with private or individual finance.
Such a comparison will help us to know how the aims and objectives and methods of public
Finance operation are similar or differed from the financial operations of the
individual.

SIMILARITIES
 1. Both the State as well as individual aim at the satisfaction of human wants through their
financial operations. The individuals spend their income to satisfy their personal wants
whereas the state spends for the satisfaction of communal or social wants.
2. Both the States and Individual at times have to depend on borrowing, when their
expenditures are greater than incomes
3. Both Public Finance and Private Finance have income and expenditure. The ultimate aim
of both is to balance their income and expenditure.
4. For both kinds of finances, the guiding principle is rationality. Rationality is in the sense
that maximization of personal benefits and social benefits through corresponding
expenditure.
5. Both are concerned with the problem of economic choice, that is, they try to satisfy
unlimited ends with scarce resources having alternative uses.

DISSIMILARITIES

1. The private individual has to adjust his expenditure to his income. i.e., his expenditure is
being determined by his income. But on the other hand the government first determines its
expenditure and then the ways and means to raise the necessary revenue to meet the
expenditure.
2. The government has large sources of revenue than private individuals. Thus at the time of
financial difficulties the state can raise internal loans from its citizens as well as external
loans from foreign countries. In the case of private individual, all borrowings are external
in nature.
3. The state, when hard pressed, can resort to printing of currency, as an additional source of
revenue. In fact, during emergencies like war, it meets its increased financial obligations
by printing new currency. But an individual cannot raise income by creating money.
4. The state prepares its budget or estimates its income and expenditure annually. But there
is no such limitation for an individual. It may be for weekly, monthly, or annually.
5. A surplus budget is always good for a private individual. But surplus budgets may not be
good for the government. It implies two things. a) The government is levying more taxes
 on the people than is necessary and b) the government is not spending as much as the
welfare of the people as it should.
6. The individual and state also differ in their motives regarding expenditure. The individuals
hanker after profit. Their business operations are guided by private profit motive. But the
states expenditure is guided by the welfare motive.
7. The private individual spends his income on various items in such a manner as to secure
equi-marginal utilities from them. The government on the contrary does not give as much
importance to this law as a private individual does. Modern government sometimes incur
cretin types of expenditure from which there do not derive any advantage but they do incur
this expenditure to satisfy cretin sections of the community.
8. Individuals always seek quick returns they save only a small amount for future and spend
more to satisfy their current needs. Individual tend to think more on present as they are
dead in the long run. Similarly they seldom spend if it does not yield any money income.
On the other hand, State has a long term perspective of its expenditure. It does not care
only for immediate benefit. State spends on projects having long gestation period. The
burden of taxation is borne by the present generation in the interest of long run welfare of
the community. Similarly sometimes government may have to spend on schemes which
may not yield any money income at all (e.g. Public Health).
9. An individual’s spending policy has very little impact on the society as a whole. But the
state can change the nature of an economy through its fiscal policies.
10. The pattern of expenditure in the case of private finance is often influence by customs,
habits social status etc. The pattern of government expenditures is guided by the general
economic policy followed by the government.
11. Private Finance is always a secret affair. Individual need not reveal their financial
transactions to anyone except for filing tax returns. But Public Finance is an open affair.
Government budget is widely discussed in the parliament and out sides. Public
accountability is an important feature of public finance.
12. Individuals can plan to postpone their private expenditure. But the state cannot afford to
put off vital expenditure like defence, famine relief etc. Findlay
Shiraz says that compulsory character is an important future of public finance
MAJOR FISCAL FUNCTIONS

According to Professor Musgrave there are three major fiscal or budgetary functions of the
governments. They are a) Allocation functions b) Distribution functions and c) Stabilization
functions.
THE ALLOCATION FUNCTION
There are certain cases in which the wants of all individuals cannot be satisfied through market
mechanism. In such cases the public sector or the governments have to provide goods and services.
The allocation branch of public finance deals with the provision of social goods. Social goods are
those goods and services produced to satisfy collective wants. Collective wants are those wants
which are demanded by all members of the community in equal or more or less equal amounts.
The allocation branch explains the process by which the resources in use are divided between
private goods and social goods by which the mix of social good is chosen.

THE DISTRIBUTION FUNCTION

The very important feature of a market economy is the disparity in thedistribution of income and
wealth. The distribution function of public finance deals with the adjustment of the distribution of
wealth and income to ensure “fair or just” state of distribution. That is, the distribution function of
public finance deals with the determination of taxes and transfer payments policies of the
governments.

THE STABILIZATION FUNCTION

The stabilization function explains the macroeconomic aspect of budgetary policy. In other words,
the stabilization function deals with the use of budgetary policy as a means of maintaining high
employment, a reasonable degree of price stability and an appropriate rate of economic growth,
with allowances for effects on trade and balance of payments. The major instruments of
stabilization policy are monetary policy and fiscal policy. This function is otherwise known as
compensatory finance.

THE PRINCIPLE OF MAXIMUM SOCIAL ADVANTAGE

One of the important principles of public finance is the so – calledPrinciple of Maximum Social
Advantage explained by Professor Hugh Dalton. Just like an individual seeks to maximize his
satisfaction or welfare by the use of his resources, the state ought to maximize social advantage or
benefit from the resources at its command.
The principles of maximum social advantage are applied to determine whether the tax or the
expenditure has proved to be of the optimum benefit. Hence, the principle is called the principle
of public finance. According to Dalton, “This (Principle) lies at the very root of public finance”
He again says “The best system of public finance is that which secures the maximum social
advantage from the operations which it conducts.” It may be also called the principle of maximum
social benefit. A.C. Pigou has called it the principle of maximum aggregate welfare.
Public expenditure creates utility for those people on whom the amount is spent. When the volume
of expenditure is small with a slighter increase in it, the additional utility is very high. As the total
public expenditure goes on increasing in course of time, the law of diminishing marginal utility
operates. People derive less of satisfaction from additional unit of public expenditure as the
government spends more and more. That is, after a stage, every increase in public expenditure
creates less and less benefit for the people. Taxation, on the other hand, imposes burden on the
people.
So, when the volume of taxation becomes high, every further increase in taxation increases the
burden of it more and more. People under go greater scarifies for every additional unit of taxation.
The best policy of the government is to balance both sides of fiscal operations by comparing “the
burden of tax” and “the benefits of public expenditure”. The State should balance the social burden
of taxation and social benefits of Public expenditure in order to have maximum social advantage.
Attainment of maximum social advantage requires that;
A. Both public expenditure and taxation should be carried out up to certain limits and no more.
B. Public expenditure should be utilized among the various uses in an optimum manner, and
C. The different sources of taxation should be so tapped that the aggregate scarifies entailed
is the minimum.
Assumptions of the Principle
 The public revenue consists of only taxes (and not of gifts, loans, fees etc.) and the state
has no surplus or deficit budgets.
 Public expenditure is subject to diminishing marginal social benefits and the taxes are
subject to increasing marginal cost or disutility.
According to Dalton, maximum social advantage is at a point where the Marginal Social Sacrifice
(MSS) of taxation and Marginal Social Benefit (MSB) are equal. The point of equality between
MSS and MSB is referred to as the point of maximum social advantage or least aggregate social
sacrifice. Musgrave calls Dalton’s principle as “Maximum Welfare Principle of Budget
Determination.” He puts that the optimum size of the budget is determined at point where Net
Social Benefit (NSB) of fiscal operations to the society becomes zero. The NSB is the difference
between MSB and MSS. (NSB=MSB-MSS). Musgrave presented Dalton’s principle of MSA with
some slight differences.

CATEGORIES OF GOODS
PUBLIC GOODS
The indivisible goods, whose benefits cannot be priced, and therefore, to which the principle of
exclusion does not apply are called public goods. The use of such goods by one individual does
not reduce their availability to other individuals. For example, the national defence.

CHARACTERISTICS OF PUBLIC GOODS

1. Non-rival in consumption: - One person’s consumption does not diminish the amount
available to others. Once produced, public goods are available to all in equal amount.
Marginal cost of providing the public goods to additional consumers is ZERO.
2. Non-excludable:- Once a public good is produced, the suppliers cannot easily deny it to
those who fail to pay. That is, those who cannot (or do not agree to) pay its market price
are not debarred or excluded from its use.
3. Free-rider problem: - People can enjoy the benefits of public goods whether pay for them
or not, they are usually unwilling to pay for public goods. This act is the so-called free-
rider problem.
PRIVATE GOODS
Private goods refer to all those goods and services consumed by private individuals to satisfy their
wants. For example, food, clothing, car etc.
FEATURES
1) Excludable: - The suppliers of private goods can very well exclude those who are unwilling to
pay.
2) Rivalry in consumption: - One person’s consumption reduces the amount available to others.
That is, the amount consumed by one person is unavailable for others to consume.
3) Revealed Preference: - The consumers reveal their preferences through effective demand and
market price. These revealed preferences are the signals for the producers to produce the goods
the individuals want.
MIXED GOODS
Mixed goods are those goods having benefits which are wholly internalized (rival) and others, the
benefits of which are wholly externalized (non-rival). The cost of producing such goods partly
covered by private contributions and partly by government subsidy.
MERIT GOODS
Those goods whose consumption and use are to be encouraged are called merit goods (e.g.;
education) and goods whose consumption and use are to be discouraged are called non-merit goods
or demerit goods (e.g., liquor, narcotic etc.) drugs Merit goods are socially desirable goods which
promote social welfare. Merit goods are rival and excludable. Governments provide merit goods
in order to ensure distributional justice. These are goods which governments feel if people will
under consume or produce and therefore should be subsidized or provided free. Examples of merit
goods are education, mid-day meals in schools, essential food articles etc.This concept was
introduced by Prof. R. A. Musgrave in 1959.